Guess? Inc (NYSE: GES) Q1 2021 Earnings Call Transcript

Guess? Inc (GES) Q1 2021 earnings call dated Jun. 10, 2020

Corporate Participants:

Carlos Alberini — Chief Executive Officer

Kathryn Anderson — Chief Financial Officer

Analysts:

Susan Anderson — B. Riley FBR — Analyst

Janine Stichter — Jefferies — Analyst

John Kernan — Cowen & Company — Analyst

Omar Saad — Evercore ISI — Analyst

Dana Telsey — Telsey Advisory Group — Analyst

Presentation:

Operator

Good day everyone and welcome to the Guess? First Quarter Fiscal 2021 Earnings Conference Call.

On the call are Carlos Alberini, Chief Executive Officer and Katie Anderson, 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 impacts from the coronavirus outbreak. 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 descriptions of the measures can be found in today’s earnings release.

Now, I will turn the call over to Carlos.

Carlos Alberini — Chief Executive Officer

Thank you, operator. Good morning and thank you all for joining us today.

I think that what we all have experienced during the last few weeks is not only unprecedented, but extraordinary in multiple ways, impacting our daily lives at present and most definitely into the future. In addition to the pandemic, the recent events and outrage caused by the killing of George Floyd and what it means in terms of racism in our country is tremendously painful for all of us, but it also brings hope for change. As Martin Luther King said, injustice anywhere is a threat to justice everywhere. We condemn racism and we pray for more justice everywhere in the world. I strongly believe that we all have our part to make that a reality. At Guess?, we are partnering with the National NAACP and our Local Chapter in Los Angeles to help fund and support their empowerment programs. Our Guess? Foundation committed $1 million to this cause.

In connection with the COVID-19 crisis, we launched our #INthistogether campaign, Protect. Give. and Inspire which was set in motion in April and was featured in our website worldwide, social media and flagship stores. We and the Guess? Foundation contributed more than $1 million to buy protective equipment and made product donations for people in need.

I will first address how we approach the health and business issues related to the COVID-19 crisis and where we are now. I will then briefly touch on our first quarter results. And lastly, I will update you on our strategy and how the crisis has impacted our thinking. Katie will then review our financials in more detail, our actions and our outlook. And after Katie, we’ll will open the call for your questions.

I strongly believe that in times like this, the true character of an organization and its people show most clearly. I couldn’t be more proud of our teams around the world as we accomplished the unimaginable in a short time. They demonstrated a level of commitment, leadership, and empathy that is unparalleled and very inspiring to all of us. I want to thank every associate in our company today in our stores, our distribution centers and corporate headquarters for their extraordinary attitude and relentless commitment to our company and each other. I hope that you and your families are all safe and well. At Guess? throughout all of this, we have made people safety our top priority. Our focus has been on our associates, our customers and the communities that we serve. We continue to be very careful with our actions and follow strict protocols as we reopen our stores, showrooms, headquarter operations, and distribution facilities. And we are excited to see the light at the end of the tunnel when we become fully operational as we plan to have all our stores reopened by the end of June.

We can all sit here and reflect on how challenging this crisis has been to our operations and our financial results and how to cut costs and protect our liquidity. We can also look at the opportunities that it can unleash for our business and our organization and build an entire new model. We are doing both. Fortunately, we came into the crisis with a strong financial position and sufficient liquidity, a clean inventory position, and most importantly a great team, capable and ready to proactively charge the crisis head-on, acting decisively, quickly, and strongly on everything that was in our control, big or small. We challenged everything from expenses to capital projects, inventory purchases, payment terms, product line development, store closings, and bank facility renewals, just to name a few. We also looked at how our customers’ lives and priorities are being impacted by the current events and the stay-at-home practices and we carefully reassessed our strategic planning initiatives in light of the significant changes that we are observing. The great news here is that those changes are completely aligned with the priorities that we set a few months ago and we now plan to aggressively accelerate the execution of those initiatives. I will review this further in a few minutes.

As you all know, our company has an extensive global reach with sizable businesses in the Americas, Europe and Asia. As the virus outbreak impacted our business in China first, our initial experience there, presented us with a significant opportunity to learn about what to expect and how to mitigate the risk to our team and our business. Being ahead in the cycle by about 10 weeks from the other regions where our business is much bigger proved highly valuable. When you have a situation like this, accurately forecasting the demand cycle is critical for success. This should guide the inventory strategy, cost structure, and liquidity requirements. Based on this thought, we analyzed the demand curve that we were experiencing in China and applied it to Europe and the Americas to determine the expected inventory ownership and flow that we were going to need to satisfy the new demand for the remainder of the year. Of course, this rebuilt an excess of product availability compared to our original plans.

We then worked intensely to adjust our assortments and we eliminated several product programs, adjusted purchase order quantities and extended certain seasons to optimize selling at full price and capture sales opportunities for each business. We worked side-by-side with our merchant teams and our wholesale partners to accurately anticipate the needs by product category. This exercise required tremendous effort globally from our cross-functional teams as well as our valued vendors, wholesale customers, and licensees. In spite of all the changes, today, our supply chain remains intact and is operating very well. We are well positioned to fulfill the expected demand and have put in place fast-track processes to react to increased business needs. I want to thank all our valued partners including our vendors and licensees who stood by us during this challenging times to see this through and win together. I believe that we architected a very strategic inventory plan with the opportunity to optimize margins and the flexibility to capture sales as demand improves. And the execution of this strategy is starting to pay off as we finished the quarter with a clean inventory position, down 18% from last year in spite of the effects of the pandemic.

