Michael Kors Holdings' (KORS) CEO John Idol On Q1 2015 Results - Earnings Call Transcript

Aug. 4.14 | About: Michael Kors (KORS)

Michael Kors Holdings (NYSE:KORS)

Q1 2015 Earnings Conference Call

August 04, 2014 08:00 AM ET


Christina Lack - VP and Treasurer

John Idol - Chairman and CEO

Joe Parsons - COO


Kimberly Greenberger - Morgan Stanley

Brian Tunick - JPMorgan

Erinn Murphy - Piper Jaffray

Simeon Siegel - Nomura Securities

Faye Landes - Cowen & Company

Omar Saad - ISI Group

Paul Lejuez - Wells Fargo

Adrienne Tennant - Janney Capital Markets

Dana Telsey - TAG

Camilo Lyon - Canaccord Genuity


Welcome to the Michael Kors Holdings Limited First Quarter 2015 Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions. As a reminder, today’s conference is being recorded.

And now, I would like to turn the conference over to Christina Lack, Vice President and Treasurer. You may begin.

Christina Lack

Good morning and thank you for joining us for our first quarter earnings call. Presenting on today’s call are John Idol, Chairman and Chief Executive Officer; and Joe Parsons, Chief Financial and Chief Operating Officer.

Before we begin, let me remind you that certain statements made on this call may constitute forward-looking statements, which are subject to risks and uncertainties that could cause actual results to differ from those that we expect. Those risks and uncertainties are described in today’s press release and in the Company’s SEC filings, which are available on the company’s Web site. Investors should not assume that statements made during the call will remain operative at a later time and the Company undertakes no obligation to update any information discussed on the call. I will now turn the call over to Michael Kors’ Chairman and Chief Executive Officer, Mr. John Idol.

John Idol

Thank you, Christina. Good morning, and welcome to Michael Kors’ first quarter fiscal year 2015 earnings call. With me today is Joe Parsons, Chief Financial and Chief Operating Officer. I will begin with a brief overview of our first quarter performance and discuss our long-term growth opportunities as we continue to expand our presence as a leading global luxury fashion brand.

I will then turn it over to Joe for detailed review of our first quarter financial results and our outlook for second quarter and full year. We are very pleased with our first quarter results, which we believe demonstrate the great momentum in our brand and a significant grow opportunities that lay ahead. Michael and our design team continue to deliver an amazing, diversified collection of fashion products that is resonating with consumers worldwide. This has positioned Michael Kors as a true luxury lifestyle brand with a compelling offering of handbags, small leather goods, footwear, ready-to-wear, watches, jewelry, eyewear and fragrance.

The strong performance across our product lines and geographies contributed to our financial results in the first quarter. Revenue grew 43% to $919 million and gross margin expanded 20 basis points. Income from operations grew 40%, leading to an operating margin of more than 30%. We achieved these strong results as we continued to successfully execute on our six growth strategies.

First, revenue in North America grew 30% driven by comparable store sales increase of 18.7%. We've been very successful in our North American business thus far and we are still building momentum. As we look ahead, we believe that we continue to have significant growth opportunity in this region, driven by comparable store sales growth, new store openings and expansions, shop-in-shop conversions and expansions and the transition of our e-commerce business in-house.

In addition, we believe that the expansion of certain existing categories will fuel incremental growth of footwear, women’s ready-to-wear and men’s wear. Second, we are on track with our retail expansion in North America. During the first quarter, we opened 13 net new stores. Long-term, we believe that North American market can support 400 stores excluding potential men’s locations.

Third, we successfully converted a 108 department store doors in the branded shop-in-shops globally and ended the first quarter with 1670 shop-in-shops worldwide. For fiscal year 2015, we now plan to convert 750 department store doors into shop-in-shops across all categories globally.

