Guess?, Inc. (GES) Earnings Call Transcript & Summary

The Vice President on Kimberly Greenberger's team covering branded apparel and footwear, department stores and specialty retailers here at Morgan Stanley. We are super pleased to host Guess? management with us today. Guess? is a global lifestyle brand with a broad product offering for men's, women's and kids. It was founded in 1981. Its denim, apparel and accessories are now offered in more than 100 countries worldwide through its retail and wholesale channels, generating nearly $3 billion in revenue in its fiscal year 2020. Today, we are joined by Carlos Alberini, Guess?' CEO; and Katie Anderson, Guess?' CFO. Carlos has been -- has been Guess? CEO since February of 2019. Before that, Carlos was Guess?' COO and President from 2000 to 2010, Co-CEO of Restoration Hardware from 2010 to 2014 and Chairman and CEO of Lucky Brands from 2014 to 2019. Katie Anderson joined Guess?' senior leadership team in December of 2019. She previously served as CFO at a number of consumer companies, including California Pizza Kitchen and Sprinkles Cupcakes. Before that, she worked as an investment banker at Citi and Moelis. Welcome, Carlos and Katie, and thank you so much for being here with us today.

Thank you very much. Thank you for having us.

Thank you.

Great. So we'll start today's session in a question-and-answer style fireside chat, where we will explore Guess?' business model and long-term strategies, then we'll dive into the latest quarterly results if we have some time. Finally, before we begin, I need to remind everyone that for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. So with that, let's kick off the session.

Carlos, turning to you. I would love to start the session by learning a little bit more about the 5-year strategic plan you laid out at your Investor Day back in 2019. Can you just talk through some of the key initiatives and how the pandemic has changed or accelerated some of those plans?

Yes. Thank you, Alex. Again, thank you for having us. Well, so I came back to the company and as you said, in February of 2019 as CEO. And after being -- I had left in 2010. And I -- when I came back, I was very impressed with some of the great progress that the company had made, especially international growth and expanding into countries where we have had some limited presence but not the kind of presence that we do now. And there have been a lot of improvements on IMU, on some margin opportunities. But then I also saw that there were significant opportunities to really improve operating activities and functions. And among those, there were some challenges with distribution centers network opportunities for sourcing improvement. There were many things on the optimization of the global footprint that we saw as big opportunities for the company to improve margins. And so we crafted a strategy that it took us about 9 months, and we then share that, as you said, in December of 2019. And the strategy was primarily about operating margin expansion. We thought that we could find a way to take the margin, which for that year, was about 5.6% for the company to about a 10% within a 5-year planning horizon. And we are very, very happy because we were able to accelerate a lot of those initiatives. And through the crisis, with the pandemic and everything that has happened, we are now looking at an operating margin for this year in excess of 11%. And we have talked about accelerating and increasing this operating margin goal to 12% by fiscal year 2024, which is not next year but the following year. So very excited about that. And the great thing about this is everything that happened to create this opportunity. Now it's not just the numbers, but all the things that we have done that I think have changed and transformed our business model in a very significant way. We have dealt with all those operating initiatives that I mentioned, including distribution, including things to eliminate redundancies and really design a business that operates a lot more efficiently. We are also operating with less asset capital in terms of inventories. We are turning inventories faster. We have done a lot to really create a business that operates with a lower capital base. And as a result, we are seeing an opportunity for return on invested capital to exceed 30% by that year, fiscal year 2024. And -- but as the pandemic hit, we were very quick to really look at other opportunities. And one big initiative was something that we call the elevation of the brand. And we put that in place, and that consisted of elevating the quality, styling and a big focus on sustainability. We believe in climate change. We think that we have to make a stand for that as a brand, and we have been doing a lot on that. We also included one big initiative, which is the intro, the launch of a global line of product. And this is something that we have thought about for a very long time. Our business is now very concentrated outside the U.S. We -- over 70% of our revenues are generated outside of the U.S. It used to be a completely opposite type of business model. But having 2 global lines as -- or 2 lines as we used to have, our product was something that offers significant opportunities for efficiency. So we launched this one global line for all the product categories that we represent across the board, and that has been a huge success story for us. We have been able to reduce SKU intensity by about 40% as a result of this transformation. The brand is now represented consistently across all markets. And the ultimate test that this is working really well for us is that the bestsellers are bestsellers everywhere in the world. And we are truly a global company. We are in 100 countries. So you can imagine the spread of markets and be represented consistently and be able to tie all that one global line to the marketing campaigns that we do with imagery, everything that we do on the website. Just -- it has been a huge catalyst for the transformation of the company. We -- another big area that was already part of our initiatives back then, but again, the COVID crisis really helped us to accelerate this, is digital. The digital transformation of the company has been very deep. We have invested in new technology. We are working with probably the best company in this space to provide solutions for both e-commerce and also data analysis, and we are in the middle of that implementation. We started with Europe with respect to data analytics, and we are very happy with the suite that we are using from this provider. And the idea is to fully roll it out by the end of this year in Europe and then bring it to North America next year. And our business results show very good return from this investment. So we are very excited. We think that we are in the inflection point here and we feel that the company now can focus more on the growth opportunities that we have, which are many. And that's where we're going next. We have a plan that we think is -- that can deliver significant value creation here for our shareholders, stakeholders. And we feel that we have the team to do it. So very exciting times for Guess?.

