Guess?, Inc. (GES) Q2 2023 Earnings Call Transcript

Guess?, Inc. (NYSE: GES) Q2 2023 earnings call dated Aug. 24, 2022

Corporate Participants:

Fabrice Benarouche — Vice President, Finance and Investor Relations

Carlos E. Alberini — Chief Executive Officer

Dennis Secor — Interim Chief Financial Officer

Analysts:

Dana Telsey — Telsey Advisory Group — Analyst

Presentation:

Operator

Good day, everyone, and welcome to the Guess Second Quarter Fiscal 2023 Earnings Conference Call.

I would like to turn the call over to Fabrice Benarouche, Vice President of Finance and Investor Relations.

Fabrice Benarouche — Vice President, Finance and Investor Relations

Thank you, operator. Good afternoon, everyone, and thank you for joining us today. On the call today with me are Carlos Alberini, Chief Executive Officer; and Dennis Secor, Interim Chief Financial Officer.

During today’s call, the company will be making forward-looking statements including comments regarding future plans, strategic initiatives, capital allocation, and short and long-term outlook, including potential impact from the Corona virus pandemic. The company’s actual results may differ materially from current expectations based on risk factors included in today’s press release and the company’s quarterly and annual reports filed with the SEC.

Comments will also reference certain non-GAAP or adjusted measures. GAAP reconciliations and description of these measures can be found in today’s earnings release.

Now, I will turn it over to Carlos.

Carlos E. Alberini — Chief Executive Officer

Thank you, Fabrice. Good afternoon, everyone, and thank you for joining us today. I am pleased to report our second quarter performance, which exceeded our expectations for revenues, operating earnings and operating margin, in spite of a challenging environment impacting several of our markets.

Our revenues grew over 2% in US dollars and almost 12% in constant currency, demonstrating the continued strong momentum of our brand and our ability to gain share in a difficult market. We delivered an 8.7% adjusted operating margin and $56 million in adjusted earnings from operations. While our financial performance was solid, I am most impressed with our team’s strong ability to navigate through the current macro environment, which continues to present meaningful headwinds that impact our revenues, margins and expenses. Our team continues to focus on what we can control, managing costs, inventories, and free cash flow carefully and planning the business based on expected customer demand by product category, channel and territory. Paul and I want to take this opportunity to thank all our associates for their outstanding work and great dedication. Your contributions have made all the difference in the last few years and we appreciate your commitment and hard work.

Today, I will first review our performance by business. I will then provide an update regarding our key strategic initiatives and I will close with a brief update of our outlook for the year.

Let me start with our performance by business. Our Europe segment reported a 4% revenue increase in US dollars and a 21% increase in constant currency for the period. While our brand continues to gain momentum in this region, the weaker euro is having a major impact on our results and was one of the main drivers for the lower profitability in the quarter.

Our Americas Retail business reported a small revenue contraction and an almost 40% decrease in earnings from operations in the period. Last year, our second quarter performance in this business benefited from greater spending due to the stimulus checks distributed by the US government. Product availability was low and sales at full price were extraordinary then. This year, while we continue to run our business with a lower promotional cadence and a healthy inventory position, lower customer traffic and weaker conversion impacted our store productivity and margin performance during the period.

Our Americas Wholesale segment was up slightly in revenues, though operating margin declined in the period due to increased customer accommodations. Our Asia business reported a small revenue increase in US dollars and a double-digit increase in constant currency, while the business was once again impacted by COVID restrictions in China, we were able to reduce the loss from operations. Lastly, our licensing business registered another successful quarter with revenues up 13% and earnings from operations up 5%. Several categories posted solid results in the quarter led by handbags, watches and fragrances.

Regarding our product performance, I strongly believe that our current product offering is by far the best it has been in a very long time, if not forever, and the customer is responding well to our collections. Across both our Guess and Marciano brands our elevated styling, great quality, superior prints and sophisticated fabrications continue to resonate, driving repeat customer engagement.

