PVH - Earnings Call - Q2 2012

Transcript

Speaker 6

Good day, everyone, and welcome to this PVH Corp. second quarter 2011 earnings conference call. This webcast and conference call is being recorded on behalf of PVH and consists of copyrighted material. It may not be recorded, reproduced, retransmitted, rebroadcast, downloaded, or otherwise used without PVH's express written permission. Your participation in the question and answer session constitutes your consent to having any comments or statements you make appear on any transcript or broadcast of this call. The information made available on this webcast and conference call contains certain forward-looking statements which reflect PVH's view of future events and financial performance as of August 30, 2011. Any such forward-looking statements are subject to risks and uncertainties indicated from time to time in the company's SEC filings. Therefore, the company's future results of operations could differ materially from historical results or current expectations as more fully discussed in its SEC filings.

The company does not undertake any obligation to update publicly any forward-looking statement, including, without limitation, any estimate regarding revenues or earnings. The information made available also includes certain non-GAAP financial measures as defined under SEC rules. A reconciliation of these measures is included in the company's earnings release, which can be found on the company's website, www.pvh.com, and in the company's current report on Form 8-K furnished to the SEC in advance of this webcast and call. At this time, I am pleased to turn the conference over to Mr. Emanuel Chirico, Chairman and CEO. Please go ahead, sir.

Speaker 0

Thank you very much. Good morning, everyone. Joining me on the call this morning is Mike Shaffer, our Chief Financial Officer; Allen Sirkin, our President and Chief Operating Officer; Ken Dwayne, who runs all of our North American wholesale businesses; and Dana Perlman, who is our Treasurer and Head of Investor Relations. We're very pleased with the results that we reported for the second quarter and our ability to take up the projections for the year, for 2011. I'm going to start with the Calvin Klein businesses and more or less try to give you a little bit of an update of the trends of business as we see them in the second quarter. Mike will then quantify the results in the second quarter, and then I'll come back and just talk about some of the trends we see in the early part of the third quarter.

Our Calvin Klein business continued its strong growth momentum in the quarter. Total revenues in the second quarter for the combined Calvin Klein businesses were up 19%, and our operating profits increased over 20%. The CK Apparel business, wholesale and retail that we run in North America, those businesses posted a 21% sales increase in the quarter. The strong performance was driven by our men's wholesale sportswear business, as well as a very strong performance in our own retail stores in North America. Our Calvin Klein retail businesses posted a 21% comp store increase in the quarter. In our licensing segment, royalty revenues were up 12%. I'll put some color on some of the larger businesses. Our underwear business was ahead about 14% worldwide. All regions in the quarter, Europe, Asia, and the Americas, posted double-digit sales increases.

The growth was driven by the continued growth of international retail square footage and the extremely strong performance of CK One. CK One product has been supported by a significant marketing campaign and marketing investment through the first half of the year. CK One is the largest launch in the brand's history, and retail results have been strong in all markets. In men's, CK One continues to exceed our plans and has helped us to grow and maintain our number one position within U.S. department stores. CK One is expected by the end of the year to represent about 10% of our total men's underwear business. On the jeans side, our jeans and related businesses were up about 8% for the quarter, fueled by the strong growth internationally in Latin America, Asia, and Europe.

Overall, our international jeans business grew over 20%, while our domestic jeans business was down about 8%. The jeans business in the United States continues to be under pressure overall, and we see our men's business outperforming our women's business within the United States. Moving on to fragrance, our Coty fragrance business had a strong quarter posting a 10% increase in revenues. Business was very good across the board with our Euphoria, Calvin Klein Beauty, and CK One fragrances continuing their strong growth momentum. In the third quarter, we'll have a major product launch with CK One Shop. It will be supported by a strong marketing campaign. It will be a global launch. Product has begun shipping in early August. We'll see much more of a presence as we step into September and going into the fall holiday selling season. We have very high expectations for CK One.

We see excellent placements of the product. We think the marketing campaign, which started in the first half of the year around CK One, will accelerate in fragrance in the second half of the year, and we're very positive as we see that business going forward. In our North American women's apparel and related accessory business, we had very strong performance in the quarter. Our revenues were up a little in excess of 15% for the quarter in those combined categories. On the apparel side, the growth is being fueled by strong selling of women's sportswear and dresses, as well as good performance in the outerwear category. We'll get a better view into the outerwear category as we really get into the third quarter of this year. We have a very strong placement across the board. In footwear, in North America, revenues are running over 25% ahead.

In addition, our new handbag and accessory business is off to a very strong start, exceeding our expectations and our plans. G-III has seen excellent placement and sell-through both at Lord & Taylor and at Macy's. We think the footwear accessory area will continue to be a growth area for Calvin Klein the balance of this year into the next couple of years. We see real opportunity there. Our watch and jewelry business, which watched for significant growth in the quarter, posting a 35% increase over last year. The growth was driven by door expansion and significant comp store sales growth in both Asia and in Europe. On our CK Bridge business in Asia, that business continues to grow very strongly with Club 21. We posted a 40% increase in revenues for the quarter.

The growth is being driven by China, Hong Kong, and the Korean markets, where we are experiencing door expansion and double-digit comp store growth. Moving on to Tommy Hilfiger, from a brand marketing perspective, we are just introducing the third chapter in our very successful Meet the Hilfigers marketing campaign as we continue to invest and broaden the reach of the Tommy Hilfiger brand worldwide. We have just recently increased our fourth quarter marketing spend by about $10 million. Our global fall holiday campaign will have significant exposure in major markets throughout North America and Europe. The fourth quarter marketing campaign calls for a significant television and cinema component for our marketing exposure in Europe and in Asia, in the United States, excuse me. We are very excited about that campaign as we go forward, and we think it'll just continue the momentum in the brand.