Fourth, in Europe revenue grew 128% driven by a comparable store sales increase of 54.2% and the opening of 21 locations. We see great runway for growth in Europe. Over the long-term, we continue to believe we can expand our store base to 200 locations and now believe this market can generate of approximately $1.5 billion for Michael Kors. This growth will be driven in-part by store openings in new and existing markets, the expansion of select retail locations as well as the increased penetration of the wholesale business in this region.

Fifth, our business in Japan continues to develop. Revenue in the quarter grew 89%, driven by a comparable store sales increase of 48.8% and the opening of four new locations during the quarter. Looking forward, we continue to believe that this market can support 100 stores.

Sixth, we opened nine locations in the Far East region through our regional licenses, bringing our total to 112 stores.

Stores in this region saw strong double-digit comparable store increases in the first quarter. Overall there a tremendous opportunity for us in Asia. And we are in early stages of growth and believe we can ultimately have 200 stores in this region in the long term. In addition to these core strategies we are just now starting to put together a greater emphasis on the men’s business.

And you will see this clearly displayed in our new soon to open SoHo flagship store, which will feature an entire floor devoted to men's. From there we will begin to test free standing men’s store next year and believe that there may be the potential for us as many as 500 men stores worldwide over the long term.

To leave the development of this important strategy we recently brought Mark Brashear on Board as President of the men’s division. Mark’s background with Hugo Boss in Nordstrom makes him a perfect fit to lead our men’s extension. With the right team in place I believe that we have the potential to be leading global men’s wear brand.

Turning to segment performance for the quarter, retail net sales grew 48% with global comparable store sales increasing 24.2% this marks our 33rd consecutive quarter of comp store sales growth which is best in class performance and speaks to the continuing demand for our luxury products.

Growth in the retail segment was driven by 115 new stores opening since the first quarter of last year with 38 net store openings -- net new store openings in the first quarter. We ended the quarter with 443 company owned retail stores globally. In addition we had 162 locations operated through our licensing partners bringing our total to 605 stores in concessions worldwide.

There is a great runway for growth in our retail business globally and we continue to strategically open new stores to ensure we are in the best cities and the right locations to serve our customer base. Ultimately we believe that we can have 700 company owned retail stores worldwide which does not include potential men’s locations. We are also moving forward with our store expansion plans we’ve expanded or relocated a total of six locations globally, roughly doubling the average size of this stores to approximately 5,000 square feet. The largest stores enable us to have a more prominent presentation of footwear, ready to wear, watches and jewelry which we believe will drive increase frequencies of visits and incremental purchases.

We are pleased with the performance of these locations and we believe we can maintain high sales per square foot productivity in our expanded stores. In our wholesale segment net sales grew 40% driven by strong performance in both accessories and footwear as well as the expansion of our European operations and the continued conversion of wholesale doors in the branded shop-in-shops. For fiscal 2015 we now expect to open approximately 750 shop-in-shops worldwide in ready-to-wear accessories and footwear. Overall we are very pleased with both the first quarter performance and the future opportunities in our wholesale segment.

Turning to our licensing segment, revenues increased 30% driven primarily by the strength in watches and jewelry as well as growth in our fragrance business. We are expanding our watch and jewelry offering both in our retail stores and with our wholesale partners and rolled out an additional 30 watch and jewelry shop-in-shops in department stores worldwide during the first quarter.

We now have 155 watch and jewelry shops globally and continue to believe that there is an opportunity for approximately 500 shop-in-shops globally over the long term.

We also continue to expand our fragrance offering. Our new men’s fragrance Michael Kors for men will launch in September and will be available exclusively through Macy's as well as our own boutiques and website.

The set was created with the men on the go in mind and balances urban sophistication and rugged style. We are also launching an ad campaign to support this and including a thrilling TV spot, reminiscent of an action movie and print ads that exudes (jet set glamor) [ph].

