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GUESS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) General Unless the context indicates otherwise, when we refer to "we," "us," "our" or the "Company" in this Form 10-Q, we are referring to Guess?, Inc. ("GUESS?") and its subsidiaries on a consolidated basis. Important Factors Regarding Forward-Looking Statements This Quarterly Report on Form 10-Q, including documents incorporated by reference herein, contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may also be contained in the Company's other reports filed under the Securities Exchange Act of 1934, as amended, in its press releases and in other documents. In addition, from time-to-time, the Company through its management may make oral forward-looking statements. These statements relate to analyses and other information based on forecasts of future results and estimates of amounts not yet determinable. These statements also relate to our goals, future prospects and proposed new products, services, developments or business strategies. These forward-looking statements are identified by their use of terms and phrases such as "anticipate," "believe," "continue," "could," "estimate," "expect," "goal," "intend," "may," "outlook," "pending," "plan," "predict," "project," "strategy," "will," "would," and other similar terms and phrases, including references to assumptions. Although we believe that the expectations reflected in any of our forward-looking statements are reasonable, actual results could differ materially from those projected or assumed. These forward-looking statements may include, among other things, statements relating to our expected results of operations, the accuracy of data relating to, and anticipated levels of, future inventory and gross margins, anticipated cash requirements and sources, cost containment efforts, restructuring charges, estimated charges, plans regarding store openings, closings and remodels, plans regarding business growth and international expansion, plans regarding supply chain efficiencies and global planning and allocation, e-commerce and omni-channel initiatives, business seasonality, results of litigation, industry trends, consumer demands and preferences, competition, currency fluctuations, estimated tax rates, results of tax audits and other regulatory proceedings, raw material and other inflationary cost pressures, consumer confidence and general economic conditions. We do not intend, and undertake no obligation, to update our forward-looking statements to reflect future events or circumstances. Such statements involve risks and uncertainties, which may cause actual results to differ materially from those set forth in these statements. Important factors that could cause or contribute to such difference include those discussed under "Part I, Item 1A. Risk Factors" contained in the Company's most recent Annual Report on Form 10-K for the fiscal year ended February 1, 2014 and in our other filings made from time-to-time with the Securities and Exchange Commission ("SEC") after the date of this report. Business Segments The Company's businesses are grouped into five reportable segments for management and internal financial reporting purposes: North American Retail, Europe, Asia, North American Wholesale and Licensing. Management evaluates segment performance based primarily on revenues and earnings (loss) from operations before restructuring charges, if any. The Company believes this segment reporting reflects how its five business segments are managed and each segment's performance is evaluated by the Company's chief operating decision maker to assess performance and make resource allocation decisions. The North American Retail segment includes the Company's retail and e-commerce operations in North America and its retail operations in Central and South America. The Europe segment includes the Company's wholesale, retail and e-commerce operations in Europe and the Middle East. The Asia segment includes the Company's wholesale, retail and e-commerce operations in Asia. The North American Wholesale segment includes the Company's wholesale operations in North America and Central and South America. The Licensing segment includes the worldwide licensing operations of the Company. The business segment operating results exclude corporate overhead costs, which consist of shared costs of the organization, and restructuring charges. These costs are presented separately and generally include, among other things, the following unallocated corporate costs: accounting and finance, executive compensation, facilities, global advertising and marketing, human resources, information technology and legal. Information relating to these segments is summarized in Note 8 to the Condensed Consolidated Financial Statements. 24 -------------------------------------------------------------------------------- Table of Contents Products We derive our net revenue from the sale of GUESS?, G by GUESS, GUESS Kids and MARCIANO apparel and our licensees' products through our worldwide network of retail stores, wholesale customers and distributors, as well as our on-line sites. We also derive royalty revenue from worldwide licensing activities. Global Economic Conditions Economic and market conditions have continued to be volatile and uncertain in many markets around the world and consumer behavior remains cautious. In North America, the relatively weaker levels of consumer confidence and the highly promotional conditions among retailers may persist. In Europe, sovereign debt issues, government austerity programs and bank credit issues have impacted the capital markets of numerous European countries, resulting in reduced consumer confidence and discretionary spending in those countries. These circumstances have had, and could in the future have, a negative impact on our business, particularly in our more mature markets in Southern Europe. The impact could be greater in our multi-brand wholesale channel, particularly in Italy, where many customers are relatively small and are not well capitalized. While the economic environment in Southern Europe has shown signs of improvement, the turmoil in Russia and Ukraine could negatively impact our Eastern European business. We also continue to see evidence of a more cautious consumer in China, where the economy has shown clear signs of slowing, as well as a more volatile environment in South