Guess? Inc (GES) 2006 Q2 法說會逐字稿

Good day and welcome to today's Guess? conference call. Today's call, including the question-and-answer portion, is being recorded and being made available to the public. Please note that during the course of this call, the Company may make forward-looking statements regarding future plans or future financial performance, including expected results of operations and projections for current and future periods.

Forward-looking statements are only expectations and involve known and unknown risks and uncertainties which may cause actual results and the future periods to differ materially from what is currently anticipated. Additional information concerning factors that could cause actual results to differ materially from current expectations is contained in the Company's most recent Annual Report on Form 10-K, and other filings with the SEC including the risk factors discussed therein.

Now for opening remarks and introductions, I would like to turn the call over to Paul Marciano, Co-Chairman and Co-CEO of the Company. Please go ahead.

Thank you. Good afternoon and thank you for joining us to Guess? 2006 second quarter financial results. Joining me is my brother, Maurice Marciano, Co-Chairman and Co-CEO; Carlos Alberini, President and Chief Operating Officer; and Dennis Secor, Senior Vice President and Chief Financial Officer.

We're very pleased to report our financial performance for the second quarter '06. Our consolidated revenue reached $231 million representing a 30% growth over last year quarter and a seven-quarter record for the Company. In the period, we more than tripled our earnings from last year's net income. Our consolidated net income of $13.7 million also a seven-quarter record, represented a 230% improvement over last year.

We posted diluted earnings per share of $0.30, or a 233% increase over the $0.09 we posted a year ago. I'm pleased also to report that all of our business format delivered improved results during the quarter verses a year ago period. I'm pleased also to report that all of our business formats delivered improved results during the quarter versus the year ago period. Each of our segments grew revenues, improved gross margin, improved leverage over SG&A costs, and as a result increased operating margin by 510 basis points.

This performance highlights our management's focus on execution and discipline. We announced key initiatives in the last 12 months. While many of these initiatives are still in the early stages, they have already resulted in a more balanced geographically diversified brand portfolio earnings stream. For the first six months ended July 1, 2006, earnings were divided as this: 32% retail for North America, 26% for Europe, and 34% for licensing U.S. and international.

In North America, we continue to execute our retail expansion with store growth across all multiple store formats. In the quarter, we opened 10 new stores, which are five retail stores, two Marciano stores and three accessory stores. In the quarter, we also closed three stores and ended the period with 320 stores. This compared to a total of 301 stores open at the same time last year. The composition of our current store portfolio is 289 retail stores, 17 Marciano and 14 accessory stores.

By the end of 2006, we expect to have a total of 339 stores, which are 299 retail stores, 23 Marciano stores, and 17 accessory stores. We see good benefit to multi-store format store strategy. While we have a significant business in U.S. and Canada, there is still considerable opportunity for revenue growth in North America allowing us to leverage our brand equity and customer recognition of the Guess? and Marciano name. The next part of our strategy is to expand our distribution outside North America.

We announced last quarter that our partners across the world plan to open 117 new stores in 2006; 40 of these will be Guess? Accessory stores and 77 will be Guess Jeans or Guess?/Marciano retail stores. At the end of Q2, 56 of these 117 stores have been opened. Europe continues to be a key part of international growth strategy. We have invested significantly in building infrastructure to support that growth. Our jeans wear business continues to grow faster than anticipated when we acquired that business last year.

In our accessory business in Europe has exceeded also expectation consistently. Most recently was a distribution of Guess? footwear in that region. The current business is mainly concentrated in Italy, France, and Spain. While these countries still provide growth opportunity, we see significant room to expand into markets like UK, Germany, Scandinavia, and eastern Europe. We believe we have chosen very strong partners in Europe who show passion for brand as well as global vision. At the end of the quarter, we had 80 stores open in Europe, including 20 stores which opened this year.

Our goal for 2006 is to open a total of 33 new stores in Europe. Asia is a wide open opportunity for us. We are still in the early stages of development there. This quarter we open a new showroom in Hong Kong which will give our international partners faster and easier access to the full collection from Europe and from the U.S.. I will address Asia in the closing comment.

About Guess licensing, our global licensing initiative allows us to bring a full product assortment to our customers. The accessory business has performed very well and significantly above our expectation again. We are the dominant brand, fashion brand in many countries in the handbag and watches category. One of the strongest categories is footwear.

We intend to play a significant role in the footwear business. The revenue for the trailing 12 months in that category has more than doubled from original plans and we expect the same for the remaining of 2006. Finally, talent and management selection continues to be a primary focus for Guess?' retail success. Last month, Dennis Secor joined us as our Chief Financial Officer, Catherine Thielen started as our new Vice President of Human Resources. These appointments are in addition to the one we announced in February of this year.

Now, Dennis will give you some more detail in our second quarter results and Carlos will then update you on the outlook for the rest of the year. And I will return with closing comments on the new growth opportunities in international businesses. Dennis?

