Guess? Inc (GES) 2006 Q3 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 the current and future periods. Forward-looking statements are only expectations and involve known and unknown risk and uncertainties which may cause actual results in 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 10K 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 today to discuss Guess financial result for the third quarter of 2006. Also joining me today are 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. I will begin with an overview of the third quarter. Next, I will provide you with an update of our growth initiatives, then Dennis will discuss the quarter in detail followed by Carlos, who will review the outlook for the fourth quarter of 2006 and fiscal year 2007. Then, we will do the Q and A.

First, we're extremely pleased to report that the third quarter results represent an all-time high for our Company. We [brought in] record revenues, record operating margin, and record earnings and earnings per share compared to any quarter in the Company history. We posted [concerning the] net revenue of 349 million in the quarter representing an increase of 31% over the year ago quarter. We reported net earning of 48.4 million, 134% more than last year net earning of 20.7 million. Our diluted earnings per share reached $1.05 versus $0.46 for Q3, 2005, which represents 120% increase in diluted EPS for the period. All of our business formats across all regions of the world exceeded our expectation and grew revenue, improved gross margin, improved leverage over [inaudible] cost, and expanded operating margin considerably. As a result, the Company operating margin increased 780 basis points in that period.

Let's address our business by segments. North America, during the quarter our [retail] business performed strongly and delivered the 14th consecutive quarter of positive comp sales, posting 8.6 same store sales growth. During the period, we opened 10 stores in U.S. and Canada. For the latest 12 months, our sales per square foot for all store concepts combined reached $432 and we expect to reach about $442 by the end of 2006. We're on target to exceed $500 per square foot in the next two to three years. We plan to achieve this by investing in key product [activities] as footwear, denim and Marciano to improve their performance and extend their penetration in our stores, by continuing with our remodeling program for Guess stores. By addressing the underperforming stores, by increasing the number of stores like Marciano [want] a much higher sales productivity, and by further increasing average ticket price in our Guess and Marciano stores.

During the last few years, we have successfully elevated the stature of our products in North America. Just to give you an example, the average price for women's Guess jeans was $63 three years ago. Today, the average is $103, which represents an increase of 63%. The average price for Guess men's jeans represents an increase of [66%] over the same last three years.

For 2007, we plan to open 48 new stores in U.S. and Canada. Part of the plan expansion is a launch of a new [inaudible] brand extension, which we will call G by Guess by mid year 2007. G by Guess is meant to capture market demography [inaudible] price point between retail and factory stores. The G by Guess brand will carry apparel for men and women that is [aspirational], timeless, and fun. The stores will have a fresh feel directed toward a full customer experience with fashion, but not cutting-edge fashion. We will describe the store design as [inaudible] and the store will have a smaller footprint than Guess stores, around 4300 square feet. We will convert 10 Guess retail stores, 11 factory stores, and also open 9 new stores. That will give us 30 G by Guess stores by the end of the year.

Our wholesale business in North America also had a remarkable quarter and increased operating earning by nearly five-fold for the period. We were able to achieve this through increased shipment of 34% to our core full-price customers, plus a reduction in expenses and inventory level, despite the loss of over 100 via the Federated-May merger. We're being able to successfully replace many of these doors with new door rollout at Federated. In addition, our new joint venture in Mexico just started on a good note, and we're already distributing through a major department store chain, Liverpool, with 21 Guess shop-in-shop locations. We also expect to operate 3 free-standing stores by the end of this year.

Europe, we had a terrific quarter in Europe. Operating earnings increased by 139%, driven by revenue increase of 73% in the quarter. Europe was the largest contributor to the Company outstanding earning growth and represented almost 1/3 of our revenue for the quarter and more than 1/2 of operating earning for the period. We have set a goal to reach $500 million business in revenue in Europe in the next four years, and we're well-positioned to achieve that by any measure or angle that you look at. It is clear that the continued success of the Guess brand in Europe today is attributed to the acceptance of the lifestyle product that Guess offer in all categories, but above all, to the senior executive team in Florence, Italy, who has made an incredible impact in the results that we have today. As a result, I'm pleased to report that today our business continued to be more diversified across all territories and product categories, providing a well-balanced earning model. Year-to-date operating earnings are: North America, 63.6 million which represents 40%; international 59.2 million, 37%; and licensing 37.4 million which is 23%. The resulting balance of earnings for the quarter and the year-to-date also demonstrates how significant our international business has become for Guess. [Would we never have] this result, our testament to our focus on execution of a strategy toward achieving these goals. We are truly building a unique business format in our field.

Asia, South Korea is a very young and attractive consumer market with strong purchasing power. In 60 days, we will start selling directly in 31 shop-in-shops in South Korea, 3 major department stores, as well as 8 free-standing stores. We have a very experienced team in place there ready to transition and run that business. Greater China, we have already hired a managing director with 20 years of experience in retail in that region and we have other executives in place as well. We have opened a [shome] in Hong Kong in July '06 and by February '07 we will have 4 stores in Beijing, Shanghai, Hong Kong, and Macau. Also, our plan next year is to start building a strong wholesale business in greater China through concession in department stores.

Our business will also grow as our partners open new license stores internationally. By the end of the third quarter, our partners open 80 new stores and we expect to end 2006 with 117 international stores with a break down of 65 Guess stores, 41 accessory stores, and 11 Marciano stores. Our plan to open on 2007, 102 new stores which include 61 Guess stores, 32 accessory stores, and 9 Marciano stores for 2007. About half of these new stores will be in Europe, including cities such as Cannes or Barcelona or Vienna or [Vasso], Zurich, Stockholm or Brussels. With these new plans -- with these plans, we expect to close 2007 with more than 500 stores outside North America. Keep in mind that many of our European stores are within historical centers. Therefore, store size is not comparable to our [spirit] stores. The expansion of our licensed stores continued to grow a strong base for wholesale business and also provide the platform for growth for our licensees in all categories. Our licensing business continued to perform beyond our expectations in both domestic market and international. The business in the quarter was very strong. In the year-to-date period, earning from operation increased by 50% to 37.4 million, almost 1/3 of the Company profit for the period. The largest categories by far are watches, handbag and footwear. Once again, international have the greatest increase in these categories.

