Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Joseph R. Gromek - President and Chief Executive Officer

Lawrence R. Rutkowski - Chief Financial Officer

Frank Tworecke - Group President, Sportswear

Deborah Abraham - Vice President, Investor Relations

Analysts

Jeff Klinefelter - Piper Jaffray

Todd Slater - Lazard Capital

Brad Stevens - Morgan Keegan

Eric Beder - Brean Murray

Susan Sansbury - Miller Tabak

David Glick - Buckingham Research

John Curti - Principal Global Investors

Carla Casella - JP Morgan

The Warnaco Group, Inc. (WRC) F2Q08 Earnings Call August 7, 2008 9:00 AM ET

Operator

Welcome everyone to the Warnaco Group Inc. second quarter 2008 earnings conference call. (Operator Instructions).It is now my pleasure to turn the floor over to your host Deborah Abraham, Vice President of Investor Relations.

Deborah Abraham

This morning I am joined by Joe Gromek, Warnaco's President and CEO, Larry Rutkowski, our CFO, and Frank Tworecke, our Group President, Sportswear. Helen McCluskey, our Group President, Intimate Apparel and Swimwear is unable to join us today as she is in Beijing.

We will begin this morning with some general comments on the quarter by Joe. Larry will review the financials, then update our 2008 guidance, and then Frank and Joe will take you through some segment highlights. Following our comments, there will be an opportunity for you to ask questions.

Today's comments are based on Warnaco's adjusted results on a continuing basis, which exclude restructuring expense, pension income, and certain tax related items, including the non-recurring tax charge related to the repatriation of proceeds from the sale of Lejaby. The company believes it is important for users of company's financial statements to be made aware of the adjusted financial information related to the company's income from continuing operations as such measures are used by management to evaluate the operating performance of the company's continuing business on a comparable basis.

A reconciliation of actual results to the adjusted is available in the schedules accompanying today's press release. As we have done on past calls, our operating results will be discussed excluding the allocation of shared service expense. These allocation amounts can be found in the tables attached to our earnings release as well as in our Form 10-Qs and 10-K.

Finally, today's call may include comments concerning the Warnaco Group's business outlook and may contain forward-looking statements. Any forward-looking statement and all other statements that may be made on this call that are not based on historical facts are subject to risks and uncertainties. Actual results may differ materially; information concerning a number of factors that could cause results to differ materially from the information that will be discussed is available in Warnaco's filings with the SEC including Warnaco's Form 8-K furnished today.

Now let me turn the call over to Warnaco's President and CEO, Joe Gromek.

Joseph R. Gromek

We are pleased to report another strong quarter. Clearly, the positive momentum we have experienced over the last several quarters has continued into Q2. Net revenues climbed 22% and earnings per share from continuing operations increased 54%. Our diversified global business model continues to perform with all geographies and segments reporting increased revenues and profitability.

International revenues increased 46% and despite a challenging domestic environment US revenues grew 5%. Strong brands, innovative product development, and solid execution on the part of our global team, all contributed to this positive performance.

We continue to advance the key strategies we established for our business more than two years ago. First, maximizing the potential of our Calvin Klein business; second, expanding internationally; and third, growing direct to consumer.

Calvin Klein global revenues increased 34% in the quarter. We demonstrated strength across the board in Underwear, Jeans, Accessories and Swimwear. We continue to leverage our regional and country platforms to drive Calvin Klein business and accelerate our direct to consumer initiatives in Europe, Asia, and the Americas. Our target remains to double our Calvin Klein revenues over the next five years.

International revenues accounted for nearly 50% of total company revenues. While recent reports suggest that some European economies have softened, we are continuing to experience solid growth. We reported strong growth in all international regions, with Europe up 51%, Asia up 42%, and the Americas up 41%.

The powerful performance in Europe reflects not only our expansion into Eastern Europe, but continued momentum in both the Jeans and Underwear business as we leverage our existing commercial infrastructure as well as comp store growth at retail. We believe this momentum reflects the strong consumer demand for our Calvin Klein brands as well as the significant wholesale and retail opportunities in mature and emerging markets.

Turning to direct to consumer, revenues rose 39% including a 20% increase in comparable store sales. During the quarter we added 43 new points of distribution. At quarter end we operated over 800 shops in our direct to consumer channel around the globe.

We remain very pleased with the performance of our Calvin Klein Underwear and our Calvin Klein Jeans stores and are beginning to roll out Calvin Klein Accessory stores in Europe and Asia. We are on plan to add well over 80,000 sq ft of additional retail space in 2008 as we grow direct to consumer to over 20% of our total business.

