Guess? Inc. (NYSE:GES) Q3 2015 Earnings Conference Call December 3, 2014 4:30 PM ET
Executives
Paul Marciano - CEO
Michael Relich - COO
Sandeep Reddy - CFO
Analysts
Eric Beder - Wunderlich
Erinn Murphy - Piper Jaffray
John Kernan - Cowen and Company
Dan O'Hare - Bank of America Merrill Lynch
Alex Pham - Mizuho Securities
Richard Magnuson - B. Riley & Company
David Glick - Buckingham Research
Operator
Good day everyone and welcome to the Guess? Third 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 Mr. Paul Marciano.
Paul Marciano
Thank you. Good afternoon and thank you for joining us today. We reported third quarter results and posted earnings per share of $0.24, which was above our guidance. Our operating performance was in line with our expectations. Overall, the environment remained soft in the North America retail stores, we have a continuation of the last quarter trend. In Europe, despite a softer third quarter than expected, we are encouraged by the current performance of both our retail and wholesale businesses.
In North America, our e-comm business grew by 48% in the third quarter, [indiscernible] a very good momentum we have seen since year ago. The efforts we have taken in the past year to build the true omni-channel experience across brick-and-mortar, online and mobile transform continues creating a true and consistent shopping experience for our brand in every channel enabled by the strong technology platform we established. Our retail stores in regular malls continue to operate with challenging traffic and in a constant promotional environment. We lapped a total North America retail business including e-comm finish in line with our expectation, with comp sales down 5% for the quarter.
In term of product as expected, we saw weaknesses in women’s and especially woven, basic denim and dresses. But we are pleased with the improved performance of our accessories and footwear business. In particular, women handbags and women footwear comes positively in the quarter driven by strong new product introduction. On the men’s business, woven and knits top performed well and posted positive comps and the Marciano brand total business finished up 6% for the quarter.
Now looking at the fourth quarter so far, including the Thanksgiving weekend, we’ve seen a slowdown in comps in North America as a result of traffic trend and conversion. But clearly also Guess? product in the store did not perform up to expectation due to prior design and buys we discussed in our last call. However, we remain pleased with the performance of Marciano which come positive double-digits for the month and is gaining momentum. This product is unique for what is it in the market today. Improving upon the assortment in our Guess? women business is our top priority and as we discussed in our prior call again we have realigned the women design team and we’re confident that we are going to have the right product offering in the Spring season.
In Europe, our retail stores performed below our top-line expectation as the unusual warm weather over the course of the third quarter caused a slowdown in traffic and resulted come down in mid-single-digits. However, first quarter definitely improved and went back to positive comp for the entire region. In Europe wholesale, we made encouraging progress as well even as the actual business was weak during the third quarter. We just completed the market for Spring summer 2015 collection and we’re pleased with the definite improvement in trend we’re seeing.
Looking at the same-store buy, they were up in the low single-digit. This along with the slowing of the rate of door closure by our wholesale partners shows a stabilization of trend. This is quite an improvement compared to the full winter of 2014.
In Asia, our business finished slightly below expectation in the third quarter. The South Korean economy remained soft in consumer demand and we have to be more promotional than we plan. In Greater China, we continue to see softness in comp mainly driven by overall macroeconomic environment.
Mike will address all this guidance during the call, but before that I would like to address my key focus which is to improve the company profitability. A central part of that plan in addition to constant drive to improve our product offering is to evaluate the profitability of the different business in our global portfolio reducing the size and cost structure for less profitable ones while securing capital investment to the one with more profit potential growth in this area. We’re exhibiting currently the integration of our Guess? and Marciano brand as well as the Factory and G by Guess? brand. With the goal of gaining synergies by leveraging common teams, while elevating the product assortment in both Guess? group wise and Guess? factory stores.
