Guess? Inc (GES) 2012 Q2 法說會逐字稿

Good day and welcome everyone to the Guess?

second-quarter fiscal 2012 earnings conference call.

On the call are Paul Marciano, Chief Executive Officer; Maurice Marciano, Chairman of the Board; Michael Prince, Chief Operating Officer; and Dennis Secor, Chief Financial Officer.

During today's call the Company will be making forward-looking statements including comments regarding future plans and financial outlook.

The Company's actual results may differ materially from current expectations based on the risk factors included in the Company's quarterly and annual report filed with the SEC.

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

Thank you.

Good afternoon and thank you for joining us.

We are very pleased with our second-quarter performance.

We executed well with each of the businesses, delivering earnings at or beyond the level we had anticipated three months ago.

Overall, we generated record second-quarter revenues and delivered adjusted earnings that exceeded our guidance.

During the quarter we increased our revenue by over 17% to $677 million and delivered topline growth in all regions.

International remains our biggest growth driver with Europe and Asia combining to represent nearly 80% of our sales growth.

We also executed well in our strategy to support and elevate our brand, focusing on inventory control and markdown management which resulted in overall product margin increase and adjusted operating margin that exceeded our expectations.

For the quarter, excluding the settlement charge that Dennis will describe, we delivered adjusted earnings per share of $0.84, a 17% increase over last year's second quarter.

Overall the results demonstrates the continued strength and momentum of our brand and the ability of our management team to deliver solid results in this economy.

In North America retail we increased our profitability by focusing on full price selling, reducing our markdowns and driving faster sellthrough which generated a significant improvement in our product margin.

Also with good expense control, we substantially improved retail profitability, 170 basis points better than the Q2 of last year.

While sales have been impacted by significantly less markdowns, we feel we've made strong progress towards elevating the brand even in the current environment.

Low inventories coupled with renewed visual merchandise initiatives have resulted in a shopping environment that is much more attractive.

This is our lowest second-quarter markdown rate since 2003 and this is very important to us.

Overall, we are seeing a great response to our basic denim which has been a top priority for us and our accessory business continued to grow.

Our success with this initiative has supported a substantial increase in our average unit retail price during the quarter.

In Europe where our business continued to expand even as the economy there has shown some recent sign of slowing, in the second quarter, we increased our revenue by 30% in US dollars.

We have also made progress on three very important initiatives that offer long-term expansion opportunities.

First, we continued to expand our owned retail stores presence.

We have opened 28 stores so far this year and we now operate 165 of our own retail stores of the 443 total stores in Europe.

Expanding outside of Italy has been another priority and retail development is a key factor of that strategy.

As I said previously, we are underpenetrated in certain countries in Europe where we enjoy a strong brand awareness but have underdeveloped distribution.

At the end of 2008 we operated only 24 stores outside Italy.

Today we have quadrupled that number, leveraging our retail capabilities to expand our business in important markets like France, Spain, the UK and Holland.

We also see Russia as a significant growth opportunity where our business has doubled within the last 12 months.

We operate directly in 10 different countries in Europe today.

Our business continues to expand but we now enjoy a much more balanced and diversified European business.

Next is Asia where South Korea and China both delivered strong results with overall revenue increasing 31% in the quarter.

In Q2 we achieved an important milestone in South Korea with the launch of G by GUESS.

So far we have opened four locations in South Korea and the business is off to a great start.

We believe this concept represents a great opportunity for our business.

By the end of the year, we expect to open a total of 40 G by GUESS locations in South Korea.

In China we continue to work with strategy partners to open stores in secondary cities and have increased our presence by over 40%.

We currently have 113 locations in China and we are on track to open another 40 for the remainder of the year.

We continue to of course to see this region as one of the greatest opportunities ever for our Company.

Our goal is to have 500 stores and concessions in China in the next five years.

Our overall performance this quarter is a testament to the strength and diversity of the Guess?

brand.

Recently however, we've seen increased volatility and uncertainty in financial markets around the world and the global economy.

As we know from the past, volatility can significantly impact consumer confidence.

It remains to be seen how consumers will respond, but we believe we are well-positioned to continue our long history of solid financial performance.

For that, we have a strong management team with significant experience.

We also have a strong balance sheet and ample access to capital.

But above all, we have the Guess?

brand.

Our number one priority is to support the presence of our iconic brand in every market we enter.

We remain committed to our key expansion initiatives in Europe, Asia and opportunities in new markets like India, Latin America and specifically Brazil.

The brand has such great potential worldwide and we want to take advantage of that in a very strategic and disciplined way.

With that, we're committed to focus on improving productivity and long-term profitability in all the markets we operate.

But of course as always, we will navigate the short-term with a prudent approach with our eyes focused on the long term.

With that, I will pass to Dennis.

