PVH - Earnings Call - Q3 2012

Transcript

Speaker 5

Please stand by. We are about to begin. This webcast and conference call is being recorded on behalf of PVH Corp. 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 that reflect PVH's view of future events and financial performance as of December 1, 2011. Any such statements are subject to risks and uncertainties indicated from time to time in the company's SEC filings, including those identified in the company's Safe Harbor statement that is part of the earnings press release that is the subject of this webcast and conference call.

These include the company's right to change its strategies, objectives, expectations, and intentions, its need to use significant cash flow to service its debt obligations, its vulnerability to weather, economic conditions, fuel prices, fashion trends, loss of retail accounts, disease epidemics, war and terrorism, availability of raw materials, and other factors, its reliance on the sales of its licensees and retail customers, and its exposure to the behavior of its associates, business partners, and licensors. 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 statements, including, without limitation, any estimate regarding revenue 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 would like to turn the conference over to Chairman and CEO Emanuel Chirico. Please go ahead.

Speaker 2

Thank you, Ravit. Joining me on the call this afternoon is Mike Shaffer, our Chief Financial Officer, Allan Sirkin, our President and Chief Operating Officer, Ken Dwayne, the Head of All Our Wholesale Businesses, and Dana Perlman, our Treasurer and Head of Investor Relations. We're very pleased with our results for the quarter. We beat the top end of our third quarter earnings guidance by $0.08. Given the momentum in our business, we also took up the fourth quarter by raising our full-year guidance by $0.13. Let me start with our Calvin Klein business as I get into each of the individual components. Our Calvin Klein business continued its strong growth momentum. Total revenues in the third quarter for our combined Calvin Klein businesses were up 11%, and operating profits increased 13%.

The Calvin Klein wholesale and retail businesses that we operate directly posted a 13% sales increase in the quarter. The strong performance was driven by our men's wholesale sportswear business, as well as very strong performance in our own retail stores. Our Calvin Klein retail business posted a 12% comp store increase in the quarter. In our licensing segment, royalties were up 8%. The business posted strong revenue growth across all geographic regions. Specifically, North America was up about a little bit more than 7%. Europe was up 8%. Asia sales were up about 18%. Latin America and South America were up just a little bit over 20%. Moving on to some of our big categories and businesses, I'll start with underwear. The Calvin Klein underwear business was ahead about 11% in the quarter, with all regions—Europe, Asia, and the Americas—posting strong sales gains.

This growth was driven by the continued growth of international retail square footage and the extremely strong performance of CK One. CK One's retail results are strong in all markets. In men's, CK One continues to exceed our plans and has helped us to grow our number one share position within U.S. department stores. CK One currently represents over 10% of our annual underwear business. In women's, our Naked Glamour introduction is off to a strong start in all international markets. The supporting marketing campaign has been very well received. New product initiatives alongside breakthrough marketing campaigns have been a hallmark of the Calvin Klein underwear business. This strategy has enabled us to grow our market position globally as the number one intimate apparel dual-gender brand. Moving on to jeans, our global jeans and related businesses were down 2% for the quarter. Relatively soft sales in the U.S.

and Europe were offset by strong business throughout Asia and South America. For the fourth quarter, we expect the jeans business to grow in the mid-single-digit range, driven by new products, particularly our Power Stretch program, which will be a significant initiative for the spring season. Fragrance, our KODI fragrance business had a strong quarter. Just as a reminder, we were up against the Calvin Klein beauty launch in last year's third quarter. Despite that, we posted a 5% increase in revenues. Business was very good across the board with our Euphoria and CK One fragrance continuing their strong growth. Our new fragrance, CK One Shock, launched in the third quarter, and we are seeing very strong sales performance in November. As we look out, we are expecting fourth quarter fragrance revenues to be up over 10%.

Moving to women's apparel in North America, the business was very strong apparel and footwear. Our royalty revenues with our licensees G3 and Jim Law were up over 15% in the quarter. On the apparel side, this strong growth is being fueled by strong selling of women's sportswear and outerwear. In footwear, revenues are running ahead about 20%. In addition, our new handbag and accessory business is off to a very strong start. G3 has seen excellent sell-throughs at both Lord & Taylor and Macy's. Our CK Bridge business in Asia continues to grow dramatically, posting a 40% increase in revenues for the quarter. The growth is being driven by China, Korea, and Hong Kong markets, where we have experienced significant door expansion and double-digit comp store increases. I'm going to move to the Tommy Hilfiger business.

From a brand marketing perspective, we just launched the third chapter in our very successful Meet the Hilfigers campaign as we continue to invest in the brand worldwide. For the fourth quarter, our global marketing spend will be about $5 million higher than last year. Our global holiday campaign will have significant exposure in major markets throughout the United States and Europe. The fourth quarter marketing plan calls for a significant television and cinema presence in all major markets throughout Europe and the United States. Overall, all of the Tommy businesses had a very strong quarter and significantly exceeded our expectations. Total revenues in the quarter were up 17%, and operating earnings increased 27%. We exceeded our revenue guidance by $30 million. The brand's performance in both Europe and North America was particularly strong. Let me start with the European wholesale business.