Regarding our first quarter results, we entered the quarter with the majority of our stores closed in Asia. In April, as we began to reopen these locations, we experienced a significant drop in customer traffic, but a meaningful improvement in conversion rates, resulting in a materially lower sales productivity compared to last year. But since then, we have gained momentum and same-store sales in Asia for Q2 to date are running at 75% of last year’s sales productivity, a significant improvement.

Regarding North America and Europe, by mid-March, we decided to temporarily close most of our stores in both regions. At present, we have reopened over 400 stores in Europe and over 180 stores in the US and Canada with operations resuming over the course of mid-April to June. As we experienced in China, in these stores, we have seen slow customer traffic, partially offset by improved conversion rates. I’m thrilled to report that most reopened stores are performing better than we anticipated, resulting in our quarter-to-date sales productivity of roughly 75% in the US and Canada and 70% in Europe as compared to last year’s levels. As you would expect, stores that depend on local customer demand have performed better than those that depend on tourism as nobody’s traveling now.

In connection with our online business in the US and Canada and in Europe, we experienced a deceleration in performance in the first quarter compared to the trends that we experienced in the fourth quarter last year, as we believe customers were exclusively focused on essential products that we do not provide. However, starting in April, and so far in the second quarter, trends have materially improved and our online business is now trending up double digits in the second quarter to date.

Our wholesale and licensing businesses behaved similarly to our retail businesses. All in all, we had a very challenging quarter as we reported a sales decrease of 52% and an operating loss of $109 million. I believe that the negative results were exclusively due to forces that we could not control and we were very proactive managing what we could control, including reducing costs aggressively, controlling inventories well, and protecting our liquidity. While we expect sales and profitability to be impacted in the second quarter due to the same forces, we have great product coming for back-to-school that capitalizes on the current trends and the holiday collection is also very strong. We expect our outlook for the second half of the year to improve significantly and for our liquidity to continue to be strong. Katie will spend more time on these issues and the specific actions that we have taken.

Let me touch on the customers’ lifestyles in connection with the crisis. I believe that the recent events are impacting profoundly customers’ lifestyles and their priorities. I believe that the companies that adapt their business models to actively embrace those changes and the new consumer preferences will be the winners in the new environment. Fortunately, this isn’t a departure from where we were heading before the crisis. An obsession for customer centricity, inclusivity and celebrating customer diversity has been a big priority for us. I also think that our authentic focus on sustainability and a true drive for quality and durability, will become not just desirable, but critical factors to win in this new world. I strongly believe that our product lines rooted in comfortable apparel and accessories will serve the new customer lifestyles well and a seamless experience between stores and digital channels will contribute to stronger customer engagement for our brand.

All of these factors are the building blocks of our long-term strategy and we now plan to accelerate the execution of each of our initiatives to capitalize on these opportunities faster than originally planned. I strongly believe that on the other side of this crisis, we will see a much cleaner competitive environment with less promotions and fewer trusted brands offering similar products. Guess? is a strong brand with a broad multi-channel global reach and an enviable distribution. We expect to capitalize on this and gain market share.

As you may recall, the primary financial drivers of our plan to expand operating margin by 500 basis points consisted of cost savings, operating efficiencies and gross margin improvements. As we further challenged our cost structure in light of the crisis and the new normal model, we have identified new opportunities for additional efficiencies by eliminating redundancies across the organizations and simplifying our global model. We believe we can also accelerate the execution of these initiatives, positioning our business for further profit improvement that we had planned. Among the strategic initiatives that will be emphasized are our customer centricity initiatives, which include our global e-commerce strategy, the sales force implementation and omni-channel experience redesign projects that we previously discussed. In addition, we will be launching a new Customer 360 project to optimize customer data integration, personalization, journey engagement and results analysis.

Customer centricity is an initiative that we decided to continue to fund and accelerate its implementation due to its criticality. We now believe we can increase our e-commerce business penetration by an extra 5 points in the next three years as a result of this initiative.

We also plan to focus on elevating our brand and continue to leverage brand partnerships. As part of this effort, we will continue to focus on global product excellence and have identified key product categories that will bring the Guess? roots back, including high standards of quality, simplicity, focus on essentials and lower promotions. These key categories include active wear, denim, knits, outerwear and handbags. In addition, we plan to accelerate the global consolidation of functional capabilities to achieve new efficiencies, global consistency and performance, and increased accountability. As part of this initiative, we are working on a redesigned organizational structure worldwide.

Last, but not least, the recent stock performance and expected demand under our new normal model made very clear that our stock portfolios around the world could be optimized to increase profitability. This is particularly true in North America and China and we have plans to close over 100 stores in those territories within the next 18 months. Fortunately, we have significant flexibility with lease terms in every region, with about 70% of all our leases globally expiring within a three-year timeframe, which also gives us significant negotiation power for future renewals.

