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Luxottica Group SpA (NYSE:LUX)

Q2 2014 Results Earnings Conference Call

July 24, 2014 12:30 PM ET

Executives

Alessandra Senici - Group IR Director

Andrea Guerra - Chief Executive Officer

Enrico Cavatorta - CFO & GM Central Corporate Functions

Analysts

Bassel Choughari- Berenberg

Daniel Hofkin - William Blair & Company

Cedric Lecasble - Raymond James

Domenico Ghilotti - Equita

Francesca Di Pasquantonio - Deutsche Bank

Operator

Good afternoon. This is the Chorus Call Conference Operator. Welcome and thank you for joining the Luxottica Group Second Quarter 2014 Results Conference Call. As a reminder, all participants are in listen-only mode. After the presentation there will be an opportunity to ask a question. (Operator Instructions).

At this time, I would like to turn the conference over to Ms. Alessandra Senici, Group Investor Relations Director of Luxottica. Please go ahead, madam.

Alessandra Senici

Thank you, operator. Good afternoon and thank you for joining us today. Here with me are Andrea Guerra and Enrico Cavatorta.

Before we begin, first, I have a couple of quick items to cover. As a reminder, a slide presentation which we will informally follow during this call is available for download from our website under the reading Investor Relations, Presentation section.

This presentation includes certain non-IFRS financial information within the meaning of Regulation G under the U.S. Securities Exchange Act. Further information, including additional information required by Regulation G is also available in Luxottica Group’s press release relating to its results for the second quarter of 2014, which may be found on our website, under the reading Investor Relation, Press Releases section. This conference call is being recorded and is also available via audio webcast from our website.

During the course of today’s call, certain projection or other forward-looking statements may be made regarding Luxottica Group future financial performance or future event. We wish to caution you that such projection or statements are based upon current information and expectation and actual results may differ materially from those projected in the forward-looking statement. You can read more about such forward-looking statement on page two of the slide presentation.

We also refer you to our filings with the SEC and Italian Securities Authorities. These filings contain additional information concerning factors that could cause actual results to differ materially from those contained in management projection or forward-looking statements.

We will begin with our CEO, Andrea Guerra.

Andrea Guerra

Thanks Alessandra. Welcome to all of you. Welcome to our quarter two business review. We’re pretty happy of our performance. As soon as some external factors whether in United States moved out of the picture, we’ve been able to go back to our usual rhythm. Q2 is a very important period for us and we have been able to perform. Not everything in the outside world was favorable.

One, currencies, yet today currencies are a little bit an issue, Enrico will enter into some more details, but things are very improving. Things are improving because of our actions; prices changes in many different countries and on the other side because looking forward, the comparison phase will ease during either during the next couple of quarters.

Two, sunshine in summer in Europe, especially Mediterranean Europe has not been very strong so far and in any case we have been able to obtain the performance that we had in mind. American consumer is not really today attracted by consumer goods but frequently much more by higher tickets, cars, houses. In any case, we have been able to reach our performance.

We have done well in North America, plus 4%. Considering the fact that in the period we have constantly closed 30 something stores in series and we are constantly moving on and continuing our conversion in Pearle from corporate to franchising another 41 stores we were able to move to franchising in this quarter. So 4% percent is really an outstanding result for the period; in Europe, plus 8%; high teens in New Europe; high single-digit in Continental Europe and slightly positive in Mediterranean Europe.

Great performance in emerging markets of over 20% with some great peaks in our important markets Brazil, China, India, Turkey. China is moving and moving fast, China is growing for us. We have been working hard for the last six years, educating, building, investing and our last six to eight quarters in China have been constantly accelerating, sun, wholesale, optical retail all have had in this period outstanding performance.

I would say that China has discovered finally our industry and we are happy to see the results of all our efforts. Profitability jumped to our peak in the quarter, happy to see this. Free cash flow was another record, well above the EUR 300 million. So I think that all in all considering Q2 being an important quarter for us. We are happy of the performance. Enrico?

Enrico Cavatorta

Thank you, Andrea. Let me say that it’s easy to compare the quarter like this. We had a very strong growth all across market and geographies and also profitability result that were full in line with our estimated with our expectations.

We have achieved a 7% constant ForEx growth in the quarter and this come on top of the growth that was close to 10% last year in the same quarter. So the two year performance is really amazing. 5 percentage points have been the negative effect coming from our currency, you will see then a little bit more in detail in a minute. So on a reported basis we had grown 2%.

By division, particularly impressive again is the growth in our wholesale business double-digit and let me recall that last year wholesale delivered 14% growth. So, again tier performance is really outstanding.