Thank you, Paul, and good afternoon. The second quarter was a very successful quarter for the Company. We operated the business efficiently, delivered solid margins, and managed expenses effectively. As a result of this effort, for the second quarter ended July 1, 2006, we posted record net earnings of $13.7 million, a 230% increase over the prior year's second quarter net earnings of $4.2 million. Diluted earnings per share for the quarter reached a record of $0.30, a 233% increase over the prior period, when we earned $0.09 per share.

Total net revenue increased 29.6% to $231 million from $178.2 million in last year's second quarter. Gross margin for the period was 40%, a 270-basis-point improvement from the 37.3% recorded in the prior year's quarter.

The improvement in gross margin was the result of higher gross margins in our European business, a greater share of revenues coming from this higher margin European business, improved occupancy cost leverage in North America due to higher retail sales productivity and better margins in our North American wholesale business.

During the quarter, we continued to leverage our SG&A investment. SG&A as a percentage of sales decreased 240 basis points to 30.5% compared to 32.9% in the prior year's quarter. This leverage of SG&A was the result of cost efficiencies in our North American business and the leverage of fixed costs in both North America and Europe, partially offset by stock compensation expense as a result of the new accounting rules and increased performance compensation.

Our total SG&A expenses reached $70.6 million in the period compared to $58.7 million in the second quarter of 2005. The additional spending occurred primarily in store selling expenses to support the 19 net additional stores in North America, additional spending on infrastructure to support our growing European business, and additional marketing costs in line with the sales growth.

For the quarter, we achieved an operating margin of 9.5%, a 510-basis-point improvement from 4.4% in the prior year quarter. Net interest expense in the second quarter of 2006 was $200,000 versus $1 million in the prior year's quarter. This $800,000 improvement resulted from higher levels of invested cash, higher rates earned on those balances, and lower outstanding debt. Our tax rate was 39.8% compared with 38% for the prior year quarter. This increase in rate is primarily attributable to the comparable quarter last year, including a year-to-date adjustment to the then expected rate of 40%.

Next I'd like to break down our revenues and earnings by business segment. Our North American retail revenues totaled $163.9 million, up 23.4% from last year's second quarter of $132.9 million. The growth was driven by a 17.4% increase in same-store sales, plus the contribution from our new stores, which represented a 4.9% increase in average square footage compared with the prior year's quarter. Operating earnings in the second quarter for our retail segment increased $7.5 million to $21 million from $13.5 million. This represents a 56% improvement.

Operating margin improved 270 basis points in the period, driven primarily by higher sales productivity, resulting in equal leverage improvements of both occupancy costs and SG&A expenses. Revenues in our North American wholesale business in the second quarter grew 18.2% to $30.8 million from $26.1 million in the prior year's quarter. We were pleased with the performance of our wholesale business, particularly in light of the impact of the Federated/May consolidation. At the end of the second quarter, we were at 860 doors as compared with 930 in the prior year's quarter.

Our wholesale operating earnings improved to $3.6 million during the second quarter compared with $300,000 for the prior year's quarter. The improved contribution was driven by the increased volume, higher gross margin as a result of lower mark down allowances, and better expense management. We continue to be very pleased with the performance of our European business. Revenues in the quarter increased by 130% to $22.8 million from $9.9 million in the prior year's quarter.

Remember that our European business operates with two seasons each year, spring/summer, and fall/winter. As a result, the first and third quarters are typically our strongest sales quarters as we sell our new lines into the channel. Sales for the second and fourth quarters are typically lower as the business becomes more a function of reordering activity and immediates.

Operating results for the second quarter improved from a loss of $4.9 million in the prior year's quarter to a loss of $2.3 million in the current period. The operating improvements were the result of the higher volume, better gross margin, and significant SG&A leverage even after considering the higher administrative costs we incurred in connection with our new European headquarters operation in the current quarter.

Our worldwide licensing segment continues to perform well and has once again exceeded our expectations for the period. Revenues increased 44% to $13.4 million in the second quarter, up from $9.3 million in the prior year's quarter. During the quarter, we increased licensing operating earnings by 52.3% to $12 million from $7.9 million during the prior year's quarter. Operating expenses were slightly down quarter-over-quarter.

For the six months ended July 1, 2006 net earnings increased 136% to $29.1 million compared to net earnings of $12.3 million for the first six months of 2005. Diluted earnings per share increased 129% to $0.64 per share in the current six-month period versus $0.28 per share in the comparable period last year. Total net revenue increased 24.4% to $490 million in the 2006 six-month period from -- sorry, from $393.8 million in the prior year period.