Great. That's a super helpful overview. And I just wanted to drill down into one piece in particular, and that was just expanding the product categories and diversifying the offering. Could you just talk about how you guys have done that, what categories you've maybe mix shifted into more versus others? And then just drilling down on that global line, just for those that aren't as familiar, what was it before versus now in terms of what all of that meant? And how are people reacting to it? Have you grown market share? What do the consumers think about these changes?

Yes. Great. Yes, great question. Well, so with respect to the product categories, I think we are -- we have a very unique brand because I think that there are a lot of brands that are very good at certain product categories. I feel that we have something that is really special because we do participate and have big businesses in multiple product categories. So really, we are more a lifestyle brand. And I think that, that gives us an opportunity to go into different markets with very robust offerings. And so far, these businesses have become kind of like significant businesses on their own right. So of course, everybody knows Guess? as a denim brand. But denim, just -- it's a relatively small moderate part of our business. It's in the teens. So it's not a major part of our business model but it's very critical, and we see it as a huge opportunity for growth. We are going through a denim cycle, and we see this as a big opportunity for us to continue to grow in that category. But if I told you that we are very strong in dresses. We have a big dress business, not only in Guess? but also in our -- under our Marciano brand. We have a big business in outerwear. This was another surprise for me coming back to the company, just at the time that I was with Guess? before. We had -- we did some business in outerwear, but it was a very limited selection and it was a very small part of the business. And today, this is a very big business. We do a great business. We offer amazing product. The price points are very attractive for the quality that we offer. And we think -- and of course, it's a high ticket item. So we could build a very big business relatively quickly in terms of unit growth. Then just with the pandemic, we -- at that time, we didn't have any participation in the athleisure business. And we decided to introduce our own interpretation of that type of product. And it has been an incredible success. It went from 0, representing about 7% or 8% of our business. This is primarily in Europe but we also do big business in North America as well but not the 7% or 8%. But we believe that the brand has its unique DNA and that has been fully implemented in how we integrate that product category. We see a lot of opportunity for this. We have opened stores that are just activewear stores. And this is not just women's, but also men's and even if it extends to the kids' line. So we feel that the quality of what we present and offer is also pretty high level. The pricing is absolutely aligned with the perceived value of that product and with that quality. And we see the growth and the acceptance on the customer side. We are also looking at -- like our big customer groups. We have 3 customer groups. One is what we call the heritage customer, business, the customer has grown with the brand, very familiar with guests, and they are very loyal. They shop our -- and engage with the brand very frequently. And they represent over 40% of our business, so very, very significant. There we have a new customer, another one of my findings coming back that I thought was remarkable, is we do a big business with the millennial customer base. They have big purchasing power. They represent also over 40% of our business. And we think that this customer is going through this new times in life, having kids. Just -- they are pursuing their careers aggressively at -- and making more money. And all this, we think, it bodes very well for our offering, and they like the brand, and they are very engaged, and the younger customer. And the third customer group is this Gen Z generation, which we think is very, very powerful. We have a completely different set of strategies to address this market. And we do different events with the younger generation. We feel that this is also a big opportunity for the future that represent about 18% of our business, between 17% and 18% for the latest 12 months in North America. And we feel that there is a lot more to do. Obviously, with the pandemic, we had to slow down on some of these events, but we are back. This is anchored on collaborations with key celebrities, of people in the music business, And we have been very successful in creating capsules of products to represent those artists and then going to market with a type of offering. It's always very limited in quantities. The idea is that is always exclusive, unique and difficult to get. So then there is a sense of urgency to get it every time they can. So overall, I think that the product is in the right place. I, in all my years with the brand, I think that this is the best representation of product, completely aligned with the DNA of the brand. And the quality is just incredible. We keep elevating. This is part of what we are trying to do, and we are doing it across the board. We have -- I didn't mention handbags, which is an incredible category for us. It's a very big business, probably one of the bigger businesses in Europe that you will find from any brand. And we think that we deserve it because it's incredible product, great quality. The prices are very attractive and the newness that we insert in the category is probably among the best even compared to luxury. So we are very excited about all these opportunities to grow. Just -- we believe in elevating the experience as well. So it's not just about elevating the product, but elevating the entire -- all the points of contact that we may have with the customer should be elevated. So I'll stop there. Maybe I forgot a few things.