Retail better than Q1, we were at comps at 4.8%, we were able to turn LensCrafters back into the positive field plus 1%. As Sunglass Hut was again basically in the double-digit area. China still in the double-digit area and even Australia with a mid-single digit growth 2.5% was better than first quarter.

So, all across there was an improving in our sales results in market individual. Now looking a little bit at the currency more in detail in those graphs that you see on slide number 7 is explanation why we believe in the second half of the year as we are expecting a much lower negative effect from the currency.

Those are the four major currencies for our group. So the U.S. dollar, the Australian dollar, the Brazilian reals and Chinese renminbi. And their exchange rate against the Euro and you see here the exchange, the average exchange rate per quarter that we had last year what we had this year in Q1 and Q2. And basically if the exchange rate remain in the second half at the same level of to-date you will see what is going to be the effect.

So just few numbers the euro dollar basically we're expecting a much lower devaluation of the dollar in Q3 and neutral effect in Q4. And also for the Brazilian real where we had 19% and 12% devaluation respectively in Q1 and Q2. Basically in the second half should be a neutral effect.

And for the Australian dollar where we have 17% and 10% devaluation in first half we should even expect a positive effect during the second half. All of these translates in our P&L. In terms of sales impact in first half we had lost 5 percentage points. And that translated into loss of 50 bps half of the percentage point in terms of operating margin.

In these value exceeded our expectation for the second half is much, much lower. We expect to lose 1 percentage points and basically should be a breakeven effect of just a minor loss 10 bps in our operating income. So bringing the average of the year to around 3% in sales anticipates on operating margin.

So unless there is another sudden shake in currencies that we won’t expect now but if again the currencies remaining on today's level against the euro these are the effects that you might expect for the second half for the total year. So a much better result than what we’ve seen in the first half.

Looking at our margin as Andrea mentioned we have achieved record profitability and record cash flow. In terms of profitability we had the growth at the Group level of 80 basis points on a reported basis, 110 on a constant currency. And again let me recall last year in the second quarter we had a growth of 120 bps of constant currency. So we are in two years 2.5 percentage point higher margin for the group at constant currency. But this I think is an impressive growth.

And again wholesale clearly outperformed retail 110 bps here and 50 bps in retail that in any case we see as a very outstanding result if you consider that basically most of our retail is in North America where we had the lowest growth of all. So 50 bps improvement at constant ForEx in retail really was the effect of a full year cost control and the good management.

Net margins we are at the record all time high with 11.4, in the famous magic year 2007 that was used to be the record in the second quarter (inaudible) we achieved 10.7 so we are well above that effect. And clearly we’re on track or even better than our expectation towards our end of the year results.

Looking at the cash, 320 million, again we never had such results in our history in the quarter, 320, so basically we were able to maintain our net debt at the same level that we have at the end of March, slightly above EUR1.4 billion. Despite the fact that we are paid 308 million of dividend during the quarter, so 320 million was the biggest figure.

Let me say, we had some positive non-recurring effect in the tax area and coming from stock option exercise. That non-recurring or unusually higher positive effect was in the region of EUR50 I'm and to EUR60 million. So in any case with EUR270 million to EUR260 million these would have been a record quarter initiatives. Working capital control again has been one of the key drivers. We were able to reduce our DSO quite significantly five days. We were up one day last year. So it has been a partially helps by the last year has been a weak quarter for DSO.

While in days outstanding 17 days, last year were flat. Basically this come after already a very good quarter that we had in Q1, you might recall, we had 17 days also in Q1. So the longer weighted efficiency and reduction and inventory this year is only [currently]. On payable we are close to the limit, so we have are steadily improving yet another day to the metrics.

Finally, our rule of thumb was fully achieve, a custom product for the first half is our first half, not second quarter only, first half growth we were up 6%; 11% we were up on operating income and 13% net income. So fully in line with our payments wrote down that is proving to be valid also this year.

Andrea Guerra

Fiscal revenue roadmap, so basically in all regions we see an acceleration in Q2, beginning with wholesale North America historical TEUs at journey, at journey which is well balanced between brands, businesses (inaudible) and channels update. So happy to see continuing and really being able to plan for other quarters and years at this kind of speed.

Western Europe showed steady growth also considering the very high base of Q2 2013 plus 10%, so happy to have been able to keep up with our positive performance in Western Europe.

Emerging markets, already talked about it, nothing else to be added, happy to see a plus 21% on a plus 23% of a year ago. So, we had a little bit of a slower start. We added clearly that probably we had exaggerated with some shipments at the end of 2013. As soon as inventory was sold, immediately our rhythm is back to normal standard.

