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Tough to find anything good about this quarter. Sales look flat-out bad. Bookings are ‘ok’ but in actuality are really only as good as mgmt credibility. Questionable. The biggest issue is cutting SG&A when 90% of cash flow is derived from other Brands’ content.

Report Card: D-  WRC missed on the top line even after setting expectations for a year over year decline. In addition to the expected decline in wholesale results however, which was amplified in Q1, European sales were down(-13%) and Korea (1/3 of Asian business) experienced a sharp sales decline driven by double digit comp decreases. Additional markdowns in the sportswear channel as well as continued macro economic uncertainty in Europe & Korea will offset the expected 2H recovery. Although Underwear bookings (37% of sales) are flat and management does not expect a slowdown in replenishment, it’s pretty tough for us to bank on what management says.  

All in, just about every piece of WRC’s businesses disappointed, and inventories remain very much out of whack (5th consecutive quarter of a negative sales/inventory spread below -10%). SG&A was down 5%, which helped cushion the blow. But we can’t imagine that PVH or RL – whose brand names account for nearly 90% of WRC cash flow, appreciate such meaningful SG&A cuts when the business is down. There’s still plenty of sales and gross margin risk here. We’re not going to fall on our sword and chase it.

What Drove the Miss?

This was largely a revenue miss, (-7%) vs. -1E.

  • Sportswear (52% of sales & 42% of EBIT),  was originally expected to be down $25-30mm in Q1; sales materialized down ~$40mm (-11%) which contributed ~6 points to the 7% sales decline in Q1
  • Underwear (37% of sales & 47% of EBIT), was about flat in the quarter
  • Heritage (11% of sales, 12% EBIT) down 10% largely due to planned reduction In lower margin sales (note: every sale any company ‘walks away from’ is usually one where it is simply undercut in price, or someone else simply has a better value proposition).
  • By Geography, US and EUR were the biggest contributors to sales decline both down 13% (US =40% of sales, EUR 20%)
  • Asia +9% (Korea, ~1/3 of Asia, DD comp decline with sales down 6%)
  • Mexico, Central & South america +3%
  • Canada -2%
  • GM down 112bps due to product cost inflation, costs +7-10% vs prior expectations of +5-7%
  • SG&A down 5% (deleveraged 80bps) resulting in EBIT margin -190bps

WRC: It’s In the Cosmos - WRC SIGMA

 

Deltas in Forward Looking Commentary

 

In order to properly measure performance relative to original expectations, we look at management’s 2012 guidance headed into the quarter as well as the key deltas in Q1 results vs. expectations :

 

 

First Quarter Guidance:

  • 1Q12 revs expected to be down primarily as a result of $25mm reduction in US sportswear sales to off price and value channels MISS: Revenues came in down 7% Driven by increased markdowns as well as weakness in Europe & Korea in addition to decline in off price sales


Full Year Guidance (Former Guidance in Black. Revised in Red):

  • EPS $4.20-$4.45 REDUCED: now $4.000 to $4.25
  • Revenues: +MSD (4-6%) REDUCED: now flat to +2%
  • Gross margin expansion UNCHANGED Continue to expect product costs to be flat YoY
  • First half to be challenged by cost inflation and currency headwinds with stronger 2H12 UNCHANGED
  • Product costs expected to be up 5-7% in 1H, down 7-10% in 2H WORSE: Product costs +7-10% YTD but will be down 7-10% in 2H
  • SG&A as percent of sales expect to increase in 1H12 due to restructuring of the business but improve in 2H UNCHANGED: Will continue to invest in growth initiatives but have levers if sales slow
  • Expect to add nearly 150,000 square feet of new space in 2012 ( have identified 60,000 square feet) REDUCED: now planning 120K square feet
  • Will be skewing new square footage towards ASIA and emerging markets until there are signs of improvement in Europe UNCHANGED

Highlights from the Call:

 

 

Revenues: -7% below original expectation due to Markdowns in US Sportswear, Soft retail comps, Weakness in Europe & Korea

  • Now anticipate these trends to continue through 2012
  • International sales (60% of revs in Q1) down 3%
  • Growth in Asia (+9%) and Latin America (+3%) offset by Europe
  • China led Asia, +30%
  • International growth was offset by Korea (1/3 of Asia) down 6% despite some market share gains
  • Europe: down 13% due to continued macroeconomic stress
  • Growth slowed in Germany, France, UK
  • US: Revenues down 13% primarily due to sportswear  which included $30mm reduction in value channel sales and markdowns in Calvin Klein

Retail: +7%

  • Added 39K feet
  • Comps down 2%
  • Latin American comps +DD
  • Europe comp flat
  • Asia comp down 5%
  • Planning to add 120K of square footage this year

Calvin Klein: (-7%)

  • Growth in underwear & DTC offset by declines in US and European wholesale jeans
  • CK underwear +3% with DD growth in US and Asia
  • Men's +7% with launch of bold
  • Jeans: (-11%) reflecting reduction in value channel sales
  • Women's down DD

Heritage (Speedo)

  • Most revenue decline reflected planned elimination of low margin sales

Chaps:

  • Increased markdowns to clear fall/holiday impacted results
  • Spring summer merchandise sell troughs are more encouraging

Guidance

 