Thank you, Paul, and good afternoon.

Let me start with the settlement charge.

In late July we experienced a temporary disruption with one of our logistics service providers in Italy and subsequently opted to settle that relationship and transition to a new provider.

That transition is ongoing and we expect it to be completed over the next several months.

Based on the settlement, we recorded a charge that negatively impacted second-quarter operating earnings by $19 million.

Including the related income tax effect, the impact on second-quarter earnings per share was $0.19.

This charge has been included in our GAAP diluted earnings per share of $0.65 for the second quarter.

In our press release, we have isolated the settlement charge in our income statement and have also provided disclosure which reconciles our GAAP results to adjusted results excluding the charge.

During this conference call, all of our comments and analyses for both the second quarter and the full fiscal year are on an adjusted basis excluding the settlement charge to provide relevant period to period comparisons for better operational visibility to the business.

Moving then to the business overall in the second quarter we increased adjusted net earnings by 17% to $78 million and increased adjusted diluted earnings per share by 17% to $0.84 from $0.72 in last year's second quarter.

Second quarter revenues increased 17% reaching $677 million, ahead of expectations.

Constant dollar revenue growth was 9%.

Total Company gross profit increased 19% to $300 million and gross margin increased 60 basis points to 44.3%.

Our overall product margin increased in the quarter driven by lower North American retail markdowns and the favorable impact of retail mix and currencies in Europe.

These were partially offset by a higher occupancy rate given the retail comps and our continued retail expansion.

Our total adjusted SG&A expenses increased 20% to $187 million which included a significant unfavorable currency translation impact.

The increase supported our store and sales growth including higher variable selling costs, store selling expenses and increased distribution costs.

General and administrative costs increased to reflect the additional infrastructure investments we made in Europe throughout last year and as we develop our organization in Asia.

Our adjusted SG&A rate increased 60 basis points to 27.6%.

For the period, adjusted operating profit increased 17%, totaling $113 million which includes a $9 million favorable currency translation impact.

Adjusted operating margin was flat at 16.7%.

For the second quarter we reported other net income of $3 million.

This amount includes $4 million or $0.03 per share in net unrealized revaluation gains on foreign currency contracts and balances partially offset by net unrealized losses on non-operating asset.

Our adjusted effective second-quarter tax rate was 31.4% compared to 30.1% in the prior year.

The increase mainly reflects a higher anticipated full-year adjusted effective income tax rate due to the effect of currencies on our projected tax liabilities and a different distribution earnings among tax jurisdictions.

Now I will review our segments starting with North America retail.

In North America retail, second-quarter revenues increased 8% to $261 million.

Consistent with our expectations, same-store sales declined 1.9% in US dollars and 3.4% in local currency.

Operating income increased 25% to $33 million and operating margin expanded 170 basis points to 12.6%.

This operating margin increase reflects significant product margin expansion due to our success in reducing markdowns, lower relative store selling expenses and leverage over our G&A structure.

These were partially offset by our higher occupancy rates due to the negative comps.

During the quarter we opened nine new stores and closed three, ending the period with 490 stores in the US and Canada.

European sales increased 30% in the quarter reaching $289 million.

In local currency, the increase was 14%.

Our owned retail stores drove the largest part of the revenue growth despite a decline in comp store sales.

In European wholesale our apparel business performed strongest fueled by healthy reorders while we experienced some decline in handbags and jewelry.

Adjusted operating income increased 26% to $64 million and increased 12% in local currency.

Adjusted operating margin declined 60 basis points to 22%.

The decline resulted from product margin expansion given the impact of the relatively stronger euro as well as a higher mix of retail stores.

This was more than offset by a higher occupancy rate, higher distribution costs as well as the infrastructure investments we made during the latter part of last year.

In Asia, revenues for the second quarter increased by 31% to $55 million as we continued to expand our distribution in both South Korea and China.

Both of these markets posted positive comps and double-digit revenue increases.

Operating profit decreased 15% to $5 million and operating margin declined 470 basis points to 8.8%.

The operating margin decline was due to lower gross margins mainly due to channel mix in our Korean business and a higher SG&A rate given our planned infrastructure investments to support our growing business.

In North America wholesale revenues decreased 1% to $44 million.

Operating profit and margin were both roughly flat at $11 million and 24%, respectively.

In our licensing segment, revenues increased 6% to $28 million and operating profit increased 6% to $25 million.

Now turning our attention to the balance sheet, we ended the quarter with cash and equivalents of $430 million.

Operating cash flows for the first six months of fiscal 2012 were $88 million, down 15% from the prior year period due to the timing of tax payments and the funding of working capital needs to support the business.

Accounts receivable increased 30% over last year to $391 million.

In constant dollars, the increase was 20%.

Overall, DSOs were higher compared to last year mainly due to the unfavorable timing of the earlier month end fiscal close this year.