Now for our operations by region, in North American revenue grew 30% to $719 million during the quarter. Comparable store sales increased 18.7% and we opened 13 net new locations ending the quarter with 301 North American retail stores. Looking ahead we remain on track to open 45 North American retail stores this fiscal year.

We are also on track to bring our North American e-commerce site in house this fall which we see as a tremendous opportunity to grow our brand. Our new site will serve as a powerful marketing tool and will also allow us to more fully engage our customers every step on the way on their path to purchasing a Michael Kors luxury product.

In our North American wholesale business overall growth was driven by comparable store sale increases primarily in accessories and footwear which were similar to or greater than the increases in our retail stores.

We also continued to successfully convert North American department store doors into shop-in-shops. We will continue these conversions going forward to create a world class presentation of our brand within department stores. Our brand is expanding internationally as well. In Europe we saw revenue growth of 128% during the quarter to $185 million, with a comparable store sales increase of 54.2%.

We opened 21 stores in the region and ended the quarter with 101 retail locations across Europe. We continued to see a positive response from consumers as we’re very pleased with the performance in this region. In the wholesale business strong sell through continued in both department and specialty stores and comparable store sales primarily in accessories and footwear were similar to our higher than our retail store comp growth during the quarter. We clearly continue to gain strength in Europe as our exceptional product and unique jet-set experience drive acceptance of our brand. That said we’ve only just begun to maximize our potential in this region.

For fiscal year 2015 we expect to open 55 new stores in Europe and are on our way to 200 Michael Kors retail locations in the long-term. We also anticipate that our wholesale business will continue to expand as we capture market share and increase our brand presence. In all, Europe is a very important and exciting piece of our growth strategy. This growth is coming from several categories including accessories, footwear, ready-to-wear as well as jewelry and watches.

Based on the strong acceptance of our brand in Europe as I said earlier, we now believe that we can reach revenue of approximately $1.5 billion over the long term in this region.

Turning to Japan, we continued to make steady progress with our business and remain excited about the great opportunity that this market provides for the Company. We are still in the early stages of building this business and remain focused on creating a strategic framework to support long-term growth.

During the first quarter revenue in Japan increased 89% to $15 million and comparable store sales increased 48.8%. We opened four net new retail locations during the quarter and now have 41 locations in this market. We also saw strong growth in the rest of the Far East with a double-digit comparable store increase in retail stores operated by our license partners.

During the quarter nine stores were opened in the Far East and we now have 112 Michael Kors retail locations in Greater China, Korea, Southeast Asia and Australia. Overall Asia is an important region for development as we continue to grow our luxury brand globally. As such we recently brought Stephane Lafay onboard to serve as President of Asia.

Stephane Lafay has a long history of building luxury businesses in the region, including his recent experience leading Tiffany’s growth in Asia. He will be cast with capitalizing on the momentum that we have created thus far to reach our long-term goals.

As we have said we believe that the Asian consumer is truly starting to understand the essence of Michael Kors as a global fashion luxury brand. Under Stephane’s direction we will continue to build the brand in this region and grow the business over the long-term.

Finally the travel retail business continues to be strong during the quarter. We now have 66 locations in the best airport and travel destinations worldwide and believe that we can ultimately have 100 travel retail shops globally. In summary we’re off to a great start in fiscal start 2015. But our focus goes well beyond one year. In order to support our growth objectives we’re making strategic investments in our business.

We’re building our store base, expanding or relocating select stores, building shop-in-shops, investing in marketing as well as in our distribution centers and technology. To ensure we have the foundation to support our global growth.

Looking forward we have a long run way ahead of us to remain poised to deliver our long-term sales and earnings growth objectives.

I will now turn the call over to Joe Parsons for additional analysis of our financial results.

Joe Parsons

Thank you John, good morning. I will begin with a review of our fiscal year 2015 first quarter financial results followed by our outlook for the second quarter and full year.