We are very pleased with our performance and we're moving forward with our growth plan here, in North America, and around the world. In the last three years, we're focusing our strategy to transform from a [inaudible] wholesale denim company in 90s to a global multi-format business in channel distribution for this lifestyle brand. I'm very proud to be part of this achievement. I believe and I'm confident that 2006 will be the best year ever. 2007, we have a very clear global strategy that is focused on long-term success and the expansion of the Guess brand. We have a strong and experienced management team in every region of the world and continue to reinforce them everyday to be an outstanding world-class organization. Our supply chain systems are more than ever playing a vital role to expand distribution and quality of product, and to deliver [just-in-time] information to all associates. We will continue to invest to supply the best tool to our team, which is paramount to our success. We want to thank all associates in different regions of the world, that represent to be more than 8,000 people. With that passion and commitment, Guess will continue to be global brand it is today. We want to say thank you again for such a terrific performance this year, and we hope to carry that dream for years to come.

Thank you, and now we'll turn over to Dennis.

Thank you, Paul. And good afternoon.

Let me now share some of the financial highlights for the quarter. Total net revenues for the Company increased 31.3% to $348.7 million in the third quarter. Gross margin was 47%, a 390 basis point improvement from the prior year quarter. This improvement was due to, first, a higher mix of European business which carries higher margins than North America, plus Europe's own strong margin improvement. Second, more full-priced selling in our retail business and, third, improved North American wholesale margins. In the third quarter, our total SG&A expenses were $89.8 million or 25.8% of revenues. Our SG&A rate improved by 390 basis points, driven by North American cost efficiencies and better leveraging of fixed costs in both North America and Europe. For the quarter, we achieved an operating margin of 21.2%, a 780 basis point improvement over the prior year quarter.

Before I move on to our segment results, I'd like to highlight a couple of items that benefited the current third quarter. We made some shipments in September that we had planned for October, impacting our revenues for the quarter by $1.9 million in Europe and $1.5 million in wholesale. Also, we sold some non-operating assets which generated income of $1.7 million which is classified as other income in the income statement. Our tax rate was 36.1% compared with 40% for the prior year quarter. We adjusted our tax rate for the year, primarily for two significant reasons. First, we generated capital gains in the third quarter, which allowed us to realize capital loss carry forward. Second, as our estimate for annual net income has increased, the impact of permanent tax differences has lowered our overall tax rate. We now expect our tax rate for 2006 and for the fourth quarter to be 37.5%. We are planning 2007 with a 38% effective tax rate.

Next, I'd like to review our revenues and earnings by business segment. Our North American retail revenues totaled $178.1 million in the quarter, up 13.9% from last year. This revenue growth was driven by an 8.6% comp sales increase and 5% average square footage growth. Retail segment operating earnings increased $7.2 million to $26 million, a 38.5% improvement. Operating margin for the retail segment improved 260 basis points to 14.6%, primarily driven by higher sales and better gross margin performance.

Our wholesale business had an excellent quarter. Revenues grew 37.8% to $42.7 million. At the end of this quarter, we were in 970 doors in the U.S., the same as the prior year quarter. Operating earnings improved 380% to $8.5 million, driven by increased volume, partially due to the preshipment of October orders that I just mentioned, a higher gross margin, and significantly reduced expenses. Operating margin reached 20%, reflecting an improvement of 14.3 percentage points from last year's 5.7%.

Third quarter European revenues increased by 73% to $111.5 million and operating profit increased by 139% to $40.4 million. Higher sales volume, better gross margin, and significant SG&A leverage led to an operating margin of 36.2%, a 990 basis point improvement over Q3 2005.

Global licensing also continues to perform beyond our expectations. Royalty revenues increased 18.3% to $16.4 million. Operating earnings for the licensing segment increased 67% to $13.1 million due to revenue growth and a reduction in expenses of $2.7 million from the year ago quarter. The third quarter of 2005 contains special performance-based compensation expense of $4.6 million, which did not reoccur this year.

Now some highlights from our balance sheet. Cash and restricted cash increased by $50.1 million to $189 million compared to a year ago. This includes $35.3 million of restricted cash that we pledge to collateralize existing trade and stand-by letters of credit when we signed our new credit facility in September 2006. We expect these trades LC to be settled and the cash restrictions removed by the end of 2006. Our total debt including capital leases was $86.8 million at quarter end, up from $83.2 million. We reduced debt in North America by $15.2 million and in Europe by $1.5 million. We also increased capital lease obligations in Europe by $20.1 million. Capital expenditures in the quarter reached $11 million before tenant allowances compared to $13.5 million last year. Because of the significant growth of wholesale businesses in both North America and Europe, accounts receivable increased by $68.8 million to $172.6 million. The increase in receivables was consistent with the $47.1 million revenue growth in Europe and $11.7 million revenue growth in our North American wholesale business. Inventory increased 10.5% to $139.7 million from the year ago period. Our average inventories in North America were up only 3.8% for the quarter, while total sales expanded 17.9%, reflecting a very clean inventory position throughout the period.

Before I close, I'd like to highlight some key historical financial metrics. During the last three years, Guess has delivered consistent annual earnings growth from $0.17 per share in 2003 to $2.26 per share for the latest 12 months. An increase in earnings per share of over 13 times in less than three years. The financial returns that we are generating have been improving steadily and consistently. Our annualized return on equity has grown from 4.2% for fiscal 2003 to 32% for the 12 months ended September 2006, increasing more than seven-fold in less than three years. These facts highlight the earnings power that our diversified business model can deliver as we grow, with the effective execution of all of our businesses.