During the quarter, we continued to leverage the flexibility of our brands lifestyle offering and appeal, adapting our assortments and product buys to meet our customers’ demand for their appropriate purchase occasions. With increased customer interest and engagement in traveling, going out, socializing and attending events, we saw strength in our dressy products, including dresses and skirts, woven shirts and non-denim pants for both women and men, men’s blazers, and special outerwear pieces. Our accessories business was very strong in the quarter, driven by outstanding sales of women’s handbags. We also delivered solid results in women’s and men’s travel accessories, small leather goods, jewelry, eyewear, fragrances and watches.

Regarding our strategic initiatives, I will focus on a few key areas that we consider critical to win in this environment. I will start with our supply chain and inventory management. We have strategically responded to the supply chain disruptions that we experienced last year by ordering product earlier. In addition, global supply chains are recovering and delivery times have improved. As a result, we have been able to receive product early and meet the demands of our business very effectively. We closed the second quarter with inventory growth of $505 million, up 25% in US dollars. About 80% of this increase represents the anticipation of deliveries with roughly half of that received in our warehouses, and the other half in transit. The remaining 20% is due to increases in average unit costs, reflecting quality upgrades and the effect of inflation. We are very pleased with the quality and mix of our inventory ownership and future orders to service our business well during the remainder of the year.

With respect to inbound freight cost increases, we are seeing some relief from last year’s peak levels. We have focused on reducing our air freight with success resulting in meaningful cost reductions, while the freight cost pressures we experienced may subside in the future, we are not planning significant improvements for the second half of this year.

Our experience during the pandemic made it very clear that our business can benefit from increased inventory visibility, efficiencies and more effective planning and allocation processes. Accordingly, we have been investing in several new applications to upgrade our existing systems to improve information availability, productivity and data analytics. We have already implemented some of the solutions in Europe with very good results and plan to complete the rollout in North America by mid-next year. We have also re-architected our replenishment processes into stores to accelerate the delivery cycle to improve conversion and sell-throughs.

Next, I would like to provide an update on our brand elevation strategy, which continues to drive many of our product initiatives with a strong focus on our key target customer groups. Since the launch of our global line for all product categories over two years ago, Paul and the product teams have done an extraordinary job integrating the multiple phases that impact our product development and presentation lifecycle. This effort touched every aspect of design including taste, style and quality, with a strong focus on sustainability. They also impacted pricing, marketing campaigns, e-commerce inventory, and visual merchandising. Our ultimate goal here is to deliver a globally consistent and seamless presentation of all our products in the 25 categories that we do business in, regardless of the channel the customer is choosing to engage with our brand.

We have significantly improved the quality of our products across the board, including fabrics, trims, and make and we have priced every product based on its respective perceived value. We have raised prices but very thoughtfully, so the customer recognizes why these increases are warranted. We are now focused on further tightening our assortments and buying the big story groups with significant conviction to improve sales and optimize service levels. We also plan to develop exclusive products for our direct-to-consumer channels, leveraging a speed-to-market model anchored on new sourcing countries that are in proximity to where the product will be distributed for sale. We believe this is a big long-term opportunity for us.

Enhancing the customer experience also remains a priority for us and we have implemented several upgrades to our store and ecom infrastructure to improve ease of shopping and increased customer conversion. In this regard, we made remarkable progress towards building a best-in-class platform, which offers strong omnichannel and data analytics capabilities. We continue to make good progress with our Customer 360 project implementation in Europe. This includes a new CRM platform, a new segmentation tool, a new marketing tool, and a clienteling app. While all these modules have been released already, we are going through an optimization process as we speak in Europe, which we plan to finish by year-end. In line with this timeline, we now expect to finalize the rollout in North America early next year.

We also believe the current environment presents a great opportunity to focus on delivering outstanding customer service as a competitive differentiator to drive increased engagement and conversion. Our sales teams in the field are our best brand ambassadors and customers always complement their assistance and product knowledge. We are investing in product and process training for our store associates and our customer care teams and have increased our labor schedules to improve coverage, especially during high traffic periods, including holidays.

Our stores continue to be at the center of our customer engagement strategy and they represent a critical venue for customer acquisition and data collection. We have made meaningful investments over the last few years to remodel many of our stores and we opened several new stores in the US and Europe that feature a more elevated store design and a much-improved customer experience. Our sales for certain product categories such as accessories continue to outperform. We have reallocated the space dedicated to those categories to optimize sales productivity by store and we are very pleased with the early results this initiative is generating. Last year, we opened 87 new stores and this year, we are opening 60 additional stores and closing 70 locations.