Overall, all of the Tommy businesses had a very strong quarter and significantly exceeded our expectations. Total revenues in the quarter were up over 30%, and operating earnings increased 34%. The brand's performance in both North America and Europe was particularly strong. Let me start with the European wholesale business. The fall holiday, we have seen sales growth of over 15% over the prior year. On a product category basis, we have seen double-digit growth in men's and women's sportswear, denim, and in footwear. We are also seeing strong growth in accessories and handbags, as that business is just really starting to ramp up. We are seeing strong growth across all of Europe for the fall holiday season. Business in our largest market, Germany, is running ahead about 15%.

Our second largest market, which is Spain and the Spanish market, as you know, is under significant pressure. We are seeing very healthy growth in Spain of about 5%, really focused on our Corte Inglés, where we continue to grow our presence and our market position in the store. Our key growth markets of Italy, France, Russia, and the UK are all growing at over 15%. Also, in the second quarter, we saw about a $20 million increase in early fall shipments as major customers accelerated their deliveries forward in order to meet the consumer demand that we saw for our product in early fall. That was very exciting as well to see product being pushed forward by our customers. Moving to the Tommy International retail business, in the second quarter, comp store sales were up 12%, driven by the strong performance of all European markets across the board.

They all posted double-digit sales increases in all the major markets that we operate in. Our North American retail business posted a very strong comp store growth in the quarter of plus 13%. We're seeing strength in all regions of the country, with particularly strong performance in the geographic areas that cater to international tourists. The Tommy retail results are very consistent with the strong sales performance we're seeing in our Calvin Klein retail business throughout North America. The Tommy Hilfiger wholesale business continues to perform ahead of plan at Macy's. We're seeing in the second quarter average unit retail increases in excess of 5%, and we're seeing sell-throughs that are exceeding our sales expectations in the sportswear area. Moving on to our Heritage business, revenues increased about 9% in the quarter, driven by a 20% increase in dress furnishings and an 8% increase in wholesale sportswear sales.

Our Heritage resale business has posted a healthy 2% comp store increase, which is right on plan. Operating earnings for the quarter were relatively flat, as the strong dress furnishings earnings performance was more than offset by a gross margin decline in our Izod sportswear business. Due to increased promotional selling, we wanted to significantly get ahead of the curve, clear goods as we went back into the fall selling season. As we head into back to school, we feel very good about the position we're in from an inventory point of view on the floor, and we think we're well positioned for the Izod sportswear business as we move into the third quarter. With that, I'm going to turn it over to Mike and ask him to quantify some of the results of the quarter.

Speaker 1

Thanks, Manny. The comments I'm about to make are based on non-GAAP results on a reconciled most second quarter class release. Our revenues for the second quarter were $1.334 billion. Revenues for the quarter were greater than our previous guidance and significantly greater than the prior year, driving the higher revenues with strong performances in our Tommy Hilfiger and Calvin Klein businesses. Gross margins for the quarter were 54.4% of sales and were ahead of plan and down 120 basis points from the prior year. The rate decline was predominantly driven by product cost increases, which our Heritage business did not offset with AUR increases, coupled with promotional selling in our Izod wholesale sportswear business. Our Calvin Klein and Tommy Hilfiger businesses had a lower gross margin rate decline in the quarter as we sold more product with higher cost increases in the latter part of the second quarter.

In addition, Tommy Hilfiger and Calvin Klein were able to attain AUR increases of about 5% on spring product. SG&A for the quarter was 43.1% of sales, a 140 basis points decline versus the prior year. Our SG&A expenses continue to show improvement as a result of synergies that we attained through the Tommy Hilfiger acquisition, coupled with our ability to leverage our large revenue increase for the quarter. In addition, our SG&A for the quarter included approximately $10 million in higher marketing expenses from the prior year. Operating income for the second quarter was $151 million, a 24% improvement or $29 million increase over the prior year. Driving the increase was our Tommy Hilfiger and Calvin Klein businesses, which had earnings increases of 34% and 21% respectively and were driven in large part by the revenue increases mentioned previously.

Inventories for the quarter were $877 million, about 26% greater than the prior year. Our inventory increase reflects a higher level of core product inventories, primarily in the dress shirt furnishings business. In addition, cost increases as well as continued early purchasing to take advantage of downtime production were also factors. Our inventories are on plan and very clean. As a reminder, and as we called out in the previous quarters, we'll continue to see higher inventory levels as we will continue to take advantage of downtime production. Inventories will come more in line with last year in the fourth quarter. Lastly, on the second quarter, we made debt repayments of approximately $100 million. Moving to our guidance for the year, our revenues are planned at $5.78 to $5.82 billion, an increase of about 26% over last year.

Tommy Hilfiger revenues are planned at $2.94 to $2.97 billion and compared to $1.95 billion for the nine-month period last year. Our Calvin Klein revenues are planned up between 12% and 13%, and Heritage revenues are planned to grow about 2%. We're planning our gross margins down about 150 to 180 basis points as a result of product cost increases. Our expenses are also still planned to be down about 100 to 150 basis points, reflecting expense reductions and SG&A leverage. Operating margins are now planned at 11.3% to 11.5% of sales. We've raised our earnings per share guidance for the year to $5.00 to $5.12, a 17% to 20% increase over the prior year. This increase reflects the $0.12 actual beat over the high end of our second quarter guidance, as well as a $10 million increase in fourth quarter marketing spend for Tommy Hilfiger.

For the third quarter, we're planning revenues at $1.61 to $1.63 billion, an increase of 6% to 7% over the prior year. Driving this increase is Tommy Hilfiger business, which is planned at a 9% to 12% increase over last year, as well as our Calvin Klein business, which is planned to increase 8% to 9%. Our Heritage brands are expected to increase 1% in the third quarter over last year. For the third quarter, we're planning our gross margins down about 250 to 270 basis points as a result of product cost increases. Our SG&A expenses are planned to be down about 190 to 200 basis points, reflecting expense reductions and SG&A leverage. Operating margins are planned at about 13.5% of sales. We're projecting third quarter earnings per share to be $1.75 to $1.81, an increase of 5% to 8% over the prior year.

