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The Magic Behind the Hot Streak at Guess

Guess has gone from sliding to skyrocketing.<BR><BR>

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LOS ANGELES — Guess has gone from sliding to skyrocketing.

In 2001, Guess’s earnings and revenues were deteriorating, its wholesale division was unprofitable, and the brand had lost fashion relevance. Today, Guess has transformed itself into a retail-focused company with 706 directly owned and franchised stores worldwide, generating $58.8 million in net earnings and $936 million in revenues in 2005. The company is on track to achieve revenues in excess of $1.1 billion this year. The company will disclose third-quarter results Wednesday.

In the past three years, Guess has experienced numerous financial highlights, among them, 11 straight quarters of double-digit revenue gains; earnings that have risen at least 25 percent the last 12 quarters; 14 consecutive quarters of same-store sales growth, and net profits that nearly doubled last year after quadrupling the year before.

The brand that flew high in the Eighties and early Nineties on the back of a series of famously sexy “Guess Girls” now covers a multibrand portfolio that includes Guess, Guess by Marciano, Marciano, Guess Accessories and a brand-new retail format that will roll out in North America next year called G by Guess.

The first G by Guess store will debut in the first half of 2007. Prices will be between Guess stores and the factory outlets, and the new brand is targeted to compete with retailers such as Hollister, said Paul Marciano, co-chairman and co-chief executive officer of Guess Inc. He said it will be geared to “young, sexy women,” ages 18 to 30. “It’s not as edgy as Guess,” added Maurice Marciano, co-chairman and co-chief executive officer. By the end of 2007, some 30 G by Guess stores are slated to open. Some will be in prime locations and others in “B” malls. G by Guess denim will retail between $44 and $69, whereas Guess denim goes for around $100.

These days, Guess has become a Wall Street darling. Guess shares hit a 52-week (and all-time) high of $57.20 on Oct. 13. Back in January 2003, the stock was trading between $3 and $4.

How did the 25-year-old company dramatically turn around its ailing fortunes?

The Marcianos, along with Carlos Alberini, president and chief operating officer, sat down with WWD at company headquarters here last week to talk about the company’s transformation.

“Basically, it was our own analysis of the market [in 2000] and what was the future of our brand,” said Maurice Marciano. “At the time, I announced that not only for us but for any lifestyle brand, there will be no alternative [over the next five to 10 years] than to control your own distribution. For us, we decided to focus on setting up our retail stores to be completely in control of our own distribution.”

As a brand, Guess was competing with vertical retailers like Abercrombie & Fitch, said Marciano. “But we were fighting with them through our wholesale customers. It’s like going in an arena fighting a very fierce competitor but with one hand behind my back,” he said. Since he couldn’t control what was happening on the selling floor of the department stores — where there was excessive promotional activity, markdowns, returns and charge-backs — he said he was at a distinct disadvantage.

“That’s why I said we couldn’t continue like that and had to have our own retail distribution. It was painful for the first two and a half years,” said Maurice Marciano, reflecting on the company’s poor financial performance during 2001 and 2002.

In 2001, Guess’s earnings fell 62 percent to $6.2 million, while net revenues declined 13 percent to $677.6 million. (The firm’s wholesale division lost $11.2 million on sales of $260 million.) In 2002, the company spilled red ink for the first time, reporting an $11.3 million loss on net revenues of $583.1 million. (The wholesale division lost $44.9 million on revenues of $159.6 million.)

“We owned 80 percent of the stock at that time, so we felt the pain,” added Paul Marciano.

“If it [the business model] didn’t change to retail, we wouldn’t have been in business today,” admitted Maurice Marciano.

Not only did Guess wish to control its own destiny, but it needed to go back to its fashion roots. At the time, the brand was situated in the status jeans areas of department stores, competing with Polo Jeans, CK Jeans, Tommy Jeans and DKNY Jeans.

“All of them kept bringing the prices down. Everything was about price point, price point, price point. That was the main trigger. Basically, I didn’t like what I was doing anymore. I didn’t enjoy it. I had no passion for the product anymore. I was not proud of what I had out there anymore,” said Maurice Marciano.

He said the company made the decision to “forget about all the promotions. This is not what we’re about. We’re about quality of product and creativity. So we raised our prices, and sure enough, in our stores, there was absolutely no resistance. This is really who our customer is. But by the same token, we lost a lot of business at the wholesale level. We were not able to open retail stores fast enough to compensate. But we knew from the beginning, that this was a tough decision, it would be painful, but it was the right thing to do for the longevity of the brand.