At the end of the quarter about 52% of our receivables were supported by insurance coverage, bank guarantees and letters of credit.

We ended the quarter with inventory levels at $343 million, about 12% higher than a year ago.

Half of this increase resulted from currency translation.

The vast majority of our inventory growth supports our international businesses, primarily Europe, but Asia as well.

When measured in terms of finished goods units, inventory volumes are up about 3% compared to the same period a year ago.

Overall we feel we are well-positioned with our inventories with strong positions in trending categories to support our business for the back half and the holiday season.

During the quarter, we invested $29 million in net capital expenditures mainly to support retail store expansion and remodels.

We are now planning full-year CapEx to be around $135 million.

Our Board of Directors has approved a quarterly cash dividend of $0.20 per share on the Company's common stock.

The dividend will be payable on September 23, 2011 to shareholders of record at the close of business on September 7, 2011.

Now we'll move into our recent business trends and our outlook for both the third quarter and full fiscal year 2012.

In North America retail so far in the third quarter comps were down in the low single digits as we continue to reduce our emphasis on promotional events.

We expect this general trend to continue throughout the quarter as our lean inventory position should enable us to continue to reduce our markdown sales in a profitable manner.

Overall we are planning third-quarter comps to be down in the low single digits and for total revenues to increase in the mid to to high single digits.

For the full year we are now assuming comps will be down in the low single digits.

This reflects a more cautious outlook for the economic and competitive environment in the back half of the year.

We now expect to open 38 new stores during fiscal 2012 and expect full-year revenues to increase in the mid to high single digits.

In Europe most of our third-quarter revenues relate to initial wholesale deliveries of the fall/winter collection and we expect our revenue growth will be driven by our owned retail stores.

In our accessories business, we expect to ship less product than previously planned in order to reduce the distribution and protect the brand position and integrity.

This should affect the quarter-over-quarter EPS comparison by about $0.08 per share.

We expect that European third-quarter revenues will increase in the low single digits in local currency and in the mid to high single digits in US dollars given our assumption of a modest strengthening of the US dollar.

For the full year we now expect total European revenues will increase from 10% to the low teens in euros and in the mid to high teens in US dollars.

In Asia we continued to be very pleased with the momentum of our brand and we expect our sequential growth trends to continue.

We expect that our growth will continue to be driven by new door expansion in both South Korea and China as well as by positive comps.

For the third quarter as well as the year we expect revenues to increase in the mid to high 20% range.

In on North America wholesale business, our customers have continued to buy tighter to reduce their inventories and improve their turns.

Wholesale backlog is currently flat and we expect third-quarter revenues to decline in the mid-single digits.

For the full year, we expect wholesale revenues to be flat to slightly down.

In global licensing, we expect third-quarter royalties to increase in the mid-single digits and for full-year revenues to now also increase in the mid-single digits.

Turning to gross margins, we now have good visibility on product costs for the remainder of this year and inflationary pressures are consistent with what we described a quarter ago.

While there has been some recent easing of cotton prices, we do not anticipate that this will impact our business this fiscal year.

Our strategy is to offset product cost inflation and remain intact.

We have implemented strategic price increases which we believe should offset more than half of these cost increases.

In addition, we expect that our continued focus on full price selling should lead to a year-over-year improvement in markdowns and we continue to expect a favorable currency impact on second-half margins.

Overall, we're planning a slight improvement in gross margins for both the third quarter and the full year with product margin expansion being nearly absorbed by a higher occupancy rate given our comp assumptions and the overall retail mix.

We expect our SG&A rate will increase slightly in the third quarter as the impact of the lower European accessory revenues will more than offset anticipated North American leverage.

For the full year we expect our adjusted SG&A rate will be flat to slightly down.

With respect to taxes, we are now planning our full-year adjusted effective tax rate at 30.75% though this rate could be impacted further by fluctuations in currencies especially the Swiss franc and the euro.

This adjusted rate excludes the impact of the settlement charge.

With respect to currencies, we're planning assuming the euro declines modestly against the US dollar from its current levels.

Assuming this, we would expect a small net marked to market gain related to currencies in the third quarter.

Given all these factors, for the full year we now expect revenues to range between $2.74 billion and $2.78 billion, adjusted operating margin between 16% and 16.5% and we now expect full-year adjusted EPS in the range between $3.25 and $3.35 per share.

Including the settlement charge, full-year EPS would be in the range between $3.06 and $3.16 per share.

For the third quarter, we expect revenues in the range between $650 million and $665 million.

We're planning an operating margin of around 15% and for EPS in a range between $0.71 and $0.74 per share.

With that, I will conclude the Company's remarks and open the call up for your questions.

Before doing so, let me remind everyone to please limit themselves to one single-part question.