Our tax rate for the third quarter is projected at 30.5% to 32.5%, and our guidance for the year is at 30% to 31%. In the second quarter, our taxes were higher than planned as a result of the timing of recording certain discrete items. The recording of these items was originally planned for the fourth quarter of this year but was booked in the second quarter. Finally, we're projecting our debt repayments of about $200 million during the remainder of 2011, which will bring our total repayments since the Tommy acquisition to about $700 million. With that, we'll go back to Minh.

Speaker 0

I just wanted to take a moment. I know, besides our results for the second quarter, everyone has some focus on what the trends in the business have been for the first month of our third quarter. Our trends overall have been very strong. Zac's selling has been, continues to be, very strong. Just to put some flesh on that, in our U.S. retail businesses, our Calvin Klein and Tommy Hilfiger businesses, prior to the hurricane—and I'll put some flesh on that in a moment—prior to the hurricane, the Thursday before the storm, we were running up double digits. It's 10% to 12% on a comp store basis. Those businesses for the second half are planned up in the mid-single-digit range. Our Heritage business was running up about 3% for August, with a planned increase for the second half of between 1% and 2%.

The hurricane on Friday, Saturday, and Sunday, with our business being so East Coast focused, we saw about an impact of about $3 million in sales due to closed stores or stores that were really impacted by traffic because of the storms. It was worth to us for the month of August about 300 basis points comp. A business on following the weekend, early reads Monday and Tuesday, has been very strong following the hurricane. We feel really good about the trend of business in our retail stores. All of the stores are running ahead of our plans for the second half of the year. On the wholesale side of the business, both the Calvin Klein and Tommy Hilfiger businesses continue to perform ahead of sales plan. Although it's still very early, we've not seen any customer resistance to our full retail price increases at all.

The momentum in those businesses continues. In dress furnishings, we have had excellent success passing along the cost increases and the retail price increases that we've seen in the business. We're seeing a significant increase in AURs out the door in our dress furnishings business at the wholesale level. On the Heritage sportswear business, it's too early to tell. The August business is very much, particularly on the main floor and going up against private label in August, is very much driven by continuing to be driven by spring clearance and summer clearance. It's too early to really get a strong handle there. As we would expect, we think that's the area where we'll be most challenged trying to raise prices in there. We'll update you further on that as we move into the third quarter going forward. That business represents less than 20% of our total volume.

80% of our volume, really, we're seeing good response to our higher price tickets in North America. Moving to Europe, our wholesale business really continues to see strong momentum. Wholesale represents about 70% of our total European business. Our spring 2012 order book, which will start shipping in the fourth quarter, is running ahead about 13%. We're planning that business up about 9%. We're running significantly ahead. As I said in my previous comments, we've seen our customers accelerate deliveries forward to really get pre-fall in early. No lack of momentum that we're seeing in Europe on the wholesale side of the business. Moving to our European retail comps, the comps for the month of August are up about 3% against the second half plan of about plus 4%. That business seems to be running on plan. Margins there are strong.

We've raised prices in our European retail businesses at the customer level. We're getting a good response to that. We feel good about how that business has been set up. On our overall guidance, I think Mike did a really good job of quantifying that to you. We've tried to be prudent with our estimates. We haven't changed any of our estimates, really, for the second half of the year. All of our operating assumptions about gross margins, how much of the sales retail price increases that we will ultimately be able to pass along to the consumers, we haven't changed any of our assumptions there, although the results have been significantly ahead of where we're planning them right now.

We believe we continue to have momentum in the Calvin Klein and Tommy Hilfiger business, which will continue to drive our growth and should allow us, if trends continue to exceed the projections that are out there. With that, I'll turn it over. I'll open it up for any questions that you might have.

Speaker 6

Thank you, sir. If you would like to ask a question, please signal by pressing the star key followed by the digit one on your telephone keypad. If you are using a speakerphone, please be sure your mute function is turned off to allow your signal to reach our equipment. Once again, that is star one if you would like to ask a question. We'll pause here for just a moment. Our first question will come from Kate McShane with Citi Investment Research.

Speaker 2

Thank you. Good morning.

Speaker 0

Hi, Kate.

Speaker 2

Manny, I heard you speak about sportswear, and I wondered if you could just go into a little bit more detail when it came to price increases. I know in the first quarter, you had seen a little bit of inversion in share because you didn't see a lot of other competitors raising prices in the sportswear category. I wondered if you could tell us what you saw in the second quarter and what you expect for that half in that category.

Speaker 0

I guess sportswear in general, on the collection side of the floor, the Calvin Klein and Tommy Hilfiger business for us specifically, we saw continued price retail out the door increases of about 5% in the second quarter, very healthy. On the more moderate businesses, particularly the Izod business, we needed to move through some excess inventory that was on the floor. We needed clear product. Clearly there, we saw no increases in retail prices. In fact, in Izod, our retail price out the door was down as we were very aggressive about moving product together so as to position for back to school. Again, on the main floor, I think we continue to see some pressure, and it's just too early to give you a read. Clearly on the floor, ticket prices have been raised across the board via private label, collections, branded main floor business as well.

All of those have seen ticket increases of anywhere from 10% to 20%. How the consumer reacts to that, the amount of promotions that will go off of that, I think will clearly be determined over the next four to five weeks as we go forward, as we really get into department store selling and back to school. We'll keep you posted on it, but that's what you know. I think it's still an open book at this point, particularly for the main floor.