We continue to manage our heritage businesses for profitability. Core intimates, had a great quarter and reported both top and bottom-line growth. We were also encouraged by the improvement in Chaps operating margins and while Speedo revenues and operating margins were off slightly, Speedo continues to generate a lot of excitement ahead of the Beijing Olympics.

In summary, we recorded a powerful quarter and first-half demonstrating the strength of our brands, the success of our business model, and superior execution on the part of our worldwide team. While we are mindful of macroeconomic challenges, we believe our strategies will continue to fuel growth and create long-term shareholder value.

Our confidence underscores the decision today to again raise guidance. Longer-term, we see opportunities for consistent and sustainable growth.

Now, let me turn the call over Larry to give you the financial highlights.

Lawrence R. Rutkowski

Turning to our adjusted second quarter results, revenues rose 22% to $504 million, $15 million of which is from incremental club sales in the quarter. Gross margin increased 240 basis points to 45%. SG&A as a percent of net revenues declined 60 basis points to 33% reflecting our disciplined attention to cost efficiencies.

Operating income was $55 million compared to $31 million in the prior year quarter. Income from continuing operations increased 56% to $33 million or $0.71 per diluted share, up from $21 million or $0.46 per diluted share in the prior year quarter.

The prior year income included $6.3 million or $0.10 per diluted share, up other income related to transactional currency benefits. Reflected operating results, the translation of foreign currency increased second quarter 2008 net revenues, gross margin, and operating income were approximately $17 million, $8 million, and $2 million respectively, compared to the second quarter of fiscal 2007.

Our second quarter effective tax rate was 32%, up from 26% in the first quarter. The increase reflects the additional tax expense to attain the company's anticipated annual effective rate of approximately 29%.

Looking at the balance sheet, cash and cash equivalents at quarter end were $155 million compared to $163 million as of June 30th, 2007. Accounts receivable increased to $311 million from $279 million as of June 30th, 2007, primarily due to the increased sales, a very strong June, and the growth of our European business. Net inventories as of July 5th were $316 million, down from $357 million as of the end of the second quarter 2007, primarily as a result of discontinued operations.

On a normalized basis, inventories were up 4% while revenues were up 22%. We are comfortable with our inventories, which are trending well below our revenue growth. Additionally, we have commenced refinancing and intend to enter a new $300 million asset based revolving credit facility, which we expect to close during the third quarter. As part of this refinancing, the company expects to retire the outstanding balance of its Term B loans.

Now, turning to guidance; as a result of our strong first-half performance, we are increasing our guidance. We now expect net revenues to grow 13% to 15% over comparable fiscal 2007 levels, and on an adjusted basis, excluding restructuring expense, certain non-cash tax items, and assuming minimal pension expense, earnings from continuing operations are expected to be in the range of $2.80 to $2.90 per diluted share.

Now let me turn the call over to Frank, to discuss Sportswear.

Frank Tworecke

The Sportswear Group continues to build on its positive momentum delivering strong operating results across all geographies. Second quarter revenues increased by 29% while operating income grew by 80 basis points to 13% of sales.

Beginning with Calvin Klein Jeans; for the quarter, revenues increased by $57 million to $207 million while operating income grew by 31%. All geographies experienced double-digit growth led by a 57% increase in Europe and a 43% increase in Asia, and in the US, where overall retail sales were soft, Calvin Klein Jeans' sales increased by 14%.

Each segment of the business contributed to the strong performance as worldwide wholesale revenues grew by 36%. Sales at retail which now represent over 31% of the Calvin Klein Jeans business, increased by 40% with comparable store of sales for the quarter increasing by 22%.

In the quarter, we continued to execute on our key merchandize initiatives of emphasizing product innovation and design as we build the Calvin Klein Jeans into a lifestyle brand. We experienced above-average sell-throughs in our Jeans assortments of light-weight denim fabrics with back pocket details, knit polo shirts and shorts. We have had a strong response to our product offerings in all channels of distribution and geographies and believe we are positioned to continue our positive performance throughout the remainder of the year.

Now, turning to the Chaps Brand; in an evermore challenging domestic retail environment, revenues for the quarter were flat year-over-year. However, operating margin improved to 19% versus 11% last year due to a 430 basis point improvement in gross margin and a reduction in SG&A expenses. Sell-throughs at retail were exceptional, and reduced the need for markdowns necessary to keep inventories current. Strong customer response to our merchandize assortment validates the strength of the brand. We continue to focus our attention on improving the product offerings while maintaining strong operating disciplines and believe we can continue to improve on year-over-year results.