And now I'll turn the call over to Carlos.

Thank you, Dennis, and good afternoon.

Let me begin by briefly addressing our outlook for the fourth quarter of 2006. We just announced our retail sales for October 2006. Same store sales reached 11.8%. We are very pleased with our business which showed strength across the board, including the Marciano brand that performed well in the period. The new product is selling well and this is a strong sign for the holiday season. And our sales continued to be driven by a larger percentage of full price sales as compared to the prior year. Based on these trends and our plans for the holidays, we now expect fourth quarter comps to be in the mid-single digit range, up from our previous expectation of low single-digit comps. This follows a 15.9% comp in the fourth quarter of 2005. We now expect total retail sales to increase between 8 and 10% for the quarter.

Next, we expect wholesale sales to increase in the high single digit range. With respect to Europe, we expect Q4 revenue growth in the range of 30 to 40%, and keep in mind, this is from a relatively small base. We now expect capital expenditures for the year of $56 million or $51 million net of tenant allowances. This amount is lower than previously anticipated by $4 million; therefore, depreciation and amortization will be slightly below our previous guidance of $40 million. We remain comfortable with our previous guidance in the areas of licensing revenues, gross margin, SG&A, inventory levels, and interest expense. These expectations, together with the tax rate change that Dennis mentioned, should translate into an EPS range of $0.65 to $0.67 for the fourth quarter.

Now, before I share with you our outlook for 2007, we want to tell you about some important changes we will make to the information that we regularly provide to investors. We have concluded that reporting on North American retail sales more frequently than on the rest of our business focuses a disproportionate attention on that business. Therefore, after the end of 2006, we will only report comps on a quarterly basis. The next item relates to guidance. During the last three years, our practice has been to offer our expectations for specific income statement line items for our business segment, but we have not offered guidance for consolidated results. Beginning with the guidance we are sharing on this call, we will provide the Company's expectations for annual consolidated revenues, operating margins, and earnings per share.

Now let's talk about our outlook. In 2007, we expect the Company's consolidated revenues to range between $1.3 billion and 1.350 billion, and we expect to deliver operating margin in the mid-teens. We expect diluted earnings per share in the range of $2.75 to $2.85. Capital expenditures for 2007 are expected to be approximately $80 million net of tenant allowances and depreciation and amortization should be in the low $40 million range. In addition to the new store expansion, we plan to execute on a significant remodeling program and fund several key growth and corporate initiatives in our three regions worldwide: the Americas, Europe, and Asia.

In our retail business in the U.S. and Canada, we plan to open 48 new stores in 2007, including 22 Guess stores, 10 G by Guess stores, 10 Marciano stores, and 6 accessory stores. This expansion, net of store closures, should result in approximately 6% average square footage growth. We're planning comps in the low to mid single digit range for 2007, and expect higher comps in the second half of the year versus the first half. Total retail revenues are expected to increase in the low teens range for the year. Operating margin for our North America retail segment for 2006 should be around 13%, and we plan to improve this performance to 14% in 2007. In our North American wholesale business, we see modest revenue growth with limited door expansion.

Now for Asia, which is also reported as part of our wholesale segment, our business in 2007 will consist primarily of the operations in South Korea, which Paul mentioned earlier, plus our existing Asian wholesale exports. Remember that currently our profits from South Korea come to us only in the form of a royalty. All considered, our 2007 expectations for our wholesale segment is for revenue growth of about 20%. And we expect operating margin to run in the mid-teens for this business.

Regarding Europe, our priority for 2007 is to grow, first, in existing markets with current and new customers including our licensed Guess stores, and second, in other territories where the brand is strong, but our business is very underpenetrated. Our expectation is for European revenues to grow 25 and 30% in 2007 and for operating margins to run in the 20%. The growth in our licensing business will be driven by a couple of factors. First, our core business has been very strong with key product categories contributing to significant organic growth. We plan to continue this expansion both domestically and in the international field. And based on the commencement of the new term of the watch license in 2007, we will increase the recognition of the revenues that we deferred at the time that we renegotiated that license in 2005. This alone will represent about $8 million of incremental operating earnings. These factors considered, licensing revenues should increase 8 to 10% in 2007. This is net of the royalty stream that we will lose from the South Korean business. In 2007, we plan to maintain the high operating margins that this business is delivering in 2006. While we expect the seasonality of our business to be consistent with 2006, we do not anticipate the items that benefited the third quarter, which Dennis described earlier, to repeat in the 2007 third quarter.

And with that, I think we are ready to open lines up for your questions.

[OPERATOR INSTRUCTIONS]. Jeff Klinefelter, Piper Jaffray.

Thank you. First of all, congratulations to everyone on a very impressive quarter and a fantastic year.

Thank you.

Thank you, Jeff.

Lots of great news here. Just a couple of questions I wanted to drill into. In terms of the European growth, just to be clear, sort of on the -- I think it was, Paul, you described a three to four year growth strategy for the stores building up to, I think you said a total of 500 stores; is that correct?

No. It was outside America by end of '07, we will have total of 500 stores. Not for Europe. That includes the Middle East, Asia, but half of them, there will be -- for '07 the new opening for '07, half of them will be in Europe.

Okay. Okay. That helps. I guess what I'm curious on is thinking about the Asian, Middle Eastern, and European expansion -- and I don't know if you distinguished at this point or if it's worth going western versus eastern Europe, but clearly a very successful retail model -- partnership model that's driving your wholesale business. Any sense for, as we think about over the next couple of years, how many of those stores are going to be 2007, 2008 and beyond in Europe, versus Asia versus the Middle East?