Speaker 2

Okay. Great. Mike, I was wondering if you could break down the inventory increase into a little bit more detail as to how much is coming from higher costs and from bringing some products forward.

Speaker 1

We've talked about our cost increases being up somewhere between 10% and 20%. To give you 15% for cost increases, the dress shirt increase we've talked about, we've added core product. It's all we've added core product for dress shirts. The early sourcing piece is the biggest factor. We are utilizing downtime production. We are seeing the benefit in our costs, and that is the largest component of the increase. That will continue through the third quarter. We will see inventories get back in line.

Speaker 2

Okay, thanks very much.

Speaker 6

Next, we will hear from David Glick with Buckingham Research Group.

Speaker 4

Yes. Good morning. Congrats on the quarter. I just wanted to touch on Europe for a moment. If I missed, I apologize. Can you kind of walk us through, Manny, what your comparisons are, you know, Q2 through Q4 in European retail? I know it's only 30% of your business, but it sounds like you had a very strong second quarter results on plan so far for Q3. Just remind us on the comparisons. Secondly, what gives you the confidence on the wholesale side? I mean, the bookings are really strong, kind of in line with the strength in the first half. That hasn't moderated at all. Is there any risk to the European wholesale bookings for fall holiday and spring in Europe where trends seem to be moderating?

Speaker 0

Okay. Let me take it and try and think those in pieces. I guess on the European retail business, to remind everyone, last year, second quarter, our comps ran about flat to plus 1%. We put on a internationally, we put on an increase of about 12% against that. As we went into the third quarter, our comps significantly improved, depending on the market, of 10% to 12%. We saw a real improvement in comps third and fourth quarter of 2000 in the 2010 fiscal year. We're up against much tougher comp store comparisons, about 10 full percentage points increase in the second half of the year versus our first half comparison. I think that is part of why we see our comps really moderate to about plus 3%, which we think is still very healthy. That's European retail, and hopefully, that puts it in some perspective.

On the wholesale side, based on the trends, based on the way business is done in Europe, I don't see any risk to shipments before the goods are falling holiday. Goods are really much of the selling season at this point is really being shipped in the month of August, early September. We've seen no pullback. In fact, as I mentioned, if anything, we've seen customers really accelerate the pull-out of goods. The spring orders, absent a catastrophe across Europe, I don't see any real risk to those. Those are hard orders. Those orders are placed. Again, you don't want to force goods into any channel, but our read of business and how the Tommy brand is performing against all of the competitors across Europe, we continue to outperform at retail. I think that's clear from the results.

If anybody is going to be pulled back or stopped, it's not going to be the Tommy business. I see very little risk in our wholesale business for the balance of 2011. I think just the way we've planned the business, given the fact that we're planning spring only up 9% from a financial point of view and bookings are running 13+% at this point, I think is just the indication of the conservatism that's built into the wholesale plan.

Speaker 4

Okay. Great. Thanks. Just one follow-up on North America. Can you help us understand the strength in dress furnishings? Is there a fit or a fashion trend going on there? Does that give you a bit of a buffer against your risks that you might see in the sportswear business on the margin side?

Speaker 0

Sure. Look, our dress furnishings business represents about a little bit on an annual basis, represents about 33% of overall wholesale business. The balance was between our retail direct and our wholesale sportswear. It is a very big piece of our business on the Heritage side, very stable, and we're seeing very significant AUR increases in dress shirts. I think that's a combination of the significant position that we hold on the floor in each of our major customers, that we've been able to very thoughtfully raise retail prices across the board, continue to promote off of the higher retail prices. In the first month of August, we've seen AUR increases, I guess, if you look across the board of 10% and more as we've gone forward. Very healthy AUR increases.

We think it's a category that, given its dynamics, is one where the AURs are going to stick as long as the inventory is controlled. At this point, the inventory is very well controlled. From a fashion point of view, I think dress up is clearly an area that's in cycle at this point. Even on the sportswear side, with more refined sportswear, it's doing much better. We're seeing real good performance there. Slim fit is a real significant fashion cycle, and that really plays into the strength of a number of brands, particularly Calvin Klein. All of those really factor in to give us an ability to raise price across the board there. The dress furnishings area is an area that we're really feeling very good about as we go into the second half of the year.

Speaker 4

Great. Thank you very much. Good luck.

Speaker 6

Next, we will hear from Bob Dribble with Barclays.

Speaker 4

Hi, good morning.

Speaker 0

Hey, Bob.

Speaker 4

Yes, hey, Manny. I guess the first question that I have is, when you go back to the hurricane impact on your sales, how much of the business do you think you lost? How much do you think you can get back this weekend? How are you approaching it from the business standpoint?

Speaker 0

Yeah, I guess, look, we're looking at it day by day. I think I mentioned we quantified, we believe it was about a $3 million sales dip in our own retail stores. I think if the first two days of this month are any indication of it, there's a good chance we could get a lot of that back in the next 10 days as we sell into Labor Day weekend, which is a huge weekend for us. We're seeing very, very strong comp store performance Monday, Tuesday. You never can tell what's driving that and what was happening. Clearly, there seems to be some pent-up demand. People are looking to shop. We continue to be appropriately aggressive from a promotional point of view, but not overly aggressive. I don't think it's going to cost us anything significant from a margin point of view.

We'll get a better read on that in the next 10 days, but I'm optimistic about some of that coming back to us in September.

Speaker 4

Okay. Great. I just have a question on the pullback in cotton. Can you give us an update in terms of where you are from a lead time perspective and sort of how far out you guys are bought and how soon some of the lower-priced product can flow through the income statement?