Regarding remodels, in the last two years we impacted 230 locations between North America and Europe. And we now have plans to impact an additional 335 this year.

I would now like to touch on our ESG focus, which includes our efforts regarding diversity and inclusion, social responsibility and sustainability. At Guess, we have a very diverse and inclusive culture. As we last reported, over 40% of our senior executives are female and over 70% of our managers are female. Guess has also achieved gender pay parity at our US corporate offices and we will continue to monitor and report on this metric globally. Regarding sustainability, we have launched exciting partnerships with resourced, homeboy industries and their brand Canada to facilitate a program to recycle clothing returned by customers. Regarding carbon emissions, in fiscal 2022 we achieved a reduction in absolute value of 49% from our 2019 baseline, well ahead of our original goals. Last, we have just begun a collaboration with a start-up company called Edmonton Climate Network to develop a solution to measure carbon emissions at the product level to optimize carbon emission analysis during the product development cycle. This platform will eventually allow the purchase of carbon offsets certificates creating a precise path to a net zero strategy.

Let me now share a brief update of our outlook. We anticipate that softer consumer demand trends as well as currency and other macroeconomic headwinds will continue to weigh on our results even as we continue to control what we can control and manage the business effectively. We now expect our revenues for the year to reach a low single-digit growth rate in US dollars and a high single-digit growth rate in constant currency. We also expect our adjusted operating margin to reach 10% for the year. This outlook is down from the one that we share with you in our last call, primarily due to currencies and Dennis will explain how our key assumptions have changed.

Looking forward to our expectations for fiscal year 2024, with changing macro conditions of significance, we expect to review the assumptions underlying our long-term targets in the next few months and we’ll update you on any changes to our assumptions and plan when this work is complete.

Before I conclude, I want to reiterate our strong commitment to returning value to all our shareholders. In line with this, during the quarter we completed our accelerated share repurchase program and together with other stock purchases that we executed earlier this year, we have retired 14% of our shares outstanding at the beginning of the year.

In closing, as I reflect on what we have all lived through since the pandemic began, our team at Guess has faced challenges by leaning in and using the dynamic environment to our advantage. We have completely transform our business and I couldn’t be more impressed with the results that our team delivered and more confident in the positioning of our company for the long-term as a result of this work.

During the last three years, we executed our brand elevation strategy, including our global line initiative. And today, we have the strongest product assortment in our company’s history, consistently presented across all markets. We transformed our digital platform, improving the customer experience and data analytics capabilities. We optimized our store portfolio closing underperforming stores and renegotiating favorable lease terms. And we reorganize our operating model achieving efficiencies and eliminating redundancies globally. This transformation contributed to delivering double-digit operating margins and high return on invested capital for the first time in a very long time for the company.

Today, our brand momentum is strong and our customers are responding well to our collections. We have a powerful business model and a robust capital structure. We are managing the business with discipline, controlling what we can control and deploying our capital where it can deliver the highest returns and we have a great team that is ready to jump at every opportunity to make the business better, aggressively gain market share and grow profitably. Paul and I couldn’t be more proud of this team and more excited about our future.

With that, let me now pass it to Dennis to review our financials and our outlook in more detail. Dennis?

Dennis Secor — Interim Chief Financial Officer

Thank you, Carlos, and good afternoon, everyone. Echoing Carlos’ remarks, our team is managing our business well in an evolving commercial environment. In parts of our business, we delivered strong growth, as some markets regained traction after long pandemic restrictions. In other areas, there were challenges as consumers are reacting to global inflation and softening economic sentiments by tightening their spending. We mitigated these challenges by reducing controllable spending. Overall for the quarter, we delivered both revenues and adjusted operating earnings that exceeded the outlook that we provided a quarter ago, even as significant currency headwinds persist.