Full year

  • Expect Net revs to be flat to +2% (+2-4% constant currency)
  • Expect EPS to be in the $4.00-$4.45 range

2Q12:

  • Expect 2Q revenues and earnings to be down YoY (less so than first quarter)
  • Planning comps to be down
  • Will continue to invest in growth initiatives which will increase SG&A YoY
  • Products costs up 7-10% will continue to impact the bottom line

2H12:

  • Expect improvement in all key operating metrics
  • Product cost headwind becomes tailwind with costs down 7-10% driving gross margin expansion
  • 2H Regional Growth Expectations:
  • Expect LSD in US in 2H
  • Latin America and Asia expect return to DD in 2H
  • Expecting a decline in Europe in 2H

Q&A:

New Store Productivity:

  • Korea having significant impact on comps and thus overall retail group
  • Additional square footage dependent upon timing and location which is included in overall retail projections

SG&A:

  • Some of the cuts through variable expenses associated with retail particularly in Asia
  • Overall tight cost control in the quarter whether it was new hires, replacements, etc.
  • None of the pullbacks expected to have impacted any long term investments
  • Continue to be levers to reduce SG&A if need be
  • Will be making investments in core strategic plans and initiatives

Gross Margin:

  • Will continue to see FOB costs in 2Q, but in 2H, retail mix and low costs should push GM higher
  • Expect to lift gross margin in 2H considerably

Off Priced sales reduction:

  • Full $30mm took place in 1Q

China:

  • Really pleased with the results in China with revs +30% in the Q over 50% last year
  • Total retail +20%
  • Did see some falloff in foot traffic in particular in Shanghai and Beijing with impacted comp results overall
  • Expect traffic trends to improve
  • Continue to focus on presentation at POS, visual merchandising at a store fixture level, improving service, etc.
  • WRC remains bullish on China- no intent to pull back on new store openings

Korea:

  • Know in the first quarter WRC performed slightly better than competitors and gained market share
  • Saw a significant improvement in march which is expected to continue
  • Believe they are now outperforming the department store competition
  • No new store square footage plans in Korea as of now
  • Roughly $200mm business
  • Major change in the quarter was a DD comp decline

Europe:

  • Continued to grow in Northern Europe, Germany up slightly, UK flat, France up slightly however trends slowed from Q4
  • Spain and Italy continued to be down DD, expect these trends to continue
  • Continue to actively explore new relationships in Europe

Women's CK

  • Had great results on colored denim- sell through better than some of past launches but only 10% of women's business
  • For Fall, have a major replenishment program planned on denim, increasing penetration on denim where in the past WRC has pulled back and focused more on lifestyle

Latin America:

  • Constant currency revs +10%
  • Have been investing in infrastructure to really build up the platform for long term growth
  • Brazil down slightly in the quarter on top of +55% increase in last year
  • Planning Brazil to be up currently for the same year, HSD-LDD growth rate there

Positive wholesale results in 2H:

  • Combination of visibility into bookings (primary reason for driver) as well as product initiatives
  • Large portion of the business is from Chaps which is largely booked already for 2H
  • Expect CK sportswear to decline in 2H in wholesale based on fall bookings and product launches in the US and Europe

Forward bookings

  • Chaps up substantially with bulk of 2H growth through Chaps
  • Seeing increases in golf and outdoor that are looking strong for 2H
  • Underwear is roughly flat (large portion of the business is replenishment)

Replenishment

  • US replenishment is up DD in the US
  • Not seeing any inventory reductions that aren't relative to sales
  • Seeing a slowdown in replenishment in Europe

2H Comparable store sales expectations:

  • Expect low positive comp stores sales in 2H reflecting improvements from tactical initiatives
  • Up against lower comps in 2H11
  • Expect accelerated growth in total retail in 2H through productivity improvement in non comp stores, additional square footage
  • April comps down as expected due to Easter shift
  • Off to an incredibly strong start in May

Retail Operating Margin

  • Current forecast shows GM continues at a 4 wall basis of over 65% near 68%
  • Expecting a 20% contribution margin on a full year basis

Pricing:

  • Expect a slight increase of out the door price in the Fall
  • Quality and value of the product is going to be enhanced
  • Have not been any price increases in the Spring, did take some up in the Fall which carried over and there has not been any resistance to pricing

Costing (Inflation)

  • Costs up 7-10% depending on the category
  • Seeing similar reductions in 2H, expecting costs to be flat YoY
  • Anticipating LSD increases on an annual basis go forward via labor rates, material costs, etc.

Reduction in 2H marketing:

  • Reductions in marketing spend will closely reflect change in revenue growth/declines

Women's marketplace:

  • Great deal more competitors in women's with new entrants frequently
  • Highly fragmented category
  • Need more insight into the consumer which is particularly true in the consumer
  • A piece of 2H spending is on additional customer analytics

M&A Potential:

  • No change in the strategy- believe there is a significant organic growth opportunity
  • Will evaluate opportunities as they arrive but priorities rest in the current business and execution of plan

Share Repurchase:

  • EBITDA approaching $350mm, generating $270-280mm in Free cash
  • Have 189mm authorized to repurchase
  • Using share count of ~43mm for guidance

CK Bridge:

  • Still delivering product throughout 2012 and will not impact Q1 or Q2 and may have slight impact in 2H
  • Not expecting this to have any significant impact on operating results