Retail North America, as Enrico was saying accelerated. So we are happy with that and the same thing we could say about Optical Australia; we are fully in line with what we wanted to achieve this year and emerging markets like-for-like is growing pretty fast in retail as well.

When we look to North America specifically, obviously we are back with the wholesale and three years cumulative growth has been above the 40%. And I think that there is a long way to go.

Sunglass Hut great momentum, another 8.5%. And I would say that this is a good mix between units and value and even in a world today of pretty bigger discounting and promotions in United States, our full line, full price Sunglass Hut achieved great performance in Q2.

LensCrafters back to positive as Enrico said, led by strong customer conversion rate and we will go through some more details soon.

Sunglass Hut, many things are proving right, the business model, the stores, the experience. I would say that it's a great business model, we know how to manage it, consumers are responding. One thing to point out is the great performance of the online in-store combined performance. This has now been managed basically only in North America in the last 15, 16 months, has been well thought, well planned, well executed, basically in plus 10% like for like, in Q2 is an important achievement and one of the great bricks of this performance, of this achievement is the ability that we've been able to build in this customer, consumer experience between digital and store base.

LensCrafters, encouraging. A lot of signs which are the numbers, but even are the KPIs that allow us to be encouraged. Four months of positive comps with pretty regular weeks and number of plans move to execution. The single point to be highlighted is people's motivation engagement. Happy to see so many people proud to be in LensCrafters in the last survey we did in May, plus 10% in happiness and engagement.

A lot of things happening, a lot of plans happening and I think that we will be constantly even better. We talked about euro; we talked about some Mediterranean Europe and nothing else to be added.

Regarding emerging markets, some numbers, obviously these are also some shifts in shipments as we said from Q1 to Q2. Turkey has been great. We were implementing SAP last year; China another plus 28%; India plus 24%; and the big Brazil up plus 17%. So really happy to see how Luxottica in the last six years thought about these countries, wish to become domestic, invested in adapting business models, brands, people, culture, infrastructure, and we are achieving the results we wished.

We are in Q3. I think that the positive momentum is continuing, portfolio is good, our Luxottica, there is the full month of buying season in [comp] is doing pretty well. And I would say that we started well. Obviously we wish a very long Mediterranean now. So let's hope that summer in all sense is around us with us with also some days of holidays soon. Thank you and waiting for your questions.

Question-and-Answer Session

Operator

Excuse me. This is the chorus call conference operator. We will now begin the question-and-answer session. (Operator Instructions).The first question is from Bassel Choughari of Berenberg. Please go ahead.

Bassel Choughari- Berenberg

Hello. Couple of questions from me please, just first for me is on China, maybe you can share with us (inaudible) best performing brands there, is it more luxury or was it more the Ray-Ban and Oakley? The second question is on FX. Now you seem to be looking for an impact on net sales of minus 1% in the second half of the year. I believe this is going to be excluding old pricing measures you’ve been taking so next should we expect no negative impact on the group top-line? And the last one is maybe on southern Europe maybe if you can share a couple of numbers or maybe Italy, Spain, and Portugal please. Thank you.

Andrea Guerra

So China I would say obviously as usual Ray-Ban is the captain the category captain, but it’s well balanced between Vogue,Ray-Ban and Oakley and I would say some of the luxury brands which are more popular today in China, so moving from Burberry to Prada I would say Tiffany, Dolce I would say these are the strong leadersI would say the strong leaders of our Chinese growth. Regarding effects, Enrico?

Enrico Cavatorta

Regarding effect you are exactly right the 1% impact on sales is simply the difference between the current ForEx and constant ForEx. So excluding the impact on price increases that we have our performance. Let me again repeat, we are not predicting any particular change rate for the second half simply those estimates are based on the side of exchange rate remainsat today's level for the next five months.

Operator

Your next question is from Daniel Hofkin of William Blair & Company. Please go ahead.

Daniel Hofkin - William Blair & Company

Good evening. Just first question is regarding sunglasses side and if I can reading this directly looks like the North America was almost as strong as global all together 8.5% versus 10% am I reading that right?

Andrea Guerra

Yes, you are.

Daniel Hofkin - William Blair & Company

Okay. And let's say either where you want to take that is on the transaction count side of that, is transaction count less than half of the total like for like increase at this point were price mixes greater than half?

Enrico Cavatorta

Do you wanted immediate answer or you got other questions?

Daniel Hofkin - William Blair & Company

I have a couple of other question. So that would be one and I guess within the transaction count is your footfall still kind of like we're seeing in general with mall traffic, where a foot traffic is generally flat or down, but you're seeing higher conversion rate. I just want to understand what the dynamic is in there effects continuing,my next question is just a quick question regarding the Chanel license the press release refers to renewability through 2020 just to be clear is that I mean that’s something that could continue to be renewed presumably beyond that as well right I mean in other words it’s a long standing license for you?