And before I review our performance, I want to first quantify the material impact that currencies are having on our financial results. Recall that currencies affect our financials in three ways. First is translation, where we convert foreign currency sales expenses and profits into US dollars. Second is transaction, when our foreign subs buy products in US dollars. They now need, for example, in Europe, more euros to buy their inventory. It is in essence an additional form of product inflation. And last is non-operating mark-to-market changes. This represents changes in values at certain foreign assets and liabilities and hedge contracts among other things.

For the second quarter, the negative currency impact on revenue was $60 million, reducing top line growth by about 10 full percentage points. The negative impact on operating earnings was $13 million and on operating margin it was 110 basis points. Finally, the adjusted EPS headwind was about $0.19, including also the year-over-year impact of the mark-to-market currency headwinds. While we do have a hedging program, it is limited in its ability to mitigate the full currency impact. I’ll share the full year impact in a moment, but I wanted to provide this overview first to give context to our second quarter results. So let’s get into the quarter.

Second quarter revenues reached $643 million, a 2% increase in US dollars and a 12% increase in constant currency. Our revenue growth was primarily driven by strong performance in our European wholesale business, positive European Retail comps, along with sales from new stores that we’ve added over the last year. Comp declines in our US stores partially offset this growth.

In Europe, our business performed well with higher sales, both in our retail stores and from our wholesale customers. Revenues increased 4% in US dollars and 21% in constant currency. Revenue growth for the segment was driven primarily by higher shipments to wholesale accounts, a 12% constant currency store comp sales increase and new stores that have been added in the region over the last year. Our revenue growth in Europe includes about $18 million in wholesale shipments to customers that we had previously anticipated would be delivered in the third quarter. In our European retail stores the 12% comp was driven by strong traffic increases, similar to our Q1 levels. Conversion headwinds abated from the first quarter and AUR increases also decelerated sequentially. European operating earnings decreased over 30% and the operating margin declined by 560 basis points as a result of lower gross margins across all channels, partially offset by expense leverage.

In Americas retail, revenues decreased 2%, both in US dollars and in constant currencies. Revenues benefited from the reopening of Canadian stores that have been closed last year due to COVID restrictions as well as new store growth. These were more than offset by an overall 5% constant currency store comp decline as well as some permanent store closures. In the quarter, both traffic and AURs were higher than they were in last year’s second quarter, so both of these metrics decelerated from their levels a quarter ago. Conversion also continued to be down. Our tourist locations, while still outperforming the rest of the fleet did not outperform at the same level we had seen in the first quarter, likely affected by the strong US dollars impact on tourism. Americas retail operating profit declined 38% and operating margin declined 720 basis points, driven by lower gross margins, higher store selling costs and a lower level of COVID relief this year. In Americas wholesale revenues increased by 1% in US dollars and 2% in constant currency. Operating profit declined 12% and operating margin declined 320 basis points, mainly due to the lower product margins from the increased customer accommodations Carlos mentioned earlier.

In Asia, revenue grew 3% in US dollars and 15% in constant currency. The main drivers of the increase were the direct operation of some of our South Korea retail stores which we acquired from one of our wholesale partners. Our retail stores in Asia also delivered constant currency comp growth of 13% in the quarter. While traffic was down compared to a year ago, improvements in both conversion and AUR drove our comp growth. These increases were partially offset by the temporary closure of some of our stores due to COVID restrictions in China. The segment operating loss improved nearly $2 million, driven mainly by lower SG&A expenses this year.

And finally, in our licensing segment, royalty revenues increased 13%, driven primarily by a strong increase in global selling of handbags. Segment operating profit increased by roughly $2 million. In the quarter, total company gross margin contracted 470 basis points to 42.1%, driven mainly by product margin compression. That decline was driven primarily by a different mix of full price versus markdown business, both in the Americas and in Europe, along with the currency headwinds which intensified in the quarter. Last year’s second quarter occupancy costs benefited from COVID related rent relief, which did not recur at the same level in the second quarter this year.

Adjusted SG&A for the second quarter increased 5% to $215 million, including a favorable currency impact of $18 million compared to last year’s expense level. The largest increase in our SG&A expenses came from our retail stores where we continue to experience labor cost pressures, given both the impact of global inflation and strong employment in many of our markets. In addition, we operated with more retail stores fully opened in the second quarter this year compared to a year ago. In last year’s second quarter we also benefited from about $3 million of COVID related subsidies that did not recur at the same level this year. For the quarter, our adjusted SG&A rate increased 70 basis points to 33.4%.