No, that's a great overview, a perfect answer. I think one thing that maybe we could get in a little bit more detail around, is you talked about opening stores as one thing that you guys have done. And I believe that optimizing your real estate footprint was a key strategic priority back in that Investor Day a couple of years ago. So could you just give us a quick overview of the current channels of distribution, how they differ domestically versus internationally? And then also, what were your hopes for repositioning it? And kind of what inning are you guys in now?

Yes. So let me start and then probably Katie can jump in with some of the -- what we have been doing this year and so forth and what we are looking at in the future. But we have -- this is another characteristic of the company that I think is very unique and a very good one. And it's the business model we have. We play in different channels. But I think that the Guess? ecosystem is highly synergistic. A lot of the things that -- we have a business in wholesale that represents about 35% of our revenue base. We have a very strong retail business, represents about half of our revenue base. Our e-com business, the whole digital is -- represents about 12% and the remaining is licensing. So now of course, the distribution and the channel penetration varies by the market. But we have a strong wholesale business in Europe, for example, and it's comprised of thousands of accounts. It's somewhat different than the wholesale business here in North America where we only have a few accounts -- partners that we do big business with. But overall, when you look at retail, it has always been a very key part of our business model. We think that this gives us an opportunity to represent the brand in the most effective way to represent the brand because we are lifestyle. So -- and normally, when you think about retailers that would buy the product from our brand at wholesale, they will probably merchandise by merchandise classification as opposed to having a full look or outfit, which we can do in our own stores. So being able to really display and show and do that visual merchandising for the customer that they can see what the total look and lifestyle of the Guess? brand is, is very important to us. In addition, we consider the stores as a great tool for customer acquisition. We think that, that is the best way to get customers that really consider the brand very relevant for them, that they can -- we can really provide a level of service that is superior. Our people in the stores are the best ambassadors for the Guess? brand. So we feel that all that is important. We have about 1,600 stores globally. So it's a big presence. As I mentioned, we are in about 100 countries. We -- when you take this size or diversity of stores, about 600 of them are owned and operated or licensed or franchisees. The remaining 1,000-plus are stores that we own, operate and we run directly in different parts of the world. We have closed about 170 stores during the last 21 months. And we have renegotiated about 400 leases. So you can imagine, when you put all of it together, this has been a major catalyst of value creation for us, just lowering the occupancy costs across the board because, obviously, the stores that we close are those that were unprofitable or did not belong with the brand and they have been very accretive to our profitability model. So we are very happy where we are. We have opportunities in the future. And I think Katie is going to touch on those.

Yes, sure. So let me just frame what we've done this year. So we're planning to open 80 to 90 stores this year. We've opened 55 so far in the first 9 months. And a lot of these are pop-up stores. So we have our core Guess? and factory stores, but we also have specialty concepts like accessories, kids, our Gen Z concept, which is Guess? Originals; our Marciano, which is like our higher-end concept. And these are shorter leases. So they help us maintain flexibility. And we see opportunity. We have white space across the world. There's a lot of markets where we have a presence, but we could have more stores. Germany is an example of that, even in the U.S. where we used to be in some markets, we feel like we have a lot of opportunities to open stores. At the same time this year, we'll close around 60 underperforming stores. And we've reengineered the economics of the stores so we can maintain profitability going forward because, as Carlos mentioned, we closed a lot of stores this year to really boost the profitability at the store level, and we're going to maintain that going forward. Also, in connection with the elevation of the brand, we're embarking on a remodel program. We have some done. We'll be kind of remodeling into next year about 100 -- or sorry, 630 stores. And that, combined with the new stores means that about 80% of our portfolio will be upgraded by next year.