In closing, the process we went through revealed great opportunities for eliminating duplication of efforts worldwide, gaining efficiencies across our operations, rationalizing our store portfolios and simplifying our product development and supply chain functions. I fully expect to be on the other side of this crisis with a more efficient business model, a more focused and consistent global brand strategy, and a more nimble and agile organization. Guess? is a very strong brand that was built over the last 40 years with a unique and consistent point of view and it has become an icon all over the world. This company has been relevant and thriving for 40 years because of its strong business sense and incredible foresight into the future, of not only consumer preferences, but also dynamic business models. I strongly believe that Guess? will once again capitalize on the new customer preferences and gain market share in a world more focused on quality, simplicity, and sustainability and less on quantity and price. We have a great business model and global distribution that can scale very rapidly and we are well positioned to do so.

During the last few weeks, we have all been tested in ways we couldn’t have imagined prior to this crisis. I’m very proud of everything our team has accomplished. I’m confident in our future and couldn’t be more excited about what we will accomplish next.

With that, let me pass it to Katie.

Kathryn Anderson — Chief Financial Officer

Thank you, Carlos. Good morning, everyone.

I’d like to start by echoing Carlos’s comments and express how thankful I am for the Guess? leadership team and our associates around the world. Last time we spoke in mid-March, we had closed our stores in North America just two days prior and two days later, we were all suddenly working from our homes, but the team did not miss a beat and came together with determination and a sharp focus on navigating Guess? through these fluid times. All of our actions reflected an undeniable emphasis on the long-term health and sustainability of our brand. We worked seamlessly with each other across the globe, sharing ideas and solutions in order to optimize both our plans and our execution. This team spirit, agility, and focus was humbling to say the least.

On that last call, we told you we were implementing swift and strong measures to appropriately react to the crisis. We did that. And even though we couldn’t control the massive drop in demand that has paralyzed our industry during the height of this global pandemic, we have controlled our cost and cash burn to limit the impact to the bottom line, preserved cash, and strengthened liquidity and our Q1 results reflect that. We’ve removed more than $60 million in operating expenses from the business this quarter. We significantly decreased capital expenditures, spending only one-third of what we spent in Q1 last year and postponed the decision to pay our dividend and we ended the quarter with $419 million in cash, including $194 million of borrowings on our credit facilities.

Let me take a couple of minutes to give you some additional details on these measures and their impacts. Let’s start with our cost savings. In the beginning of April, we furloughed a 100% of our field and 50% of our corporate office employees in the US and Canada in conjunction with our stores closing. We recently restructured our headquarters in Los Angeles to permanently reduce about 150 of these positions. We implemented temporary salary reductions ranging from 15% to 70% and deferred all merit increases. We optimized government funding programs, particularly for store and corporate payroll in Europe. We evaluated every cost in our organization in a very deep and granular way. We continue to assess all aspects of our business to reduce any redundancies that we have across regions and operate in a leaner, more efficient, and more agile model with a cost structure that makes sense as we enter a new normal. A large portion of the positive impact of these actions will extend to the remainder of the year and beyond.

We are also in negotiations with our landlords to appropriately adjust our rental expenses in line with store closures and declines in traffic that the industry is experiencing. We are making progress with multiple landlords and are optimistic about what we can achieve here. It’s worth noting that we suspended rent payments beginning in April, but all rental expenses have been accrued until final agreements are in place, at which time, the proper adjustments will be made.

Outside of operating expenses, we canceled all capital expenditures that were not mission-critical, reducing capex from $18 million in Q1 last year to $6 million in Q1 this year. As Carlos mentioned, the one area that we protected in terms of discretionary spending is our digital platform. We believe this investment will have a very high and rapid return. We expect this level of capex spending to be pretty consistent for the rest of the year. We’ve also adjusted our payment terms to help manage cash flow. Our teams have worked with our vendors and licensees define term extensions while remaining conscious that these are challenging time for everyone. We are postponing the decision to pay our dividend again this quarter as a proactive measure to preserve cash. Our Board will revisit this as we move through the pandemic. Lastly, to maximize liquidity, we renewed our $120 million asset-backed loan facility for three years, drew down on our credit facilities, and raised additional funding where it made sense. Our $419 million in cash compares to $113 million this time last year and we have access to another $51 million in available borrowings.

Let me give you some additional insight into our first quarter results now. First quarter revenues were $260 million, down 52% in US dollars and 50% in constant currency. Revenues were negatively impacted by store closures in all regions and lower productivity of the stores that were open, both as a result of the COVID-19 crisis. In addition, our wholesale order cancellations increased and our royalties decreased as our wholesale and licensee partners were experiencing similar decreases in demand. Gross margin for the quarter was 13.2%, 20.7% lower than the prior year. Most of the margin pressure came from occupancy deleverage, but we also recorded reserves of roughly $17 million for inventory obsolescence as well as additional reserves for returns and markdowns as a result of the crisis.

Adjusted SG&A for the quarter was $143 million compared to $204 million in the prior year, a decrease of $62 million as a result of the cost savings measures and head count, travel and professional fees, advertising and other discretionary spending. Adjusted operating loss for the quarter was $109 million versus a loss of $22 million last year. Our first quarter adjusted tax rate was 6.6% down from 10.5% last year, driven by the mix of statutory earnings. Inventories were $392 million, down 18% or $86 million in US dollars and 15% in constant currency versus last year.