Now, I will turn to the call back to Joe to comment on Intimates and Swim.

Joseph R. Gromek

Our positive trend in Intimate Apparel continued in the second quarter. Revenue was up 24%, operating income increased 38%, and operating margin improved 210 basis points compared to the prior year. All brands in all geographies contributed to the increase.

Calvin Klein Underwear posted particularly strong results for the quarter with revenue up 29% and operating income up 40%. The key drivers were Men's business, which was up 30%, and International, which grew an impressive 44% benefiting from a 39% increase in direct to consumer, a 20% comparable store growth, and some favorable currency effect.

Our Men's business continues to post gains from the success of the Steel launch and strong seasonal fashion products. We believe that the fall launch of Seductive Comfort would generate similar results in our Women's business. The advertising campaigns and point of sale elements featuring Eva Mendes will break in early September and had been very well received by our retail partners.

We are also launching a new Men's campaign this fall supporting our new updated body collection. We are very encouraged by the results to date and we expect that the combination of exciting new products and strong advertising imagery will continue to be a key component as we move towards our goal of doubling the business over time.

Despite a relatively difficult market segment, our core Intimates business delivered growth in the quarter; fueled by successful new products, expanded distribution, and additional space, revenue increased 12% and operating income was up 30%.

We continue to execute our strategy of delivering focused differentiated new products with superior operational execution to generate improved results. We are comfortable that this strategy will meet our objective of achieving a mid-operating margin in the next few years.

Driven by Calvin Klein growth, Swimwear revenue was up modestly but operating income increased 27% for the quarter. These results were very positive in light of a soft US retail environment. Our market data shows that the competitive Swim segment is down even today and is reflected in a 2% revenue decline in Speedo, but buoyed by unprecedented results and extensive PR of the Laser Racer, Speedo's leadership position in competitive Swim has strengthened, and we have gained market share in every major category.

The Laser Racer has dominated sports news stories, giving Speedo an estimated $100 million worth of publicity. We are proud to have supported so many talented athletes in recent competition. Forty-eight world records have been broken and all US Olympic trial winners wore the Speedo Laser Racer. We are anxiously awaiting the start of the Olympics and pleased to be part of what we anticipate will be history-making performances.

Being well-represented at the Olympics reinforces our leadership and commitment to competitive swim, which is essential to Speedo's long-term success. We are working to translate the success and technology of the Laser Racer into more mainstream swim categories to further develop and build the business. Work is also underway on the implementation of new procedures to improve our inventory management and the product development processes which are key to an improvement in profitability. We expect a modest increase this year, and more significant improvements in the next few years as the effect of the new processes and strategies are translated into measurable results.

We are very excited about the enthusiasm for Speedo in the upcoming Olympic Games and continue to believe that it will provide a springboard for future success that will return the business to historic profit margins.

Before I open the call to questions, I want to take a moment to recognize our associates around the globe. Their dedication and commitment to execute our strategic initiatives has allowed us to continue to report strong results and create long-term shareholder value.

That concludes our prepared comments this morning. We will open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from Jeff Klinefelter with Piper Jaffray.

Jeff Klinefelter - Piper Jaffray

I wanted to talk about two things; one, is the domestic market, and then two, would be a little bit more detail on Europe and International. First of all, on domestic, I guess, what begs the question is, with the beat in Q2 and flowing through, most of it, but not all of it to the year, was there any sense that there are shipments in the second quarter that are coming out to the third, or is there is any sense that retailers are getting more cautious and so you want to handicap some of those bookings in the second-half? Does club business play into this, the flow of that, just wanted to clarify that and get your perspective, Joe, on the domestic market?

Joseph R. Gromek

Obviously we had a 5% increase in the quarter, so we feel very good about the domestic market. If you are looking at first half, remember in Q1 we had an extra week so that helped us to some degree, and in terms of club business, we had about $15 million more in Q2 than we did a year ago, so there was some impact to that. Having said all that, our brands are continuing to perform very well and we are seeing it across basically all channels of distribution. Our brands in the mid-tier have done an exceptional job, both in the sportswear area with Chaps and Warner's and Olga, so that they are really gaining market share. And I think if there if we are seeing any softness at all, it would be in two businesses in the department store channel. I think the Calvin Men’s businesses and Underwear has been very strong. We saw some weakness in the Calvin Jeans business, and in Underwear, Calvin Women's business has been a little softer and we expect to see a major shift when we launch Seductive Comfort. So those are the only issues that I think we are facing at this point in time.