Yes. I think the number that you have also in mind of 100 million was the goal we set ourself to have in the next three to four years of $500 million business. That was a number that was 500 or so for Europe. That may be why you have that number in mind. About the retail stores in direct or partnership, the majority will continue to be expanded in Europe. That's our goal. In the next two to three years. The exact percentage, I don't have it, but definitely now, the format we have in Asia, especially China and South Korea, is a different format. It's not a country where you open stores in the street. It's mainly department stores driven where you have concession, it's shop-in-shop and the size is much smaller, but you can open a much bigger numbers of these kinds of concessions. That is for South Korea and China. The same would apply for Japan, which we're in the middle of discussion for [joint venture] also in Japan.

Okay. That's very helpful. On a recent trip into China, I did notice that you do have, for example, watch concessions or kiosks in some of the malls even in Shanghai. Is that under a partnership and how will that help you as you leverage those into sportswear, apparel, and denim?

I'm glad you asked that. In fact, as of January '07, we will operate that part of the direct operation for us. It is under a distributor right now. In January '07 we are going to do that directly part of our operation. So it will be part from our Asian office to run the concession of our [inaudible] but also the accessory stores. So we will take control of that as well.

Okay. That's very helpful. One last thing on the international side, in terms of the Asian expansion, do you see an opportunity to drive the brand through the accessories, the handbags, and the watches and the fragrances as sort of driving the brand and then filling back in with the apparel? Is that -- do you anticipate that being successful?

Yes, in fact, there's one thing that maybe you may be missing there would be the footwear. The footwear is going to come very, very strong in the next, let's say, three years as a catalyst for all the accessories of Guess. And, of course, handbags continue a tremendous growth of double digits quarter-after-quarter for years. And watches even after 22 years, they show growth this quarter of 20%. So we are definitely continuing to focus on handbags, watches, footwear, eyewear, these are the key drivers for us, and these are big, big demands.

Okay. One final clarification on that side, will it be a similar structure in terms of you serving as the distributor in both Europe and Asia for those accessory categories?

It's very fragmented there. In Europe, we definitely control that as a distributor of these categories, but in Asia, these already existing partnerships who are in place some of them for 10, 15, 18 that we're not going to disrupt that. We will continue with the existing distributor of, for example, watches or some of handbags who have been there like for 12 years, which is a group who has been doing business with Guess for 15 years now. And they do handbags and do an excellent job in southeast Asia.

Okay. Thank you. One just last question for Carlos. In terms of the U.S. stores, you talked about a remodeling program, could you just remind us out of your current fleet in the U.S., what would you consider a remodeled or new prototype versus a remodel candidate?

Well, in every case that we are going to invest in a store, of course, we want to make sure that we have adequate term on the lease. We -- the remodel program that we have planned for this coming year is pretty ambitious. We have a lot of our big doors that are considered for remodel. We are excited about the new concept and we feel that there is a significant investment return here, opportunity. Every time we invest in remodels, we see a significant improvement in operations in those stores. So we know that there is a lot of opportunity here. We have about 100 projects including the new stores that we're going to be embarking on for next year. That compares to about 60 stores this year.

Okay. Great. Thanks a lot. Congratulations again.

Thank you, Jeff.

John Rouleau, Wachovia Securities.

Hi, guys. All I can say is, wow. Great quarter.

Thank you, John.

You're making us look good here. Couple of questions, the -- when you really look at the European margins, I mean, obviously spectacular, but if you had to pick one or two things as to what's really driving the margins in Europe, is it higher mark-ons and better sell-throughs benefiting gross margins? Is it the expenses are really starting to rachet down given your volumes there? I mean, what -- can you add some color and help us better understand a margin structure that we're not used to seeing here in the U.S.?

Yes, I think -- Paul would address the margins -- the gross margin issue, but with respect to expenses, this was a very unusual quarter. We were -- obviously, we were able to leverage an amazing revenue growth and the expense structure there is variable in many issues, like, all distribution is variable so it depends on the number of units that you process, the costs that you incur. The same thing applies to commissions on sales and so forth. We did not anticipate this kind of operating margin for the period, and we think that is somewhat related to the fact we had such and explosive growth on revenue. We think that's why we're planning 2007 with an operating margin in the 20%, and we think that that is the way that we're going to be able to grow the market as Paul mentioned, to really grow aggressively in all those regions.

Okay. Second question has to do with the stores in northern and Eastern Europe, which is where the opportunity is, really, from a new store perspective. Do -- can you share with us maybe how many stores you have in that region now compared to what you have in Western Europe and how are those stores performing, maybe on a per store or per square foot basis? Are they just as successful as the Western Europe stores? Maybe you could put a few numbers around it.

Okay. I can answer you that. If you look at north Europe, basically there's nothing right now. We're opening -- we have a few doors, like Stockholm, Oslo, Antwerp, Amsterdam -- it's like maybe 6 or 7 doors, so we cannot really have an a measure, but we know that the potential is tremendous there. As far as Eastern Europe, which is -- I would consider mainly like Russia, Hungaria, Poland and all that, we are doing very well there. Again, because of the location of these stores, a lot of times the size of the stores is not what we would dream about, but we target always very strategic location, more than the size of the store where nobody would walk by. We want to be where heavy traffic is and by that measure, we're doing extremely well. Then, the potential where we're really focusing now Eastern Europe and north Europe, which has been completely untouched. As far as Western Europe, there are really three markets that need to be addressed and the next step will be, in fact, next week we'll be all in Barcelona, in Spain, to focus to open and expand Spain, UK and Germany. That is a big focus as far as the western group to push these three countries of opening stores with partnership or directly.

Okay.

And again, we want to continue to act carefully. And because we know personally well Europe, we want to act carefully because it's easy to make mistakes there.

Got it. And the opportunity it sounds like in Western Europe, between Spain, the UK and Germany, is still probably significantly larger than northern and eastern? Is that a fair way to characterize it?

I think it's a fair way to characterize that, yes, definitely.