Adjusted operating profit totaled $56 million in the quarter, a 37% decline compared to last year’s Q2 and adjusted operating margin declined to 8.7%, 540 basis points lower than a year ago. In the quarter, we recorded non-operating net charges of $9 million related primarily to revaluations of certain of our foreign subsidiaries, net assets and liabilities into US dollars. Our second quarter adjusted tax rate was 40% up from last Q2’s rate of 22%. Adjusted EPS in the quarter was $0.39 versus last Q2’s $0.96.

Moving to the balance sheet. During the quarter, as Carlos noted, we finalized our $175 million accelerated share repurchase program that we initiated in March of this year. We made no open market purchases in the quarter, leaving our remaining authorization at $62 million. As we shared on our last call, in the quarter, we finalized our EUR250 million revolving credit facility in Europe, more than doubling the region’s borrowing capacity. The initial term of the facility is five years and provides options for a two year extension at a EUR100 million expansion, both subject to certain conditions.

We ended the first quarter was $174 million in cash, compared to $459 million a year ago. The decrease in cash was primarily driven by $238 million of share repurchases executed in the last 12 months, including the ASR as well as the $107 million tax payment related to last year’s IP transfer to Europe. We ended the quarter with a total of $342 million of borrowing availability on our various global facilities. We believe we are in an excellent financial position with a solid capital structure, access to ample capital and an operating model that generates strong cash flows, supporting our operating and investment needs and our goal is to return capital to shareholders.

Inventories were $536 million, up 24% in US dollars and 38% in constant currency versus last year. As Carlos mentioned, our additional inventory investment primarily reflects our strategy to order earlier this year and we do expect year-end inventory to better align with the trends in our business. Receivables were $302 million, roughly flat to last year’s $300 million. On a constant currency basis, receivables increased about 15%. For the first half of this year, capital expenditures were $51 million, up from $22 million in the prior year, mainly driven by investments in remodels, new stores and technology. Free cash flow for the first half of this year reflects a net investment of $54 million versus a net source at $18 million in the prior year, the change being mainly driven by this year’s inventory acceleration, higher capital spending and lower net cash earnings. Today, we also announced that our Board approved our quarterly dividend of $0.225, which at recent stock prices represents an annual yield over 4.5%.

So now let’s talk about the rest of the year and next quarter. I want to first reflect on our business model, our second quarter performance and how we managed our business as I feel that will give good insight into what we expect for the balance of the year and how we plan to manage. We operate in over 100 countries with multiple brands at different price points and in 25 product categories. This diversification provides tremendous flexibility to deliver on our earnings goals. Beyond that, different parts of our business are also at different points in their pandemic recovery. The US market reopened first, unleashing significant pent-up demand that drove strong revenue and earnings growth last fiscal year. Europe and Canada, however, reopened later and we expect that much of that post pandemic demand should occur this fiscal year and significant population centers in Asia, while less impactful in our business were shut down for much of the first half of this year and are only recently opening.

On top of all this, we operate with an agile management team that monitors business carefully and controls expenses tightly. We took advantage of that diversification and agility in delivering the results we achieved in the second quarter and that reflects how we plan to manage the second half. We expect current macroeconomic factors, including ongoing inflation, a more price sensitive customer and a very strong US dollar to persist. And we expect to use our ability to reduce or defer certain previously planned operating expenses to mitigate those pressures with one exception, currencies. At roughly prevailing exchange rates currencies now will represent over an 8 percentage point headwind to full year revenues, a 120 basis point compression to adjusted operating margin and nearly a $55 million negative impact to adjusted operating earnings. $15 million worse than it was at our last update, and it is that further $15 million headwind that we do not expect to mitigate.

Therefore, for the full year we are updating our outlook and now expect US dollar revenues will grow about 1.5% and over 9.5% in constant currency. We expect gross margin compression, primarily driven by currencies, a modest decline in IMU as higher product and supply chain costs are nearly offset by price increases, higher markdowns and an increase in our occupancy rate as our entire retail store fleet has now reopened. We’re planning the full year with an adjusted operating margin of roughly 10%, driven mainly by gross margin declines. Based on all of these assumptions, assuming no further share repurchases, for the full year we expect adjusted earnings per share of approximately $2.65. We have included a table in today’s release that provides detail of how we arrived at our adjusted EPS calculation.