Gross margins also expanded during the first half of 2006 to 40%, a 220-basis-point increase from the 37.8% rate recorded in the first six months of 2005. SG&A spending as a percentage of net revenues declined to 30.2% during the 2006 period, a 180-basis-point decrease from the 32% recorded during the prior year period. The revenue growth combined with our gross margin expansion and the leverage of SG&A expenses all contributed to our operating margin improvement of 400 basis points to 9.8% in the first six months of 2006 compared to 5.8% in the prior year period.

Now, some highlights from our balance sheet. Cash increased by $109 million to $197.3 million at the end of the second quarter compared to $88.3 million a year ago. Our total debt, including capital lease obligations, at the end of the second quarter this year was $75.2 million, down $12.7 million from $87.9 million at the end of the 2005 second quarter. The $12.7 million decrease was compromised of an $18.7 million decrease in European debt and a $13.6 million decline in North America, partially offset by a $19.6 million increase in capital lease obligations.

In total, we improved our net cash position year-over-year by $121.7 million, a remarkable achievement. Capital expenditures for the second quarter of 2006 were $15.4 million before tenant allowances compared to $14.1 million before tenant allowances in the second quarter of 2005. In addition for the period, net cash used in investing activities includes a deposit on a commercial aircraft, which will replace our current fractional ownership share on a corporate aircraft.

Accounts receivable increased by only $1.4 million or 1.9% to $75.8 million at July 1, 2006, compared to $74.4 million at July 2, 2005 while sales for the respective businesses were up 39.7% in the quarter. Inventory increased by $14.2 million or 12.6% to $127.4 million at July 1,2006 compared to $113.2 million at July 2, 2005. The increase was driven primarily by our European business as we received product for third quarter shipments, and in our retail business, due to additional stores.

Our average inventories in North America were up only 9.7% for the quarter while total sales expanded 22.5%, reflecting a very clean inventory position throughout the period and good sell throughs. Finally, I'm pleased to report that on July 18, 2006, we received notification from the SEC that they have completed their review of our 10-K and related filings and have no further comments.

Now Carlos will update you on our business trends and our outlook for the balance of 2006. Carlos?

Thank you, Dennis, and good afternoon. In order for you to get some clarity on our outlook for the balance of the year, I would like to address some trends and results in the context of our operating initiatives and share with you how we see those trends and initiatives evolving over the balance of the year. As Dennis just mentioned, our performance this year has delivered a significant expansion of our operating margin, four points for the six-month period.

On a full-year basis, our operating margin for 2005 was 10.9%. Over time we believe that we can drive our annualized operating margin to the mid-teens, with our retail business performing in the mid-teens, and our wholesale business achieving at least a 10% operating margin. Our European business is already operating at nearly 20% operating margin and regarding 2006, we now expect our operating margin to reach over 13% for the Company, which will position us well to reach our goal of mid-teens within the next couple of years. We have undertaken several initiatives that we believe will continue to drive operating margin leverage.

First, a critical initiative has been and will continue to be to improve sales productivity in our retail stores. Total sales per square foot last year reached slightly over $400 and for the latest 12 months through June we've reached $424. Our target is to deliver $500 a square foot in the medium term. While we have made progress in this measure during the last three and a half years with 13 consecutive quarters of same-store sales growth and a compounded growth rate of over 9%, we still see considerable room for improvement, especially when benchmarked against many of our competitors in the retail marketplace.

Our recent sales trends have been very encouraging and we believe our plans for back-to-school and holiday capitalize on these trends. Our inventories are very clean, and we are confident the assortment is right to continue to deliver same-store sales growth in the months to come. In this regard, we announce today our retail sales for the month of July 2006. Comparable store sales increased 10.7% for the month and total retail sales increased 16.3%. For back-to-school, we believe we have considerable opportunities in our young contemporary line, men's, and accessories to drive and continue to improve sales in our stores.

Consistent with our previous guidance, our forecast is for comp sales growth in North America in the mid-single digits in the third quarter and in the low-single digits in the fourth quarter, which should contribute to total retail sales increases in the low to mid-teens in the third quarter and in the high-single digits in the fourth quarter compared to the respective periods last year. Please remember that comp sales growth last fourth quarter was 15.9%, so we want to be cautious with our expectations for the fourth quarter.

Second, during the year, we have closed several underperforming stores and the stores we opened, including the new concept stores, Marciano Accessories, have contributed to increase our sales productivity. Third, regarding gross margin performance, we have focused our efforts in running the business with very clean inventories, which has contributed to a less promotional business. As a result, we have experienced a higher proportion of regular price sales, we plan to continue with this strategy, we should drive improved margin performance this year.

Our fourth initiative relates to expense control. We have focused on several areas of our cost structure and reduced discretionary spending, including marketing expenses, actively managed store expenses to leverage on our sales growth, reduced our wholesale cost structure further, and funded key projects that should result in revenue growth in the near term, both domestically and abroad.