Free cash flow for the quarter was negative $68 million, an increase of $46 million versus a negative $115 million last year. If we exclude the impact of the $46 million European Commission fine paid in the first quarter of last year, our free cash flows were relatively flat. This is a great accomplishment considering the circumstances and was achieved through a combination of both significant cost and spend reductions and adjusted payment terms.

As you saw in the release, we’re not going to provide formal guidance given the high level of uncertainty in the current environment. However, I want to share with you how we’re thinking about our business over the course of the year. In the second quarter, we expect our level of revenue decline versus last year to be similar to Q1 with store closures for about the same portion of the quarter affecting our retail business as well as the businesses of our wholesale and licensee partners. We believe e-commerce will continue its strong momentum, but it won’t be enough to compensate for the decline in our other businesses. We anticipate normalization over the back half of the year and as Carlos mentioned, we are encouraged by our recovery curve so far. Lastly, and importantly, we are confident that we have sufficient liquidity to support this company through the crisis.

In closing, I’m really proud of what our team has accomplished amidst this unprecedented situation. I have to be honest, the last quarter was not easy. The nature of this crisis puts a lot of pressure on the financial function and we worked tirelessly to manage the company through this in the right way. But the passion to win from our leadership, the people on the finance team across the organization, and the tangible results that we were able to achieve, made it some of the most fulfilling work of my career. I know that Guess? will emerge from this period stronger than when we came into it.

With that, let’s open up the call for your questions.

Questions and Answers:

Operator

Thank you. [Operator Instructions] And our first question comes from Susan Anderson from B. Riley FBR.

Susan Anderson — B. Riley FBR — Analyst

Hi, good morning and thanks for taking my question. I was wondering on the productivity in the stores. Thanks for the color there. I was curious, why do you think the US has been a bit better than Europe. And then also, are you seeing that build over the weeks that the stores have been open? So, I guess the longer the store open, are you seeing that increase. And then also, maybe if you could talk about the conversion that you are seeing in the stores?

Carlos Alberini — Chief Executive Officer

Yeah, sure. How are you, Susan? Good morning.

Susan Anderson — B. Riley FBR — Analyst

Good. Good morning.

Carlos Alberini — Chief Executive Officer

Yes. Really, let me start by saying that when you look at this productivity, because we have been opening stores gradually and we didn’t necessarily choose the stores that we wanted to open in every case, it was more a function of locations that could be opened or landlords that decided to open the malls and so forth. What we have is not necessarily representative of the entire fleet and this comment applies to both the US, Canada, but also in Europe. That being said, many of the stores that were opened in North America were opened in areas that were probably less impacted by things like tourism and what we have seen is that, stores that were impacted by tourism did not do as well as those that were more dependent on the local traffic — or local customers.

The productivity I think is a function of two big things and I think we mentioned we are seeing lower customer traffic — significantly lower, but somewhat compensated by improved conversion rates and of course we’d like that. We think that this phenomenon is applicable to almost every single area where we reopen stores which suggests that the customer is coming with a purpose and we see a lot more of that in the conversion rate. So we see less people, but they are buying more. And I think that, what we did see, especially in Europe, is that after a couple of weeks of stores being open, we see that the customers are behaving with a more comfortable attitude and being more kind of like open to going back to certain of the old ways of shopping and less concerned about the virus and all the things that come with that.

So, I think that overall, we were very pleased. We applied the curves that we were expecting based on our experience in China, which were very difficult at the beginning, significantly better now. And based on those curves, we were very pleased with how both regions which are a lot more significant for us in terms of both sales and profitability, how they behave as we reopen those new markets. And of course just — there are several countries that are doing better than others and that will be as expected, and again, some of those countries are more dependent on tourism than others. So again, that — the tourism factor is impacting us in both regions in the US and Europe as well.

Susan Anderson — B. Riley FBR — Analyst

Great, that’s very helpful. And then, I was wondering if maybe you could talk a little bit about marketing just in terms of how much you pull back? And then also, how much have you continued the digital or social media marketing and how are your sponsors connecting with consumers during this time?

Carlos Alberini — Chief Executive Officer

Yeah. I’ll just say a couple of things and then probably Katie will jump in with a little bit more direction on the numbers. But overall just — we did pull back on marketing, in general, because just realizing that people were not going to be just very, very open and very exposed. So, most of what we kept is more related to the things that people would see from the homes. So, we did continue to support social and we did continue to support what we needed to market our online business and — but overall, the dollars were significantly less. Katie?

Susan Anderson — B. Riley FBR — Analyst

Great.

Kathryn Anderson — Chief Financial Officer

Yeah, Susan. We pulled back on marketing in the quarter, but there is a little bit of lag to that. So, we were able to achieve a lot of that in Q1 and then going forward, we’ll make the right decisions given the environment.

Susan Anderson — B. Riley FBR — Analyst

Great. Thanks so much. Hope everyone’s safe and healthy and good luck in the next quarter.

Carlos Alberini — Chief Executive Officer

Thank you. Thank you, Susan. Thank you.

Kathryn Anderson — Chief Financial Officer

Thank you.

Susan Anderson — B. Riley FBR — Analyst

Thanks.

Operator

Our following question comes from Janine Stichter from Jefferies.

Janine Stichter — Jefferies — Analyst

Hi, good morning.

Carlos Alberini — Chief Executive Officer

Hi, Janine.