If time permits, we will allow people to ask a follow-up question.

Operator?

(Operator Instructions) Jeff Klinefelter, Piper Jaffray.

Yes, thank you, everyone, for the detail today.

Dennis and Paul, could we just follow up on Europe in a little bit more detail?

Obviously a lot of discussion on what is happening particularly in Southern Europe.

Could you give us some color on trends between southern markets like Italy and Spain versus Northern markets in Q2 and what you have seen so far in Q3 and what's incorporated into that new guidance going into the second half?

Thank you.

Yes, so so far in Europe, last quarter we said that as we moved from spring/summer 2011 to fall/winter 2011 we saw a slower growth rate in the business overall for Europe.

And Italy was part of that.

It was still growing at a modest clip.

So far with the spring/summer orders, I'm talking about the wholesale business right now, the spring/summer -- and we were about three-quarters of the way through that market -- we're seeing a fairly similar trend both for the European business and Italy.

Italy is up slightly in the order book.

When we also look at our retail business meaning the owned stores that we have there, the comps were down as we said.

Overall in Europe -- and it was a very similar profile in Italy and the southern parts of Europe.

So far Italy is obviously our most penetrated region, so you would naturally expect that it would grow at a different rate than the rest of the business.

But so far Italy has been performing roughly in line with what you would expect given the way the rest of Europe is performing.

Dennis, have you made any changes to how you're protecting your margins in Europe?

You mentioned that your receivables are insured.

I think it's slightly over 50%.

Are you doing anything else with your credit lines to protect your margins in the back half?

Nothing different from the same process that we have always followed.

We manage through a combination of insurance, letters of credit, as we also put our customers through scrutiny before and in some cases we collect payments upfront or put companies on payment plans.

So nothing really is different now from before.

Christine Chen, Needham & Co.

Thank you and congrats on a good quarter.

Wanted to ask, could you talk a little bit about the performance in the US and maybe share some detail?

How did trends progress throughout the quarter?

Did you see a slowdown in the end of July like a lot of retailers did and thus far in the beginning of August?

I know you said that month to date things are down negative low single digits.

But just wondering about that trend, and then wondering if you saw any regional differences and a difference in performance across the concepts?

Thank you.

Hi, Christine, this is Russell Bowers.

In regards to the trends throughout the quarter, it was fairly consistent.

During the quarter though comps did get better each month as we progressed.

July was the best month for us both in terms of comp and in terms of product margin improvements.

In August the trend has been similar to Q2.

Through the first two weeks we were running with our comps flat, but then we ran into a big promotion that we did last year that we really deemphasized.

So the end result is our comps are down in low single digits again with markdown improvements.

Regionally, the best regions were the West and the Southeast.

The toughest areas was Canada and the mid-Atlantic was tough.

Good news for us is the Northeast started to improve.

It was tough for us in Q4 and again in Q1.

So we are getting better there.

Concepts, the best concept for us has been G by GUESS which continues to be on a roll.

They were up almost 10% during the quarter again with markdown improvements in that concept.

And the Guess?

brand is where we've really gone through the big changes of inventory and promotional decreases.

So that has been a little bit tougher.

Thank you and good luck.

Randy Konik, Jefferies.

Dennis, can you just re-clarify the impact of the conscious decision to pull back on accessories distribution?

I guess you said that's solely impacting Europe.

Can you give us the -- I think the EPS impact is $0.08 but just re-clarify that.

And then what is the revenue impact?

And then the second piece of the puzzle is it looks like you guys are doing a good job of taking control of the inventory and that is leading to improved US margins.

I think we're starting to go up against some easier margin compares later in the year in Europe and so forth.

When could we start to see the Europe margins start to base out here, just curious?

Thanks.

With respect to the impact in the third quarter, yes, you are right.

We did say it's $0.08.

As we -- the brand is very strong, there's a lot of demand.

In some parts of the business we're a bit overexposed.

So we've taken this as the opportunity to take control over the distribution, protect the brand.

so $0.08 in the third quarter, that's the quarter in which I expect the biggest impact.

We didn't specifically quantify the revenue impact, but if you look sort of sequentially as well, you will see that -- the second quarter we came out of the most favorable currency environment.

So if you're looking sequentially, the trending in Europe is going to be impacted both by that topline and by now with the tighter currency lift for the third quarter.

And the rest of your question -- the inventory (multiple speakers)

You're starting to see the fruits of your labor, of pulling back on the inventory on the US side of the business where the gross margin are now coming back up.

And it looks like -- I think the Europe margins were down in the quarter on a year-over-year basis.

When can we start to see that geography start to show stabilization in the operating margins for that region?

If you're thinking about the European business, the margins -- we expect currencies to be favorable for us as we continue through the rest of the year.