Jeff Klinefelter - Piper Jaffray

One other point on domestic; with Mervyn's filing, the Boscov filing, any perspective you would like to share on exposure there or how do you anticipate this unfolding for second half for revenue and EPS?

Joseph R. Gromek

Unfortunately those three accounts were relatively small revenues for us. We are fully reserved for the write-downs. In terms of the business, in 2007 those three accounts amounted to $9.7 million worth of revenue; so in our $2 billion company, it is relative modest.

Jeff Klinefelter - Piper Jaffray

And then just lastly, on International, it sounds like great growth across all the markets, and you are right, there is a lot of speculation about Europe in particular slowing. Could you share just a little bit more detail, Joe, on the country-specific dynamics in Europe, out of that 51% growth in Western Europe, what performance are you seeing in those major markets and what visibility you have, while you have that visibility in the second half for bookings?

Joseph R. Gromek

I think you really have to take into consideration the fact that in Western Europe we had a very dramatically underdeveloped Calvin Klein Jeans business, and based on our ability to integrate that business with our Calvin Klein Underwear businesses, we have been able to really generate incremental business that did not exist in the past. Italy accounted for approximately 80% of our European business and based on that we are now spreading that product through other geographies, into Spain, which has been a big big growth initiative for us, and the UK as well where we have been opening retail stores and will continue to do that.

So, much of this growth is coming from our own retail initiative, but we are also getting the benefit of wholesale as well. So, we are seeing growth not only in the eastern block, but also in the mature markets, and where we have owned retail, we are performing at an exceptional rate. I think the team that Frank has put together in Florence on the product development side has done a brilliant job of updating the ranges and really running our retail channel in a very professional way and when you are getting comps at 20% that clearly kicks into the bottom-line very nicely. So, I do have some current events. We looked at the month of July for example, and our Jeans business in Spain with the major retail account, ran up 60%. So we are feeling very comfortable that our business is continuing.

Operator

Your next question is from Todd Slater with Lazard Capital.

Todd Slater - Lazard Capital

I just want to follow up on Jeff’s International question one more time just to sort of clear the myths and reality. You said Spain was up 60% in Calvin Klein Jeans in July?

Joseph R. Gromek

In our retail with our major account.

Todd Slater - Lazard Capital

Okay and there is a wholesale component to that?

Joseph R. Gromek

Yes sir, it's not included in that number because I don't really have visibility at sales through. This is sales through to the consumer, and that's the most important thing in my mind, Todd, how we are performing at retail and the business in July grew by 60%.

Todd Slater - Lazard Capital

Well, that is obviously a great result. Just that there has been a lot of noise circulating around, buzzing around the street, that Calvin Klein, I don't know if it was wholesale or retail, but that Spain had fallen off dramatically, and I am just wondering how that squares with what you are seeing?

Joseph R. Gromek

No, it doesn't square at all. I think if we looked; again, we have got a lot of white space and we have new doors in Spain that's adding to this, that's not a comp number; our Calvin Klein Underwear business continues to perform much much better than any of the competition at this point in time and continues to run positive comps as well.

Todd Slater - Lazard Capital

And then on the Italy front, it is 80% of your European business, that's a big nut.

Joseph R. Gromek

When we bought it, that’s when we acquired the business.

Todd Slater - Lazard Capital

Oh, when you acquired it? What is it now and what sort of trends are you seeing and what kind of visibility do you have there for second half in Italy?

Joseph R. Gromek

In Italy, it is primarily the wholesale business and the retail stores are typically managed by third parties and we are gradually taking some of that back inhouse. So, it’s primarily a wholesale business and candidly it is challenging. We are flat in Italy right now in our wholesale revenues, in our forecasts moving forward.

Todd Slater - Lazard Capital

Okay, what does that represent now for your total International business, how big is Italy?

Frank Tworecke

It is about 50%.

Joseph R. Gromek

Frank thinks it is around 50%.

Frank Tworecke

50% of the Jeans business for Europe at this point.

Todd Slater - Lazard Capital

Okay, and then the rest of Asia and America, so how much would that represent of the total piece, your international business, do you think?