By reducing the complexity across our brand portfolio, we can virtualize a common platform over time to support all of our businesses and leverage our cost structure further. This year has not been an easy year for company. From product standpoint to channel management to retail landscape in general, we could and we should outperform better than what we did. For that, I believe we made the change needed in each of this area from the merchandisers to design new action and reassessment of the store portfolio. I’m convinced with our team that we have made every right decision we have to make, even if it has been somehow painful. We are committed, we are engaged and we are determined to make it happen. To make sure that 10 years from now we will be here to celebrate 43 years in business. it is our goal to carry, to carry on and improve a profitability, but to always keep protecting the brand as a priority. This has been our ultimate goal from the last three decades and will always be. With that I will pass it on to Sandeep to discuss the financial.
Sandeep Reddy
Thank you, Paul and good afternoon. During this conference call, all our comments for the third quarter are on an adjusted basis, which excludes the impact of certain restructuring charges in the prior year third 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 third quarter was $21 million and diluted earnings per share was $0.24, compared to $0.42 adjusted diluted earnings per share in last year's third quarter. Third quarter revenues were $590 million, 4% lower than the prior year and down 3% in constant currency. Total company gross profit for the third quarter was below our expectations at $214 million, down 6%, and gross margin declined 90 basis points to 36.3% due primarily to negative comparable store sales and more markdowns in North America Retail.
SG&A dollars increased 6% versus the prior year to $189 million. The increase in SG&A was primarily due to higher asset impairment charges related to underperforming retail stores in North America and Europe. Operating earnings for the third quarter was $25 million. Our operating margin declined 390 basis points to 4.2%. Other net income was $7 million and mostly consisted of net unrealized and realized gains on foreign currency contracts and unrealized gains on other non-operating assets. Our effective third quarter tax rate was 33%. This is higher than our expected full year tax rate of 32% due to a shift in earnings distributions between different taxable jurisdictions within the quarters.
Moving to segment performance. In North America Retail, third quarter revenues dropped 4% to $243 million, including the unfavorable impact of the weaker Canadian dollar. Negative comps in brick-and-mortar stores were partially offset by 38% 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 two percentage points. Operating earnings decreased by 17 million to a loss of 11 million, and operating margin declined 670 basis points to negative 4.3%. Compared to last year's quarter, gross margins were lower due to occupancy deleverage and more markdowns. The SG&A rate deteriorated due primarily to higher impairment charges. During the quarter, we opened eight new stores and closed four, ending the period with 492 stores.
In Europe, third quarter revenues were $190 million, a decline of 6% in U.S. dollars and 3% in local currency. This was driven by the impact of the weaker euro, negative mid-single-digit comp sales in our retail stores as well as lower wholesale shipments. Operating earnings decreased by 43% or $6 million to $8 million, operating margin decreased by 270 basis points to 4%, driven by the impact of negative comps and higher asset impairment charges. In Asia, revenues in the third quarter declined 2% to $71 million and declined 5% in constant currency. The decline in revenues was mainly driven by negative comps in South Korea and China. Operating earnings fell 64% to $2 million, and operating margin dropped 510 basis points to 3%. The decline in operating margin was primarily driven by a promotional pressure on gross margins in South Korea and a higher SG&A due primarily to an increase in store selling expenses.
In North America Wholesale, third quarter revenues were flat compared to a prior at $54 million partially helped by a timing shift to sales previously expected in the fourth quarter. Operating profit increase by 15% to $14 million, and operating margin increased 350 basis points to 26.1% primarily due to improvements in product margins. Royalties generated from sales by our licensee partners were down 1% at $22 million, in line with our expectations.
Now moving on to the balance sheet. Accounts receivable was 9% lower at $236 million and overall, DSOs improve slightly compared to last year. Inventories were down 3% versus last year at $413 million. The decline in inventory continues to be 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 $375 million, compared to last year's $360 million. Free cash flow for the first nine months was an outflow of $58 million driven by changes in working capital and lower earnings with CapEx spends slightly below last year.