Great. In the retail stores -- switching back to the U.S. retail business, obviously the strong comps are providing some nice leverage on fixed costs and the store occupancy, but you also mentioned that there is just some better efficiencies, reducing expenses, in those stores. I mean, without quantifying it, can you kind of help us think about that? So if comps do moderate a little bit, how much leverage can we get just from the better efficiencies, or how much is that really contributing when you look at the reduction in SG&A?

Well, the significant reduction in SG&A rate was primarily driven by the performance of Europe and the performance of our wholesale business and to a large degree, licensing this quarter, okay?

Okay.

Now, that being said, we do see opportunities to continue to leverage our fixed costs more efficiently as we increase the self-productivity that Paul referred to earlier.

Right.

We have -- we have leveraged our occupancy costs pretty effectively this year, but that shows in cost of goods sold. So it's part of margin, and -- and we did get some leverage of some of the store expenses, but it was not the primary driver of the SG&A reduction.

Terrific. Okay. I will hop out here and let somebody have a chance and get back into queue. Thanks.

Thank you, John.

Christine Chen, Pacific Growth Equities.

Fabulous, fabulous quarter. That's all I have to say.

Thank you.

Congratulations. So I think in the past, if I recall, you had mentioned that your long-term operating margin goals are mid teens. And you've done such a great job this year, it looks like you're pretty on track for that, and that's what you're guiding to '07. Where do you think operating margins can ultimately go long-term?

Well, I mean, obviously the big opportunity here is the North American business. We feel that Europe is running at an amazing margin, and like we said, we want to keep it over 20%. With respect to licensing, I think that what we have is pretty remarkable. So the big opportunity is North America and one of the biggest factors to drive operating margin expansion for us is self-productivity. That's why we have made that such a central focus of everything we're doing here. We feel that the new portfolio of stores can help us do that, and that's what we are trying to accomplish. We think that gross margin is also an opportunity, but it's more of a medium term type of goal. Of course, the mid teens is our goal right now and just for this coming year with all the investments that we are making in infrastructure throughout the world, including North America and the remodeling program, which is also going to increase our ongoing costs as well. So I think that over time, of course, we're going look for something much higher than the mid-teens, and we think the Company has tremendous potential to continue to expand margins as North America becomes more effective and efficient.

If I can -- Christine, if I can add something there.

Sure.

I think also what I mentioned at the beginning of the conference, if you look at the level of where we move the average price of the Guess jeans where it was in the 2001 or 2002, if you go back 2001, 2002, it was around, 50, 55, and now it's average in our stores is $103 [at the door]. That shows you that there is no price [resistance] by the loyalty of the customers, but also because we don't have anymore -- that obligation we had at the time we have such a massive business of wholesale that we had to follow what was done. We have a completely different strategy today. And we are going to continue to [limit quantity] and price when it's -- [we want it] and also, to be less and less promotional. That's a key target for us. And that will continue -- if you look at the progress in the last three years, you will continue to see our stores with less and less promotion. And you see it even, I mean, in the last 12 months. That will continue to improve the margin no question about it.

I certainly see that in the stores. And then the new -- the new concept -- if I missed it, I apologize -- what is the potential as far as the number of stores for the new concept?

Well, let's -- let me try to start with that -- '07, we're going to have like 9 new doors on G by Guess, 10 retail converted and 11 factory converted. So that gives you like around 30. We're going to analyze that and see how it performs, but we have, we are shooting for between 3 to $400 a square foot to start with, and an average door between 1.8 to $2 million average. So from there, the potential, we will have a better answer of that end of the year next year, but easily, if it's what we think it will be, it should be easily on 100 maybe 200 stores on a -- I would say 5 years to 7 years.

Sounds great. Congratulations once again. Thank you.

Thank you.

Eric Beder, Brean Murray.

Hello.

Hello.

Yes, this is Eric Beder. How are you doing?

Hi, Eric.

Great quarter, guys.

Thanks.

Thank you.

I was starting to see some European product in the U.S. stores in the handbags and higher prices. Could you kind of talk about the integration in terms of product from the U.S. and Europe?

From U.S. and Europe or from Europe to U.S.?

Europe to U.S.

Europe to U.S. Well, about -- no, it's about -- you're talking about handbags or denim?

Handbags.

Okay. So we did -- we have a customer in Europe who again has no issue of price resistance, and the handbags we sell in Europe can be 50, 100% more than what we sell in U.S. So we started to pick up some styles from Europe line and introduce that in our [A doors] line, and we have been doing well in these stores. We call that line Timeless. And instead, for example, of pleather trimming, it would be real leather or suede. And -- but only this is in few doors that we're doing that. In the top, I think, 20 or 30 doors. And we will do the same for footwear.

You talked about denim as an opportunity in U.S., you're already about 25% or so denim. What is -- is it opportunity in terms of higher pricing? Is it opportunity in terms of more penetration? What are you looking at in terms of denim opportunity in the U.S.?

We think we have good opportunity to increase the penetration of denim in our stores. Specifically now, because the trend right now in denim is going more into fashion denim in the different silhouette in different -- in different bodies and everything. So that gives -- that's going to give us a really good opportunity and on top of that, we basically -- when you go to one of our stores today, you're going to see basically two businesses side-by-side. One is what we call the regular or the -- not the regular but the opening price point, okay, which for us in the basic is $78 and then you have the premium. And they really work well, both -- both of these lines are working very well. So we're going to continue to do the expansion both for men and for women. Mostly for women. There's more potential for women because obviously, we can do overalls, we do jump suits, we can do jumpers, dresses now, and skirts in denim. So we see a big potential for denim there. Okay?

Great. And final question. Outerwear last year was a little bit weak. And I'm curious how it is doing this year with -- I guess, with the colder temperatures?