We exceeded our top and bottom line expectations in the first quarter reflecting strong demand for the Michael Kors brand and continued progress across our strategic growth initiatives. We are raising our full year guidance primarily to reflect the better than expected performance in the first quarter which I will discuss in more detail in a few minutes.

We will continue to make strategic investments in our business to support our growth plans and position us to realize our long-term potential as a global luxury lifestyle brand.

Now, turning to the first quarter results, total revenue grew 43.4% to $919.2 million as compared to $640.9 million for the first quarter of last year with strong growth in each of our retail, wholesale and licensing segments.

Retail net sales increased 47.5% to $480.2 million as compared to $325.7 million in the first quarter of last year, resulting from a comp store increase of 24.2% and the opening of 115 net new stores since the first quarter of last year.

Our comp store sales performance was driven by increases in traffic and conversion. We also saw a strong performance across categories with the largest increase in accessories primarily handbags and small leather goods. Wholesale net sales grew 40.0% to $406.8 million in the first quarter compared to $290.6 million in the same period last year. The increase was led by accessories and footwear categories as well as our continued conversion of wholesale doors to shop-in-shops and the expansion of our European operations.

In our Licensing segment, revenue grew 30.5% to $32.1 million for the quarter as compared to $24.6 million last year, primarily driven by watches as well as jewelry. As you know we are transitioning our new eyewear partner Luxottica in January 2015 and we expect this transition to impact our royalties for at least two quarters.

We are anticipating single-digit to low teen revenue growth in our third and fourth quarters in the licensing segment. Additionally, because advertising expenses charged to licensing, we anticipate lower operating margins as the expense will be higher relative to the revenue increases in the licensing segment.

Gross profit increased 43.9% to $571.6 million as compared to $397.3 million in last year’s first quarter. Gross margin expanded 20 basis points to 62.2% reflecting a year-over-year increase of 63 basis points in our wholesale segment primarily driven by a geographic mix shift offset in-part by a decrease of 48 basis points in our retail segment, resulting from increased markdowns.

Total operating expense grew 47.6% to $294.9 million in the first quarter of fiscal year 2015 as compared to $199.7 million last quarter. As a percent of total revenue, total operating expenses increased to 32.1% from 31.2% in last year’s first quarter. Selling, general and administrative expenses increased 44.7% to $265.9 million as compared to $183.7 million for the first quarter of last years.

The increase in selling, general and administrative expense is primarily due to higher retail, occupancy and salary cost related to new store openings, higher distribution cost as we continue to improve warehouse operations, increases in corporate employee related cost and an increase in advertising and marketing expense.

As a percent of total revenue selling, general and administrative expenses was 28.9% compared to 28.7% for the first quarter of last year. Depreciation and amortization expense was $29.0 million for the first quarter as compared to $16.0 million for the first quarter of last year primarily due to the build out of new retail locations and the expansion of existing locations, accelerated depreciation related to store expansions, new shop-in-shops, increase in lease rights purchase for our new European stores and investment in our infrastructure to support our growth.

Depreciation and amortization increased to 3.2% of total revenue during the first quarter compared to 2.5% for the same quarter of last year. As John mentioned, we are strategically investing in our business including building our store base, expanding our relocating select stores, converting and expanding shop-in-shops and improving our distribution centers and technology.

As a result of these investments, you will see larger year-over-year increases in depreciation as a percentage of total revenue going forward. As a result of these factors income from operations was $276.8 million or 30.1% of total revenue as compared to $197.6 million or 30.8% of total revenue in the same period last year.

In the retail segment, operating margin declined 199 basis points, 150 basis points of the decline was due to an increase in retail operating cost attributable to accelerated depreciation expense associated with expansions and relocations, retail overhead cost including preopening rent expense and higher e-commerce cost the remainder was primarily due to a decrease in gross margins.

For fiscal 2015 we believe the gross margins for the retail segment will decline approximately 50 basis point and our operating margins for the retail segment will decline 100 basis points due to the continued investments that I mentioned earlier.