Great. That's a super fulsome answer on both of your ends. I think we've covered kind of the store piece, but it sounds like the broader customer experience is a clear focus for you guys. And a big piece of that is omnichannel capabilities, so much even more than just the store. So can you just discuss what your omnichannel strategy is longer term and what investments you've already made versus what are some of the larger ones maybe you have coming up and how we should think about that?

Yes, yes. Thank you, Alex. We -- this is -- as I mentioned before, this has been a major initiative for us. Just -- we started with something that we call customer centricity. And the idea was to really place the customer at the center of everything we did. And obviously, when we started looking at what type of experience we were offering at the time and how well equipped we were to be able to really become a leader in this space, we realized that we have to make some significant investments to retool the whole infrastructure. And we started with the websites. Just the whole platform was a homegrown platform that really had been growing over the years, but really didn't have the type of flexibility and speed to be able to really service the customer with the expectations that you would have in today's world. So we decided to really select a sales force to really help us with this. We have implemented the entire platform in all the European countries, and we are done with this, and it has been an incredible project. We did it in record time. The sales force is using and trying to "use us" because of how this -- the project was very complex because you're talking about in excess of 30 countries that you have to do with different languages, and you can imagine how challenging that was, but the team did it in record time. I'm very proud of that. And then we did the same thing here in North America. So the platform is now operational in every market where we do business in North America and Europe. And we have seen improved service levels. We have seen a much faster navigation opportunity. We have seen better conversion levels. We are just leveraging this. Now we are using the platform to do better merchandising within the site. So a lot of these things are contributing to improving our results. But we are not done because the feeling here is, yes, we have these tools, but now we can use data that can work in a much more effective way, about 6 million people in our databases, the CRM, and we have a lot of data from those members to be able to contact them. And this, in many cases, we have phone numbers. So we can use -- do SMS marketing and some other techniques. In many cases, we have home addresses. So we can use this for direct mail marketing. And as a matter of fact, we disclosed the other day that, for the fourth quarter, we are planning to mail out 1.2 million pieces of direct mail. So just let me show you a couple of examples of the type of mail pieces that we are doing. It's just a very, very, I think, remarkable, beautiful images. I think we have incredible photography, and it gives us an opportunity to go into those key product categories that we were talking about before. So the key here is we will continue to invest to really become best in class when it comes to analyzing customer data, capturing data from the customers, doing the best job that we can on personalized marketing, analyzing those results so then we can continue to get better in doing clienteling. So that's kind of like where we are. The investments -- the heavy investments have already been made for most of this. So we don't see this requiring a significant CapEx investment in the near future but we will continue to consider this type of technology and innovation as high priorities for our company.

Great. So you touched on the e-commerce business a little bit there. Can you just remind us how large it is? And then also kind of as penetration increases and the world becomes a little bit more digital, what -- how does that impact your profitability? Like does that have a different profitability profile than your historical business? Or how should we think about that?

Katie, do you want to take that one?

I'll take this one, Alex. Yes. So e-commerce represented about 20% of our direct-to-consumer sales over the last 12 months. And we see a lot of momentum in this business. In the third quarter, we grew 15% to last year, 37% on a 2-year basis. And this is with a much less promotional environment in this business. So that obviously impacts the top line but also is helping us to expand gross margins. We see this as a big opportunity. We think we can reach 23% penetration of direct-to-consumer in this business going forward. And we've done a lot of work over the last few years with reworking the economics. And this business is accretive to our total company margins. So we're happy to see it grow. And we also think we have more runway to help the middle of the P&L here as well, both through more operational efficiencies but also sales leverage as the business continues to grow.

Great. So maybe before we dive into the more quarterly-oriented questions, we've only got a few minutes left here, is there anything that you think kind of the investor community doesn't understand about the overall Guess? story right now as you've kind of laid out? Or I mean, put differently, is there anything that's kind of misunderstood or undervalued as a piece of the story overall that you'd like to talk about?