Joseph R. Gromek

Well, when we acquired the businesses 2-1/2 years ago, two countries dominated; Italy with 40% of the business, Korea with 40% of the business, and the world made up the other 20%. So the growth that we have seen over the past 2-1/2 years has been coming from the other geographies. Having said all that, Korea continues to comp very positively more so than we have achieved in Italy today.

Todd Slater - Lazard Capital

Real quick, on the warehouse club shipments, can you tell us how you expect that to shake out in the back half of the year versus the back half last year? Is this an increment debt? Is it the same amount? Similar, up, down; what do you see there?

Joseph R. Gromek

In terms of our total club business, as you know that we tried to curtail this as a percent of our total US sales. So, as I mentioned the club sales in the second quarter were up 50 and we expect a slight growth in the second half of comp of clubs to clubs because of the revenue growth, but as a percent of our US business, clubs should be relatively flat.

Todd Slater - Lazard Capital

Okay, so for the half, it is up a little bit, how does it shake out between third and fourth quarter? When is that big shipment going to be?

Joseph R. Gromek

We don't typically give that type of detail about the quarter, Todd. It's when the customer wants it, Todd.

Todd Slater - Lazard Capital

Okay, and then the last thing on the revolver, just talk about your new debt facility and you are thinking there, is there something strategic we should be thinking about?

Joseph R. Gromek

One of the things is that at the end of the first quarter we had almost $48 million of revolver outstanding. We paid that off in the second quarter. So we had no revolver outstanding by the end of the second quarter. What we are planning to take out the $225 million revolver that exists today and replace it with the $300 million asset-based credit facility and basically take out the Term B loan, which is approximately $106 million at the end of the second quarter. So, net-net, we think it better positions us for the long-term and this would a new 5-year facility.

Todd Slater - Lazard Capital

Can you tell us what the terms are on it?

Joseph R. Gromek

We are still finalizing that Todd, we plan to release something once we close on the transaction.

Operator

Your next question is from Brad Stevens with Morgan Keegan.

Brad Stevens - Morgan Keegan

Joe, could you give us some more color on the comps. You said they are up 20. Can you give us an idea by comp sales in Jeans versus Underwear and then just of 80,000 sq ft that you are opening this year, what is Jeans, what's Underwear, and then just give us some matrix around that productivity-wise?

Joseph R. Gromek

I think both Jeans and Underwear comped in the 20s, I think Jeans was up 22 and Underwear was up 20. So, they were both very consistent in the performance and consistent in geographies as well. So we are seeing this grow candidly around the globe.

Lawrence R. Rutkowski

The comps were a little bit stronger in Asia. We had approximated 25% comp in Asia, 17% in Europe, and still good comps than what we are seeing in the Americas over 22%.

Brad Stevens - Morgan Keegan

Can you tell us of 80,000 sq ft, what's Jeans and what's Underwear, and just maybe sales per square per foot of each?

Joseph R. Gromek

We are doing three or four things. We are opening up Calvin Klein Jeans stores, which is 80% Jeans, 10% Accessories, and 10% Underwear. Then we have Underwear stores, which is 100% Underwear. Then we have some flagships that are Jeans, Underwear, and Accessories in a more major way and some of those will also include the CK Bridge collection, and lastly we have the rollout of our Accessory stores, and those are all different by geography where we have the rights to do that. So, we are seeing a balance. I think if you have looked at who is the biggest beneficiary of all this, it would be the Jeans business. If we had to allocate space, the Jeans business is probably getting close to two-thirds of the space.

Brad Stevens - Morgan Keegan

Just the last question; given how strong the comps are and with the balance sheet starting to shape up, how do you start to approach your square footage goals for '09 and beyond, do you try to get more aggressive at this point?

Joseph R. Gromek

We are very aggressive right now. We have detailed 80,000 sq ft, we would like to beat that number. So it is really, the real estate that is available and our team's ability to handle it and to execute at the levels that they have been able to achieve today. So we are very aggressive in terms of 2008 and beyond.

Again, we continue to move into new markets and as we do that we want to be prudent. So, one of the major markets for us in Europe for example, is Germany where we are dramatically under-penetrated. So, we plan on opening up flagship stores in Düsseldorf, in Berlin, in Hamburg and in Munich. So, we are taking one step at a time and we want to see strong performance and as the performance develops geography by geography, then we can run much faster. In terms of 2009, I would be disappointed if we weren’t in the 100,000 sq. ft. range in terms of the new retail space.

Operator

Your next question is from Eric Beder with Brean Murray.