For the third quarter, we expect US dollar revenues will decline by roughly 4.5% with constant currency revenues increasing by roughly 4.5%. We expect adjusted operating margin of about 8.1%, down roughly 280 basis points. The biggest drivers of the margin compression will be currencies and last year’s COVID relief.

I’d like to close with a quick reflection and complete the thought on currencies. Since I’ve been back now a bit over five months, I’ve been so impressed with the great work that the team has done to grow and transform this business. Unfortunately this year currencies are masking so much of the great work that this team is doing. To give that context, if I eliminate this year’s $55 million operating profit currency headwinds, all other things being equal, the full-year outlook would have instead been for sales growth of over 9.5% to reach over $2.8 billion, operating margin over 11% and operating profit exceeding $310 million and excluding this year’s mark-to-market charges along with a $55 million operating profit headwind, that total currency impact would be nearly a $1 per share. A genuinely compelling story masked by so much currency noise.

So with that I’ll conclude the company’s remarks and let’s open the call up for your questions.

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Presenters, I show — we do have a question that just queued up. We have Dana Telsey from Telsey Advisory Group. Your line is now open.

Dana Telsey — Telsey Advisory Group — Analyst

Good afternoon, everyone. Dennis and Carlos, as you spoke about the…

Carlos E. Alberini — Chief Executive Officer

Hi.

Dana Telsey — Telsey Advisory Group — Analyst

Hi. As you spoke about the macro environment…

Carlos E. Alberini — Chief Executive Officer

Hi. How are you Dana?

Dana Telsey — Telsey Advisory Group — Analyst

Good. How are you doing Carlos?

Carlos E. Alberini — Chief Executive Officer

Very well. Thank you.

Dana Telsey — Telsey Advisory Group — Analyst

As you spoke about the macro environment and what you’re seeing in retail and wholesale, both in the US and in Europe, how do you foresee pricing relative to promotions, given the inventory levels as we go through the back half of the year and into the upcoming holiday season? And then, in terms of the product assortment, you talked about the strength in dressy, product accessories, handbags, what are you seeing in core denim and how that’s trending relative to raw material price increases? And then lastly on — Dennis, as you think about the headwinds of the currency impact, as we get to the fourth quarter how are you planning it? Is any shaping of the — of how you’re thinking about in the fourth quarter relative to the third quarter in terms of currency? Thank you.

Carlos E. Alberini — Chief Executive Officer

Thank you, Dana. Well, let me start with your first question about the macro environment. I think that — I think that Dennis talked a little bit about this in his prepared remarks, but we see that the world is different in depending on the regions where you are looking and a lot of this has to do with the COVID and the recovery that each of those markets has been going through. So, the US was first on this and there was a significant intervention from the government with a lot of stimulus checks and a lot of money put into and huge pent-up demand drove very strong business last year. And at the same time the disruption in supply chain obviously had put some type of limitation on the amount of inventory that was available. So I think we all enjoyed a very unusual and extraordinary margin increase as a result of full price selling that was extraordinary for sure. And the fact that the consumer didn’t have access to all the inventory that demand was requiring. So those two things were very unusual and impacted both our full price selling and of course margins.

The Europe is growing — it also had a good experience last year, but then we had a reissue that impacted COVID in a significant way and so now we are up against a very different type of cycle, but when I look at inventories, just that, we are hearing and we are seeing that there is a lot of inventory in the system and there are many companies that will have to move a lot of that inventory. We have seen some normalization of our full price versus clearance or promotional business, but really is still a lot healthier than what we had seen pre-pandemic. So we are very, very pleased with how the business is evolving. And we think that the normalization of full price versus promotional price is very much in line with what we were expecting and what we are expecting for the future. So we think that the business model that we are running now is very sustainable.