Janine Stichter — Jefferies — Analyst

Good morning. So I wanted to ask a bit about Europe and the wholesale customer base there. I think it’s quite a bit more fragmented than what you have in the US. Just curious about anything you’re seeing out of your customers there that would suggest maybe a contraction in the number of doors that you sell to and just how you view the overall health of the European wholesale accounts?

Carlos Alberini — Chief Executive Officer

Yes. So, you are absolutely right. The two wholesale businesses are very different than in Europe than they are in the US and Canada. The European customer base is a lot more fragmented. We sell to thousands of accounts, but the interesting thing there is that when you think about the top customers, just the — if you took the Top 10 customers in each of the countries and markets where we do business, they represent more than half of our business. So, there is a big opportunity to really continue to really grow our share with those customers. They are in very strong situations and we have a very close relationship with them. In fact, we did quite a bit of work with them through this exercise and it has been very, very helpful. We are seeing very healthy trends in the way they are thinking about our business which leads us to believe that they believe very strongly in the brands and they think that we can play even a bigger role as part of their business.

With respect to the others, I mean, obviously we’re anticipating that there is going to be a significant impact as a result of the crisis in our customer base and we are being very careful with how we think about the future. We have cut our production pretty significantly just to anticipate or reflecting how we anticipate that the demand is going to be impacted in terms of future deliveries. And also, we are very pleased with the fact that we have a pretty good size of our receivables in short. So we are — we think that that there is going to be a significant impact and we are going to watch it every day. I think that the team in — especially in Europe, has a lot of experience in managing through similar situations as we experienced something similar a few years back.

And then, with respect to our business in North America, just there was a very instant change in the way they were looking at receipts and there were a lot of cancellations, very early on which forced us to go back and work with our vendors to really readjust our purchases and shipments to us. And fortunately, we have amazing partnerships and we were able to really reallocate and cancel what we could and so forth and we’re in a very good position and we think that some of those cancellations will probably come back in the way of new demand. So, we want to be prepared to be able to fulfill those new orders when they come. And so, we feel that we are in a very good position.

Janine Stichter — Jefferies — Analyst

Great, that’s helpful. And then just maybe, I think you mentioned the 182 store closures over the next 18 months between North America and China. Any more context you can give there either on regionally or any context on the profitability of those stores? I think that’s it for me. Thank you.

Carlos Alberini — Chief Executive Officer

Yeah, sure, Janine. Well so — we have — I think what I mentioned is that, our plan is to close about 100 stores globally over the next 18 months and they’re primarily in North America and in China. Just to give you an idea, between February and May, we have closed 42 stores in China. So, there is a significant opportunity for us to really optimize our portfolio there and we have a few more to go between now and the next few months. And in the case of North America, we have a lot of lease expirations too that gives us a lot of flexibility. In fact, about one-third of the fleet is coming up just in a very short horizon here. So, it doesn’t mean that we are going to close all those stores. There are a lot of stores very, very healthy and even with the new normal numbers here, we think that we can continue to maintain a very strong presence on the store side.

And in terms of Europe, we have about — over 15% [Phonetic] of our stores are also coming up for renewal within the next year and we feel very strongly about our business here and how important stores are and we feel that in that particular case, we are not going to go through many closures. And overall, we think that having all these exploration opportunities, we think that is not just an opportunity to close stores, but also to renegotiate lease terms, and considering that there may be an impact that may be more medium term as a result of the crisis and what we have just experienced. But just — I want to make sure I make this point very strongly because we believe in stores and we think that that is an important piece of our success. We think that there is no better way to represent the brand than with a great, well-positioned and well-merchandised store and this has always been part of our big representation of the brand. And we also think that stores are the Number 1 customer acquisition vehicle that we have. So overall, we will continue to support having a very strong presence in stores.

Janine Stichter — Jefferies — Analyst

Great, thank you.

Carlos Alberini — Chief Executive Officer

Thank you, Janine.

Operator

Our next question comes from John Kernan from Cowen & Company.

John Kernan — Cowen & Company — Analyst

An early good morning to you, Carlos and Katie. Congrats on navigating the company through all the uncertainty of this and you sound very confident about where things are headed. So, congrats on that.

Carlos Alberini — Chief Executive Officer

Thank you, John. Thank you very much.

Kathryn Anderson — Chief Financial Officer

Thank you.

John Kernan — Cowen & Company — Analyst

Carlos, in your prepared remarks you talked about how the consumer was going to move towards quality, I think simplicity and sustainability and how you thought the Guess? brand can play a role in that. What else — what do you think — what’s the best way to pivot the business model towards that and in your view of the future now, how is it reinforced by what is done on during this recent pandemic?

Carlos Alberini — Chief Executive Officer

Yeah, I think that it starts with the brand for me. Just I think that the brand has a very strong legacy and heritage and I think that the brand always stood for quality. Also, I think that just looking at being less promotional and leveraging our brand partnerships and collaborations as we have just started a couple of years ago, I think, is a big opportunity for us. And then, just after you think about the brand, product — I mean product is everything. It starts and ends with product in terms of what the customer is looking for. We have — we see an opportunity as a result of these changes in consumer lifestyle to really focus on essential products. We want to ensure the high standards of quality are present in everything that we do as it relates to product, including details and everything fabrics that we take.