Wholesale operating margin expanded 100 basis points primarily as a result of the gross margin improvement discussed earlier, as well as operating expense leverage.

Finally, the licensing segment margin decreased 330 basis points due to an increase in operating expenses including advertising costs as well as administrative expenses incurred in connection with the formation of our new licensing operations in Europe.

Income taxes were $88.3 million in the first quarter as compared to $72.1 million in the first quarter of last year. Our effective tax rate was 32.0% as compared to 36.6% in the same period of last year. The decrease in our effective tax rate was primarily due to the increase in taxable income and certain non-U.S. subsidiaries which are subject to lower statutory tax rates.

Net income increased 50.2% to $187.7 million for the first quarter and diluted earnings per share were $0.91 bases upon 207.2 million weighted average diluted shares outstanding. Net income for the first quarter of 2014 was a $125.0 with $0.61 per diluted share based upon $204.3 million weighted average diluted shares outstanding.

Turning to the balance sheet, at the end of the quarter cash and cash equivalents were $1.1 billion as compare to $639.2 million at the end of the first quarter last year. There were no outstanding borrowings under our credit facilities in either year.

For the quarter inventory increased $207.8 million or 65.0% versus last year, which compares to a 43.9% increase in our sales for the same period last -- for the same time period.

As you know we typically plan inventory growth in excess of our sales growth, during the first quarter there were some factors that resulted in our current inventory levels. Approximately 1.5 of the additional inventory increase was related to the expansion of our retail business, including an additional 42 store openings and expansions plan for the first three quarters of this year as compared to the same period last year.

Inventory for comp store sales growth and the preparation of the e-commerce launch, the remainder was primarily related to timing differences due to early receipt of good this year versus last year and in Europe the increase on replenishment stock and a category mix shift towards higher priced goods.

As we have stated in the past, given our stage of growth, our inventory increases will continue to out pay sales growth as we open and expand our retail stores, expand replenishment stock, convert shop-in-shops and rollout our e-commerce business.

Capital expenditures for the quarter totaled $43.2 million. These expenditures were related to a global retail store expansion and innovation, construction and renovation with shop-in-shops, investment in the infrastructure, systems infrastructure and expansion of our distribution in corporate facilities.

We opened 38 net new stores in the quarter, 13 in North America, 21 in Europe and 4 in Japan and ended the quarter with 443 retail stores including concessions. In addition, we expanded 6 locations globally, 5 in North America and 1 in Europe and converted 108 department store doors into shop-in-shops.

Turning to our outlook for the second quarter of fiscal year 2015, we expect total revenue to be between $950 million and $960 million assuming a comp store increase in the high teens. We expect diluted earnings per share to be in the range of $0.85 to $0.87 assuming a tax rate of 32.5% and 208.0 million shares outstanding.

We expect gross profit margin to be approximately 50 basis points lower compared to the second quarter last year and operating margin decrease approximately 200 basis points as compared to the second quarter last year.

Operating expense during the second quarter are expected to be higher as compare to the same period last year due to increased retail operating cost associated with new and expanded stores, higher e-commerce cost, increased overhead cost relating to enhancements of our distribution center and technology and higher depreciation and amortization expense including the impact of accelerated depreciation related to store expansions.

For the fiscal year 2015 we expect total revenue to be between $4.25 billion and $4.35 billion assuming a comp store increase in the high teens. We expect diluted earnings per share to be in the range of $4 to $4.05 representing approximately 26% growth versus fiscal year 2014. The expected diluted earnings per share range assumes a tax rate of approximately (32.5%) [ph] and 208.4 million shares outstanding. We expect gross margin to be approximately 50 basis points lower and operating margin to decrease approximately 150 to 200 basis points as compared to fiscal year 2014.