Regarding medium-term initiatives, supply chain is the most significant area for operating improvement for us. Our key initiatives in this area include the development of a core global assortment, systems improvements, improved planning and sourcing, and the further development of our Guess? Asia office.

For our wholesale segment, based on current trends on our backlog, we now expect revenues to increase in the low-teens range in the second half of the year. In May, we updated our forecast for revenue growth in our European segment to an increase of nearly 35% in the second half. Based on the recent strength of this business and our backlog, we now expect second half revenue increases of nearly 45% in Europe, with the third quarter accounting for nearly all of this increase.

Regarding our licensing business, we remain confident that revenues will be in the mid-single digits on a percentage basis in both the third and the fourth quarters. Considering that during the second half of this year, we will anniversary the launch of our fragrance and relaunch of our shoes businesses and also the recognition into income of the amortization of certain fixed cash rights payments. Taking these factors into account, the expected rate of revenue growth in this business is consistent with our recent trend.

Regarding all other financial guidance that we provided previously, we reiterate those expectations, including gross margin and SG&A performance. To summarize, we believe all the changes discussed today could contribute to higher revenues in the third quarter with an increase of slightly over 20%, and increased earnings per share from previous expectations by $0.03 to $0.04 in the third quarter of this year.

I would now like to turn the call back to Paul for closing remarks. Paul?

Thank you, Carlos. In conclusion, we feel very confident of the planned expansion around the world. And some important development that happening as we speak today. In early 2002, we acquired the trademark Yes Clothing, Y-E-S. In early 2006, we signed a license agreement with our key licensing designer classic for an exclusive line design and sold through Target stores. This product is currently on the floor in more than 1,700 doors for the Yes clothing girls and boys line. This is the first delivery of our licensee there. We will keep you appraised of our action plan which will be based on the sales results.

Between 1984 and 2005, Guess? has a licensee in Mexico. As a strategy decision, we decided in early 2005 to now operate that country directly. Guess entered in a joint venture agreement in Mexico this year. We have a controlling interest in a partnership. We already open a flagship store in Mexico and another one just opened last week in Cancun. We made our first wholesale shipment in department stores Channel Liverpool, which is the strongest department chain in Mexico. The same situation happened in South Korea.

We had the licensee for more than 16 years, and as part of our global strategy, we decided that for the brand integrity Guess? will operate that business directly. As of January '07, we will be in full operation in South Korea, and all senior management has been in place already for the last four months to establish headquarters. The first shipment to our stores in South Korea will be for Q1 '07. Also, we're in the process of hiring senior management for direct operation for a greater China retail operation, and we're actively involved in that project. Japan, we still remain active for search of the right joint venture, but we will look for the right one and we are in no rush for that. These are big commitments in time, people and financial obligation that Guess? is pursuing. This is our plan and the world is our field step by step.

Thank you again for your time with this conference call and we would like now to open up the call to answer your questions.

[OPERATOR INSTRUCTIONS] Please stand by while we structure a list. Your first question comes from the line of Eric Beder with Brean Murrary & Company. Please proceed.

Good afternoon, guys. Great quarter.

Thank you. Hi, Eric.

Could you talk a little bit about you know, kind of you're, obviously, up against some difficult comp comparisons in the second half of the year. Where are your product opportunities when you look at, and margin opportunities in the second half? I guess the North American channel in terms of consumer?

There are quite a few great opportunity for us, and there are some obvious ones which are in, believe it or not for us, in denim, okay, we're consistently growing our denim business. We are now developing also new business, kind of a new business for us, which is active wear. We're experiencing a strengthening in women's tops and dresses and shorts for women, as well.

And besides that, in men's we have great opportunity again in denim and in tops, both in knits and woven shirts. For men, the woven shirts are strengthening again. So we are very encouraged by that. Then we have the accessories. In the accessories, we have great opportunities also in our shoe business which is developing very strongly right now and really running way above our plan. So we are very happy about that. And our handbag and watch business continues to be very strong.

Wow. In addition, you've talked about kind of combining U.S. and European. How can -- what kind of synergies are you going to get from the U.S. and European in terms of product and fashion trends?

Yes, this is an initiative we started at the beginning of this year. And I'm very, very enthusiastic about that personally because I'm the most involved in design. And what we're doing right now is we're combining the two lines, and basically we want to achieve a core line, which is going to be basically -- which is going to comprise approximately 50% of the line, will be the core line, and 50% will be specific to the market where today we have like almost nothing. And so that will result not only in more consistency all over the world, but beside that, in a great saving in development of all these samples and all the lines. So more efficiency.

Sounds great guys, again, great quarter.

Thank you.

Thank you, Eric.

Your next question comes from the line of [Tim Gaier] with Piper Jaffray. Please proceed.

Good afternoon, and congratulations on another great quarter.

Hi.

Thank you, Tim.