Eric Beder - Brean Murray

Can we talk a little bit about the Calvin Klein Accessories line, Jeans Accessories line, how the initial response has been to that and where do you think that can go and is that also integrated into your Jeans stores, I assume?

Frank Tworecke

First of all, let me give you an overview of the business. We said last year that within the next three years, by 2009, our Accessories business would grow to approximately $150 million. We are currently on track to do that, and as we begin to develop the Accessories retail stores, we believe that on an ongoing basis, as they develop, we have opportunities above that. Just to give you some initial response to the Accessories line for the quarter, we picked up over 90% in Accessories in Europe and in Asia. So, we believe we are well-positioned with the categories of products that we’ve developed; we’re excited about the opportunities that are developing as we go into the retail arena with our own stores, and as we begin to penetrate the existing retail stores that we have in Jeans by adding Accessories to the mix. So it’s an exciting time for that segment of the business and we believe that we have strategies that will allow us to execute to the revenue opportunities over the next three to five years.

Eric Beder - Brean Murray

And then could you talk a little bit as to last conference call about, there was the kind of impending Seductive Comfort, compared to what the last roll-out you had in two years, could you give kind of an update on where that is when you kind of look at the two different roll-outs, how this one is shaping out?

Joseph R. Gromek

First, we’re beginning to ship the product at the end of this month, and with the major marketing and PR campaign to kick in September, but if any of you have been following any of the international press, the amount of attention that Eva Mendez has gotten off this campaign is staggering. So the PR machine has worked brilliantly and there is a lot of pent-up excitement. In terms of scale, what we like to do is measure this against our Steel launch last year of men's wear, and we said that, yeah, this would rival the launch of Steel, which was I think approximately 1.2 million units. When we start doing the math of this, however, when you add the price of the product, the women's prices are significantly higher; you have an element of top priced, the bras are much more expensive, the pants are much less, but when you add it all together, the scale of this is about a third larger than what we did with the Steel launch. So, I think it's about $16 million with the initial out-of-the-box commitment there for Seductive Comfort versus about $12 million for Steel a year ago.

Operator

Your next question is from Susan Sansbury with Miller Tabak.

Susan Sansbury - Miller Tabak

I just wanted to address guidance a little bit, Joe. This is the second quarter in a row where you substantially beat, or at least for this fiscal year, substantially beat expectations, and then modified your guidance in a very conservative manner with respect to the balance of the year. Can you talk to how much of this is your attempt to be conservative in an uncertain macro environment, and again, try to tell me where that concern rests; the market seems to think it’s international, specifically Europe, but I just like to hear your comments on it.

Joseph R. Gromek

We believe that our business is quite solid and that's why we have stepped out into the second quarter in a row, we are raising our guidance, and we think we are being very prudent about this. We have excellent visibility to our business and we have excellent visibility to the wholesale aspect, which is about 60% of our business wholesale initial bookings; about 20% of our business is replenishment and about 20% is direct to consumer. So, we have visibility to the forward bookings and we’re very comfortable with that. We believe that the reorders will come as our products perform. Yet, there is certainly an unknown factor, our product has to perform. To-date it has, we believe it will in the future, but we have to see it, and lastly the retail component which again has been quite powerful for us, but it still has to happen. We read the papers, we listen to everything that you folks are talking about, and we think it just makes sense for us to be prudent at this time.

Susan Sansbury - Miller Tabak

Okay, no arguments here, but where do you think the greatest risk is, US or outside US?

Joseph R. Gromek

Well, I think US department stores have been a little bit shaky. So, we’ve had a couple of successes and a couple of disappointments there. All in, we managed to come out well ahead, but I think that's a bit of a challenge, and US represents 50% of our business; so we are cautious there. On the European side, we’ve also had a phenomenal year in 2007, our comps are much greater, and so now we’re anniversing ourselves. So, I think we have to take that into consideration as well. We had an excellent Q4 last year and Q3. So, the bar has been raised. I think our team is up to the challenge, but the bar certainly has been raised.

Susan Sansbury - Miller Tabak

One final question Larry, this is a nit-pick; with respect to inventories, you said it was normalized at 4%. Is it down in the US?

Lawrence R. Rutkowski

No, I think it's relative to that small growth percentage in the US. I think that it is pretty flat, but as we said the benefit is that on a comparable basis where inventories are at 4%, revenues grew 22%, and again we are projecting our revenues outpaced inventory growth.

Operator

Your next question is from David Glick with Buckingham Research.