We believe that they are major opportunities in key product categories for us. I did make this comment in prior calls, but I think that now this becomes even more and more important. Denim as a category has always been a dominant piece of our assortment for us and brings the customer back and we think that this can be even a much bigger part of our key opportunities here. We have gained significant traction during the last few months on denim and we think that there is more to come. Handbags, I think that we are just incredibly well positioned with handbags and is a big business and it can continue to gain share. Outerwear is another big category where I think that our product and when you think about the quality, the styling and how incredibly well positioned in the marketplace our outerwear is, at a great price, I think a big opportunity for us to continue to gain market share and there is also a big opportunity with that because of the high price points as an item.

Activewear — just — we always had a meaningful activewear business, but now with the changes in lifestyle, we think that this is an even bigger opportunity. Knitwear will continue to be and this impacts both men and women. As you know, we have a very meaningful and sizable men’s business in addition to our women’s business. So, just you put it all together and it’s like, wow, how many opportunities we have. Just, there is very little of the line that is very dressy. So, the changes we think that are very positive for us and we are very excited.

We were able to impact some of the product that is going to be delivered and we were already going in that direction with some of the activewear lines and so forth. And I think that we can capitalize on this new trends and we are very happy with what’s coming for holiday as well. So, that’s just a big part of the entire strategy here that we think that we can accelerate. And then, you think about what we always talked about customers centricity, improving the customer experience, we think that is key. We have been working on the implementation of Salesforce and actually, we already have something that went live this past week in France and we are going to be rolling this out for all the countries and we think that is absolutely the right priority for us as a company and so much so that we decided to really extend and make another big project here that we are launching, as we speak is called Customers 360 is also a big application that has been built by Salesforce where you could bring all the data and all the big customer knowledge into one application that is completely integrated to be able to do customer data integration better, to do personalization better, journey engagement I mentioned and also analyzing results, which is something that right now we don’t have anything close to this to able to analyze our customer database. We have a lot of customers, we have a lot of data, but we don’t have a great application to be able to analyze it effectively.

John Kernan — Cowen & Company — Analyst

Understood. Thanks for all the detail there. Katie, could you talk about the gross margin environment going forward. We’ve heard some updated commentary from some of the retailers in the US and some of the brands about what the second quarter and maybe the rest of the year might look at from a markdown perspective. Do you think — do you feel like you’re where you need to be from an inventory reserve perspective? Certainly, you’ve done a good job reducing inventory on the balance sheet. Just curious in terms of how we should think about the overall gross margin environment, really, for Q2 and the rest of the year, if you can give any detail. Thank you.

Kathryn Anderson — Chief Financial Officer

Yeah, sure. So, as you know, we came into the year — into the first quarter with clean inventory and we feel pretty good about our plans. Carlos talked about all our plans for inventory over the course of the year and the adjustments that we’ve made. Really, the bigger inventory adjustment that we made was in China. And total reserve we took [Phonetic] about $17 million, but really the biggest piece of that was coming in from China where we have — with the crisis, we have some opportunity for product and assortment there. So, we think that we have a really good — we took really good strategy in inventory in the go forward and feel good about where we are.

Carlos Alberini — Chief Executive Officer

Yeah and I just want to add on that, the significance here is that we start — instead of starting with, okay, how much inventory we have and what would be a good number, we started with demand and we kind of like then re-architected what inventories needed to look like to be able to have a very desirable outcome and healthy margins. So, we feel that going into the rest of the year, our margins should be absolutely aligned with what we have seen in the past. If anything, we may see some product margin improvement because of not being as promotional. So, we are planning to be very, very tight with inventories and if anything, we would rather walk away from an extra dollar of sale, but — in order to protect our inventory position on our margins and the brand most importantly.

John Kernan — Cowen & Company — Analyst

Excellent. Then just maybe one final question. Going back to the 2019 Investor Day, much of the margin improvement for the consolidated business was forecasted to come from gross margin, you seemed really confident in that. Really wasn’t — there wasn’t that much reduction in SG&A rate embedded in that plan. Do you think now having identified a few — some store closures, you talked about some of the reductions you made in headquarters, how do we think about the SG&A opportunity over the next — over a longer period of time into that 2025 timeline?

Carlos Alberini — Chief Executive Officer

Yeah. Let me just start with that and I’m sure that Katie will have additional comments. But just going back to that Investor Day, we had identified 500 basis points of operating margin increase. And when you look at what was underneath that, the key drivers that supported that improvement, there were two big categories. One was around operational efficiencies and that was worth about 350 basis points of the 500 basis points and the remaining was more aligned with top line expansion.

So, let me touch on the first one. We had about four buckets. One was the logistics opportunities that we had identified. The second one was supply chain efficiencies. The third one was about the store portfolio and we just touched on it. And the fourth one was about expense streamlining. And really, I think that you look at all those and they are tremendous opportunities here to continue to really tackle all those savings and we are kind of like, again, accelerating some of this. We have consolidated our vendor base. If I told you that about a year ago, we had about 527 vendors. Today, we are operating with less than 200. This is what this team has done. Fabric platforming, another big opportunity, and we are doing quite a bit of that. We are — we launched a project to digitalize our supply chain processes. We have eliminated all agents. So now, we are going all vendor direct and that also has contributed to savings.