Before holiday season, we have seen sales growth of about 15% over the prior year. On a product category basis, we're seeing double-digit growth in men's and women's sportswear, denim, and footwear. We are seeing strong growth across Europe for the holiday season. Business in our largest market, Germany, is running ahead 15%. Our second largest market, Spain, is reporting healthy growth of about 5% in a very tough market with our key partner there, El Corte Inglés. Our key growth markets of Italy, France, Russia, and the UK are all growing at over 15%. In the third quarter, moving on to the European business, in the third quarter, comp sales were about 5%. With the exception of Italy and Belgium, all major markets posted positive comp sales. We saw particularly strong sales performance in France, throughout the Scandinavian region, and throughout Eastern Europe.

Moving to North America, retail, we posted strong comps in the third quarter of about 15%. We are seeing strength in all regions of the country with particularly strong performance in geographic areas that cater to international tourists. The Tommy retail results are very consistent with the strong sales performance we are seeing in our Calvin Klein retail business. In our U.S. wholesale business, we saw good performance at Macy's in both men's and women's sportswear. Sales are running significantly ahead of last year, and sell-throughs at retail are above plan. Our average unit retails in the quarter are running up about 7% over the prior year. Moving to our heritage businesses, revenues were down 2% in the quarter, driven by a 7% decline in sportswear sales, which was partially offset by a 4% increase in dress furnishings. Our heritage retail business posted flat comps for the quarter.

Operating earnings for the quarter were down significantly. Driving this decrease was a decline in gross margin rates from the impact of higher product costs, relatively flat sportswear selling prices, and the challenging competitive environment, which has driven more promotional sales than planned. For the fourth quarter, we're planning for these trends to continue and have taken aggressive actions to move inventory and ensure that year-end inventories are very clear. Our fourth quarter guidance fully contemplates all of these actions. Moving out and talking about our trends in the early fourth quarter in November, we're off to a very strong start in November. We saw business accelerate over our strong third quarter performance. In particular, the business trends in Calvin and Tommy continue to outperform our plans. In our U.S.

retail business, comps for our Calvin Klein and our Tommy Hilfiger business, it's for November, ran ahead over 15% against a mid-single-digit comp store plan. Comps for our heritage businesses are running up in the low single digit against a flat plan. Moving to our U.S. wholesale business, both Calvin Klein and Tommy continue to perform ahead of sales plans. We have not seen any significant customer resistance to our increased fall retail selling prices. In dress furnishings, we have also seen excellent success passing along the higher selling prices, and retail prices are up about 8% to 9% in our dress furnishings business. As I said, we continue to see a difficult market for our heritage businesses on the main floor. Moving to Europe, in Europe, our wholesale business, which represents about 70% of our business, continues its strong momentum.

Our spring 2012 order book closed being up about 13% against last year's bookings. We have also booked pre-fall, which is a relatively small season, but is a good indicator for how fall may turn out, and bookings there are running ahead 15%. At retail in November, as the weather turned cold, we saw a significant acceleration in Europe. Our comps in Europe for the month of November are ahead above 15% against a 4% comp store plan. We saw a dramatic improvement in Italy, which was running minus 12% and is now comping in November plus 12%. In Belgium, where we were down 10%, we saw our business go to plus 11%. In Germany, our largest market, where our comps were up low single digits, we've seen our business go to double-digit increases. That trend has been consistent across the board, seeing very strong selling throughout Europe.

It's good to see the brand is being well received by the consumer. As the weather turned, that cold weather apparel really kicked in. Finally, I think we've been prudent about our estimates for the fourth quarter. We feel we've put together projections that we can meet. If trends continue, we could beat as we go forward. We believe that the momentum we see in our Calvin Klein and Tommy Hilfiger businesses will continue to drive our growth and should allow us to continue to outperform our current projections. With that, I'll turn it over to Mike to quantify some of the details. Thanks, Manny. The comments I'm about to make are based on non-GAAP results in our reconciled mock test release. Our revenues for the third quarter were $1.654 billion. Revenues for the quarter were greater than our previous guidance and 9% greater than the prior year.

Driving the higher revenues were strong performances in our Tommy Hilfiger and Calvin Klein businesses. Our Tommy Hilfiger business delivered revenues of approximately $827 million, 17% greater than last year. Driving this increase was a strong wholesale performance internationally, as well as strong retail comps of 15% in North America and 5% in Europe. Also contributing to the Tommy Hilfiger revenue increase was the benefit of approximately $25 million from a weaker U.S. dollar in the quarter versus the prior year. Our Calvin Klein businesses had a strong quarter as well, with revenue increases of 11% fueled by wholesale growth, strong retail comps of 12%, and royalty revenue growth of 8%. Overall, heritage business revenues were down 2%. Within the heritage business, our dress furnishings business posted a 4% revenue increase, while our retail revenues were flat for the prior year.