This year, outerwear has been -- I'm surprised you're picking up on that because you're absolutely right. Outerwear has been performing really well -- really well this year. So we're very happy with that business and we're going to continue to -- we're going to continue to expand it and increase the penetration of outerwear for next year -- next fall we're going to increase our penetration there and build on the success that we've had this year.

Great. And, again, great quarter, guys.

Thank you, thank you.

Erin Moloney, Merriman Curhan Ford.

Hi, good afternoon, guys.

Hi. How are you, Erin?

I'm doing good, thank you. Just a couple of questions. One, going back to the new G concept. I'm sorry if I missed this, but what did you say was going be the timing of the -- next year of the conversion of the stores and opening of the new stores?

We will have -- the conversion will be done by first half of 2007 and also by the first half we will have 3 new stores. So you look at 23 by the end of the first half. 23 G by Guess by let's say August 1st -- I'm sorry, July 1st.

Okay. And then the rest completed -- the full second half, or kind of Q3?

Q3. We will shoot at end of Q3.

Okay. Great. And then just -- looking at the locations you're converting, what is -- I guess, what's the key piece? Why do you think this concept will succeed there? Why didn't a Guess store succeed there? Is there a certain trend that you're seeing where there's a real opportunity for this concept?

If you take out the retail conversion, we target the store to be converted on underperforming stores and where we encountered sometimes some price resistance of the change of mix of product we did, as I just explained about the jeans on average of $100. And we are feeling confident that the stores we target, which only 10, will absolutely perform with a new price structure, a new concept and maybe little bit less trend, cutting edge and more -- more price-focused customer. For the factory conversion, it's a little bit of the opposite. We took some really good performers and we're going to convert them to even increase now, basically, all the priced by G by Guess, and again, we feel very confident that we see the right approach for that. And talking to the landlord, the owners of these malls, they are beyond excited about that because it's a complete new customer for Guess and we don't see any [cannibalization] on it. And the new stores, it's only 9, have been carefully done on certain places, in California, in New Jersey, and certainly markets in Florida and Illinois.

Okay. Great. And then just a question on your domestic wholesale business. That business has been tremendous the last two quarters now. What's really driving that business? Is there product categories you've changed -- a focus more, I think you mentioned denim last quarter. What's really driving that business?

This is very -- it's very simple. What's been driving that business is product and basically doing the kind of product that we wanted to do, and that we wanted to do from a long time, and that we've been able to do now because of our retail expansion. And I was convinced from the beginning that by us doing the right thing in our stores, then our wholesale would benefit from it, and that's exactly what we're seeing happening right now. So we're very happy with the outcome here.

Fantastic. Great. Thanks so much, guys

Margaret Whitfield, Ryan Beck.

Good afternoon, and, again, congratulations.

Thank you, Margaret.

I guess this is for Paul, back to the G concept. It sounds like you have opportunities to open -- rather, to convert a lot of the stores that are not performing as well as you would like as well as the outlets that would be better off with the G concept. Do you see a lot of conversions in terms of the stores that you talked about earlier for G, down the road, beyond next year?

You talk about the retail stores?

Yes.

Yes. It will be very selective, Margaret, on a sense that we know our stores pretty well, door-by-door, and if we see that really there's an issue of not only the price resistance, but even the customer base, we definitely will address that, but the bottom line is the contribution to that store cannot be in the negative or break even, it has to be on a positive, and we feel strongly about that. We did some tests, for example, the best example -- we had a store was not performing in Florida. It was a retail store, very large, 11,000 square feet, and we were losing a lot of money on that store. We decided that we cannot go against what the customer wants. The customer was resisting the price. We changed the concept, we converted to a factory store. Not only we erased all the losses, we went from losing money to break even to making money. Obviously, the customer was responding -- and responding to that product at that price and this store now has been a continuous positive trend. And that is what we address, that is the [Gs type] of business.

Yes, and -- this is Maurice. And to answer further your question, basically we feel that we have addressed basically all of the underperforming stores. Between these that we're converting and few that we're going to close, then all of the underperforming stores will have been addressed by then.

So by the end of '07 --

We're not going to see a lot -- going forward, we're not going to see a lot more conversion of retail stores.

Okay. So by the end of '07, you will have addressed most of the under-performers in some way or form?

That's correct, yes.

That's exactly right. We'll be closing about 10 stores next year.

Okay. And you mentioned back to October that Marciano was a key driver. Could you comment on what that contributed to comp in October as it had been a drag in the prior two months?

Yes, Marciano comped positively in October and we are very pleased with that. That was exactly our expectation. And the swing in performance was pretty remarkable from August and September into what we saw in October. Now, we were fortunate that the rest of the business also performed extremely well. So -- but if Marciano -- the turn around that we were expecting is definitely happening. We think that this is a very strong point when you look at the fourth quarter overall because as you know, last year Marciano, in the fourth quarter didn't perform in line with expectations. So we see a lot of opportunity going into the holidays.

And could you comprise the comp between traffic and ticket, Carlos?

Traffic was pretty consistent with what we had seen in the year-to-date period. So traffic was slightly down. We improved conversion again, and we're very happy about that because the business was definitely much more regular-price driven as I said before. So we think that we are exactly where we wanted to be. We think that this is pretty strong, again, to anticipate good business for the fourth quarter overall.

And AURs were up again?

Of course. More regular price, and also we have -- like Paul said, we have been increasing prices across the board very successfully. So that is definitely impacting AUR.

Okay. You didn't mention today the plan to open 3 test Guess footwear stores. It was mentioned in an article in the trade press the other day. Is that -- can you confirm that indeed that is your plan for '07?

Yes, I do confirm that. This is Paul. We will have -- we want to try, as usual, because as a global company now, we want to try as usual on three regions of the world. One will open in U.S., one will open in Europe, and one will open in Asia. Most likely Singapore, China and Florida.

Florida. Okay. All right. Well --

I'm sorry. I missed Florence, I'm sorry.

Florence. Okay. All right. Thanks again, and good luck in the fourth quarter.