Speaker 0

Sure. I think we're buying spring as we speak. Have been buying it, you know, spring one, spring two. We've bought February and March at this point. What we're basically a flow-through on the lower cost that we're anticipating in spring really won't be seen until we get into the first quarter of next year, and really the second part of the first quarter of next year. I think the way I look at it, Bob, is right now we're seeing, in general, when you factor all the cost increases, we're seeing a pullback in cost from fall holiday prices of about 8% to 10%. When you compare that spring to spring, we're probably looking at an increase spring 2011 to spring 2012 of somewhere in the 6% to 9%, 10% range, which is significantly under the kind of increases we saw fall.

If those trends were to continue, we could actually see the decline in cost as we go into the second half of next year. That, again, is all in the come. Indications are that there should be some margin recovery if we're able to hold the retail prices into the first quarter, into the second quarter of next year, into third and fourth quarter of next year as well. It's looking much better as cotton has really pulled back. It's not just cotton. It's all the raw material components that go into our product.

Speaker 4

Great. My last question is, on the Tommy Hilfiger advertising spending and the additional $10 million in the fourth quarter, with the increases that you've invested into the business last year and then this additional $10 million, does that put you at a level that you think is the new ongoing run rate, or do you believe there's still opportunities to continue to invest in the advertising over time?

Speaker 0

I think as a % of sales, I think we will continue to invest in marketing as we go forward. As the business grows and as we're really expanding into new markets, particularly Asia, which you know is a significant growth area for the Tommy branding on a relative basis compared to North America and Europe, we're significantly underdeveloped there. I think we will continue to make major investments in marketing as we go forward, in line with the growth of that business. I think from an operating margin point of view, we should actually start to see, continue to see improvement in the operating margin % of the business as we leverage the growth. We'll continue to make those marketing investments proportionate with the growth in the business. Hopefully, that answered the question that we're looking at it going forward.

Speaker 4

Yeah, thanks. Thanks very much.

Speaker 6

We will hear from Adrian Shapira with Goldman Sachs.

Speaker 7

Thank you. Manny, just a few questions. First, if we could spend a little bit of time on the gross margin as it relates to the guidance. The first half clearly above plan, Q1 up 200 basis points, Q2 down only 120. It sounds as if while Heritage remains a wild card as it relates to pricing, now that you've cleaned up that Izod inventory, help us think about the 150 to 180 basis point gross margin guidance. It would seem to suggest sort of the worst case or perhaps declines from here. How do you, how would you have us think about to get to the 150 to 180, given how the first half was well above plan?

Speaker 0

I think we've tried to adjust the annual gross margins, some level of improvement against that. I think there is opportunity. I think the opportunity clearly is in the dress furnishings area and in the Calvin Klein and the Tommy Hilfiger businesses to outperform our plan. At this point, when you look at the macro environment that we're dealing with and some of the volatility that we just saw in the month of August from a geographic point of view, politically, all of that chaos that's out there, it just doesn't seem prudent for us at this point to start changing our plans, our financial plans to move forward. I think given the strength of the businesses, those particularly three businesses, dress furnishings, Calvin, and Tommy, it gives us more, it makes us more optimistic about what we see for the second half of the year.

I wouldn't call, I don't call anything a worst case, but I think it's a conservative case, and I think there's an opportunity to outperform against that. Again, we'll deal with that as it unwinds and as we've kind of laid it out there. I think your observations are all appropriate, but given the macro environment, I don't think at this point in time we want to change any of our future projections.

Speaker 7

Right. Makes sense. Speaking to the chaos that we saw in August, we appreciate the hurricane clarity that you gave us. Maybe spend a little bit of time on how you saw August trends, given the market volatility that we've seen, the kind of roller coaster, how you've seen the consumer respond. Have you seen, did you see trends intra-month similarly be quite volatile, or did you not see much change at all intra-month?

Speaker 0

Not really any dramatic changes into month. You know, there's a couple of crazy days when the market went down 900 points. I think there were people a little nervous. Absent the, you know, a period of time, about a week in the middle of August, it was nice to see then business really bounce back very strongly in the last two weeks of August. You know, I can't tell you if that is just vacation patterns, if that's the consumer, very hard thing to read at this moment in time. Overall, the August trends are very positive when we looked at them overall.

Speaker 7

Great. My last question as it relates to the domestic jean business that you cited, some weakness down 8%. Maybe shed light on that weakness, especially as we are in the back-to-school season and clearly looking for some steeper price increases. How should we be thinking about that business and what sort of plans to kind of see some recovery there?

Speaker 0

Okay. I guess I would first say on a direct basis, we've got limited visibility on the jeans business. By that, I mean the biggest business we have, obviously, is the Calvin Klein jeans business worldwide. That's a licensed business. We see our results and we understand what's going on in that business, but we don't look at it day-to-day as we would if it was an operating business. From that point of view, I think that business is under pressure. I think the women's jeans business is under significantly more pressure than the men's jeans business. In our Tommy business, from a European point of view, that business continues to be very strong for us. It's growing in the high single-digit range for us on both a retail and a wholesale performance level. We've really seen not a lot of impact there.

I was really talking about the Calvin Klein jeans business, where I said it's down 8%. That was a function of a big function of the women's jeans component. When you're running an overall brand like Calvin or Tommy and you have a sportswear business, that sportswear business, I think, is benefiting from the lack of jeans business. We're selling a lot of dress pants. We're selling a lot of khakis. We're selling a lot of non-denim product, which is really benefiting both the Calvin U.S. business and the Tommy U.S. businesses that are much more focused on those areas.

Speaker 7

Great. Thank you. Best of luck.

Speaker 6

Next, we will hear from Jeff Kleinfelter with Piper Jaffray.

Speaker 4

Thank you. Congratulations, everyone. Great quarter. I just wanted to follow up on something, Manny and Mike, on the Tommy Hilfiger business. In terms of the operating margins, I think someone referenced this earlier in terms of the leverage potential going forward. Given the very strong top-line trends this quarter, modest margin expansion, how should we think about sort of like charting this leverage path going forward? I know you're going to continue to put dollars in, marketing dollars, as you have effectively with your other brands. Where are the leverage points and how much higher can these op margins go for Tommy over the next, call it, four to six quarters?