Our wholesale sportswear business had a difficult quarter with revenue down 7%. Operating income for the third quarter was $227 million, a 5% improvement or $12 million increase over the prior year. Driving the increase was our Tommy Hilfiger and Calvin Klein businesses, which had an earnings increase of 27% and 13% respectively. This was driven in large part by the revenue increases I previously discussed. Also favorably impacting operating income in the Tommy Hilfiger business were operating expense synergies. Our heritage business earnings for the quarter were down 33% versus the prior year. This is a result of the revenue decrease, as well as significantly lower gross margin rates in sportswear and retail. The current promotional environment has made it difficult to pass price increases on for our moderate brands. Inventories for the third quarter were 21.1% greater than the prior year.

Our inventory increase reflects higher product costs and a higher level of core product inventories, primarily in our dress furnishings business. All inventories are on plan and very clean, as we have been aggressive in dealing with our heritage divisions. Moving to our guidance for the year, our revenues are planned at $5.825 to $5.854 billion, an increase of about 26% over last year. Tommy Hilfiger revenues are planned at $2.99 to $3 billion and compares to $1.95 billion for the nine-month period last year. Our Calvin Klein revenues are planned up between 13% and 14%, and heritage revenues are planned to grow about 1% to 2%. We're planning our gross margins down about 120 to 130 basis points as a result of product cost increases. Our expenses are planned to be down 80 to 90 basis points, reflecting an expense reduction in SG&A leverage.

Operating margins are planned at 11.4% to 11.5% of sales. We've raised our earnings per share guidance to $5.23 to $5.25, a 23% increase over the prior year. This increase reflects the $0.08 actual beat over the high end of our quarter three guidance and an increase in quarter four of $0.03 to $0.05. Our tax rate for the full year is estimated to be 29% to 29.5%. We've revised our tax guidance to reflect a higher level of international earnings, which are taxed at a lower rate than our U.S. earnings. For the fourth quarter, we're planning revenues at $1.467 to $1.487 billion, an increase of 5% to 6% over the prior year. Driving this increase is our Tommy Hilfiger business, which is planned at a 7% to 9% increase over the prior year, as well as our Calvin Klein business, which is planned to increase 8% to 10%.

Our heritage brands are expected to be relatively flat in the fourth quarter as compared to the prior year. Overall, we're planning our gross margins down approximately 200 basis points in the fourth quarter as a result of product cost increases. Our expenses are planned to be down approximately 100 basis points, reflecting expense reductions and SG&A leverage. Operating margins are planned down approximately 100 basis points in the fourth quarter. We're projecting fourth quarter earnings per share to be $1.03 to $1.05. That's an increase of 11% to 13% over the prior year. Finally, even with our Tommy Hilfiger India acquisition, we are projecting debt repayments of approximately $165 million during the remainder of 2011, which will bring our total repayments since the Tommy Hilfiger acquisition to approximately $700 million. With that, we'll open it up to questions.

Speaker 5

If anyone would like to ask a question, you may do so by pressing STAR, followed by the number one on your telephone keypad at this time. Please make sure that your mute function is turned off to allow your signal to reach our equipment. Once again, that is STAR, followed by the number one to ask a question. We will go first to Robert Durbell of Barclays Capital.

Speaker 3

Hi, good evening.

Speaker 2

Hey, Bob.

Speaker 3

A couple of questions. First, on the European business, the pickup, do you think it's all weather, or could you just maybe shed a little bit more insight in terms of that acceleration that you've seen since the quarter ended into November?

Speaker 2

I think clearly weather played a role in the acceleration. I think there was pent-up demand for cold weather apparel, and once it turned, the consumer turned on. Bobby, for me to try and give you insights on what's going on in Europe with all the volatility that's going on there is hard. I could just tell you what's going on in our business and the trends we've seen. We've seen a real acceleration against the trends in the third quarter, which weren't particularly bad, but just weren't as strong as we were trending. I think from that perspective, that's the best I could do. Clearly, Northern Europe continues to be stronger overall, both in our wholesale business and Southern Europe, no surprise.

Since our business tends to be skewed more towards Central and Northern Europe, I think it's part of the reason we're not hit as heavily in some of those markets.

Speaker 3

Got it. Manny, can you talk a little bit about the MSRP increases versus AUR increases in all brands and how that's been trending for you? How much of a hit is the heritage pricing challenges that you've had thus far? Is there much more risk in it, or do you think you have it all contained?

Speaker 2

I think we have it all, and I think we've been pretty conservative on the fourth quarter projections, how it's come together. I think we've contemplated it all. It's been a real, on the heritage side, we just haven't had the ability, and you could see that in the third quarter, our gross margins for the heritage overall are down over 400 basis points. That's the pressure it's putting on with relatively flat selling prices up 1% and costs up 15%. That's the kind of pressure we're seeing. Obviously, it's more severe in sportswear since dress shirts is actually doing well. That business is under pressure. On the Calvin and Tommy side and on the dress shirt side, we've really seen little resistance to the price increases. As we've asked for the goods, especially on fashion product, we've been able to have the customer pay up for it.