The operating expense increase for the year will be associated with the investments I described earlier. Capital expenditures are expected to total approximately $400 million for fiscal year 2015 the majority of these expected expenditures related to new retail store planned openings for the year with the remainder being used from investments in connection with developing new shop-in-shops build out of our corporate offices and distribution centers and enhancing information system infrastructure. We expect to open 110 retail locations including 45 in North America, 55 in Europe and 10 in Japan expand and or relocate 41 retail stores globally in select locations in key cities and covert 750 shop-in-shops.

In summary we continued to make progress on our strategic initiatives as we invest in the business and remain well positioned for long-term growth. I will now turn the call back to John Idol.

John Idol

Thank you Joe. In closing we are extremely pleased with the strong momentum we have behind our brand. As we solidify our leading position within the global luxury market, we are investing in our company to enable us to fully capitalize on the long-term potential in our business segments across our categories and throughout our geographic regions.

When we look at our growth opportunities we see ample runway in North America our largest market as well as in our emerging regions including Europe, Asia and Latin America. Our ability to achieve our long-term potential first and foremost stems from our product offering. We continued to deliver luxury product assortments with the highest quality standards that our customers demand and trust.

We are a leader in the global luxury market but we still have enormous growth potential ahead of us. Handbags and small leather goods represent approximately 70% of our global net sales. We see additional growth opportunity in our less developed categories. Today men’s and women’s ready-to-wear combine represent 13% of our global net sales.

Footwear is 10% and watches and jewelry are 7% combined. We believe that there is an opportunity to expand market share in each of these categories given their current size and the great performance in our stores and shop-in-shops.

The driving force behind our product is Michael himself, an iconic designer who has a standard on pulse of global luxury fashion. People around the world look to him for fashion and style queues and trust him to create products that make them look and feel fabulous.

Michael’s motto is why not have it all? And the passion for design that is embodied in every product combined with its unique Michael Kors experience makes you feel like you can have that. It is this attitude that has made Michael Kors synonymous with fashion leadership and jet-set luxury.

And finally our jet-set luxury in-store experience creates a state of mind for consumers embodying glamour and style. Our consumer aspires to have a lifestyle that is on the go. Our jet-set philosophy enables us to give each customer a luxury experience and to create a personal attachment to the brand. In the end we believe the ultimate luxury in life is to feel great about yourself and that is how we make consumers feel every time they wear the Michael Kors brand or step into a Michael Kors store.

When you combine all these unique facets of our business, it is clear why Michael Kors has multiple geographic and product expansion opportunities as a global luxury fashion brand. For fiscal 2015 we’re poised to achieve 30% plus projected revenue growth and 26% projected earnings growth. At the time we’re positioning ourselves to deliver sustainable, double-digit revenue and earnings growth over the long-term.

We will now open up the call for questions.

Question-and-Answer Session


Thank you. (Operator Instructions). And we’ll take our first question from Kimberly Greenberger with Morgan Stanley.

Kimberly Greenberger - Morgan Stanley

John I am wondering if you can talk about the progress on bringing e-commerce in house and what you have planned for that business? And any way to sort of integrate ecommerce with your in-store experience here over the next one to two years?

John Idol

And I just might add that I think we delivered best-in-class results given what other retailers have reported and I might also add we delivered best-in-class results in what other luxury retailers reported.

Many time analysts look at us compared to only one Company and I think the analysts should look at us compared to the global luxury market place and look at the results that we achieved.

The e-commerce business is really exciting. We're on track to launch the e-commerce site in the beginning of September, so please all of you go on and shop, we would be very appreciative. This site looks phenomenal and as I said to you previously, we really did not think we were best-in-class in our current e-commerce experience.

So, that experience will now be, what we believe will be best-in-class in terms of a shopping experience also in terms of the branding experience in particular our Destination Kors portion of our website which really will tell you everything about what’s happening with the brand around the world, what’s going with Michael’s fashion advise and we are really very powerful that way with consumers, they look to us as almost their person stylist and again not many companies have that ability, certain companies or brands, we are a fashion leadership company globally. And the integration will be through omni-channel and that will come on through the balance of the year where we will be able to create a seamless experience for the consumer when they shop online we can deliver it from the store, we can deliver it from the website and as you know this is becoming a more and more of a competitive issue in the marketplace and the speed at which you can deliver product.