A couple questions for you. I guess, first of all, regarding the Marciano product line, which I believe is in all of your Guess? stores now. I was wondering how much floor space you dedicate to the line? And what kind of sales run rate you've experienced with that line in your domestic stores?

We are -- I think I would like to correct that. We are only in 80 doors out of the total Guess? stores. And we are 17 Marcianos. And if you look at the percentage of the space we currently occupy in the Guess? stores, I would say it varies between 15% to 16% of the floor in the Guess? stores.

Okay. And what kind of sales run rate have you experienced with the line? Can you break that out?

I can tell you for the Marciano stores and the average you ask it's $689 a foot. And in Canada it's slightly above $700 a foot.

That's the Marciano stores, Tim. I think with respect to the rate of sale, we try to operate that sale with about 10 weeks of supply, normally. Okay, so and that's the way we have been running.

Okay. Great. And then, I guess, looking at the European operations you talked about, you know, developing a core line representing 50% of your business over time. Just wondering what progress you've had there so far and what type of impact that may have had already on your profitability? And also if you are planning on expanding your sourcing network going forward?

Yes. This is Maurice. I think this needs clarification. I mentioned that we are just starting, this is a new initiative for us. So this is going to be in place by the fall of '07. So by the same token, not only are we going to do the same design, but we're going to do the same sourcing. We're going to, this is going to result in great efficiency for us. But the full impact is going to be in the fall of '07, okay?

And as you know,Tim, we have not embedded any of these assumptions in our guidance at all.

Okay. Have you been able to expand your sourcing network for some of that European jeans product, though within the last year that you've had it in-house?

Yes. We have. Europe has been sourcing their product, you know, mostly in the Mediterranean Basin, especially in denim. Now what we're going to do as a result, we're going to combine the sourcing for both America and Europe. And basically we are going to have a smaller vendor pool, okay, and we're going to keep only the best for both.

And Tim, to you question, they have already been working with our Guess? Asia offices, that is what you are asking. But we see tremendous opportunities to do much more together.

Great. And then --

That's on purpose. Sorry.

Okay. And lastly, I was just wondering if we could get an update on your store remodel program. I was wondering what percentage of your stores are the new prototype and then if you could break out possibly the productivity differences of these versus the ones that haven't been remodeled yet?

I don't think we have that right now.

Okay. Thank you very much.

Thank you.

Your next question comes from the line of Erin Moloney with Merriman Curhan Ford. Please proceed.

Hi, guys, good afternoon.

Hi, Erin.

A few questions. First of all, just a housekeeping question. I was wondering if you had the split of your Guess? stores between the outlets and the full-price stores?

No, we don't have that.

Okay. And just on your domestic wholesale business, just a clarification on the door count decrease year-over-year, is that due primarily to the May/Federated closures and what's driving the strength in that wholesale business?

This is Maurice. Believe it or not, the denim. The denim is really what's driving our growth, you know in our business within the wholesale, both for men and women. Okay. And of course, you know, we have, we have the other categories there which are performing very well, as well. But I would say that the main driver is our denim business.

Okay.

The growth.

Okay. Great. And then just was hoping you could maybe talk a little bit in general on what you're seeing in the retail environment right now and maybe also I know you guys have kind of had some traffic issues as have many retailers recently. I was wondering how your traffic trends were in July, as well.

The traffic has been down in July, as well, but very consistent with what we have seen for many months now. You know, really, when you look at the year-to-date traffic numbers and look at the recent trend in July, it's very similar. So you know, what has helped us tremendously has been the conversion rate, which has been up consistently, as well. So we have been able to do more with less customers, basically.

Okay. Great. Thanks very much.

Thank you. Thank you.

Your next question comes from the line of Christine Chen with Pacific Growth Equities. Please proceed.

Congratulations on a fabulous quarter, everyone.

Thank you. Thank you, Christine.

I'm very excited.

So are we.

Housekeeping question, D&A and CapEx for the quarter? Maybe I missed it?

Yes, I think that we mentioned capital expenditures were, Dennis?, were 15, something like that before [INAUDIBLE] allowances. And --

Yes. 15.4.

And then D&A?

D&A, it's in the press release. If you go to the cash flow statement --

Oh, you're right. My mistake. Sorry. Sorry.

For the six months $17.6 million.

Okay, sorry about that. And then could you comment on July? I know that some of the retailers had mentioned that there was some softness in Florida and in Georgia because of the shifting around of the tax week in Georgia and then just weakness in Florida for another competitor. Just wondering if you guys saw any trends in that part of the country?

Yes, you know, actually we are very excited about what happened during the month. A lot of the product for back-to-school was delivered to those stores, you know, knowing that back to school started earlier and there was a tax-free event, which was anniversary. And we had great success. Those markets were the ones that did best for the month relative to the Company average. So we are very pleased and, you know, that added confidence to the assortment on how we feel about the product.

And then can you just share with us during the month of July what particular categories were the strongest sellers?