“Of course now, a few years later, with the full strategy implemented, we are completely refocused on the identity of the brand, to our roots and who we are,” said Maurice Marciano. “Now our retail business has grown tremendously, and for the first time this year, we are passing the $1 billion mark. Now, in hindsight, for everybody, we’re like a visionary. At the time, we were the dumbest people on earth. Now we’re a more exclusive brand. Not only are the price points higher, but our markdown rate is lower.”

The lion’s share of Guess’s wholesale business is done with Federated Department Stores through its Bloomingdale’s and Macy’s divisions.

“We’re having a good season with them,” said Frank Doroff, senior executive vice president and general merchandise manager for ready-to-wear at Bloomingdale’s. “They’re beating their plan, and they’re having a spectacular month.” Guess is a key resource for Bloomingdale’s, and the stores are selling denim, sweaters and “going-out” tops really well.

In 2005, the company reported a 98.9 percent increase in profitability with net earnings of $58.8 million, compared with net earnings of $29.6 million in 2004. Total net revenue for 2005 jumped 28.4 percent to $936.1 million from $729.3 million in 2004.

Increased volume of sales in its high-margin European business, comparable store sales growth, a strong accessories presentation, retail store expansion and an improved product mix all contributed to the company’s favorable results last year.

As the company shifted its emphasis, the wholesale business shrank to 15.9 percent of its North American net revenues in 2006, from 46.6 percent in 2000. Retail now accounts for 84.1 percent of the firm’s North American net revenue, up from 53.4 percent in 2000.

Maurice Marciano said it’s a ratio he’s happy to keep, provided the wholesale business remains healthy. “For us, it’s very simple: We will support and sustain the wholesale business as long as it’s a good, feasible, sustainable business,” he said. The North American wholesale business returned to profitability last year, earning $7.3 million on revenues of $121 million.

Going forward, Guess executives believe the company’s own retail operations will grow at a faster rate than wholesale, and international expansion is where the spotlight is now.

As a result of its move into retailing, Guess beefed up its employee ranks considerably. Previously, the company employed two buyers, one for men’s and one for women’s. Today, it has between 80 and 100 people on its buying, planning and allocation teams. In addition, the company now has about 8,000 employees, up from 4,100 at the close of 2000.

Alberini said the company is in “an excellent inventory position” right now, and since the business heads have gross margin accountability, they don’t have excess inventory. “There’s an incentive to keep businesses in line with the plan,” he said. In fact, both the wholesale and retail businesses provide virtually no excess product for the company’s factory outlets, and Guess, like other brands, makes products specifically for them, he said. “The outlets are very profitable,” he said.

Of the company’s 330 units in North America, 102 are outlets, 193 are Guess stores, 20 are Marciano stores and 15 are Guess Accessory units. There are presently 376 stores internationally. By yearend, the company plans to have 750 stores operating globally, and by the end of 2007, Guess projects 893 stores.

Perhaps the brand’s most significant move was the acquisition in January 2005 of its European jeanswear business, which has given it a significant platform from which to expand its European operations. The majority of Guess’ European business is presently done through wholesale accounts in Italy, France and Spain. The company sees major opportunities for expansion in the United Kingdom, Germany, Scandinavia and Eastern Europe. “Our name was underexposed, and we were underpenetrated [internationally],” said Alberini.

A snapshot of Guess’s current operation reveals that North American business accounts for 76.7 percent, or $792 million in revenues and $89.2 million in earnings; Europe generates 18 percent, or $185.3 million in revenues and $36 million in earnings, and global licensing brings in 5.2 percent, or $55 million in revenues and $45.1 million in earnings. Operating margins are much higher on the European business: 19.4 percent versus 11.3 percent on the North American business.

In Europe, Guess opened 34 stores in 2005, and by the end of 2006 will have opened another 33 new stores. Most are licensed, although 21 of the firm’s 376 international stores are owned by Guess, in cities such as Paris, Rome, Milan, Florence, London and Amsterdam. “We’ll be opportunistic again,” said Paul Marciano, adding that store openings are set for Spain, Paris and Rome.