Thank you, Margaret.

Holly Guthrie, Janney Montgomery Scott.

Thank you, and congratulations.

Thank you.

I have -- I just have a couple more questions on G by Guess. Could you talk about the current infrastructure that is in place? Will Harriet be over seeing and are you -- do you have separate buying groups? And then also a question with G by Guess, I'm assuming this is part of your full-price strategy. And will you also see some opportunity from some of your new sourcing initiatives that will be going into sourcing for G by Guess product?

Let me answer. In fact, no. It will not be under Harriet. Harriet is supervising all the retail group and -- as well as Marciano group. It would be under Wendy [Cleric] who is in charge of the factory stores. And we have a new team now. We have a new structure there and this has been undergoing for the last -- I would say 7 months, and we're not planning to open until April of '07 so we have another 6 months to continue to build that dedicated team and that is a completely independent group of the retail full-price operation.

Okay. And then a question on Marciano. I noticed in the couple stores that I have had a chance to visit that Marciano has been pulled back up front and you have a lot more Marciano product. Is that consistent across the whole chain or are you potentially maybe moving Marciano around a little more?

You're very observant. That's absolutely right. Specifically, because of it's the holiday right now, and Marciano is a dressier line than the Guess line, which is more casual. So during the holiday, we are bringing Marciano in front of the stores because that's what the customer is really looking for. So you're going to see that throughout the holidays in all our stores and it is throughout the chain of the Guess stores. That's correct.

Great. And then just one last question. Could you just break out again, the one-time, I think it was, wholesale and European revenues. I thought you said it was 1.9 and 1.5 million, respectively, that was sort of a one-time item. It was pulled into the September quarter.

Yes, that is correct. That's exactly right. 1.9 plus 1.5 million. Those were shipments that we shipped earlier -- early in September for October orders. So that obviously impacted the third quarter and the fourth quarter.

Great. Thank you so much.

Dorothy Lakner, CIBC World Markets.

Thanks. And let me add my congratulations to the pile.

Thank you.

One more question on -- on G by Guess. Just trying to imagine what the product would look like. Would you say there might be some similarity to the wholesale product?

Yes. This is Maurice.

Hi, Maurice.

Definitely the product -- we have to understand the product is a Guess product. It is G by Guess, which means it's going to address a little bit younger customer than the Guess customer.

Okay.

And more price conscious.

Okay.

It's like an aspirational -- an aspirational customer of Guess.

Okay.

So it's definitely have all the influence of the Guess, but as Paul mentioned before, it's not going to be as fashion-forward or as edgy as Guess right now.

We want to prepare our customers slowly to go to the next level to make them understand why they have to pay more for buying Guess.

Okay. Okay.

And we're -- basically what we want to do there is we want to address a much broader market, where very often Guess will not open stores in certain -- in certain shopping centers because we just don't have the demographic there.

Right.

You know? For that -- for that high end customer. So this will open a big market for us, hopefully. We are in the -- we are in the testing stage with these 30 stores, and we're going to learn a lot from these doors, and we're going to build upon that after that.

But at the same time, you're going to keep the factory stores separate and just convert some of the ones that you've identified to the new concept?

That's correct.

Okay. Great. And then while I have you, Maurice, just in terms of the denim business, could you talk a little bit -- you talked a little bit about other categories that you're expanding with denim, the dresses and so forth. But if we just look at the jeans business as is, where do you see that business going? There's been a lot -- a little bit of obsession with skinny this year and the new colors, but I wondered if you could just talk a little bit about the trends -- where you see the trends going and --

Yes.

-- especially going into next year.

The trends basically -- and you can see that when you go -- when you go look at the market also. The trend is cleaning up, okay? And it's getting -- and the skinny has been a big part of the business right now, but I tell you, as far as our business is concerned, we've not seen a slow down in the -- the boot leg jeans for women, even though the skinny has done very well. So we've been able to really increase our business there. And I -- I really see strengthening going forward. I see a strengthening of that business. And when you layer on that, all the fashion denim, that's why we mention denim as a big contributor for the growth.

Okay. Okay. And then -- that was -- that was a really helpful example you gave about the pricing on your jeans and the fact that you've seen -- you've been able to really move the customer more upscale. Are there other examples you can give in other categories where you've done something similar?

Yes, I give you an example. Four years ago, average to the door of our handbags was $42.50. Average door, handbag today for the door is above $80. We've doubled it.

Wow.

And that's a big, big impact.

Yes.

We have very high hopes with footwear. I cannot emphasize enough that we have the best partner with Marc Fisher with his team to execute an amazing job not in America, but everywhere in the world. They come from a place where they run over 1100 stores and they have, I think, one of the biggest business of footwear in the world, which was Nine West. And they are absolutely equipped with management, production team, execution of everything to address Asian market, European market, American market, I mean everything. And if you have partners like that, we can address any challenge and we mean it.

Okay.

And then in the apparel -- in the apparel, we have done basically the same thing, not to the same extent, but we've been successful in bringing up our [inaudible] price point in knitwear and in dresses as well.

Okay.

We've increased substantially.

Right.

And successfully, which is very important.

Right. And then, Paul, just going back to the handbags a second, you mentioned an $80 price point and you talked earlier about the fact that your about European handbags can be 50 to 100% higher. Is that on that $80 price point? And those are some of the styles you're bringing into the U.S.?

We have -- I can give you in Euro, because it's in my head in Euro right now. In Euro, the minimum that you would pay a handbag today in Europe of Guess would be around EUR70. And it goes up to EUR175, EUR185, which translate to 230, so yes, you are right on about 100% above here. But watches, I just remember now, watches, five years ago, the average was around $55. $55. Today the average Guess watch is $95 which is a jump of like, I think 40 -- 85%.

Yes.