And then once we get towards the very end of the fourth quarter, we start anniversarying some of the investments that we made in Europe last year.

We've also been successful at taking some of the costs we incurred in the fourth quarter out of the model.

So we expect to see some of that improvement starting to hit in the fourth quarter.

Just lastly just to re-clarify the comment on Italy is that it's not that bad, it's in line with the rest of what you're seeing in Europe.

Is that the case?

That is a fair characterization, yes.

Dana Telsey, Telsey Advisory Group.

Can you talk a little bit on the product side?

What is happening with pricing?

We heard last time about dresses and denim, the price increases being accepted.

Is it spreading to other categories now?

And how do you manage -- can you give us a little bit of the complexion of gross margin, the IMU versus the markdown rate and what you are seeing?

Thank you.

As far as pricing, the targeted price increases are in effect in our stores now.

What we have seen so far, if she likes it, there's been very little resistance to the changes.

Great example is our strong denim results, dresses as we spoke about earlier and the overall AUR increase that we're seeing at the category of all of our best selling items.

As far as the IMU, we did see some pressure a little bit on IMU starting in the second quarter and we overcame that with an excellent markdown rate and ended up with product margin expansion.

Then as you just think of the upcoming holiday season and what you are seeing on the accessory side and any of the license products, anything changing there?

Pricing or inventory levels?

Thank you.

Yes, we have -- the inventory levels are pretty consistent with last year and our accessory categories.

The pricing is up a little bit but not as up as much as they are in the apparel categories and we're not pressured in IMU at all in the accessories.

Jeff Black, Citigroup.

Yes, Dennis, looping to Europe again and staying on that, what is behind the accessories weakness?

It sounds like -- you mentioned in your comments accessories is weak.

Is it that some of your accounts over there are experiencing weakness and you're paring those and again the exposure to some of those accounts on the wholesale side?

Or is it an issue with product and we're just not comfortable with this product we have out there now and we are pulling back a little bit?

Any clarity on that would be helpful, thanks.

This is Paul.

I think it is a mixture of -- I go there basically every four weeks and when you walk the streets of every capital in Europe, clearly we always have in mind what we talk constantly about which is the brand integrity.

And if we feel that we are somehow in certain cities or malls overexposed, across the board we will give you action; being the handbags or watches or eyewear or shoes or anything, any category.

We will give you action immediately to correct that.

The demand in Europe is bigger than what we ever expected when we started to operate directly five years ago.

We will reach $1 billion this year and that came in five, six years.

And to a certain degree, we are looking to spread out that business rather than to be concentrated on only three or four countries.

So, you have that one factor.

The other factor of course is the success of GUESS accessories especially in shoes and handbags and watches has absolutely stimulated the competition.

And of course you will have some competition come with product who could be similar or close to what we do and that is what we deal with.

We continue to drive our business with discipline.

And what is a key for us and to don't overly expose, oversell in our different categories and that's what we have.

So we don't [look about] what's going to happen next Christmas.

We look at what happens the next five years, the next seven years and whatever it takes, we are going in that direction.

So it sounds like it's just a proactive move rather than reactive just on big slump in accessory trends.

Absolutely and we will conduct our meeting that we have called One World One Brand with all our partners, licensees and distributors around the world in spring 2012.

And our message has been the same consistent after 30 years.

We are looking how we're going to celebrate the 40 years, not how we're going to celebrate 31 years.

So it's not a product issue.

It's a product of strategy that most of Europe and Eastern Europe has not been addressed properly by us when we exploded in all the Southern Europe.

I mean, if you visit Europe, it's easy to find out how popular the Guess?

brand is in such a short time.

So I think if you travel there, you will understand.

Betty Chen, Wedbush Morgan.

I was wondering if you can give us a little bit more color around South Korea and China.

Very nice double-digit sales growth in that region at least in those two countries.

Give us a little flavor if you could on what products are resonating with that customer?

And also whether we should expect investments in that region to also impact operating margin in the third quarter?

And then just as a follow-up to the earlier question, given that some of the accessories business in Europe is part of your initiative to control the brand integrity, can you also just give us some color around North America accessories?

I know traditionally it's been very strong in the past.

Anything that you saw in the second quarter or early Q3 would be helpful.

I think you covered the world now.

I think you went from Asia to Europe to North America.

I'm trying.

We will try to address all that.

South Korea and China, basically I think that as we mention again, it is a major factor of our future investment.

Whatever it takes, whatever we will have to do, what we did right in Europe, we would try to do right in Asia.

So the half billion business mark is definitely visible.

The billion dollar business in Asia will be in our target.

And whatever it takes, the time, it doesn't matter to us.

What matters to us is that we have a strong team there.

We have a [distribution] of the brand different concept to be in place there.

I'm visiting there again in four weeks.

I was there eight weeks ago.

I continue to go constantly in these countries.