So, we are working very, very diligently on that and I would say that would be more of first part of next year where again we are going to try and take a leadership position in how we give service to that customer. We believe that part of being a luxury brand is service and that is going to mean speed to delivery in house.

And then lastly, I just might add that we view this as very substantial for the business long-term. We ultimately think that this can be up to 20% of our global revenues generated in the retail side from e-commerce. It’s going to take us some time to reach that goal but that is our goal and we think that that will really enhance our overall experience with our customer.

Kimberly Greenberger - Morgan Stanley

If I can just ask one quick follow-up. I am wondering if you have an update on…

John Idol

Kimberly, can you speak up, we can’t hear you?

Kimberly Greenberger - Morgan Stanley

So, I am wondering if you can just update us on the China business, your thinking, have you considered the timeframe in which you might consider bringing that business in-house.

John Idol

Yes, so let me talk about Asia first in total, as you know we're very pleased with what’s happening in Japan. We saw excellent comp store results there and that’s very similar to what’s happening in Asia, not only are we seeing that in Asia but we're seeing the Asian consumer travelling. We're seeing her all throughout Europe in our larger tourist destinations obviously, France, London and certain parts of Italy and then in our airport locations. So, they are fast becoming our number one travelling customer for us overtaking what used to be Brazilian and Russian, so we know that this is taking hold.

And as I am sure are aware it is estimated that 50% of all the luxury goods purchased by Chinese or in particular are purchased our of Mainland China. So, Stephane has joined the Company, we are going to be analyzing certain changes and arrangements with certain licenses that are actually coming due shortly and other ones that we might convert into joint ventures or in a 100% take backs into the company.

So, we are not really ready to discuss that yet but you can be assume that some of that will be horizon in the not too distant future.


And we will take our next question from Brian Tunick from JPMorgan.

Brian Tunick - JPMorgan

I guess one question for John and one for Joe. I guess John on Europe; can you maybe update us sort of on where are you from a brand awareness perspective? Where are the share gains coming from now? And as importantly as you try to be $1.5 billion opportunity in Europe, where did that share come from?

And then may be just Joe on the gross margins at retail, I think you said down 50 basis points, so just curious there that mix shift, markdowns, competition just may be give us a little more color. You did say ultimately gross margins would start coming down but just curious what’s going on there? Thanks very much.

John Idol

Number one, as we've said in the past, market share in the U.S. is at around 89% just as a frame of reference -- I am sorry brand awareness is around 89% and in Europe brand awareness is now at approximately 49%. So, we've always said to everyone that once we get north of that 50% area, you really start to see an inflexion develop. The only market that we are north of 50% is in the UK and we are on the cusp in Germany. The balance of the markets are still in 30% to 40% range, 40%, 45%, so lots of opportunity for growth there.

So market share -- and this is a really good point and I am glad you raised it. Obviously we’ve said in previous calls where was that market share coming from and then our opinion at that point in time it was coming from a lot of smaller regional players, we don’t believe that’s true today, we actually know that we are today taking market share from the leading luxury companies. In Europe as I am sure you’re aware we sit on the best street locations next to the finest luxury companies that many of you cover. And we are watching, we are watching the customers go into stores, come into our stores to shop and leave with shopping bags from Michael Kors, and they might be carrying those other luxury shopping bags as well.

So in Europe we are definitively taking market share from that category and by the way we are seeing the same thing happen in Asia as well. So we feel really good about our opportunity. We will probably just tip north of a $1 billion next year for the European business so that’s already -- no one has built a business of this size that quickly and with the sustainability of which we're building it, in terms of the locations and the way we’re building the brand with the consumers is really extraordinary and that’s been done by our -- obviously 10,000 employees around the world.