Now that being said, we are — just is very difficult to know how inventory positions from other companies are faring and what type of plans do they have to promote during the second half of the year, especially during the holidays, but we are playing our game. We are just concentrating on the things that we can control, which is, how we are buying, and we are being very disciplined in the way we are buying. We are always looking at future demand — expected demand and based on that we are adjusting our buys very, very carefully. We are being really very, very careful with buys for not just the retail business, which obviously that’s something that is based on what we expect from our retail business, but also in the way we are buying product for our wholesale business, which is all based on orders. So we are being very disciplined as well with that business.

And I think that just — we believe that the outlook that we share with you today is reflective of that normalization of full price versus promotional business. And we really are very pleased with where we are with our inventory position, because just all the inventory that we have is either justified by the current trends or based on the on the own orders that we have from our customers at wholesale.

So let me just move into your second part of the question and that is about product. And just yes, definitely what is driving our business is primarily the dressy part of our assortment and there are some differences among regions, but most strongly, just I can — we can make very clear determination that the customer is enjoying new activities and going out and attending events and social interaction. And as a result of that, just they’re looking for a dressy outfit and we are very lucky, because we have a brand that can go from casual to more a formal and more for going out type of assets very, very easily. And of course, this takes a lot of effort from our design teams. Paul has been at the center of all this and driving this. And as a result, we are seeing a big success with most of the categories that you mentioned. Dresses represents about one-third of our women’s business in Guess. It represents about half of our business in Marciano. So you can imagine how important this category is for us and we are doing really well. The prints, the textures of the fabrics that the product teams are picking, and again Paul plays a key role in this whole thing is really making us win. Woven tops is another big categories, handbags, you mentioned, very big category that we’re winning big.

Now when you get to the more casual part of the assortment, the wins are not as global as all of these categories that I just mentioned. But we are still winning in some areas. Asia is a clear example of that. Denim has been a very strong category for both women and men. And we feel that, that is an ongoing phenomenon there, we don’t see that category slowing down. The cost that you referred to, we have seen an increase in costs in our case because of the elevation of the brand strategy we have done a very unique type of price increase that is more warranted based on the increases in quality and also the investment in sustainability that we’re making, which is pretty significance. So between those two quality upgrades and sustainability, that represents about two-thirds of the increase in cost that we are experiencing, the other third is more related to inflationary forces.

And denim is no exception to that, because we are also improving the quality and we are also doing a lot for sustainability purposes. So our cost increases are, I think very reasonable. We are seeing some promotional activity here in this category. And this is obviously related to the excess inventory that may be in the system from others. But again, we are treating this category in a very similar way that we’re treating everything. Meaning, buying based on the expected demand. So I’m going to stop there and Dennis If you want to address the currency.

Dennis Secor — Interim Chief Financial Officer

Sure. Thanks for the question, Dana. So the way we’ve guided to currency rates that are about where they are right now. So that’s what we’ve run through our model and that’s the additional $15 million of headwinds that we don’t see us mitigating through the cost controls that we talked about, but just — the average about — I’ll use the euro, because it’s best example. The average last second quarter was about a $1.20, and that sort of gradually slowed over the back half of last year, the average is about $1.14 by the time we got to the fourth quarter. So as we sit here right now with a euro at parity up against a $1.14 in the fourth quarter, we’re still going to expect and we’ve assumed this in our guidance, we’re still going to expect significant headwinds, certainly on the translation part. Now we do have a hedging program in place so that cushion some of the buys that Europe makes in US dollars, but not all. So I expect that currencies should be — will be a headwind at these rates for the rest of this year.

Dana Telsey — Telsey Advisory Group — Analyst

Thank you.

Carlos E. Alberini — Chief Executive Officer

Thank you, Dana.

Operator

And speakers, at this time I show no further questions in queue. So I will turn the call back to Carlos for closing comments.

Carlos E. Alberini — Chief Executive Officer

All right. Thank you, operator. Well, I just want to say thank you everyone for your participation today. We are very pleased with our company’s momentum. And we are very excited about our future. And I believe that we are managing the business well, we are focusing on what we can control and we are acting decisively and with a lot of agility, I think, as our team is really being very proactive on this. We appreciate your interest in our company and we look forward to speaking soon. Have a great day. And thank you for your participation again. Bye-bye.

Operator

[Operator Closing Remarks]