You know, when you look at the month of July, it's almost a replay of what we experienced in June, and it goes back to some of the categories that Maurice alluded to. You know, we had great success with denim, Capri shorts. We had great success with dresses, as well. Accessories continue to be strong. Men's had a phenomenal month and many of the categories, Active Wear, which is a group that just hit the stores, is selling very well. Very much where we put our investment, it's where we saw a lot of action. So we are very pleased with how things evolved during the month.

And then the last question. Have you seen -- I guess this is just my own personal bias -- I feel like the merchandise continues to look better and better. But as it's doing so it also continues to look more sophisticated. I'm just wondering if you're seeing the age of the average consumer, particularly on the female side, skew up a little bit?

Not necessarily. This is Maurice again. I tell you, the Guess? line, we basically make it a point to really differentiate the Guess? line from the Marciano line more and more. And the Guess? line is very jeans wear and more casual oriented. And it's true that, you know, like Paul mentioned, in quite a bit of our stores we do have the Marciano line, which gives it a more sophisticated look, you know, in the store. But we have not experienced any change in our customer, which means that we have the same span of customer anywhere between, I would say 14 years old to over 50. It is true. With the core being like still 17 to 23 for Guess?, and I will say 23 to 30 for Marciano.

You just aged me out of your target customer base.

[LAUGHTER] I said the span is over 50.

And then on the last question, on the wholesale side with what's happening with Federated and May Company, do you see opportunities to increase your real estate within the door since Federated is more focused on contemporary and fashion brands than I would say May Company had been?

I tell you what, we, for the for the stores, for the department stores, we are building the business, you know, but we want to, we want to do it very cautiously, okay? You know it's -- we take it as it goes, you know? We are really concentrating on our retail business. We are sustaining and we are growing our business in wholesale, but we don't want to push it too much to not get in trouble. And if I can repeat, Christine, if I can repeat the world is [INAUDIBLE] in our field. So it becomes more and more irrelevant for us. We really see the world as really complete open field for Guess? because of the years we spent and invested to put this foundation and to continue to expand the brand in this part of the world. And I think it will become at one point the wholesale in America will represent maybe 8% of the total business of Guess?

Right.

For the time being, we are doing more business in the doors we are in.

Okay.

You know, so that's a good indication.

Well, good luck for the second half of the year. Congratulations once again.

Thank you. Thank you.

Your next question comes from the line of Holly Guthrie with Morgan Keegan, please proceed.

Good afternoon, everybody, and congratulations.

Thank you, Holly.

Thanks. Okay, I have four questions. First, domestically, could you go through when some of the new products are going to hit the store in the fall? Specifically, that some of the new Marciano line, the relaunch of shoes, and Active Wear. And I guess I'll start there and then I'll go to my other three.

Let me try to answer that. First of all, the Active Wear is already in the stores. And for fall, we have the first delivery, which is July, you know, is already in the store. We are going to have the full flavor of fall, I will say by the end of this month, which means we are going to have already July and August in the store, then we are going to have September coming in, you know, so then we're going to be all fall, you know, you're not going to see anything summery, or even transition in the stores. As far as the relaunch of the shoes, the shoes are in the store and we are doing extremely well with it.

Okay. Great. And specifically, the product I'm talking about, the Marciano, is I thought you were going to pull some ideas from Guess? Italia and kind of expand the Marciano line from, you know, occasional to more suitings and that's sort of the product I'm thinking of?

Yes, this is Paul. It will happen, I will say the same date as Maurice just mentioned just now, end of this month. We will receive the merchandise from Italy of the Guess? by Marciano, which is the translation of Marciano in U.S.

Yes --

And it will go the same for the next season spring/summer '07, but there will be a big part of suiting and classic shirts coming from Italy for the U.S. market.

Great. And then a question on, I was hoping you could go back and clarify the Yes Clothing agreement. Could you talk about, you said that it's currently in Target stores, or it's rolling into Target stores. Could you just talk a little bit about that? And is it contributing to the licensing line right now? Or how will that roll through the P&L?

Yes, let me try to address that. This is Yes Clothing, Y-E-S, it has nothing to do with Guess? and it's a kids license agreement. It's in the stores right now. I believe between 1,650 or 1,700 doors, has been shipped three weeks ago, is doing well, and I believe that this is a test that we are going to analyze in the next six to eight weeks. From there it could be some potential of different categories still as a license, Guess? would not do this business, it would be a license. And that would contribute definitely positively to the license bottom line.

Okay. Great. And then could you just quickly review, I'm sorry, you said, I think you said that you acquired the -- your license in Mexico. But then I was a little confused, is it a wholly owned division now, or is a joint partnership? And then the same question for South Korea, too.