Our Board of Directors have approved a quarterly cash dividend of $0.225 per share on the company’s common stock. The dividend will be payable on January 2, 2015 to shareholders of record at the close of business on
December 17, 2014.
With that I will pass the call to the Mike who will take you through the outlook for the fourth quarter.
Mike Relich
Thank you very much, Sandeep and good afternoon. Today, I will update you on our business trends and provide our outlook for the fourth quarter and for the full fiscal year of 2015. Most of the change in our outlook is driven by softer trends in our North America retail business.
In our North America retail business, comp sales were down in the high single digit so far in the fourth quarter and we’re planning the fourth quarter assuming the comp decline in the high single-digit range. This would translate into a revenue decrease in the mid-single digit. For the full year, we expect comp sales to decrease in the mid-single digits and for revenues to be down in the mid-single digits.
In European retail, so far in the fourth quarter, comp store sales have been up in the low single digits. For the full quarter, we expect the comps to range for an increase in the low single digits to a decline in the low single digits. For the full year, we are now planning a comp store sales with a decrease in the low single digits.
In Europe wholesale we have completed our sales order campaign for the spring summer collection and the final order book is down in the low single digits reflecting the same store buys increase in the low single digits. Considering these factors, we expect total Europe fourth quarter revenues to decline in the low single digits in local currency. Assuming the euro remains at prevailing rates this will result in a revenue decline in the low double digits in U.S. dollar. For the full year, we are now expecting revenues to decline in the mid-single digits versus the 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 fourth quarter. For the fourth quarter, we expect revenues to decline in the mid-to-high single digit range. For the full year, we continue to expect revenues to decline in the low-single digits.
In our North America Wholesale business, we expect revenues to decrease in the low double-digits to mid-teens for the fourth quarter, partly driven by the timing of shipments that benefited the third quarter. For the year, this will result in a decline in the mid to high single digits.
In our licensing business, we are expecting royalties to decline in the low-single digits in the fourth quarter and to decline in the mid-single digits for the full year. For the fourth 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 the higher SG&A rate for the fourth quarter, mainly driven by the deleverage impact of expected sales decline. 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 fourth quarter with a 35.5% [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 fourth quarter of fiscal 2015, we expect consolidated revenues in the range of $695 million and $710 million. We are planning an operating margin between 9.5% and 11.5% and for earnings per share in the range of $0.53 per share and $0.63 per share. These expectations will result in full year consolidated revenues between $2.42 billion and $2.43 billion, operating margin between 5% and 5.5% and earnings per share in the range of $1 and $1.10 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.
With that, I will conclude the company's remarks and open the call up for your questions. Before we do so, let me remind everyone to please limit themselves to one single part questions. If time permit, we will allow people to ask a follow up question. Operator?
Question-and-Answer Session
Operator
Thank you. We will now begin the question-and-answer session (Operator Instructions). The first question is going to come from Eric Beder from Wunderlich Securities. Please go ahead with your question or comment.
Eric Beder
We’ve heard a lot about death of denim, no one's wearing denim. Could you talk about what you think of this, and how you're going to combat this going forward?
Paul Marciano
Yes, a lot of people talk about that in the industry and we have seen ourselves some slowdown in the basic denim and a big pick-up in fashion denim. And interestingly enough the $128 jeans has not been a price resistant for us. So clearly because maybe is a market is kind of saturated [indiscernible] any price you want from $200 to $29, maybe it’s seen more as a commodity than anything else, but the fashion denim has picked up clearly for us than men -- women more than men.
Operator
Thank you, Eric. Our next question is going to come from Erinn Murphy from Piper Jaffray. Please go ahead with your question or comment.
Erinn Murphy
I just wanted to know, if you could talk a little bit more about the fourth quarter. You guys talked about it starting a little bit softer, kind of down high single-digit in North America. We'd just love to, if you could speak about some of the product categories that have been the biggest culprits quarter-to-date? And then maybe just some perspective on how traffic versus ticket has looked in your stores?