We've put more into the product. I think we're well positioned from an inventory point of view. I think if weather here in the Northeast cooperates a little better and gets cooler, we could really even see some more acceleration there. As you would imagine, sweaters have been under pressure everywhere. It's a big portion of what holiday is all about. Overall, I'm very happy the way Calvin, Tommy, and dress shirts, the way the consumer is reacting to our price increases.

Speaker 3

Great. Just one last question for Mike. The tax rate is, you know, the update on the tax rate, is that the way to think about it going forward as well?

Speaker 2

Yeah, Bobby, the way I would think about it is, you know, as our international earnings grow, the European business is taxed at a lower tax rate. As that business grows, if it outpaces, we will see continual declines in our tax rate. There's nothing in our rate for this year that I would consider something that wouldn't repeat next year. As we move forward and that European business continues to grow at a faster rate, I do think we can see some improvement in our tax rate.

Speaker 3

Great, thank you very much.

Speaker 5

We will go next to Adrienne Shapira of Goldman Sachs.

Speaker 6

Thank you. Manny, your comments about the holiday weekend are very encouraging, the strength that you're seeing. Could you just maybe walk us through, today we got obviously a lot of sales. The level of promotion and perhaps pull forward, do you think that happened on the weekend? How aggressive were the promotions out there to drive that kind of strength over the Thanksgiving weekend?

Speaker 2

I think in areas it was very promotional and needed to drive it. Clearly, on the main floor in department stores across the U.S., there was a promotional event, and those businesses, between the couponing and the promotions, clearly volume was done, but it was done at a price. On the collections floor, although we were promotional and we were there to do business on a comparative basis year over year, our AURs were up in the high single digits. We were very happy the way how that transacted. That premium consumer, as you worked your way up the distribution channels, clearly, you know, we use Macy's as a benchmark. Their collection business is very strong, as demonstrated in our businesses. I think the more moderate consumer has been under more pressure. I think there's more inventory sitting there as well, be it private label or some other brands.

That competitive pressure that's being applied is putting pressure particularly on the main floor. You get some categories, sweaters and outerwear, with the weather being as warm as it has. I think that has the potential to get promotional as we go forward. We don't have a major exposure there on the outerwear side, but sweaters is big for everyone. We are being cautious about the last part of your question, Adrienne, which was the pull forward. It's hard to determine. I don't have a crystal ball how much people have come out. All I could say is in our own retail stores the last three or four days and on the weekend going in, we didn't see any pullback on Saturday and Sunday. It's a weekday sales, but we haven't seen any real pullback in the first three days of December. It's hard to judge.

Usually, you expect to see some kind of lull in the first two weeks of December. We'll see how that all plays up and then accelerate again. Right now, we're planning for that lull. If it doesn't happen, clearly we have a real opportunity to outperform.

Speaker 6

That's very helpful, Manny. Just kind of continuing on that line of thought, the premium versus moderate, you know, you started the year as we thought about inflation and how that impacts your margins at $150 to $200. It sounds like now at the year end, we're now only down to $120 to $130 basis points for the year. Just help us think through. That's clearly a function of, you know, was heritage pretty much just in line with your expectations and the improvement was Calvin and Tommy? How that improvement kind of progressed through the year? As we look out to next year, as you've been helpful in sort of getting us early on thinking about the pressure, help us think about where the opportunity is on perhaps clawing back some of this margin.

Speaker 2

Sure. I think on 2011, for us, against our plan, heritage underperformed on our ability to raise prices. That's cost us on the gross margin line, and we're anticipating that to continue through the fourth quarter. Calvin and Tommy clearly outperformed on that line, and our dress shirt business has clearly outperformed on that line. The mix of business, with the strength of Calvin, Tommy, and our dress shirt business growing as they are, they've become a bigger portion of our business. That's why you're seeing a skewing on the gross margin line. We're outperforming on the top end and dress shirts and underperforming in heritage. It's a relatively small piece of our business on a percentage side, a big business but small in total as a percentage. That's a story for 2011.

As we look to 2012 overall for the fiscal year, we're looking at flat cost increases, but it's really a tale of two parts of the year. We would expect the pressure on cost to continue into spring. Spring over spring, we're anticipating cost increases of, you know, let's use a number, 10%. When we turn to fall, we were expecting that to reverse itself and be down 8% to 10% overall, cost to be down, to be flattish right now. Could we do better than that depending on what happens to fall? That has to play itself out, and there's a lot of still variables out there. We feel comfortable right now to say that on an annual basis, costs will be flat. The one benefit that we do have is we're getting in our bigger businesses higher selling prices today. That should benefit next year.

In Europe, where we've had an approach to deal with the cost increases as raising retail prices in step, we raised prices in fall, we raised them slightly again in holiday, and we plan to raise them in spring. We have an ability there to improve the gross margin rates as we go forward. That's a positive as I think we go forward. We're feeling pretty good about it. When you think about next year, we feel good about the year in total. I think it'll be for everybody in the industry, when you're looking at earnings growth, it'll be more second half weighted than first half weighted.