Speaker 0

I think there's a long-term answer to that and a short-term answer to that. I think clearly, when you think about the Tommy business, particularly internationally, we've been very specific. We've talked about that we've raised AURs in the area of 6% to 8% internationally with cost increases of about 15%. I think when you look at the details, you'll see significant leverage on the SG&A line, and you'll see gross margin pressure for the next two quarters. I think you'll see a relief to that in first and second quarter, but still planned down because spring will be over over there.

Once that margin situation balances itself, I think given the kind of growth we're anticipating, which is not 30% growth, but more like a low double-digit increase for the international component of Tommy Hilfiger, we should be able to grow our operating margins in that business about 100 basis points a year ongoing. We've been consistently doing that in the Calvin Klein business each year since our acquisition. I think with the kind of growth opportunities that we have with the Tommy business, with a high single-digit increase in Europe and a double-digit kind of increase throughout Asia and South America, we should be able to get leverage on that business where we could look at 100 basis point improvement each year going forward in that business.

Just directionally, without a lot of analysis, without taking through all the nuts and bolts, I think that's the way you should think about it.

Speaker 4

Okay. That doesn't assume much of a change in mix between wholesale and retail if we think about that kind of, you know, year, two, three out. Just one other question on the inventory. Mike, you mentioned taking advantage of some kind of, you know, off-cycle manufacturing and production to get some cost savings. Is there any way to estimate what kind of a benefit you're receiving from that and what kind of an offset it is to the natural inflation?

Speaker 1

Yeah. I guess, you know, when you go out there and you start hearing about what people are talking about in price increases, I think we're towards the lower end of the range of 14% to 15%. I couldn't give you much of an, I couldn't get much more definitive than that. We are measuring it, we are watching it, and we are very happy with the way it's going right now. We're getting reduced costs for bringing that product in.

Speaker 0

Look, Jeff, we're probably carrying about 30 days more inventory in between the second and third quarters of this year, all the way through. That's really twofold. As Mike said, to take advantage of the cost benefit of taking some goods earlier, taking advantage of the downtime production. It's also, given the chaos that we believe is in the market, trying to be prudent about making sure we have the goods and the availability of goods for the important back-to-school selling season to have them positioned, take advantage of the sales. I don't think if we didn't have those goods, let's be directly honest, we wouldn't have been able to fuel this 20% sales increase that we had in the second quarter. We're really trying to do it prudently, thoughtfully. We're not taking in high, high fashion goods and taking a risk on them.

We're carrying 30 days of inventory, which we think is maximizing itself in higher sales potential and higher earlier sales in the season at better gross margins. We think we're at a better position at retail in both our own stores and in department stores. I think those things are benefiting us as we go forward. The seasonal buy is no different. We're just accelerating some of the buying. I think it's been thoughtfully done and prudently done. On the second part of the question, is there a second part? I'm sorry. No, I think that's it. That's really, as a summary, how we see with the inventory.

Speaker 4

Oh, Manny, the other part of it was just the retail versus wholesale mix in the Tommy business.

Speaker 0

Thank you, Jim. I don't, I think wholesale continues to grow internationally. Retail continues to grow. Market by market, we look at this, but we don't, I would not foresee us having a significant change in the mix of our international business going forward. It'll stay somewhere in Europe about 30% and overall internationally about 35%. I think we'll continue to invest in that. I think given the growth in markets, I think it'll stay in that general area.

Speaker 4

Okay, thank you very much. Good luck.

Speaker 6

We'll now hear from Robbie Ohms with Bank of America Merrill Lynch.

Speaker 5

Oh, hey, Manny. How are you?

Speaker 0

Good, Robbie.

Speaker 5

Hey, just a few quick follow-up questions. On your North American double-digit comps that you were seeing before the storm, was there a meaningful change in the AUR component to that versus what you were seeing? Meaning, did the price increases kick in, and is that driving comps or supporting comps in your own stores?

Speaker 0

I think across the board, short answer, yes. I think across the board for, as we planned the business, we really planned the business on a retail dollar basis. We haven't planned it on a unit basis, except a little bit in dress shirts, which is such a size-driven business. For the majority of the businesses, we really looked at it from a retail point, a retail dollar point of view. Clearly, AUR is making up a big component of that increase as well as selling additional units in Calvin and Tommy. In our own Heritage businesses, we're selling at higher AURs and actually selling slightly lower units just as we would have planned.

Speaker 5

Do you have a rough number on the AUR benefit? Is the AUR up something in the neighborhood of 10% at the Tommy Hilfiger and Calvin Klein outlet stores, would you say, right now?

Speaker 0

Yeah, Jeff. For the second quarter, as I think Mike was very explicit, we said we're up about 5%, and that is in August, but I don't have an exact amount.

Speaker 5

As you look into next year and you're out of the Timberland sportswear business, are you expecting to pick up that floor space with either Hilfiger or something else you guys do?

Speaker 0

You could be sure that Ken and his team are fighting for every inch of square footage on the floor and trying to take advantage of it with the portfolio brands we have, what would be appropriate for each store to fill that in, be it Tommy at Macy's or Calvin, or be it Izod to take advantage of that as well. I don't, I'm not going to be able to give you much more color on that right now, but in general, yes.

Speaker 5

Great. Thanks a lot, Manny.

Speaker 6

We'll now hear from Erinn Kopelman with Wells Fargo.