South Korea is beyond what we ever expected to have as a business and we are the number one brand international there today.

We think that -- and don't forget we don't have any business in Japan.

Zero.

We have left that country alone for a few years to clear the market until we reenter that market in the next future -- in a dual act or joint venture.

So China is clearly -- I mean with now our new president Kitty Yung, we're making a very, very strong progress and we are having a presence well in place on every key city.

Any mall that you will visit, a meaningful mall, you will find a GUESS store.

And we continue to be present on every plan of expansion of any new development.

So that's that.

For Korea, the G by GUESS has entered just now and by the end of the year, we will have another 40 locations.

As you know, the format in Korea, it's not shopping centers.

There are no shopping centers there.

It's the same as Japan.

There's many department stores business but large shopping shops, almost the size of a store.

And we will plan to have another 40 stores here.

We are doing directly also underwear line in Korea, so we have a big plan of expansion also in Korea.

If you talk about the CapEx for example for Korea, it would be much less than what we do in the US because we don't have this big cost of store development like we do in US.

It's mainly department stores.

So, the product assortment, we have adjusted a lot of [feet] for the Asian customer and we also have a very good partnership with some franchising partners who have expertise in their region.

If you're familiar with China, some partners franchisee can have 100, 150, 200 stores and are expert in the region with management, with training with everything.

This is where we have been focusing therefore.

The big cities are controlled by us and the secondary cities are mainly partners.

And this is a clear strategy we intend to continue.

We have no intention to operate entirely China stores at all.

I think Betty asked about the accessories in the US.

We have been really successful with our watches.

They're doing great for us.

Eyewear is performing very well as is jewelry.

Jewelry has been helped by the introduction of the European line here to a lot of our stores, and so that's added some incremental business for us.

Thanks, Russ.

Dennis, just a follow-up to Asia.

Should we expect margins to also be down like in Q2 due to investments in that region?

Yes, I think in the second quarter you certainly will see impact on the SG&A lines.

Second quarter was a little bit more impacted because of just the timing of when we make some shipments in South Korea in the outlet channels.

So I think the second quarter probably will as you'd expect to see -- this quarter is kind of the most severe change quarter over quarter and it should be a little more muted.

But we still expect margins to be down because of the investments for the year.

Great, thank you so much and best of luck.

Omar Saad, ISI Group.

I was a little bit surprised to hear that in Europe, the slowdown you are seeing in Italy is about the same as the rest of Europe given the fact that you are still so underpenetrated in the rest of Europe.

Has your views changed there in terms of -- are you seeing anything in those markets there that are affecting how you're planning the expansion into those markets outside of Italy?

And then broader picture, Paul, given your experience and success in the European marketplace as well as your personal background there, any thoughts you have on kind of the big macro situation in Europe with the sovereign debt issues?

Any insights you have there would be greatly appreciated.

Thanks.

Yes, Omar, I think you have visited Italy a few times and you're right about that question.

It is a little bit strange to see why Europe is suffering now but Italy less than the rest.

And we have been implanted in Italy for many years.

So brand acceptance and recognition in Italy is extremely strong and for many reasons.

One is when we started in Europe as a direct operation in 1994 or 1995 I think, we were based in Florence, Italy and we still have a strong base office, like 200 people in the office in Florence.

So we have been really implanting that brand for over almost 15 years.

So, we -- let's put it that way.

We are part of the landscape today.

We're not a newcomer like we're a newcomer in Spain or a newcomer in the UK or a newcomer in Germany.

So when you have kind of a slowdown somewhere, like if you take the UK, the first thing will be affected is the brands who are not really well recognized or well present or well spread out for the country.

And we don't have that many stores there or not a big presence in department stores.

We're just barely beginning the last three years, that's what I call barely beginning, four years.

So now for the microeconomic honestly, every day you open the TV, you have no clue if things are going to be up or no clue if things are going to be down.

I mean nobody has been able to predict anything.

And we try to manage to see how the consumer will look at the simple basic factor is the traffic.

We look at the traffic.

People are shopping or not.

People are shopping where?

And are they looking at more product, are they looking at more prices?

Are they looking at -- this is where we navigate rather than to try to figure out what the government of Germany and France are going to do about the euro and what's going to happen to the euro itself.

Is it going to explode?

Yes, no?

We have no clue.

At our level, we have no clue.

So we try to see what is our strategy and [to agree to that].

France is continuing to expand.

Spain with this crisis, we are showing strong count across the year and when the country has 22% unemployment.

So everything is different on each country.

Germany is one of the toughest markets and yet for the small business we're doing in handbag, shoes and denim, all the numbers are positive comp for us because our base is small and because we're a newcomer like doing a small business comparing to Italy.

Italy we have a very strong presence in the roadmap of all the stores in every city.