Michael Relich
Hi Erinn its Mike. So it’s so early in the quarter, December represents a large amount of our revenue, but so far the Q4 quarter-to-date trend has been softer than the third quarter. And the main driver for that conversion is conversion year-over-year. The ABS actually improved from Q3 and the headwinds that we saw in AUR have gone away, but the big issue has been the traffic decline and that’s been down in the mid-single-digits. Actually that continued to right into Black Friday and we saw really no difference and our comps have been down in low double-digits. Now in terms of what worked, we saw outerwear with women’s worked quite well. Our denim like Paul had mentioned we have a Curve X which is a new fit in performance fabric. That actually we’re chasing that that performed quite well. And -- and but we saw weakness in a couple of categories and that was in wovens and knits for women’s. And for men’s in Q3 performed well, Q4 was a little bit softer especially the denim that Paul mentioned.
Sandeep Reddy
Just one small amendment I think Mike mentioned the trends in the fourth quarter were down about low double-digits, it’s actually down in the high single-digits.
Erinn Murphy
And then just a second follow-up question on Europe. It sounds like things have actually gotten better in the quarter-to-date period. Just would love to hear your perspective from a regional perspective, what has been the biggest region driving that improvement?
Sandeep Reddy
I think on Europe, we are really happy with the change in trend as we got into November and really the story is quite simple, it’s about the weather. The weather in October especially was unseasonably warm and the traffic really has slowed down quite significantly across the board across the entire region at the end of the third quarter. And that’s why we actually came in a little bit softer than we would have liked. But in Q4 the traffic has come back and we’re up in the low single-digits, we’re very pleased and again it is across the board. so we’re happy with what’s [happening]
Operator
Thank you, Erinn. Our next question is going to come from John Kernan from Cowen and Company. Please go ahead with your question or comment.
John Kernan
Just wondered if you could talk a little bit about the licensing business? The revenues there have been, obviously been a lot more stable than the rest of the business. What's holding that up in that segment? And just from a category perspective, between watches, handbags, eyewear, footwear, what's performing best? And then, how should we think about the sustainability of the trend in licensing revenues as you see some revenue pressure in other segments? Thank you.
Paul Marciano
This is Paul, hi. I think that’s what you see in licensing, because we have multiple licensees around the world and not recently but for the last 30 years. If you take for example handbag globally, I think you would look at maybe 7,000 maybe even 8,000 or 9,000 doors because we have a big business of wholesale. For example, watches it would be much more with that, so we were the very first in watch business as a licenses, like 28 years ago and we established very-very strong position in many-many markets, places that you would not believe that we can sell, 300,000 watches here in Indonesia which sound enormous as what it is when you see the average price. But we have a very stable business and whenever a region will slowdown, another region pick-up. And again because the business of accessories is made mainly of multi-brand stores not from freestanding stores. If you’re talking about just accessory stores the picture would be different. But we have department stores over the world on every region being in Europe and Asia, Middle-East and America of course. That’s what insures you a stability and in the watches right now being little bit slower and handbags pick upped a lot compared to last year and three years ago it was exactly reversed, watch were very strong and the handbag was slowing down. So it’s really a good balanced business we have here.
John Kernan
Just one quick follow-up. Didn't you guys thought at all about what the right footprint is for the total store base in North America, given what continues to be a lot of headwinds for everyone for traffic and have you given any more thought to store closures at this point? Thanks.