Korea. Foreign Currency Volatility Since the majority of our international operations are conducted in currencies other than the U.S. dollar (primarily the euro, Canadian dollar and Korean won), currency fluctuations can have a significant impact on the translation of our international revenues and earnings into U.S. dollar amounts. During the first half of fiscal 2015, the average U.S. dollar rate was weaker against the euro and the Korean won and stronger against the Canadian dollar compared to the average rate in the same prior-year period. This had an overall positive impact on the translation of our international revenues and earnings from operations for the six months ended August 2, 2014 compared to the same prior-year period. In addition, some of our transactions that occur primarily in Europe, Canada and South Korea are denominated in U.S. dollars, Swiss francs and British pounds, exposing them to exchange rate fluctuations when converted to their functional currencies. Fluctuations in exchange rates can impact the operating margins of our foreign operations and reported earnings and are largely dependent on the transaction timing and magnitude during the period that the currency fluctuates. If the exchange rate for the euro, Canadian dollar or Korean won weakens versus the U.S. dollar at the time U.S. dollar denominated inventory is purchased relative to the purchases of the comparable period, our product margins could be unfavorably impacted. Our product margins in Canada for the six months ended August 2, 2014 were negatively impacted as a result of exchange rate fluctuations compared to the same prior-year period. There was a positive impact on our product margins in Europe and South Korea for the six months ended August 2, 2014 as a result of exchange rate fluctuations compared to the same prior-year period. The Company enters into derivative financial instruments to offset some but not all of the exchange risk on foreign currency transactions. For additional discussion regarding our exposure to foreign currency risk, forward contracts designated as hedging instruments and forward contracts not designated as hedging instruments, refer to "Item 3. Quantitative and Qualitative Disclosures About Market Risk." Strategy International Growth. Global expansion continues to be a key component of our long-term growth strategy. Our combined revenues outside of the U.S. and Canada represented approximately half of the Company's total revenues for the six months ended August 2, 2014, compared to one-fifth in fiscal 2005. We expect to continue to expand in our existing international markets, particularly in less mature markets like Germany, the Middle East and Russia. At the same time, we plan to develop in newer key markets such as Brazil and Japan. Omni-Channel Strategy. We will also continue to emphasize our e-commerce channel as we execute our omni-channel strategy. Our omni-channel strategy allows customers to shop seamlessly in retail stores, online 25 -------------------------------------------------------------------------------- Table of Contents and through mobile devices. We have already deployed certain initiatives in the U.S. including "reserve online, pick-up in stores" as well as mobile optimized commerce sites and smartphone applications. We have also developed our in-store fulfillment capabilities which optimize inventory located in our retail stores. U.S. e-commerce orders may be fulfilled from our e-commerce distribution center, or from our retail stores, or both, and U.S. retail store sales may be fulfilled from one of our numerous retail store locations or from our e-commerce distribution center. Productivity Improvements. One of our goals is to drive increased profitability by enhancing the productivity of our existing operations. We continue to focus on improving supply chain efficiencies and optimizing global planning and allocation. In North America, we are also simplifying processes, realigning departments and merging support functions to reduce our fixed cost structure in these areas. In addition, we continue to be opportunistic with our store openings, remodels, and lease renewals to optimize our existing store portfolio. We will continue to regularly assess and implement initiatives that we believe will build brand equity, grow our business and enhance long-term profitability in each region. North American Retail. In North American Retail, we plan to increase the profitability for our brick-and-mortar locations over the long-term by improving the productivity and performance of our existing stores. In light of the changing retail landscape in North America and the shifting of consumer purchases towards e-commerce, we have conducted an analysis of our existing store portfolio and have identified under-performing stores that we plan to exit before the end of fiscal 2016 through a combination of lease expirations and kick-outs. This will provide the opportunity for us to streamline our North American Retail organization and reduce our fixed costs. In addition, roughly half of our retail store leases in the U.S. and Canada will come up for renewal in the next three and a half years, providing us with the flexibility to further optimize our retail footprint as needed in the coming years. Europe. In Europe, over the long-term, we will continue to focus on cautiously developing new markets in Northern and Eastern Europe where our brand is well known but still under-penetrated. We have flagship stores in key cities such as Barcelona, Dusseldorf, London, Milan, Munich and Paris. During fiscal 2015, we and our partners plan to continue our retail store expansion primarily in Northern and Eastern Europe as well as the Middle East, but we expect this to be partially offset by the closure of certain under-performing stores mainly in Southern Europe, as lease terms permit. Asia. We see significant long-term market opportunities in Asia and we have dedicated capital and human resources to support the region's growth and development. We and our partners have opened flagship stores in key cities such as Beijing, Hong Kong, Seoul and Shanghai, and we have partnered with licensees to develop our business in the second-tier and third-tier cities in this region. In China, where the economy has shown some signs of slowing, we see evidence of a more cautious consumer. Our strategy in South Korea, with a combined 431 stores and concessions at August 2, 