Speaker 6

Great, helpful. Last is just a question for Mike on the inventory, the up 21%. Any way maybe you could parse out how much of that is driven by higher product costs versus how much on the dress furnishings, the investments that you're making there to give us a sense of how the confidence in terms of how clean the inventory is and how much is due to higher product costs? Thanks.

Speaker 2

Sure. We've been talking about cost increases up about 15%. I would assume my inventories at cost are up about 14%, 15%. The dress shirt business, the basic business that we carry, we've increased those core, the basic programs somewhere around 5% to 10%.

Speaker 6

Great. Best of luck.

Speaker 2

Thank you.

Speaker 5

We will go next to David Glick of Buckingham Research Group.

Speaker 1

Thank you. I just wanted to take that one step further, Manny, if I could, and just in terms of how to think about next year. You guys have been executing extremely well in a really tough environment. You're starting to get some relief, at least on the cost line in the second half of next year. Is what you outlined for us, do you think it's still reasonable that given what you know today and some of the early signs and bookings in Europe, maybe that could be better than you may have thought a few months ago? Is it still reasonable to think that the typical sort of mid-teens plus earnings growth is possible given what you know today?

Speaker 2

Yeah, I don't think there's anything going on in the business that would change. We're not giving guidance today, but just as a conceptual framework for next year, we've got a lot of work to do to get there. There's nothing that we see today that should in any way change our thinking of our earnings growth for next year, given the business, with the one exception that, just given the volatility in the market, I just have to say is the chaos in the market and the macro environment that goes on. Absent something really chaotic happening, I don't see any reason why we couldn't continue to grow on the trajectory that we've talked about since the Tommy Hilfiger acquisition almost two years ago. I feel good about that.

I think, as I said to the last question, you just have to think about next year very similar to this year from a Tommy Hilfiger point of view. I think it will be back-end weighted from an earnings growth point of view, just given some of those dynamics. I think we can manage some of that with our expenses and how we do other and with the growth that we see in front of us. I think you have to consider that second half growth will be much stronger than first half growth.

Speaker 1

If I could shift to Mike, how much debt do you think you could pay down next year? At what point is your balance sheet really in a position where you guys could think about making another creative acquisition?

Speaker 2

I guess, David, from a debt perspective, we've talked about targeting $300 million per year in terms of paying down our debt. That's been our perspective. I don't think anything's changed there. From a balance sheet point of view, I think we've talked about trying to get between 2 to 2.5 times leverage. I think we will, if the fourth quarter pans out the way we expect it, we should be at somewhere in that range by the end of the fiscal year.

Speaker 1

Okay, great. Thank you very much. Good luck in the holiday quarter.

Speaker 2

Thank you.

Speaker 5

We will go next to Jeff Kleinfelder of Piper Jaffray.

Speaker 1

Yes, thank you, guys. Congratulations on a great performance. A few questions about your comps and historically where they've been tracking. I think you gave us the 5% comp out of Europe. What was Europe specifically in Q1 and Q2 of this year? I think you've been giving us overall total international comp during those first couple of quarters.

Speaker 2

Okay. I don't have it in front of me, Jeff, but directionally, it was double-digit comp store increase. Whatever the international comp was probably added 200 basis points to it. Japan, which is the other piece of it, has been running relatively flat for the year, with the exception of the first quarter, which was the earthquake. Mike is handing me a piece of paper as we speak. This is Europe. Sorry, Mike. Europe was up in the first quarter mid-teens, in the second quarter high teens, and obviously in the third quarter about 6%.

Speaker 1

Okay. What is sort of incorporated into the fourth quarter? Did you mention that?

Speaker 2

Yeah, I think I said specifically about a 4% comp store increase.

Speaker 1

Okay, you're looking at about a sequentially neutral kind of comp trend, more or less, in Europe during the fourth quarter.

Speaker 2

That's what the guidance is built on. The actual trend is 15% for the first five weeks.

Speaker 1

Okay, great. On your marketing, your global marketing clearly has been very effective, this Hilfiger campaign. Do you share any perspective on what you think are the most positively impacted categories within your offering? When you think about by gender and then also by product category, I would imagine that a few of those have really appreciated as a result of the incremental spending. What would those be? Are they similar globally to the, you know, internationally to the U.S.?

Speaker 2

I imagine that by far the biggest growth we've seen is in men's and women's sportswear internationally and domestically in our own stores. Internationally, as we've taken over the footwear business the last two or three years, we've seen very strong growth there. I think the campaign has helped everything. I think operationally, the ability to bring that business in-house has been what's enhanced the growth there more than the marketing campaign. I think to get the European footwear business to go over €100 million is a great performance. Relative to how big the apparel business is, I think it's just growing into what naturally should be a $150 to $200 million business over time. I think those are the big categories that have grown. In the United States, our kids' business continues to be very strong.