Paul Marciano
So Dan what I mean, we announced that we are going to reduce the 50 doors in the next 18 months, so we announced that three months or four months ago, we are doing that currently and we’re planning to do that it's definitely done on the sense that all good step has been taken for that. But again when we see opportunities coming up for example now we just sign some new interesting doors for Marciano is doing really well, 2,000 square feet store, no problem, we take it, because we see opportunity there. Marciano goes now also in Guess? store what to be because we wanted to reduce store we combine that and the result have been very, very good for us to add an elevated product in a Guess? store. I just came back from Singapore and -- two weeks ago and our Guess? store include a very large portion of Marciano and the business picked up couple of slots we have picked up more than 20% on all these doors. Because it given elevated perception of the store that you walk in is probably between $100 to $350 in many of the [indiscernible] accessories. So we are adapting to where we have to go, we are combining the Guess? with Marciano, we are combining the G with factory and that takes time and we do what we have to do, but clearly if you talk to me about the footprint for North America right now we are at 92 stores I think. Let's say of we have 492 that makes a profit, we want to make now, I will prefer to have 410 doors to make major profit when 500 doors don’t make the profit we want, if that can answer your question.
Operator
Great. Thank you, John. [Operator Instructions] And our next question is going to come from Robbie Ohmes from Bank of America Merrill Lynch. Please go ahead with your question or comment.
Dan O'Hare
Hi, guys, this is Dan O'Hare on for Robbie Ohmes. Congrats on the impressive e-com growth. Can you remind us what the size of e-com is, and then how is it structured? Do you have multiple platforms across regions? And then lastly, it looks like you have a solid social media presence across platforms. I am just curious how are you using social media to leverage your e-commerce platform? Thanks.
Michael Relich
Hi. This is Mike, so to answer to your question, e-commerce business is growing substantially and I think you can -- if you look at our press release you can see what the size is. But as in terms of your answer on the platform, we leverage our platform that we have here in the U.S. that is quite advanced into Europe. So Europe uses the same exact technology and anything we develop here is leverage by now. And so we do have a business in e-commerce in Europe that’s growing pretty much at the same rate as we see here albeit on a smaller base. And just keep in mind that our concentrations in Southern Europe in like Italy where e-commerce have been quite mature, but we are seeing these growth there and this is a big initiative for us.
Dan O'Hare
Then just on social media? Sorry.
Michael Relich
Social media, so we are do a number of things with Facebook, with Pinterest et cetera and with Instagram and I think there was one steady hedged that we were the fastest growing Denim brand on social media. So we work with Facebook on doing ads. We want to drive awareness and drive interaction with the customer and then we do other campaigns to drive traffic for our website for sales and we’ve had success in all of those measures.
Dan O'Hare
Thanks. And then just lastly on Europe, you said that comps were up low single-digits. I was just wondering if there was any sort of divergence between regions is north performing better than south, or anything to call out in particular there. Thanks.
Sandeep Reddy
Well, this is Sandeep, Dan and I think Europe we’ve seen across the board improvement as I mentioned earlier. But specifically I think they are really happy with Southern Europe and I’ve picked on Italy and Spain over there which have been doing well in the quarter so far.
Operator
Great, thank you. Our next question is going to come from Betty Chen from Mizuho Securities. Please go ahead with your question or comment.
Alex Pham
Hi. It's Alex Pham on for Betty Chen. I was wondering if you could talk a little bit about the softness we're seeing in Asia. It seems like Asia, and particularly it seems like South Korea in general, has been weak for number of quarters now. Wondering if you could talk a little bit about some of the strategies or initiatives that we can do to kind of combat from the weakness we've seen so far? Thanks.
Paul Marciano
If we look at Asia, Korea is two-thirds of our business and we still are the number one Denim brand in Korea and we’re quite proud of that. But the consuming environment there remains very soft. It soft not just for us but also all of our competitors and the government there just announced maybe a couple of months ago, an initiative to try to spur demand and so we see weakness altogether there. But we are investing there. We’ve invested in our design group. We’ve got some new design win sources that try to inject fashion into the line to make sure that we can keep the customers coming. But overall we’re facing a tough macroeconomic environment there.
Operator
(Operator Instructions) And our next question is going to come from Jeff Van Sinderen. Please go ahead with your question or comment.