Then the Guess Collection watch used to be on an average of $120 five years ago, the Guess Collection, which we call GC, which is extremely popular in Europe, average in Europe now is EUR250 which translates to $300. We just introduced now, now, in October a line of upscale of GC watch and the average in Europe is around EUR500, which translates to $600. And again, because of the quantity of the product, because they are Swiss made -- not made in China -- Swiss made, we have absolutely zero resistance of price.

Wow. That's great.

We're very, very, very happy with that.

Yes. Great. And then just one last question for Carlos. When you're talking about the remodels, are there any remodels/expansions in there? Is there an increase in size that you're planning on for those 100 stores that you're talking about?

Well, the 100 stores includes the new stores.

Oh, okay. Yes.

That's the total number of projects that we're doing, okay, but no, they aren't significant expansions. There are a few in Canada where we are going to get more square footage and maybe a couple of stores here or there, but overall, many these locations that we're remodeling we're remodeling in place.

Okay. All right. Great. Thank you.

Thank you.

And good luck.

Thank you.

And good night.

Melissa Otto, WR Hambrecht.

Congratulations on a great quarter.

Thank you, Melissa.

Just a couple of questions around Europe. How should we think about the seasonality of that business as we move into the fourth quarter? I know that fourth quarter's traditionally been a bit more difficult. How do you see that coming through this year?

This is Paul. Hi. In Europe it's very simple. Most of the product has been shipped already in Q3 and the business you expect in Q4 will be very light and some replenishment. So we have an expectation between 30 to 40% increase of a small base. So that's what it is. But don't forget also that we have also at the end of December, we can making some preshipment of [jerry] requested by the customers who want to have the spring product in their shop for the Christmas customers. So I think the 30 to 40% increase is something we're very comfortable with.

Okay. How about the profitability coming through for the fourth quarter?

In Europe?

Yes.

Melissa, the -- obviously because we do keep fixed expenses throughout the year, when you have a very low quarter in terms of revenue, that has an impact on profitability. We do think that because the business, even when it's a very small base, if it continues to grow, we have an opportunity to keep the profitability in line with last year's profits which were kind of flat. We didn't make much money with Europe last year in the fourth quarter, and we're not planning to make much money this year as well.

Okay. Thank you. And then I have a question around the accessories business in the U.S. Could you comment how the accessories, the watches, handbags, are doing in the U.S. department stores?

I can tell you that. On Q3, in department stores, there's an increase, I think, of high single digit. On watches, I believe it's also the same, high single digit. On footwear, it's high -- in, I would say, double digit. I think around something like between 18 and 20% and that's the three big categories.

Okay. Great. That's very helpful. And then I just had a -- a question just more broadly. Are you seeing as your business model becomes more international and you're geared more to foreign exchange risk, are you planning any sort of hedging strategy or how is the Company thinking about its foreign exchange exposure going forward?

We do, and we feel that we do a pretty effective job in that area. I mean, obviously, the two areas that we look at are Europe and Canada right now, and we do put hedging in from time to time when we consider it required.

Thank you, Melissa.

Okay. Thank you.

Thank you.

John Rouleau, Wachovia Securities.

Hey guys, I'll keep it quick. Regarding the Marciano line, at one point in time, I know the goal was to roll out a few more stores and to be a little bit more aggressive in making that a stand-alone concept. Is that still longer term, the goal, provided that the product is right and it continues to perform like it did in October? Or what are your thoughts with that?

This is Paul, [inaudible] absolutely, absolutely positively. In fact, next year our goal is to open another 15 doors. We have 20 -- we have around 20 open already now. That will bring us between 32 to 35 depending if we have opportunities to find these 15 we want. We have 10 that we for sure will have. And Europe, they are called Guess by Marciano, but it's a matter of time that we will be change name to Marciano, because the product, it is Marciano, but the customers have been asking for the Guess by Marciano, which is a upscale line there in Europe and in Asia. So definitely, positively again, and I'm sure if you receive the book -- our corporate book, we have this concept well-established there. It's something we've continued to allow throughout the world, not in the U.S., but throughout the world.

Right. So really with four different retail concepts, Marciano, the Guess, the G by Guess, and the factory, it sounds like if I'm hearing everything right, and help me characterize this, but it sounds like the goal is not necessarily to have overlap, two to three of these concepts in each mall, it's really to have one concept in each mall and to target the customer in the mall appropriately with the appropriate concept. Is that a fair way to kind of characterize it?

Yes, but again, for example, if you take certain departments -- certain shopping centers in Canada, because the space is so rare. Sometimes you end up that you have to open three stores in the same mall. One would be Marciano, one would be Guess, and one would be accessory stores.

Okay.

Because the customer demand is so big and the space is so scarce. So we need to address case by case that. But yes, we try to have a category for the G by Guess, one for our factory and one for Guess and definitely, of course, Marciano in the A mall.

But also let me add that every single time that we have opened a Marciano store where there is a Guess store, we have seen the Guess store performing even better after opening. So we know that we are addressing two very unique different customers. So there is no -- no overlap between those two concepts. That has been our experience time and time again.

Right, agreed. Yes. I guess I'm looking at it more from a Guess and G by Guess perspective.

There will not -- at this time and for quite a bit of time, we have absolutely no plan of opening a G by Guess where there is a Guess store.

Right.

Okay? So right now, there's not going to be any overlap at all in that.

Got it. Terrific. Thanks for clarifying, guys.

Thank you.

And at this time there are no more questions. I will turn the call back over to Paul Marciano for closing remarks.

Thank you for everyone. Our focus is going to be, of course, now to address the most important season of the year which is holiday, Thanksgiving, Christmas, and try to do our best to finish with the best year ever. And we thank you very much, again, for your patience for the long call, and we will talk to you next year. Thank you, again. Thank you.

Thank you.

Thank you for your participation in today's conference. Ladies and gentlemen, all parties may now disconnect. Enjoy your day.