I think it's benefiting along with the gender category, the men's and women's sportswear. We've seen very strong growth across the board in Tommy. I can't put that all onto the campaign. I think it's also been great execution by our licensing partners. I think it's been great execution by our operational team. Clearly, the marketing has played a significant role.

Speaker 1

Okay. Thank you. That's helpful. One last point. Next year, we're going to start lapping some of the cost increases. We're going to lap some difficult heritage margins, assuming the global business, Tommy, Calvin Klein, et cetera, continue to grow at these rates. It's the potential for pretty meaningful margin expansion. Can you give us some perspective on what your investment philosophy would be in terms of continuing to step up marketing and any other investments you need to put in place? Is it realistic to think that could go up 100+ basis points, or will you invest into the cycle?

Speaker 2

No, on the heritage side, let me take it in pieces. On the heritage side, that is a business that we've historically operated at margins that have been between 10% and 11%. This year, on a consolidated basis, we'll be under 8%. Clearly, we believe over a 24-month period, we will claw our way back to 10% to 11% operating margins, dress shirts, retail, and wholesale sportswear. I think that that's an opportunity. I think in order to do that, it's really not about making significant investments in those businesses. There's nothing broke in those businesses. Those brands are national brands with strong consumer recognition. These are businesses that we run on a return on investment basis and a cash flow basis. We're able to do that because they represent between 15% and 20% of the total portfolio.

I don't believe significant investments are required there to claw our way back to those operating margins and that strong cash flow. I think on the Tommy and Calvin point of view, we've clearly upped the spend on those brands. Anything that we choose to do will be discretionary in nature and will follow just strong performance in the business. There's no need for significant investments. We are, I'll just say, buying back some licenses, particularly on Tommy. Some of those businesses will require some modest startup cost. Nothing dramatic, you know, on an annual basis, $0.45 a share. Just as we're going through, we like to be transparent so you understand it. As we look at some of these businesses and these growth opportunities that we think are significant, we are making some investments in those businesses also as we go forward.

As we get closer to giving guidance next year, we'll lay that all out to you. The short answer that I've gone on for a bit is nothing in the business will require a dramatically different investment philosophy than what we've had for the last two fiscal years.

Speaker 1

Thank you very much.

Speaker 5

We will go next to Robert Ohmes of Bank of America.

Speaker 3

Oh, thanks. Hey, Manny. How are you?

Speaker 1

I'm fine. How are you, Robby?

Speaker 3

I'm good, thanks. Just two quick follow-up questions. One, follow-up to Jeff's question on heritage. How are you guys thinking about planning that for next year? Is it to get that margin back up over time? Do you think you have to shrink the business, or what do bookings and backlogs and those discussions look like given what is going on in everybody's moderate business apparently right now? The second question is, I was just curious on the European wholesale bookings. Can you give us a sense of how much of it is same door growth versus new door growth, and how much of it is driven by product extensions? Maybe a little more color on the 13% spring, 15% pre-fall numbers that you gave us. Thanks.

Speaker 2

Sure. Robby, let me start with on the heritage side, we're getting out of some businesses that weren't significant moneymakers, particularly the Timberland business, as you know. That's about an $80 million business on an annualized basis. That'll be gone by the end of the fourth quarter or the beginning of the first quarter. Besides that, I think we really would be thinking that the businesses, when you put it all together, will be relatively flat. We're really taking aggressive actions in the fourth quarter to make sure we're going to end clean and not have any inventory issues both in-house or at our customers to really move through that inventory and get it down and marked down, priced appropriately, and take what measures are necessary. I think it's really cleaning up, getting the supply and demand in balance.

Overall, where we usually would talk about 3% to 2% to 4% kind of top-line growth in heritage, I think next year, absolutely take Timberland out of the equation on both sides. I think we would say we'll be more flattish at best, with dress shirts continuing to grow, heritage wholesale probably shrinking a little bit, and our retail business is comping in the low single digits, to give you a sense there. On the Tommy question in Europe, I think maybe the better way to answer, I understand what you're trying to get at, maybe the better way to answer it is more on a country-by-country basis, you know, where we are large. If you look at, if you look for spring, if you look at some of our big markets like Germany, Germany is growing about 10%. That's not significant door expansion, but it is significant.

It's category expansion at some of our major customers where we are double exposing some of our product, where we're able to get larger presentations because of our performance. I wouldn't necessarily call it pure comp as we're getting more square footage, but it's also not new door openings in Germany. That business in Germany is up, the bookings are up about high single digits as we go forward. Market like Spain, which is a tough market, even in that market, the business will be up low single digits. The growth markets for us, which are the UK, which is being planned up about 15% for spring. If you look at the Middle East, Russia, we're planning that up over 20%. France is very strong.

That business is up over 20% as we would be adding doors and growing square footage in a country that has the potential over time to be about 80% of what Germany is. Italy, which is a tough market, we're still growing that market for spring in the high single digits. When you put that all together, that 13% growth is really coming from those markets. I think it will continue to be driven by the strength of the brand, new product categories that we're adding, both bringing back in some licenses and just some new product categories, intimates, underwear, some bodywear as we go forward, and footwear continuing an accessory opportunity to grow. Those developing countries that we really believe are growth for Europe.