Asia represents another growth opportunity for Guess. The company has a Hong Kong office, where it shows both the U.S. and European product. The company currently has nine doors in China, 12 doors in South Korea and one door in Hong Kong. “China will continue to be a challenging market. It’s not that easy to penetrate,” said Alberini. On its own, Guess plans to open four stores by February in Shanghai, Beijing, Macao and Hong Kong. Guess recently acquired its South Korean license, effective at the end of 2006. In India, it opened 10 licensed stores in 2005 and 15 this year.

The company has also entered a joint venture in Mexico with Grupo Axo, which has worked with brands such as Coach, DKNY and Tommy Hilfiger in the Mexican market. The plan is to open three stores and 15 shop-in-shops by yearend. By the end of 2008, Guess expects to have 15 freestanding stores and 75 shop-in-shops in Mexico.

One of the strategies is to align the North American and European lines, so 50 percent of the “core” merchandise is exactly the same, and the rest is geared to specific markets. The move, which becomes effective in fall 2007, is expected to give the company better leverage and a reduction in development costs. Currently, Guess develops a full line for North America and a full line for Europe.

“We see a big opportunity to bring these two lines together. There is a core assortment that can satisfy the needs of both markets,” said Alberini.

He explained that the company has two full teams of designers in the U.S. and Europe. He said that if, for example, each team is producing 700 styles, it would be much more efficient if they could produce 1,000 together. Another advantage is sourcing. Guess opened an office in Hong Kong a year and a half ago, “and it’s getting close to break-even in pushing volume through the office. The goal is to move more volume through that office. The opportunities for cost reductions are pretty significant,” he added.

Alberini noted that in the European market, the brand is positioned at a much higher level than the U.S. since the sensitivity to pricing is less in Europe than in the U.S. Distribution in Europe is more fragmented and in more specialty stores, whereas in the U.S., Guess is distributed mainly in department stores. In the U.S., Guess has successfully pushed the prices up at its own retail stores as well as in department stores, said Alberini.

Much of Guess’s success over the past few years can be attributed to its numerous licensees, and that business is targeted for substantial growth. Last year, the company signed a footwear license with Mark Fisher, former president, product development and sourcing for Nine West Group. The first Guess Footwear line launched for fall 2005, and the footwear business has already doubled in the first year. Paul Marciano said next year it plans to test Guess Footwear stores, opening one store each in North America, Italy and China. If they are successful, it could become a 200-store chain, he said.

Licensed accessory-only stores have also been opening at a fast clip. Guess Accessories opened 51 stores in 2005 and is on plan to open 40 more this year and another 50 in 2007. Paul Marciano attributed the global store expansion to the strength of the Guess brand and its relationships with its licensees. For example, Guess has had its Guess handbag license with Signal Products for 16 years and its watch license with Callanen for 23 years. Guess handbags are experiencing 20 percent to 30 percent increases a year, while Guess watches are showing 20 percent annual increases, said Paul Marciano.

The Marciano brand, a contemporary brand launched in 2004, is another growth vehicle for the company. Priced about 40 percent higher and more sophisticated than the Guess product, the Marciano brand is only available in Marciano and Guess stores. Currently, there are 20 Marciano stores in North America, and 10 are expected to open next year. “We would like to open 100 stores in North America over the next four years,” said Paul Marciano.

Analysts have given high marks to Guess’s strategies.

“It’s an incredible turnaround,” said Eric Beder, analyst with Brean Murray, Carret & Co. “This company was almost dead in 2001. It wasn’t fashion-relevant. They brought in experienced management to add discipline elements to the company.” He said the company’s increases are “pretty sustainable going forward.”

“Guess becomes rediscovered every four or five years. It’s a company that went from a totally merchant-driven organization” to putting in more systems, according to Beder. He said a unified European and U.S. line won’t happen overnight, but eventually they’ll be able to maximize the gains of owning both divisions. “It’s a long-term proposition. This way they can be more fashion-relevant.”

Christine Chen, an analyst with Pacific Growth Equities and a Guess stockholder, said, “The talent of the Marcianos is their ability to create sex appeal and demand.” She said it was a key move to hire Alberini to focus on the operations side of the business “He’s focused on all the stuff that isn’t the merchandise. He’s very focused on making the business more efficient. He complements what the Marcianos are doing. That’s why their margins are expanding hugely as well.”

Meantime, the Marcianos aren’t taking their newfound success for granted. “I always try and anticipate the unknown,” said Paul Marciano. “When things go well, that’s when you worry.”

“Complacency is a killer,” added Maurice Marciano.

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