David Glick - Buckingham Research

Frank, just a followup on Chaps; the Kohl's management has been very outspoken about how strong their business is in Men's, Women's and Kids. Obviously, the Men's, we see… And I know you guys have been focused on margin, but they are talking about strong double-digit increases, so they are opening stores albeit at a slower rate, but still growing. You made great progress in the margin. I am wondering is the rest of your business falling off and it is just the growth at Kohl's offsetting as others may be transition out of the business and are you kind of moving by default to more of an exclusive relationship with Kohl's in the Men's Chaps business?

Frank Tworecke

The first part of the question is that as you have read and everybody has read our business at Kohl's has been exceptional. They have been a strong supporter of the brand in how they bought it and how they presented it and how they marketed it, and the results reflect that. We don't have by any means an exclusive arrangement with them; however, we do support our customers that support us in proportion. You can see what's has happened in the rest of the department stores in the US where there have been challenges and filings for Chapter 11, and clearly that affects some of our distribution to Chaps, but having said that our relationship with Kohl's and response by the customer to the product in Kohl's has just been great. So, we are growing the business where the consumer is responding to the product.

David Glick - Buckingham Research

So we should still think about it as a flattish business with improving margin performance?

Joseph R. Gromek

At this point in time we think we have some opportunity on revenue, minimal at this point given the state of the economic environment in the US, and that's how we are approaching it and believe that we have continued opportunity on the profit side.

David Glick - Buckingham Research

And just a followup question on the cost and inflation environment, obviously that's a big topic, as you have really looked at sourcing now probably pretty carefully for the spring of '09, I was just wondering, Joe, if you could give us an overview, or Frank, on what that environment is and characterize it as whether it is low single digit, mid single digit, how that differs in Apparel versus Intimates, that would be helpful.

Joseph R. Gromek

David, we are obviously looking at all of the aspects of the supply chain, from the cost of raw materials, the makes of our products, and the logistics and the distribution expenses, and when we add it all up we see challenges and we see opportunities, and I think purely on the make side, raw materials are increasing and the make is increasing, but we see the ability to operate more efficiently in certain categories and certain areas to mitigate some of those rises in costs. And by the time the dust settles we would see low single digit cost increases, probably in the 3% to 5% range on certain products, and where we believe we have the ability to pass some of those along to the consumer based on the fact that we have added excellent design and innovation, then we will do that, and we believe that we will be able to continue to hold our margins appropriately and weather the storm here.

Frank Tworecke

Yes, actually we have been very aggressive in the international sourcing arena and we have gone out and really placed our product for the spring season and are in process negotiating fall. We actually believe that in the spring of '09 our cost of goods will be relatively flat, it maybe up1%. We haven’t gotten all the pricing yet on next fall. And so, we think that it will have some effect in the business from a cost perspective, but we don't see nothing substantial on material in the Chaps business.

On the European side, as Joe spoke to the opportunities, although we maybe getting some cost increases on our piece goods and on our manufacturing, we have significant opportunities to leverage our sourcing and our infrastructure in Europe to offset the increases that we maybe seeing from our product side. So, like everything else there is a give and a take for this. When you add all the chips, I think we have some great opportunity as we go through the integration in Europe to offset some of these costings that will be facing us from a sourcing perspective.

Operator

Your next question is from John Curti with Principal Global Investors.

John Curti - Principal Global Investors

My question is related to the retail side of the business; sales were up about 38%, operating profits only up about 1.5%, will you see some flow-through on those sales increases in the back half of the year; I am assuming you had some pre-opening expenses and other types of things in the quarter?

Frank Tworecke

Yes, as you know we are investing heavily in retail. Also, I would just keep in mind the second quarter last year had a very high operating margin, but as we are opening up these additional stores, there are some investments that we expect should perform and provide better margins and flow-throughs in the future.

Joseph R. Gromek

We are really investing in a future here, we are adding to the infrastructure of the company to be able to roll out of these stores in a professional manner and we believe that we are really doing something that is going to create long-term shareholder value.

Frank Tworecke

With that said, in the second quarter our retail loaded operating margin still is at the 14% as we show in Schedule 5, and like I said, we feel good about the growth in the retail.

Operator

Your next question is from Carla Casella with JP Morgan.

Carla Casella - JP Morgan

Do you have any comments about whether you would consider calling your bonds at the next call date?