And then, just when you look at our teams, supply chain and design, we are streamlining those functions as well between regions. So, we see a big opportunity for ongoing headcount opportunities for reduction. So, there is big opportunities and they are all there. We continue to work on the logistics network optimization. This is primarily a project that is touching Europe for the most part, but we also see opportunities in Canada. I think, we mentioned that. We have two DCs and we are planning to go to one.

And then the store portfolio, you just mentioned. I think that when we met, we — yes, we thought that we had opportunities to optimize the portfolio, but we weren’t planning on closing so many stores so quickly. And so if anything, this is going to help us to accelerate the savings that we were seeing as a result of the optimization of the store portfolio. And with respect to the top line expansion, obviously, this is setting us back on top line, but we hope that this is not going to be something that just would be a permanent reduction. We think that we can start gaining share and that can happen very quickly, I believe. And then, just looking at store expansion even, I think that there are going to be store expansion opportunities in many areas as landlords want an incredible brand to be represented in their centers and I’m sure that there are going to be very good opportunities to go into new real estate for us.

And then improving sales productivity. Now, the biggest top line expansion opportunity as we talked back in Investor Day was more about digital. It was about what we were going to do on e-com. And in fact, we see that opportunity to be bigger than what we thought with even to increase our penetration. At the time, I think we mentioned that we were doing about 13% of our sales on e-com and we had a plan to get to about 18% penetration by fiscal year 2025. And we think that now that number could be 22% and we think that this is part of where the consumer is going. And I’m very glad that we are so advance with the implementation of our new platform, because that is definitely something that we needed to be able to execute to this plan.

So, overall, I think that we are in a very good place and I think that we look back at that SVB and the opportunities that we have uncovered on the cost side. They are significant to us. I did not talk about all the details here, but the IT infrastructure is a big opportunity. The consolidating functions globally is another big opportunity and I think that most of this is underway for us.

John Kernan — Cowen & Company — Analyst

Thanks, Carlos, for all the detail and best of luck going into the second quarter.

Carlos Alberini — Chief Executive Officer

Yeah, thank you so much, John.

Operator

Our next question comes from Omar Saad from Evercore ISI.

Omar Saad — Evercore ISI — Analyst

Good morning. Thanks for taking my question. Thanks for all the information, guys. Couple of questions.

Carlos Alberini — Chief Executive Officer

Hi. How are you doing?

Omar Saad — Evercore ISI — Analyst

Hey. Hey, Carlos. Hi, Katie. A couple of questions. I wanted to start on China. You’re closing stores, you have been closing stores, you are closing more stores, it’s a big market and it’s a big opportunity market for a lot of kind of fashion and designer brand companies we follow, maybe kind of put the store closures into context, what’s the overall kind of update there and medium and long-term strategy? Is it shrink to grow, is it shrink to harvest and aim for profitability? Any more color around that would be really helpful. And then I have a follow-up. Thanks.

Carlos Alberini — Chief Executive Officer

Sure. We believe in China, Omar. Frankly, it has been a challenging road for us, because I feel that we have had a fair share of issues that are internal too and we are addressing those. I think we talked in previous calls about our opportunities on the product side and we are now working with the team that we have there in addition to we are putting our best merchants from the American team to really help with assortment and really helping with how to position the product story. So, I’m very confident that we are on our road here to success and I feel that. Yes, it’s interesting. Yeah, we are closing stores, but we are closing stores that were not desirable locations. So, I don’t feel that this is in anyway a representation that we don’t believe in the market or in the territory or in the opportunity. In fact, the stores that we’re going to be left with after all these closures that I had mentioned, we are still going to have presence in 37 cities. These are Tier 1 to Tier 3 cities. So, it’s not that we are walking away from the store opportunity here.

Now, I am happy that we are closing what we are closing because these are not stores that were making a significant contribution in terms of presence of the brand in that territory or in terms of profitability. So now we are — in the meantime, we think that we have to shrink to be able to grow in order to use your words and we have done quite a bit to cut our costs in the market. So, we have reduced our corporate cost and investment and I think that’s also a very good move and we are taking up a pretty aggressive approach to really clean the inventory that we had and really start over and I think that you should see a significant improvement as we go into the second half of this year. We still believe in the territory and it’s a huge market. And, more importantly, the brand is very well perceived. So, we think that we have a big opportunity, but we want to apply the same kind of principles I just mentioned about the brand and going after quality and making a big representation for this brand in a market that offers that much opportunity. So, we think that there are also opportunities on sizing and fits and we are going to be addressing all that as well.

Omar Saad — Evercore ISI — Analyst

That’s super helpful color, Carlos. Thank you for that explanation. I also wanted to ask about digital. It’s great to see the stores coming back and the digital business building double digits. It’s strong, but we’re hearing some crazy positive digital e-commerce growth numbers on some of the companies we cover. And we know e-commerce is a big opportunity for you, things like BOPUS and ship-from-store. Maybe put into contact some of the drivers behind, maybe some of that slower growth in the e-commerce side as well as the opportunities as you do more omni-channel? Thanks.