Okay. I can answer both. Both licensees were an existing agreement which came to a term, we did not renew, neither one. One became 100% direct operation for Korea, South Korea would be 100% owned by Guess? Asia or Guess? U.S. And the other, which is Mexico, will be a controlling interest of Guess? U.S. in a partnership with a Mexican company. We will do all, which is obvious, product marketing, advertising, image, they will do the other obvious, back hand, real estate and operation.

Great, very exciting. And then my last question has to do with sourcing. Direct sourcing and I was wondering how that stands with the Hong Kong office?

Yes, I can answer that. This is Maurice. We -- as you know, we have started that office approximately April and May of last year. And that office is, has already delivered, as you can imagine, quite a bit of goods. And we continue to grow our business and funnel as much program as we can through that office. And we are really looking forward to continue to grow this office and to expand even the amount of services that this office is going to provide to us. So we will look at this office as being a great sourcing and outsourcing office for us.

Could you tell me what percent of your product you now buy directly?

You mean through our office, Holly?

Yes.

Well, we are below where we want to be, obviously, you know, I think we have said in the past that this is still a cost for us. But we think that in the near future we'll be able to reverse that and see significant -- it's about --

No, what -- are you asking for the type of product?

No, no --

Oh, I'm sorry.

No, just the percent of the product.

We, you know, as we know, we do about a third of everything we do out of Asia and in terms of sourcing and, you know, the office, it has made significant change and progress. We are still, you know, below where we want to be eventually. So that's about it.

Opportunity. Okay. Thank you.

Thank you.

Thanks, Holly.

[OPERATOR INSTRUCTIONS] Your next question comes from the line of Margaret Whitfield with Ryan Beck. Please proceed.

Good afternoon, and congratulations. I guess this is for Paul. The ramp-up in the Q3 outlook for Europe is much stronger than I -- than we had expected. Can you give more color as to why that is? I know Europe was also better than expected in Q2.

I can answer. Margaret, how are you?

Good.

Few things. The reasons are, first of all, the result of the first half of '06 had been very strong, the second half definitely is a booking of all categories, not one, all categories across the board. As we explained before, it works by two seasons in Europe, has been much bigger than anticipated but especially of the handbags, the footwear, now so the denim.

We just, we acquired that business for licensee a year ago, and the response of the new line that we really introduced in spring '06 has been really strong and from there the customers came back with a much stronger booking. But you have to understand, also, that what contributed to all that is that we have a parallel strategy at the same time is to expand rapidly, direct franchisee or partnership stores, free standing stores.

And that has a huge impact on the business in a sense that they are really completely dedicated captivated customers who goes in different parts of Europe from Ukraine to Russia, to [INAUDIBLE] to London to Paris to Milan to everywhere. And that is a very, very significant for the future of Europe for us. Now we have a big plan for Turkey, we have a big plan for India, which is also source from there. This is where we see the business, the next two to five years, big expansion for Guess? brand.

In the near term, the geographic sources of the subside, is it pretty much throughout the territory?

Yes, we believe that, I mean, we have been predominantly in south Europe, and we are going to address to push now north Europe. We're very weak in north Europe because we have not dedicated the needed time or people in north Europe, we will address that in our next executive meeting in Barcelona in the next four weeks.

But the upside to the current quarter, the Q3, is in the southern European market?

Yes.

Okay, and back to the comps for July. You mentioned that the Florida, Georgia markets were strong, can you give us some other color on what you saw in the geographic sense, how the North and the West and other sectors performed during July?

Yes, you know, overall, I think that definitely those markets that we mentioned were the strongest ones. Canada also had a good month, pretty much in line with the Company average. The Southeast, Texas, also above, the Midwest, once again, was below Company average. The Northeast was mixed, for example, New York had a very strong month. Massachusetts was weak. And the West was slightly below.

And were your comps similar first half to second half, Carlos?

First half was stronger, but remember we had really helped, the delivery of the goods, you know, for the 4th of July weekend. Remember, we talked about this when we discussed June. And we think that obviously made the first week very strong. But you know, the second half of the month was definitely weaker than the first half. And for Paul again, Mexico going direct, can you give us some sense of what kind of volume you experienced last year, and what you think you could do potentially in the near term in Mexico with your joint venture?

In the mid-tern if you look at between now and three years, I would say we could look at between $25 million to $50 million. If you see the development we have in Canada, we have the licensee in Canada. You have been following our Company for the last 10 years. You remember that Canada was like a 10-store operation, today we have 70 stores in Canada. And we look at the potential in Canada of up to 120 stores in Canada and we feel confident about that. Mexico is a different market. We count on our partners to help us understand better the geographic and demographic of there. But we think that $25 million, $50 million, $60 million between all categories is easily achievable between three to four years from now.

And what roughly did it do last year?

Last year, I'm not completely clear about '05, but '04 was around $25 million, only in apparel. There was absolutely no accessories.