Speaker 3

That's great. That's really helpful. Thanks so much, Manny.

Speaker 2

Thank you.

Speaker 5

We will go next to Evan Koppelman of Wells Fargo.

Speaker 6

Thank you. It's Marin Casper in for Evan. A few quick questions. You guys noted that the U.S. wholesale business is above plan in November. Is that based on sell-through rates or actual wholesale revenues? You expect Calvin Klein jeans to be up mid-single digits in Q4 versus down 2% in Q3. How much visibility do you guys have into that? What drove the weakness in Q3?

Speaker 2

Okay. I think let me take the last part of it. I think our licensee there, Wannaco, which does a great job both with underwear and jeans, thoroughly discussed the U.S. issue. A lot of it was timing of sales into some of the special membership club business. There was timing there from that point of view. I don't think it's a surprise to anybody in the U.S. in particular. Denim is just a tough category overall. A lot of the strength you see, as you would expect, we're seeing big increases in our men's and women's sportswear businesses. We're seeing big increases in our tailored clothing businesses. I think when you balance it together, it all makes sense. The jeans business in the third quarter was impacted in the U.S. by timing of shipment and just the soft market. We've got a very close relationship with Wannaco.

We understand some of the new product initiatives that they have going on, what they're up against from last year's fourth quarter. I'm comfortable saying that they're comfortable with planning their overall jeans business at least up in the mid-single digit. I think they might have even been more aggressive on their quarterly call. I'm pretty confident about how that business is being planned out.

Speaker 6

Okay. On the U.S. wholesale business running above plan, is that actual sell-through, or is that sell-through rates or actual wholesale revenues?

Speaker 2

For the most part, that's sell-through, planned selling in, and sell-through, particularly on the sportswear side. In dress shirts, which is really an EDI business, that's a replenishment business. That business that's running ahead is running ahead both on a sales plan basis, and since you fill in product there on an EDI basis, we're also seeing the increases on a wholesale basis as well.

Speaker 6

Okay, thanks. That's helpful.

Speaker 5

We will go next to Howard Tubin of RBC Capital Markets.

Speaker 3

Thanks, guys. How are you thinking about inventory? Where do you think it will come in at the end of the year? How are you thinking about it for next year?

Speaker 2

I think we've talked about the inventory, and Mike laid it out pretty well. I think we've been really trying to manage the inventory and dealing with a lot of the sourcing dynamics around the world, concerned about the supply chain. As I said on the second quarter press release, we've moved off deliveries 30 days across the board and made the decision on categories to carry more inventory on an average basis as we've gone forward, not necessarily buying more goods for the season, but bringing goods in earlier. It's helped us in a lot of ways in order to meet demand at retail that we had goods in. We could accelerate goods and then accelerate back shipment. It's been a positive for us as it's going forward. That wasn't the driving force.

That is about half of the increase that you're seeing each quarter in the second quarter and the third quarter as we've gone forward. I think that's a piece of it. For year-end, I think we're planning our inventory should be more in line with our sales increase. I think it'll be up a couple of points higher than that because we're going to continue to carry some more core dress shirt inventory as we go forward. I think you'll start to see it become more in line with our sales expectations as we go forward.

Speaker 3

That's great. Thanks.

Speaker 5

We will go next to Kate McShane of Citi.

Speaker 6

Hi, thanks. Good afternoon. Manny, I think this is one of the first quarters where we haven't seen that you were increasing your marketing dollars when giving guidance for the following quarter. I just wanted to hear your take on why that may be the case and your view on overall marketing spend for the brand.

Speaker 2

Kate, I wanted to keep consistency. I don't think we talked about it yet, but I think in the press release, it does talk about that we've increased the fourth quarter marketing spend $5 million. We're going to be year over year in the fourth quarter at least $5 million higher than we were last year. That's where we are, and that's up against the pretty substantial spend in Calvin and Tommy last year. We feel good about that, and we think it's going to continue to drive the momentum in the business.

Speaker 6

Okay, great. Sorry about that. I didn't see that. I know one of your customers sounds like they're going to go to EDLP and possibly in 2012. I just wondered if the company had any view or visibility into what that might mean for your business.

Speaker 2

I think in general, I don't think that situation has been totally clarified and clear. I think we're talking about JCPenney, obviously. I think JCPenney is a key customer for us. JCPenney has always been a great partner for us. We believe we're going to try to support JCPenney in every way possible with all of their initiatives and some of the discussions that they had. They've been very clear to us, and we've talked to them pretty dramatically about what's going on, that they haven't totally revealed their marketing plan. They haven't totally laid out the strategy. We've got some indications about where they're heading, and we're digesting that strategy, going to react to it and go forward with it. We're still in the early stages, and I don't think that's been totally laid out yet.