Andrea Guerra

So regarding Sunglass Hut U.S. I would say that 65% to 70 % is units and remaining are brand mix and polarize mix. In terms of traffic, obviously Q2 improved compared to Q1 but I would say yet today especially more traffic in the U.S. is not exactly a winning point. And on the other side as all retailers in United States traffic is little bit down conversion is extremely up this is also as we all know a different way of American consumers behavior so browsing much more home and going much more direct and having a destination in their purchases. So traffic improved, it was likely down and obviously conversion looking to the numbers are pretty high.

Chanel renewal this is the one to third time renewal and agreement with Chanel we used to have a three years agreement, now we moved it to six we are happy about that obviously it’s a long-term partnership it’s a long-term relationship but at the end of the six years we are all obliged to go back and renegotiate not much terms and conditions because that does not, the issue (inaudible) but the business plan, the exclusivity and everything we need to do to preserve that wonderful brand.

Daniel Hofkin - William Blair & Company

Okay. So theoretically it could be, some to have what was just renegotiated now, it could be renegotiated at 2020 or whenever that would be again theoretically okay?

Andrea Guerra

Sure.

Daniel Hofkin - William Blair & Company

And then lastly on LensCrafters, can you just discuss what your expectations are let's say the next 6, 12 months, would you expect some of your continuous value initiatives, targeted initiatives to begin to show a greater impact during that timeframe?

Andrea Guerra

I'm sure, today I can say that I'm sure. Obviously then we will go month by month. We have been doing a pretty bold move right now. Now it's back to school, as you all know it's a pretty promotional period. We have good deals in store but we failed the time has come to go with a very strong eye care message, doctor is in with a number of things around it.

But we're now not out with and shouting a message of 50% of lenses, but talking about the roots of the brand, talking about eye care, talking about service, talking about our great doctors and initial feedback is good.

Daniel Hofkin - William Blair & Company

Great. Best of luck in the third quarter.

Andrea Guerra

Thank you.

Operator

The next question is from Cedric Lecasble of Raymond James. Please go ahead.

Cedric Lecasble - Raymond James

Yes, good evening. I have two questions actually regarding the wholesale business. We have had some volatility in the emerging markets to explain that to Q1 that it was question of saving. Are you sure today as we came back for some time to let's say just 20% growth that you already had last year or is it subject to potential volatility in the coming quarters, could you help us with that?

And the second question is on Southern Europe, we have had a lot of volatility here, how do you explain beyond the compression basis, do you expect any improvement in the coming quarters? Thank you.

Andrea Guerra

So I wouldn't talk about volatility in emerging markets. I mean if we go back probably five years we always had an average of between 15% and 25% positive. And we were pretty direct and transparent in telling you that probably some people had that achievement of 1 million unit, 2 million unit, $50 million. So I think that we over shaped a little bit in Q4, but I mean we're back and I don't see volatility.

Southern Europe is a different story so obviously this period is not just linked to macro, but is also linked to sand and I would say and I mean anyone living in Southern Europe could testify that we are not saying too much sand. And in any case we have been able to achieve in Western Europe that plus 4% in Europe plus 8% and barely positive in Mediterranean Europe on top of last time or a year ago.

Cedric Lecasble - Raymond James

Thank you.

Andrea Guerra

Thank you.

Operator

Your next question is a follow up from Bassel Choughari of Berenberg. Please go head.

Bassel Choughari - Berenberg

Hello. Yes, just another one for me. You often talk about online. Can you please share a couple of numbers on the online performance for the quarter please?

Andrea Guerra

The numbers in online has been stellar. So, I would say between the different brands, between plus 40 and plus 50. And moving on with the plans that we have talked about yet small numbers, a little bit like China some years ago, so I’d probably say that they’re not yet visible in our big numbers. But if we continue with this pace, probably in 2015 and for sure 2016, online will become a big part of our growth opportunities.

Bassel Choughari - Berenberg

Thank you. And just one last question please on the pricing. Have you passed on all the price increases you wanted to and do you expect more price increases this year? And maybe you can give us an idea of the impact on the top-line of these measures. Thank you.

Andrea Guerra

Everything we have to do is there. If we look at constant exchange rates and we look at the growth of wholesale, I would say that this impacted for at least 20% of our growth and this effect will be a little bit bigger in Q3 and Q4 and Q1 of next year.

Bassel Choughari - Berenberg

Thank you very much.

Andrea Guerra

Pleasure.