Speaker 2

Hey, thanks. Good morning. I wanted to ask about Europe. That's one of the biggest fears we hear from investors. On the Tommy business, the spring orders seem to be holding in pretty well. Maybe talk about when during the last recession before you even owned Tommy, did they see conditions of orders? You said it's typically unlikely in Europe to see cancellations compared to the U.S. Also, thinking about the downside, are there cost-cutting opportunities in that business? If they were a private business during the last recession, did they not cut as much maybe as you guys did as a public company? What's the inventory kind of on the downside? How to manage that? If you could give us the color on managing the downside there, that'd be great.

Speaker 0

You know, Avery, it's really hard to talk about downsides when a business is growing 13% and is just coming off of a sales increase that's probably closer to 30%. It's really hard for me to deal with that. Obviously, the Tommy business, whether the Great Recession of 2009 did very well, a lot of the business that they kind of tightened on was more driven from a credit point of view than it was driven from a cancellation of goods and not wanting to put more goods into the market. I think clearly during that period of time, just like us, and particularly with the Calvin business, it was a tough period of time. Sales were kind of flat for them, but they grew significantly in their market share. As they came out of the recession, they came out very strong.

I think they clearly have been a brand that has weathered the storms as well as anyone, if it's that case. We just don't see that, you know, again, there's no guarantees on life. We just don't see that kind of pressure in Europe at all, particularly with the order book being up 13% and retail comps being up 3% in August. We don't see that kind of pullback of double-digit negative comps that might have happened post the Great Recession in 2009. There obviously are levers to push from an expense point of view, and we would do what was appropriate given the volume. I can tell you the business was an efficiently run business. It didn't have a, it wasn't a privately owned business by entrepreneurs. It didn't have an owner. It was owned by a private equity firm.

Clearly, they were driving the profitability of business as well. I think it's obviously given the operating margin that the business delivered, very efficiently operated business, there would be places to look at from an expense point of view. Marketing would be one area. If sales came down, we would move the percentage of sales with it from a marketing point of view that we would spend. Again, I think we continue to view it as a growth vehicle, not a downside scenario.

Speaker 2

Great. That's very helpful. The other question I had was on Izod for the second half. What is your gross margin guidance assume for margins there? You said you cleared, so you're kind of entering the second half in a good position. Is your guidance assume a better margin performance for Izod in the back half because of maybe entering more cleanly relative to the first half? You know.

Speaker 1

I think we've been pretty clear, just to remind you, Izod's part of the Heritage business. As we look to the fall season, the second half of the year, our gross margins will be more under pressure on the Heritage businesses. When you look at the declines for the second half of the year in operating margins, I would expect the Heritage business and Izod to be under more pressure, obviously, than Calvin or Tommy.

Speaker 0

Yeah, everyone, I think you know we're dealing with 15% cost increases in the second half and 5% in the first half, just to remind you. Clearly, I think gross margin is going to be, it's been planned down, will be down in the second half of the year. I think what you will see is higher AURs there. I think we're very clean in inventory, and I think we have a good opportunity, particularly in the fourth quarter, where a significant amount of the AUR deterioration is on clearance goods, significantly less units in the pipeline. That's the real opportunity to improve the AUR out the doors. That's going to, that we feel we're in an excellent position to capitalize on.

Speaker 2

That's great. Thank you.

Speaker 6

Next, we will hear from Howard Tubin with RBC Capital Markets.

Speaker 3

Thanks, guys. As you continue to pay off debt related to the Tommy Hilfiger acquisition, any thoughts on maybe starting to repurchase some shares, particularly given the valuation of the stock?

Speaker 0

At $67 when somebody just held up a sign, I don't know that the stock is that cheap. I mean, at a moment in time, 10 days ago, it was $51. I guess the short answer is absolutely not. We've been very clear strategically about where we're moving and heading. Delevering the balance sheet continues to be our highest priority. We've paid down $500 million of the debt since acquisition. We plan to pay down another $200 million in the second half of the year. I think strategically, that positions us for future acquisitions. I think clearly, given the business plans and strategy, the most important thing we could do is to pay down the debt. Maybe it wasn't such a short answer, but that is where we're focused, and there's been no change on that.

Speaker 3

Got it. Thanks.

Speaker 6

Next, we'll hear from Eric Abiter with Green Murray.

Speaker 4

Good morning. Congratulations on a really solid quarter.

Speaker 0

Thank you.

Speaker 1

Thanks.

Speaker 4

I want to follow up on that debt question. What is kind of the ideal debt leverage or ratio that you want to have for the company before you start to think of acquisitions or anything other pieces there?

Speaker 0

Yeah, 2 to 2.5 times EBITDA leverage from an EBITDA point of view. I think we're on track to deliver that by next year. If things continue and we deliver and pay down the debt, we're on a track to be in that position to deliver that next year.

Speaker 4

Okay. In terms of the U.S. retail stores, is there any thought of increasing, maybe rolling out some more Calvin or Tommy stores to some tourist areas you're not in right now?

Speaker 0

If you can find some, we will open them. We are aggressive about opening in those locations, but we're also clear about balancing the number of regular-priced stores we have versus outlet stores that we have. I think that's clearly where we would look at it. I think Calvin and Tommy will continue to see good growth in the retail component of the business with a focus on tourist destination areas, lifestyle centers, really where the brands play very strongly. We will continue to make investments in those areas, but in a very balanced way against our wholesale distribution in North America.

Speaker 1

Great. Thank you again. Congratulations on a solid quarter.

Speaker 6

will now hear from Omar Saad with Evercore ISI.

Speaker 4

Hey, guys. Good morning.

Speaker 0

Good morning, Omar.

Speaker 4

A quick question on Izod. Manny, do you think what's going on there, is it brand-specific or product-specific, or do you really think it's more that that consumer is in a tough spot right now? Just help us understand what's structural versus company-specific.