As soon as it is, I think we'll react to it, and I think we'll support them in every way possible.

Speaker 6

Okay, great. Thank you. My last question is just you had mentioned on buying back some of the Tommy Hilfiger licenses. I just wondered which ones they were and what is the longer-term strategy with regards to buying back licenses.

Speaker 2

I think pretty consistent to what we've said before. We bought back India in the third quarter. In the second quarter, at the end of the second quarter, we closed the transaction on China and brought that license back. We set up both of those as joint ventures where we own 45% and 50% of the Indian business and 45% of the China business. We also brought back footwear last year. We continue to look at potential opportunities. Nothing has been finalized, but there are geographic markets that might make sense to continue that kind of joint venture strategy. One would be a portion of South America, particularly as we go forward. The tailored area is something that we're very focused on, given our dress shirt, neckwear expertise. Over time, that is something that we may want to really look at.

Those are the types of areas we think philosophically, geographic areas as we take them back in. If there are areas where we currently have operations, we like this model of being involved on a joint venture basis where we can get local expertise to really get us through the day, understand, set up the business, and then buy the balance of the business at some future date that could be four to six years out. We think that's a way to avoid a lot of significant startup costs, but also participate in the roll-up and the growth as we go forward.

Speaker 6

Okay, great. Thank you.

Speaker 5

We will go next to David Weiner of Deutsche Bank.

Speaker 4

Great, thanks. Good afternoon. Just two quick questions. The first on the euro, obviously been very volatile and weak. My question is two-parter: have you made any changes into your planning assumptions for your euro rate? Also, if you could just remind us what the sensitivity is to earnings. As the euro moves, how does it impact earnings? Second question, maybe a quick update on your planning and how you're coming along in planning for your business in China, Tommy business in China. Thanks.

Speaker 2

I'll do the euro. We plan the euro for the fourth quarter at about $1.35. Where we are through this, through today, there's very limited risk on the euro as we look for the full year. The way to think about the exposure, what we talked about was a full year was each move in the euro, about one each penny was worth about $0.02 of EPS, $2 million or so of EBIT. Having based on where we are today, midway through December, there's just very limited risk on this year. As we look forward and as we plan next year, we'll obviously have to regauge where we are and how we plan that. Just to remind that we do hedge our purchases on all our product, on European purchases. We go 12 months out. We do a rolling 12 months.

We have already hedged through next December at this point.

Speaker 4

Gotcha. Okay. Thanks.

Speaker 2

On China, we believe China is a significant growth opportunity for Tommy. To put it into perspective, the business today is about a $45 million, $50 million business in China. If you compare that to Calvin, Calvin is well over $200 million today. There's real opportunity for Tommy. The brand is well known. The brand has got strong demand at the consumer level. We are basically operating a model where we operate a number of stores through the joint venture directly, but the vast majority are distributors, franchisees, key players that know the geography, open the stores, buy from us on a wholesale basis, set it up. It's a great model for us. We think it's one that we can move quickly with to grow. To remind everyone, we're not 100% owners there of the operations, but we collect, obviously, a full royalty on the sales from China business.

We're looking for that to grow in the neighborhood of about 20% a year. That could be conservative if the business really takes off. Right now, that's how we're planning as we go forward. It's a premium price positioning in China, just like the rest of the world. It's not a luxury price position, which I think positions us very well with the consumer there and has the opportunity to be a big business.

Speaker 4

Great. Thank you.

Speaker 5

We will go next to Joseph Parkhill of Morgan Stanley.

Speaker 0

Hi. I just wanted to ask a quick question about your guidance for gross margin decline of 200 basis points in 4Q. That's an improvement from this quarter. I was wondering if you could just give us some insight as to what's driving the sequential improvement and how to think about that in the first half of next year.

Speaker 2

It's basically mixed. It's just a significantly, it's a higher quarter for our higher margin businesses and the licensing business, which has more of a consistent gross margin flow. Overall, it's just a mix-derived benefit. Yeah, basically, we're planning at the same levels business by business. As Mike said, licensing just becomes a bigger percentage of the business. Third quarter is our biggest shipping quarter by far.

Speaker 0

Got it. Thank you. I know you said November sales accelerated throughout the quarter, though. Did you see volatility, particularly in Europe, around the different news items coming out and the market volatility?

Speaker 2

Yes. We saw volatility. You know, started with the U.S. debt ceiling talks in August. It got crazier towards the beginning of September. It's hard to measure how much was weather and how much was volatility in the world. They had one of the warmest September, early October periods in Europe in a long, long time. That clearly played a dramatic impact on the business.

Speaker 0

Okay, thank you.

Speaker 5

This does conclude today's Q&A session. I will turn the call back to our moderators for any additional or closing remarks.

Speaker 2

Okay. Thank you, everyone. We'd like to wish everyone a happy and healthy holiday season and the best in the new year. Have a great day. We'll talk to you on our fourth quarter call in 2012. Have a great day. Bye.

Speaker 5

This does conclude today's conference call. We thank you for your participation and have a wonderful day.