Carlos Alberini — Chief Executive Officer

Yeah. Yeah. I think — yeah, I think at the beginning of the quarter, the first quarter we had a tougher time with e-commerce and we believe that it was more about the customer just looking into more essentials and, frankly over time, we are seeing that our business is reacting in a much more positive way. I did hear about some companies doing significantly bigger numbers, especially as their stores were closed. I’m not sure that we have a similar type of product that those companies have. I think that our trends continue to improve very significantly. And I am looking forward to — once we have the right tools in place. Just many of those capabilities, we don’t have in Europe, for example. So, even when our business has been healthy and growing, just — we don’t have the capabilities to be able to capitalize on the changes that were forced by the crisis and the outbreak here.

And in the US, while we are capitalizing on those, the business took a little bit longer to really start gaining traction. We are still having challenges with customer traffic, but we have just looked at the product assortment and we are seeing that there was a big opportunity with product and we are funding a lot more on the inventory side to be able to feed into that demand and we are very happy with the results. So, I think that as we continue to navigate through the year here, you’re going to see that our numbers will continue to improve. And when — I said double digits. I mean. double digits can be a big number, right. So it depends that — and — but it’s somewhat early for us and how we want to be realistic in the way we are modeling our numbers.

Omar Saad — Evercore ISI — Analyst

Understood. Yeah, double digits is going to be, I guess, anywhere from 10 to 99. Thanks, Carlos.

Carlos Alberini — Chief Executive Officer

Exactly. Thank you, Omar.

Operator

[Operator Instructions] Our next question comes from Dana Telsey, Telsey Advisory Group.

Dana Telsey — Telsey Advisory Group — Analyst

Good morning, Carlos and Katie. Hope everyone’s safe and healthy.

Carlos Alberini — Chief Executive Officer

Hi.

Dana Telsey — Telsey Advisory Group — Analyst

Hi. As you think about this second quarter, which you mentioned should have a sales decline similar to the first quarter, can you put any qualitative commentary behind that as stores reopen, what you’re expecting either by region, by channel in terms of what you expect to see? Thank you.

Kathryn Anderson — Chief Financial Officer

Yeah, sure.

Carlos Alberini — Chief Executive Officer

Katie?

Kathryn Anderson — Chief Financial Officer

I’ll take this one. Yes. So we have — as we said, we think the second quarter will be in line in terms of revenue with the first quarter. And really, when you start to think about retail, we’re starting to reopen our stores in phases, started really mostly in May going into June. We think we’ll have all the stores open in June. So, the store closure period in Q2 is pretty much in line with Q1, which is why we’re thinking about revenue versus prior year about the same. In terms of wholesale, the wholesale partners are under the same store closure issues that we’re having and demand deceleration. So, we think the shipments will be under pressure in the second quarter, some shifts into latter part of the year, some cancellations, but again in line with our retail business and the same goes for licensing. So, that’s why — we’re thinking that after Q2, will start to normalize.

Dana Telsey — Telsey Advisory Group — Analyst

Got it. And then, how do you think about inventory from this perspective? And then, Carlos, you mentioned simplifying the product development and supply chain process. What are you seeing there? And does it impact inventory as you go forward in terms of faster turns and how you develop the product?

Carlos Alberini — Chief Executive Officer

Yeah. So with respect to inventory, just the process that I described is exactly the one that impacted our inventory plan. So it is — Katie just told you how we are thinking about the demand will behave and then we took that demand, including wholesale and every one of our channels and then we modeled what kind of inventories we needed to really fulfill that demand in the most effective way. So, when you look into the third quarter or the second quarter even, for that matter, just we had to adjust some of the numbers. We work with our vendors canceling some orders and then placed some new orders in some cases. And then, I did mention that we — because we had to really continue to fulfill orders and many of our wholesale customers didn’t have room basically, because obviously they were sitting on the product that they couldn’t sell during the spring season as all the stores — their stores were closed.

Then, just we had to give them some time to be able to sell the products, similar to what we did with our own stores. And as a result of that, we thought that the best way to deal with this situation was to extend the fall/winter season to give them more time to digest and to give our customers even and the stores more time to digest. Just — of course, we did this with full knowledge of what was right for the season and what weather included and everything else. But as a result, we were able to balance that whole equation between demand and supply. And we are — we don’t want to walk away from the opportunity to really capture more demand. So, we put in place fast-tracking processes. So then, we could be ready and in many cases we are working with vendors to hold fabric or whatever we need to do to really be ready and be able to turn the product very quickly, and we think we are in a good place in both — for both regions, including the opportunities that we see in the US and Canada.

Dana Telsey — Telsey Advisory Group — Analyst

Thank you.

Carlos Alberini — Chief Executive Officer

Thank you, Dana.

Operator

We have no further questions at this time. I will now turn the call back over to Mr. Carlos Alberini for final remarks.

Carlos Alberini — Chief Executive Officer

Well, thank you. I just want to thank you all again for taking part in this call today. I’m really honored to lead this passionate and talented team that we have here at Guess? and I’m honored and grateful to partner with Paul Marciano, who has been incredible through this entire time and I’m very grateful to have him and his support and his guidance next to us. We will continue to navigate through this and I believe that we have a relentless commitment here and determination. The entire team shares that and I’m confident that we have the brand, the business model and the people to emerge from this crisis stronger than ever and I’m very, very hopeful. And please, I hope you all stay safe and well and I look forward to talking to you next time. Thank you, again, for your time.

Operator

[Operator Closing Remarks]