2014, is to improve productivity and expand distribution for both our GUESS? and G by GUESS branded locations. We also continue to invest in our direct operations in Japan where we had three stores and one concession as of August 2, 2014. During the first half of fiscal 2015, we and our partners opened 63 new stores and concessions and closed 59 stores and concessions in Asia, ending the second quarter of fiscal 2015 with 495 stores and 500 concessions. We and our partners plan to open between 90 and 95 retail stores and concessions in total across all concepts in Asia during fiscal 2015. Capital Allocation The Company's investments in capital for the full fiscal year 2015 are planned between $70 million and $80 million (after deducting estimated lease incentives of approximately $5 million). The planned investments in capital are primarily for store remodeling programs in North American Retail, expansion of our retail business in Europe, investments in information systems and new store openings in North America. 26 -------------------------------------------------------------------------------- Table of Contents Comparable Store Sales As a result of our omni-channel strategy, our e-commerce business has become strongly intertwined with our brick-and-mortar retail store business. Therefore, we believe that the inclusion of e-commerce sales in our comparable store sales metric provides a more meaningful representation of our retail results. In the first quarter of fiscal 2015, the Company began including the results of our e-commerce sites in our quarterly comparable store sales results for our stores in the U.S. and Canada. We also continue to separately report the impact of e-commerce sales on our comparable store sales metric. Sales from our brick-and-mortar retail stores include purchases that are initiated, paid for and fulfilled at our retail stores as well as merchandise that is reserved online but paid for and picked-up at our retail stores. Sales from our e-commerce sites include purchases that are initiated and paid for online and shipped from either our e-commerce distribution center or our retail stores as well as purchases that are initiated in a retail store, but due to inventory availability at the retail store, are ordered and paid for online and shipped from our e-commerce distribution center or a different retail store. Store sales are considered comparable after the store has been open for 13 full months. If a store remodel results in a square footage change of more than 15%, or involves a relocation or a change in store concept, the store sales are removed from the comparable store base until the store has been opened at its new size, in its new location or under its new concept for 13 full months. E-commerce sales are considered comparable after the online site has been operational in a country for 13 full months and exclude any related revenue from shipping fees. Definitions and calculations of comparable store sales used by the Company may differ from similarly titled measures reported by other companies. Other The Company operates on a 52/53-week fiscal year calendar, which ends on the Saturday nearest to January 31 of each year. The three and six months ended August 2, 2014 had the same number of days as the three and six months ended August 3, 2013. Executive Summary Overview Net earnings attributable to Guess?, Inc. decreased 44.9% to $22.0 million, or diluted earnings of $0.26 per common share, for the quarter ended August 2, 2014, compared to net earnings attributable to Guess?, Inc. of $39.9 million, or diluted earnings of $0.47 per common share, for the quarter ended August 3, 2013. During the first quarter of fiscal 2014, the Company implemented plans to streamline its structure and reduce expenses in both Europe and North America. During the second quarter of fiscal 2014, the Company expanded these plans to include the consolidation and streamlining of certain operations in Europe and Asia. These actions resulted in restructuring charges for the quarter ended August 3, 2013 of $6.1 million (or $4.4 million after considering the $1.7 million reduction to income tax expense as a result of the charge), or an unfavorable after-tax impact of $0.05 per share. Excluding the impact of the restructuring charges and the related tax impact, adjusted net earnings attributable to Guess?, Inc. was $44.3 million and adjusted diluted earnings was $0.52 per common share for the quarter ended August 3, 2013. References to financial results excluding the impact of the restructuring charges are non-GAAP measures and are addressed below under "Non-GAAP Measures." Highlights of the Company's performance for the quarter ended August 2, 2014 compared to the same prior-year period are presented below, followed by a more comprehensive discussion under "Results of Operations": Operations • Total net revenue decreased 4.8% to $608.6 million for the quarter ended August 2, 2014, from $639.0 million in the same prior-year period. In constant currency, net revenue decreased by 6.3%. • Gross margin (gross profit as a percentage of total net revenue) decreased 330 basis points to 35.6% for the quarter ended August 2, 2014, compared to 38.9% in the same prior-year period. 27-------------------------------------------------------------------------------- Table of Contents • Selling, general and administrative ("SG&A") expenses increased 2.9% to $186.9 million for the quarter ended August 2, 2014, compared to $181.6 million in the same prior-year period. SG&A expenses as a percentage of revenue ("SG&A rate") increased by 230 basis points to 30.7% for the quarter ended August 2, 2014, compared to 28.4% in the same prior-year period. • The Company incurred $6.1 million in restructuring charges during the quarter ended August 3, 2013. • Earnings from operations decreased 50.9% to $29.9 million for the quarter ended August 2, 2014, compared to $60.8 million in the same prior-year period. Operating margin decreased by 460 basis points to 4.9% for the quarter ended August 2, 2014, compared to 9.5% in the same prior-year period. • Other income, net (including interest income and expense), totaled $4.3 million for the quarter ended August 2, 2014, compared to minimal other expense, net in the same prior-year period. • The effective income tax rate increased 180 basis points to 34.8% for the quarter ended August 2, 2014, compared to 33.0% in the same prior-year period. |