Richard Magnuson
Hello. This is Richard Magnuson in for Jeff Van Sinderen. Can you talk more about your promotional levels in Q3? Did you stick to your original plan, or did you trigger some unplanned promos? And overall were you more or less promotional, or were your discounting levels higher or lower in Q3 this year versus last year? And then looking at Q4, are you planning to be more or less promotional, or run a higher or lower level of discounts versus Q4 last year? And then lastly, how should we think about merchandising margin for Q4?
Sandeep Reddy
This is Sandeep. I think on the margins for Q3 specifically I am thinking it at the total company level we did have some beneficial new improvements which we’ve talked about in the previous calls which helped us. But that was more than offset by the promotions that we have to do to care some of the excess inventory that we had. But if you look at our cadence in terms of gross margins, we actually narrowed the gap against what we saw in Q2 which is almost kind of basis points degradation we were just 90 basis points in Q3 and that’s an improvement we had.
Going into Q4, you’re going to see a similar kind of situation where you have the new benefit but we do have excess inventory that we need to go through so because of that there is going to be markdowns as we go through that excess inventory and currently our margins are expected to be going down.
Operator
Great, thank you Richard. Our next question is going to come from David Glick from Buckingham Research. Please go ahead with your question or comment.
David Glick
Yes, thank you very much. Just a question on your strategy to right-size the North American retail footprint, as part of that process, are you considering any elimination of any nameplates, or it's more a location-by-location analysis and keeping the same nameplates that you are currently running?
Paul Marciano
Yes. I think that the Marciano clearly imprimatur, and we have like, I think, [Multiple Speakers]. And definitely I guess the factory in Marciano here is the one that we decided to combat which factor we would do I guess but we have we’re looking at the resurge, we looking at the product to be introduced on the factory as we just did now on already and the one I think as a test and it has been very good for that. And over the years I think the next two years it will be basically for example the G by guess is coming G by Guess in factory. The plate on the more will not be there.
David Glick
And then from a wholesale perspective, are you going to maintain that brand because I have seen it in various department stores.
Paul Marciano
Yes, sure the -- we don’t include the apparel in the wholesale we do only just in maybe shoes…
David Glick
I've seen some handbags, yes.
Paul Marciano
And handbags, exactly, we don’t have watches, we don’t have anything only shoes and handbags.
David Glick
And then one last one, if I could. Last year you guys did a great job of bringing down SG&A levels, and into the first quarter of this year that's obviously made some investments this year. How are you thinking about your SG&A base going forward? You mentioned some reorganization efforts within North American retail. I mean should we see the dollars going down, and are there any one-timers this year that may kind of inflate the SG&A base? You mentioned compensation expense, I don't know if that’s severance expense. But how should we think about your SG&A dollar base going forward?
Sandeep Reddy
Hi David this is Sandeep. So, if you go back to the last call, we talked about $20 million of savings that we were expecting to get on an annualized basis. But clearly mostly into next year because this is going to be a tremendous year that we [indiscernible] and this would be across all of our businesses in North America. So, it includes North America Retail, North America Wholesale and even the corporation organization. And this is a gross number. So, you’re going to have investments that maybe offsetting it so I wouldn’t really get into specific direction on what that’s going to be but we talk about our guidance next year and a lot of good idea.
Operator
Great, and thank you David. And then our next question is going to come from Jeff Van Sinderen from B. Riley. Please go ahead with your question or comment.
Richard Magnuson
This is Richard Magnuson for Jeff Van Sinderen. I had one more question. It's tagging onto the last part, and that is the merchandise margin in Q3, was that up or down?
Paul Marciano
Sorry, can you repeat the question? Merchandise margins…
Richard Magnuson
Is the merchandise margin for this past Q3, was that up or down?
Paul Marciano
They were up because it’s up for the new but was down and that’s because of the markdowns.
Operator
Thank you, Richard and thank you very much ladies and gentlemen. This concludes today’s conference. Thank you very much for participating. You may now disconnect.
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