Operator

The next question is from Domenico Ghilotti of Equita. Please go ahead.

Domenico Ghilotti - Equita

Good afternoon. My first question is on your store footprint. We have seen in the second quarter basically same-store sales exceeding constant exchange growth in retail, so you're probably pruning some stores. Should we expect this trend to continue also in the second half?

Andrea Guerra

So, as I said at the beginning, this is a normal thing we're doing especially on two banners. One banner is not closing stores, but it's moving corporate stores to franchising on our strategy for that. And we still have at least another 20-30 store per quarter in the next probably year. In terms of [seers], it's a constant search of a good balance. So we have and also depending on what [seers] is doing in terms of the store base, so closing between 40 and 50 stores a year and this was a particularly strong quarter of closure for [seers]. So, I would expect a 50 stores per year to be closed in the [seers] in the next couple of years out of 800, I think 850.

Domenico Ghilotti - Equita

Okay, thank you. Just and then I have a question on the financial cost adjusted verification on explanation of the increasing financial cost compared to this quarter and previous year in spite of declining debt?

Enrico Cavatorta

Yes, our financial charge is basically stable because most of our debt is fixed cost, I would say 90% of the debt is fixed cost because during the last couple of years we took advantage of the declining interest rate in order to fix also our debt. Our debt, our gross debt is stable, because we are -- is now basically composed by the three bonds that we have outside and one remaining bank facility. And the balance is increased cash. And today the return of our cash on hand is clearly minimal, just little bit above zero due to the level of interest rate and due to the fact that our financial policy is quite prudent in terms of use of cash. So that’s why you could expect to see the financial charges to remain pretty stable.

Domenico Ghilotti - Equita

So the real question is how do you want to use the cash in hand?

Enrico Cavatorta

Yes, exactly. And there are a number of options that the Board is considering and we consider in the near future.

Domenico Ghilotti - Equita

Okay, thank you.

Operator

The next question is from Francesca Di Pasquantonio of Deutsche Bank. Please go ahead.

Francesca Di Pasquantonio - Deutsche Bank

Yes hi, good evening. I have two questions please the first is on the LensCrafters initiative whether you are expecting any impact on profitability; let’s have your thoughts around that. And the second is to understand a little bit better what is driven the improvement in the wholesale margin which was quite impressive? Thank you.

Andrea Guerra

Regarding LensCrafters if we back to in even when we were not happy of the top-line performance, we have been always able to increase profitability by 20, 30 bps every quarter. So I would say that is the expectation we have today. It’s not the problem of profitability with LensCrafters, it’s an issue of top line; this is where we are focused. And there will be things we are doing that we will continue to do even in terms of allowing all our consumer that love to get LensCrafters experience to come in and be happy of the price they find. So we will have some shift in pricing as we said as we testing and as we are moving on.

So, we will continue also to be more efficient and therefore balancing some lower unit price with some good actions on the labor, on efficiency of our labs on many different things in the LensCrafters’s portfolio and by and profit or loss.

And therefore, I think that we can keep on moving profitability of LensCrafters up by 20 bps, 30 bps a year. But the real thing is we want to go back with outline which is not just positive, but it's in the region of the three months.

Wholesale margins, I would say is scale. I would say is the mix between units and price. And the third aspect is we are also comparing this Q2 with an industrial efficiency which is much higher compared to a year ago. Keep in mind that a year ago you were launching the market Armani that has been a huge effort.

Francesca Di Pasquantonio - Deutsche Bank

Yes.

Andrea Guerra

And on the other side, we were in the startup phase of SAP in all Luxottica factories exactly 14 months ago.

Francesca Di Pasquantonio - Deutsche Bank

Okay. Can I had a follow up on the structured (inaudible) the comps acceleration, do you think or do you expect to it see in Q3?

Andrea Guerra

I don't want to enter in this thing, I say I improved and we go a little bit worse, but you send. So we are doing everything we need to do to improve the underlying performance of LensCrafters in the next period and as we said we are optimistic.

Francesca Di Pasquantonio - Deutsche Bank

Okay.

Andrea Guerra

Thank you.

Operator

(Operator Instructions). Gentlemen there are no more questions registered at this time.

Andrea Guerra

Thank you everyone I know this is normally used.

Alessandra Senici

I just wanted to thank you for listening to today's call. And I just wanted to say that we are pleased to host some of you tomorrow morning at our Luxottica Days in Lake Como and for those who unfortunately will not be able to join us we wish really a pleasant summer break. Thank you very much. Have a good afternoon and evening. Bye, bye.

Operator

Ladies and gentlemen, thank you for joining. The conference is now over. You may disconnect your telephones. Thank you.

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