Speaker 0

Look, you could always do, we could always do a better job on product, and we could always do a better job on marketing, all those things. I don't want to say, you know, we can't improve. Obviously, we can. I think realistically, there's also that consumer at the opening price point in department stores, competing against private label, which is clearly an area that's under the most pressure right now. From an economic point of view, when you look at how the consumer is being impacted, clearly, as we go up the distribution channel, we're seeing stronger and stronger sales there. As we work our way down, potentially, that distribution channel to that consumer, that consumer has got less discretionary income and is feeling less secure maybe about their job. I think there's a reality there that we have to play in.

When you run a portfolio company, you get the benefits of running that portfolio company, the strengths of the market against the weaknesses in the market. That's a component of our business that is under more pressure because of that. Clearly, Izod is by far the biggest, the largest Heritage brand we have. It is probably on the main floor, the largest sportswear brand on the main floor. I think it's feeling to some degree the pressures that are going on.

Speaker 4

Got it. Thanks. Manny, I also wanted to ask about accessories. I heard you mention it in your prepared remarks several times, shoes, bags. I know those categories are doing really well right now, watches and other leather goods. Can you talk about Calvin and Tommy? Tommy's more historically a sportswear brand. Calvin has always been big in the jeans and the underwear and the fragrances. What is the accessories opportunity for these brands? Where do you stand on that curve? How do you put that into context relative to the longer-term opportunity?

Speaker 0

Sure. Look, I think it's, look, the accessory area is clearly a big opportunity. In our own stores, both Calvin and Tommy, we do about 10% of the volume in the stores, what I would characterize as in the 10% to 12% of the volume is in that accessory area. Clearly, there's an opportunity to grow that. If you think about the Calvin, if we just focus on North America, a Calvin North American opportunity, we've sized it somewhere around $200 million on a wholesale sales basis that we would hope to accomplish maybe in a five-year period of time. That would be luggage, small leather accessories, and handbags. Today, that business is projected to do less than $20 million. It's off to a very strong start, but it's still a very small business in a very hot category where we think Calvin plays extremely well in.

We think that's a real opportunity for continued growth in the brand at very good exposure for the brand in a category that carries high margins and also high price points that we think is good for the brand overall. Clearly, there's an opportunity there. In Tommy, we think there's also a significant opportunity. In our own North American retail stores, we have a great handbag business that does extremely well. We are just starting to roll that out in North America. From a wholesale point of view, we think there's great opportunities. To remind everyone, we've bought back in 2010 the handbag and accessory license from our licensed partner and brought that in-house in Europe and internationally. Our footwear business is over €100 million in Europe. Our handbag business is about €20 million. Clearly, we think handbags could at least be as big as our European footwear business is.

Both, I think, have a significant growth opportunity at high margins. As a product category, we think those product categories are very brand-enhancing.

Speaker 4

Thanks, Manny. Great job. Good luck.

Speaker 6

As a final reminder, if you would like to ask a question today, please press star one. We will now move on to a question from Carla Casella with JPMorgan.

Speaker 7

Hi. Most of my questions have been answered, but I guess I should clarify. Going forward, now that you will have annualized the Tommy Hilfiger purchase in the next quarter, will we no longer see the acquisition-related charges and the inventory liquidation costs, or should we still see more of that in the coming quarters?

Speaker 0

You will not see the inventory liquidation costs, but again, some of the severance payments, since the accounting requires you to expense those as they are being incurred, you'll continue to see those through the balance of this year.

Speaker 7

Okay. Great. That's all I had.

Speaker 6

We'll take a question from Dave Weiner with Deutsche Bank.

Speaker 4

Oh, yeah. Good morning, and very nice quarter. Just a lot of my questions have been asked, but just a quick one. I don't think you've discussed China at all. Could you just talk a little bit about, I know you've made some recent hires there, and in terms of someone running that business and just kind of what the roadmap is for that business over the next four to six quarters? Thanks.

Speaker 0

Yeah. I guess I'd rather, to take it in context, I'd rather just speak about Asia. I think you're really talking about the Tommy Hilfiger business. We made a major hire for the Tommy business for the CEO of Asia, John Ermittinger. He came out of the GAP and has got a long background, a lot of history, and experience in that region of the world. We think he's going to be terrific to lead our growth throughout Asia there. We'll continue to make investments in that market. China, specifically for us, the brand is underdeveloped there. The brand is very well known there. We have about a $40 to $50 million business today. To remind everyone, it is a business that we receive full royalties for, and we own a 45% interest in the joint venture that operates the business there along with our partners.

We think it's clearly a market. You know, when you talk about China, everyone talks about billions, but it's clearly a market that we could see very accelerated growth in. We'll be looking at it. John is really into it significantly. We'll start to report the results for China beginning in the third quarter of this year. We'll start to update you about what we're seeing in that business as we go forward. On a relative basis, it's still immaterial to us, but could be very material to us for the growth, especially as we look to 2012, 2013, and beyond. That whole, the Tommy business, Asia represents, if you gross up the sales, both where we have licensed and we operate the businesses either on their joint venture or directly, Asia represents about 15% of the brand's total volume.

We think over time, it should represent closer to 30% of the volume over the next five to six years as we grow. It's a significant growth area for us. I think we're building the infrastructure there similar to what we have in Europe and what we have in North America to really take advantage of that growth, both from a logistics point of view, back office, senior management capabilities. We're very happy with the progress we're making and the kind of growth that.

Speaker 6

So far since we've been on the test.

Speaker 0

Great. Thanks, Randy. That's very helpful.

Speaker 1

At this time, we have no further questions in the queue. I'd like to turn the conference back over to today's speakers for any additional or closing remarks.

Speaker 6

Thank you for your attention this morning. We appreciate all your support, and we look forward to reporting to you in November on our third-quarter results. Have a great day. Bye-bye.

Speaker 1

Thank you, sir. That does conclude today's teleconference. We do thank you all for your participation.