Joseph R. Gromek

Yes, Carla. We look at the bonds closely, as you know back in the first quarter with the proceeds of the Lejaby, we did repurchase some in the open market. At this point we think it's smarter to refinance the revolver from the next five years. It gives us flexibility and latitude and they will be opportunistic where the bonds are trading. And the call rate now, the premium that we would pay basically, is not a huge or large compelling item to call at this time.

Carla Casella - JP Morgan

I may have missed this. Did you say what your sales were in the past year to Mervyn's, Goody’s, or Boscov's?

Lawrence R. Rutkowski

$9.7 million in 2007.

Carla Casella - JP Morgan

Okay, and then are there any other retailers that you feel that you have needed to increase your reserves for potential weakness, be at [Garshoks] or any of the other regional department stores?

Frank Tworecke

We believe we are adequately reserved, we have established reserves on Boscov's and Mervyn's before the quarter ended. So we are not singling out other key retailers at this point.

Carla Casella - JP Morgan

I don't know if you used vendor insurance or factoring to protect yourself versus any of the retailers, but there have been a lot of changes in that market; are you finding that it is harder to get insurance on your receivables or do you even use that market?

Frank Tworecke

We actually do, we have credit insurance that does protect us once we exceed domestic over $1 million self-insurance rate. So we were able to establish that a year ago and right now, like I said, we feel comfortable where we are.

Operator

Your final question is from Susan Sansbury with Miller Tabak.

Susan Sansbury - Miller Tabak

Going back to John Curti's question about retail margins; I assume that you are going to be under pressure for the balance of this year, is that the current assumption?

Joseph R. Gromek

Actually, one of the things that we are focusing on is the four-wall profitability, and our stores to getting to four-wall profitability within 18 months. So that's the driver here, we are adding people and infrastructure to support the organization, and we are doing it globally. As you probably read, we added a Senior Vice President of Retail, Bob Dakin who joined the business who is really going to be sharing best practices around the global, and candidly, we are looking at some things domestically as well. So, I think the systems that play into this are importance. So we are making investments into the future here. Our stores are very profitable and it's the growth initiative for the company. We said that this year we would get to over 20%. We are very confident of that and we believe that's going to be 30% of our business in the not-too-distant future. So, it is the future for our growth.

Frank Tworecke

And just to clarify one point, when Joe refers to that it achieves the four-wall profit within roughly 18 months that is in excess of 20% as our typical target for those blended stores on a four-wall profit basis.

Susan Sansbury - Miller Tabak

I got distracted when you were talking about the progress of Seductive Comfort versus Steel, you came out with some metrics or some factors that I totally missed.

Joseph R. Gromek

We talked about the scale of the Steel launch, which was our largest launch in history and we said that we measured Seductive Comfort against that one, and when we launched Steel, we basically produced about $12 million worth of products and at this point in time Seductive Comfort production is around $16 million for the balance of this year. So, it’s up about a third over our largest launch to date.

Susan Sansbury - Miller Tabak

And then finally, Larry, any commentary or insights into currency, specifically the dollar versus the Euro?

Lawrence R. Rutkowski

Obviously we don't have a crystal ball on that but what we have factored into our forecast and models today is that the benefits that we have seen in the first half where it was $27 million benefit to revenue in the first quarter, $17 million in the second, now, that will diminish in the second half in our current model. We're showing that the dollar has strengthened slightly, and again in the second half of the year last year, remember the Euro had strengthened already. So again, you won't see that type of pick up that we saw in the first half of this year on FX.

Susan Sansbury - Miller Tabak

Okay, $27 and $17 to top line; refresh my memory; bottom-line?

Lawrence R. Rutkowski

Approximately four in the first quarter and two in the second quarter and again so we are expecting to show less in the second-half than those numbers. We don’t profit.

Susan Sansbury - Miller Tabak

Less than the total $6 million? Is it a negative number in the second half?

Lawrence R. Rutkowski

Right now it is not negative, but at the same time we are not expecting to show the benefits from FX that we saw in the first half in the second half.

Susan Sansbury - Miller Tabak

Do you have a forecast for the second half that you can share with us?

Lawrence R. Rutkowski

We have a number that will be down some, but there will be benefits; we are only forecasting some benefits of revenue and profit, but just not to the extent that we saw in the first half.

Operator

I would like to turn the floor back to management for any further or closing remarks.

Joseph R. Gromek

Thank you for joining us this morning, we look forward to updating you on our progress after the third quarter. Thanks and have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: The Warnaco Group, Inc. F2Q08 (Qtr End 07/05/08) Earnings Call Transcript
This Transcript
All Transcripts