But you're saying you would only grow to $25 million to $50 million or $60 million in three to four years? Or is that incremental volume?

We want to be conservative.

Okay.

And also, Margaret, let me just add one line here. This is a joint venture, so we only have, you know, 51% of that business. Okay?

And you're talking about the total businesses is what you mentioned as being the $25 million to $50 million to $60 million?

Of course.

Of course.

And South Korea, does that represent a bigger opportunity?

I cannot tell you at this point. I can tell you how much business we were doing last year which was around $27 million at retail.

Okay.

That is again in only apparel.

Yes.

And there was absolutely no presence of footwear or really significant handbags. But again it all depends. Once we run directly this operation, after the first 18 months, we will have the true color of the potential of South Korea, which is absolutely a booming country for fashion.

Well, congratulations, sounds like you're going gang busters across the markets.

Let's put it that way, we're very, very, very busy.

I bet, thanks.

Thank you. Bye Margaret.

Your next question comes from the line of Dorothy Lakner with CIBC World Markets. Please proceed.

Thanks and congratulations, everyone. Great, great quarter.

Thank you, Dorothy.

I had a question for Maurice. The Active Wear actually looks great by the way.

Thank you.

But I wanted to ask about denim, just a little more detail there, what you're seeing in terms of pricing relative to a year ago? And also the trends in denim, we're hearing from a lot of -- a lot of retailers that skinny denim is really working and I would think it would be working for you, as well. I wondered if there's any difference between the men's and the women's side, just what the trends are in denim that are working? And then a question for Paul. What kind of time frame are we looking at on China?

Okay. Let me first address your question regarding the denim without me giving too much information to the competition.

Of course.

You know. There are things which are, you know, no secret for anybody. The market is cleaning up in denim. Okay. We don't see -- I don't see the ornamented denim going forward, you know. So it's really cleaning up in terms of look, in terms of washing and all that.

You know it's still very [vintagey] and all that. The other thing, which is obvious, there's a big trend with, what I call the cigarette leg jeans for women. Which is very, very strong. And we're starting to observe the same thing in men wanting to have slimmer jeans, as well. So, you know, these are the general new trends.

In terms of pricing, our premium denim is continuing to be very, very strong for us, I'm just talking for us. And we, we continue, by the same token also, we continue to expand the offering of our denim below 100, or so.

Okay.

Keep in mind that our opening price point is at $78.

Yes.

It's not up $48, it's not at $50, it's at $78. So it's really in the high-end of the middle market there.

Right. Would you say the premium is increasing faster than the lower price points?

No, no. No. No. Our premium denim, it's still growing very strongly. But our -- our below what I call below the $100 point is also growing very strongly.

Okay.

So that's why, you know, denim is doing really well. So I'm very pleased with it.

Okay. Great.

Okay? Now for China, that has to with Paul. Yes. Hi. China, the way we look at it and I'm going to be there three times between now and the end of the year to evaluate, continue to evaluate what's happened there. But let's put it that way, we're going to go very small. We plan for '07 to do between five to 20 shop-in-shops, not free standing stores, I'm talking shop-in-shop, which is like the formula in Japan, it means you get corners in department stores. And then we plan to do five to 15 accessory corners in '07, as well. That is even smaller.

Right.

And this, with the team we have already in place, we have the two top people already in place. We will evaluate quarter-by-quarter how the business grows there because we will be on location there between Korea and China to see how the product and price [resistance] will be perceived. And from there we will evaluate how '08 and '09 could look.

And China, China is a joint?

No, it's going to be direct 100% buyers.

Okay.

And we have met many partners and we have evaluated many situations. And we made a decision that to have a headquarter in Hong Kong with some really qualified management who have at least 15 to 20 years of presence in China will be the right way to go in our opinion and that's what we're doing.

Okay.

But we are not planning to invest a massive financial commitment there unless we see where the market goes for Guess? brand, we don't know. Okay?

So you'll start small and evaluate --

We will start small and we will see how we are perceived and how we are accepted. And what people, but then already are the watches, then already are the handbags very well. We want to have a full lifestyle stores and that's a different ball game. So we want just to act, as usual, very cautiously. It's like the Chinese say, 1,000-mile journey starts with the first step.

Okay.

That's what we're doing.

And then Japan, it's just a question of finding the right partner and you're just going to take that slowly?

Well, yes. In -- the first licensee we had was in 1985, you talk about 20 years ago, it took us 20 years to understand that we need to be committed and involved as a joint venture and cannot give the brand to a third party and say try to understand who we are. We need to be part of that. And it's clearly what some major worldwide brands have done, which we do not need to name, that you know perfectly.

Yes. Okay, great.

Thank you.

Thanks.

Ladies and gentlemen, this concludes the question-and-answer session for today's conference. Thank you for your participation in today's conference. This concludes the presentation for today. You may now all disconnect and enjoy your day.

Thank you.