So that's why our business is that strong there.

Thank you, Paul, good luck.

Diana Katz, Lazard Capital Markets.

Thank you for taking my question.

All this great color.

Speaking of traffic, can you break out traffic versus conversion within your own stores domestically and then how your tops versus bottoms performed?

Yes, as far as traffic goes, our traffic has been down consistently.

The conversion is down also but a lot of that has to do with doing less markdowns because we made a lot of progress with our AUR.

Tops versus bottoms, bottoms overall performing much better than tops.

And do you see the new tops that are coming in starting in September, do you see any initial reads on those -- if you think that could change your top comp performance?

Yeah, we do.

And we're starting to get encouraged by what we're seeing with the knit top category in particular and the table program that we had out there during the second quarter performed very well.

We're going to bring in more wovens to help build that business back up.

And for holiday we're really going after again the key item program.

So yes, we're really encouraged by what we're going to see the back half of the year.

Eric Beder, Brean Murray.

Could you talk a little bit -- I heard you mention Latin America and Brazil.

What are you planning to do in those markets?

And on a completely unrelated subject, what was the North American inventory increase per square foot and the square footage at the end of the year?

Yes, our square footage is up about 9% year over year and our inventory per square foot is down in dollars in the mid single digits and close to 10% if you look at it on a unit basis.

And Eric, this is Paul.

About Latin America and Brazil, Latin America, you should take the total business we do here, we don't count Mexico in all that.

We talk Latin America.

It's pretty small even though that we have some distribution for many, many years in all these small countries like Panama and Guatemala.

And we started some business in Peru and Chile.

But it's small in the scale of what we do as total business in Americas, all Americas.

Brazil is clearly a huge opportunity.

But because of past experience, we had a licensee there many, many years ago which was an experience of letting them produce our products.

We decided that unless we do control 100% all the joint venture operation, we will not operate in Brazil.

So we are in discussion now with three different potential partners, but it will be no question about all majority owned by us or 100% owned by us.

So again three months, six months, nine months will not change anything in our plan.

We want to act with a proper strategy meaning full control or strong joint venture with complete transparent partners.

That is our goal.

But Brazil is -- we are frustrated that we are not there.

But we prefer to don't be there than to be with the wrong partners or licensees.

Great, good luck.

Margaret Whitfield, Sterne Agee.

Good afternoon and congratulations on a good quarter.

Wondered if you could comment on the opportunities for G by GUESS outside of North America and South Korea.

And in terms of your goal to penetrate other countries in Europe, where do you think Italy might end the year this year as a percent of Europe and how do you see it trending?

And what countries do you think would take up the slack?

And finally, why do you think the accessories issue will be confined to Q3?

Thank you.

Why don't we start by G by GUESS?

G by GUESS we started a little bit on Korea and obviously has been a great success.

We did some doors in South Africa in Johannesburg and Cape Town.

And obviously for the reason you can understand because of price point.

And also we did some in Philippines where we're the biggest brand now for the last 20 years in the Philippines.

So you think of these countries and the common thread you will have somewhere is the aspirational certain young customers who would love to buy GUESS but cannot afford GUESS.

So we are moving slowly on these three different [tests in the world] three different regions of the world and see how it is evolving and our experience in North America has been very good with G by GUESS.

Visit any of the stores and I think you will have some very pleasant surprise.

I don't know which region you are in, but I think you will like it very much or look at the website.

What other question you have?

You asked about the penetration of Italy.

If you look at the business over the last several years, Italy used to be the majority and it's been becoming less and less.

While it's been growing, the rest of the business has grown even faster.

So we are right now in sort of the low 40% in terms of the penetration of Italy to total European business.

And then just to clarify with respect to the adjustment in accessories, what I -- the message was that I expect the biggest impact in the third quarter but we could see some lingering headwinds until we fully anniversary the second quarter next year.

Susan Sansbury, Miller Tabak.

And yes, you did have a great quarter.

So kudos for that.

Could you shed a little bit more light on this service provider that you severed your relationship with?

What type of service provider?

What type of service and logistic provisions are you talking about?

And do you expect any ramifications or startup problems from the new guy that you are now using?

And then secondly on this accessories question, I am still a little confused about whether this is -- whether it's a specific product category within accessories like handbags or whether it's just across the board?

Susan, this is Michael Prince.

I will take the first one.

You know, as Dennis mentioned, we had a temporary disruption with a logistics provider in Europe in late July and we evaluated the situation and assessed the potential volatility and felt like it was in the best long-term interest of the Company to transition to another provider and when you look at the long-term benefit, we believe this other provider will provide the platform to really support our growth agenda in Europe for the long term.

Well, Michael, not to be stupid, what do you mean by a service provider?

What are we actually talking about here?

Logistics.