Yes, Alex, I think I touched on most of this. But I think the size and opportunity that the company has, I think, is probably somewhat underappreciated today. We feel that we are in an inflection point. We have talked about a $2.8 billion business by fiscal year '24, which is 2 years from now, with a 12% operating margin. But this is because of the business model that we have now will deliver over 30% return on invested capital. I'm not sure that people see the power of that -- the power of the free cash flow generation that the company has today, the power of having truly a global brand. There aren't that many that you can count today that have the kind of presence that we have. And the power of the lifestyle aspects of the brand. And when you put all that together and you look at the customer opportunity, having a machine that works well, that can generate significant profitability, I think, is an opportunity that I'm not sure that is completely understood today. We -- probably the most important thing that we have here is an incredible team that is highly motivated, and they believe in where we are going here in a big way. And I think that if you talk to anybody, both in stores, in our teams at corporate, in our distribution centers, everybody will be able to tell you about the significant opportunities that we have because we believe in communication, and we believe that this is the job of our team. So we are excited. We hope that people would understand that, this year, because we have reduced promotions, and because we have increased prices, and because we have been cleansing our footprint, it has become a baseline year. We have suppressed demand artificially because of all these things that we have done. So our top line maybe is not growing at the pace that some others may be -- But looking forward, we have a much more value-creating type of business model.

That's great insight. I think as we maybe turn a bit more to the quarter, one thing that's, of course, on everyone's mind right now is every company's inventory position given all the supply chain disruption. And it really looks like over the past couple of years, you guys have made a real effort to improve your overall position by diversifying vendors, cutting SKUs. And this is probably why you guys had a pretty healthy balance as you exited the quarter. Could you talk a little bit about your inventory position heading into holiday? How are your lead times compared to normal? And what kind of strategy are you guys using to mitigate some of these bigger issues in the environment?

Yes. Great. Yes, of course, our inventory is at the center of a lot of our discussions right now as it is probably for every company that is in our space. We have done well. I think the team has done a great job in being very, very proactive on this and not waiting for things to happen. We are all dealing with the same challenges in the industry. But just, if you look at a typical delay, just the people probably have experienced delays of anywhere between 6 weeks and more, we have been around 4 weeks, and we feel that, that has been a pretty good -- I mean, of course, there are some exceptions to this on both sides. But one thing that we have been doing is making sure that we order as early as we can, so then we can protect the business. Having the inventory, we think -- we thought was very critical. We -- when you think about our wholesale business, for example, it's an order business. So obviously, we know exactly what is that -- our customers have ordered. And we have to order and try to anticipate as much as possible to be able to service that business. We have a big business in Europe, and our business is doing very well. And part of the reason why it's doing very well is because we have been able to service those customers with inventory when they need it. The same thing is true here in America, by the way. So we have -- we ended the quarter with about an inventory that was significantly higher than last year, but last year we were in the middle of the pandemic, and it's slightly lower than it was 2 years ago. But it's completely aligned with the kind of sales expectations that we have for the fourth quarter. So we have the inventory to do the business during the holiday season, and we have a lot more inventory in transit. About 25% of our inventory was in transit at the end of the quarter. And a lot of that inventory was ordered and is being moved to service our business at wholesale, which happens primarily -- shipped primarily after year-end or during -- starting in January of next year. So we feel that we are in a very good place. With respect to what we do, just looking forward, we have been doing everything from the sourcing and trying to really source closer to the distribution points. So for Europe, we are just starting to do more business and sourcing in places like Tunisia and Turkey. For America, we are doing more business and sourcing with Guatemala and Mexico. And these are operations that are very familiar to us because we have used them in the past. And overall, yes, things are challenging. We have embedded all the numbers that this has impacted into our outlook. And we feel that we have everything under control. And frankly, now we're starting to see this more as an opportunity because, at some point, we think that things are going to abate, and we'll be able to really increase profitability further if we can offset some of those excess costs that are embedded in our profitability today.

All right. Well, that's a helpful answer. We are actually running up on time now. So Carlos, Katie, thank you so much for joining us today. It's been super helpful.

Thank you. Thank you. Alex, thank you for having us again. I just -- we are excited. We think that -- as I said before, inflection point for Guess? and a great team, ready to really move forward. Paul and I are very proud of our teams and I want to say -- use this medium to be able to thank them because they are the ones making it happen. Thank you.

Great. Well, thank you, and thanks, everyone, for joining.

Thanks so much.

Thank you, Alex.