So distribution of product to the consumer or to (multiple speakers)

Third-party shipping.

Yes, retail accounts.

Okay, so this -- is this provider going to transition to the new provider or do you expect any issues as this transition occurs?

No, we've got an agreed upon transition period, so we don't anticipate any issues.

And the transition period is how long?

The next several months, as Dennis mentioned earlier.

Susan, let me make it clear.

The problem came four weeks ago, not four months ago, not four years ago.

I know, it was a surprise.

So that's why we act and we act swiftly on any issue that comes up.

We don't let any problem getting any worse.

So in four weeks what we've done was incredible.

And we have not disrupted anything.

That is the key.

About the accessories, I answered before.

I cannot pinpoint, it will be too hard to extract the two categories where there have been some weakness in general in Europe.

Comparing to the big volume we do in accessories in Europe.

I would point out more of a jewelry --custom jewelry and handbags more than anything of watches or shoes or eyewear or any other categories or belts.

It's really more sensitive in jewelry and handbags.

So this excess inventory, if I can call it that, was situation -- reflected the former owner of that jewelry business that you just bought a couple months ago?

Was the product overdistributed or how did it get overdistributed?

No, I mean -- no, we don't -- first of all we carry very, very little jewelry inventory.

So the inventory we have on our balance sheet is largely driven to support our apparel and our handbags and footwear business.

That's where our inventory investment is.

What we're saying is that the product has been overexposed.

We had a great year coming out of last year and it's overdistributed.

We do what's right for the brand for the long term and we're taking the opportunity to take a little heat off of that business.

John Kiernan, Cowen & Co.

Nice performance in Q2 especially on the gross margin line.

I guess in the North American wholesale business -- nobody has asked the question on this yet-- is there a reason why the revenues are declining in the back half of the year?

It was a growth business last year.

Do you feel like you're losing floor space in one of your wholesale accounts?

Can you talk about what's going on there in the back half of the year?

Yes, this is Russ.

It's down mostly because the department stores are managing their inventories just like we are in our stores.

They're buying tightly and they want to have faster turns.

Our sellthrough in Macy's and Bloomingdale's, our comps are up in the doors that we're in, and it is progressing very well especially in [life see] in women's.

As far as doors, we're not losing a lot of space, though we did shed some doors that were unprofitable earlier in the year.

Okay, thanks, and then shifting to Europe, is there any reason to believe your prior peak type operating margins aren't sustainable anymore given your shifting to more of a directly operated retail?

Are those prior historical margins like the margins you used to put up near 23%, 25%, can we believe at some point when the environment normalizes there that you could get back to that type of level of productivity?

This is Paul, yes.

Clearly, you know, you cannot compare what is not comparable.

If you look at when we started after we took over a licensee five years ago exactly in January 2006, we had like 10 stores, all together 10 doors.

So the 10 doors, 95%, 96% of the business was wholesale and 5% was retail.

Today we operate 165 stores ourselves.

We have 3000 employees in Europe.

At the time we had 70.

So you can see the scale is the same story as North America.

Our margin when we were wholesale in the 1990s and 1995 up to 2000 has nothing to compare with today when we operate some of the stores and 10,000 people.

So clearly the 24%, 25% margin that you mentioned about of course will be difficult to go back to knowing that we have a clear intent to continue to open stores all over Europe including North Europe, including south of Europe where we're not completely developed like Spain or France.

France we think we can double [department stores] and it will be most likely our stores.

So does that answer your question?

Yes, thank you.

Then one last final question.

The backlog in Europe in constant currency?

Did I miss that?

Dennis, did you give that?

No, the backlog is -- I just need to get my hands on it for one second.

The backlog is -- right now it's roughly flat and that includes the remaining shipments that we have for fall/winter as well as the order book that we have in spring and summer so far.

So you get some timing affects with fall/winter.

So far the spring/summer orders are up in the mid-single digits.

At this time there no further questions.

I'll turn the call back to Paul Marciano for closing remarks.

Thank you.

Basically what I want to conclude is just we finished last week one of the higher roller coaster weeks in the stock market all over the world.

Statistics show that in four weeks, it was as high of a loss around the world than the worst four weeks of March 2009.

And when you have that across the globe, you have to wonder and sit back and think what impact it has on the consumers of today who are visiting more -- who are visiting stores.

We have to think about that every day.

But we know clearly what we know and we are not economists.

We are trying to navigate in this environment and we try to make the best decisions every single day.

So that's what we do and we try to manage also what is manageable for us which is clearly inventory, margin, production, costs and try to do the best products.

The rest is not in our hands.

What the market does, it's not in our hands.

So that's it, thank you very much and we'll talk to you next quarter.

Thank you.

Ladies and gentlemen, that concludes today's presentation.

Thank you all for your participation.

You may now disconnect.

Have a good day.