I am going to touch on the gross margin for one second and then turn it over to Joe as well. The gross margin in North America, I'd like to just clarify some reports that I read which were actually incorrect. We had the same amount of SKU on sale this year as we did last year. So, whomever wrote the earlier reports that’s incorrect?

Secondly we did not take any different position on our markdowns inside the stores as we did last year at the same point in time so we’re very proud of the fact that we decided not to enter into the deep discounting afraid that obviously occurred in the second calendar quarter due to access inventories by lot of retailers.

That being said what we did have is w did tried to bring some four merchandizing early into our stores in the later part of June to try and get it jump on the fashion trend that did not really work for us to be frank. So we’re kind of probably look at that on go forward basis. And especially after there was a long winter I think people were really ready to, continue to by spring a little bit longer than they were previously. So and we just anticipate that a more normal space for the business is really what’s relevant and hence the guidance for the market. And again, we don’t think that half of percent is anything significant, we’ve always said that our margins are probably a little outsized both in gross margin and in operating margin somewhat because of the very, very, very sale through that we had.

And secondly, because of the fact that we had as Joe has mentioned many times accidental leverage and I’ll let him speak about that.

Joe Parsons

Yes. The business is just and so good I really don’t have a lot to add to -- historically it’s been so strong. I don’t have a lot to add other than we’re seeing the trends today. And we’re feeling very good about the business but we think that we’re anticipating this 50 basis point decline.

John Idol

And by the way one last thing Brain too, our handbag and small leather goods business continues to (comp) [ph] at the rates you saw in our report and/or higher. So again it just shows the strength of the brand and the business with the consumer and I’ll talk a little bit later about that in the call. Thank you, Brain.


And we’ll take our next question from Erinn Murphy with Piper Jaffray.

Erinn Murphy - Piper Jaffray

Great. Thank you. Good morning and congrats on a very solid first quarter. I guess, John, first for you, as you think about the comp drivers during the first quarter, could you just maybe speak to how the trends varied between April, May and June in the U.S., as well as in Europe?

And then as we head into the back-to-school fall season, what product categories and launches are you most excited about as you think about fueling this growth?

John Idol

Yes Erinn we actually had a very good April and May, June is a little softer for us and as I said that was really sadly self-inflicted. We brought that fall merchandizing early you may have seen it in the stores; it just wasn’t the right thing to do in hindsight. That being said we converted very quickly as you know we’re fast and we moved out of that product quickly and then have our new camouflage delivery on the floor right now. And I might add that we’re off to a very successful start in July so far.

So our customers are super, super smart, we’ve always told you that fashion is what leads our Company that’s what leading us globally. Many people write about us and competitors against us this and that, why is Michael Kors successful it’s because of our product category. So then we, you talk about in terms of what are we excited about for the fall season. Again, what’s interesting is two really big drivers for us that are kind of coming on stronger then we continue to anticipate our shoe business did excellent during the quarter both in our own retail stores and in the wholesale environment.

And then also the jewelry business continues to be strong and what we like about those two businesses, they are just bringing more customers into our stores, shopping different categories and hence that’s why we are going to upsize Joe mentioned earlier in the call. We’re going to upsize approximately 41 stores and the primary reason we’re doing that is really we’re in enlarging the handbag spaces in the stores, we’re enlarging watches and jewelry, footwear and our women’s ready-to-wear and the early results of that are quite strong.

And so yes we will end up with 400 stores in North America and I have seen the comment that we’re opening too many stores which we would absolutely disagree with. And in fact we’ll be pretty much complete with our North American store roll out within the next 24 months or so. And then we’re going to be doing this really looking at upsizing our best stores, our high productivity locations and that expansion will come from our product extensions. So again we think we’re poised to continue our growth in North America and have the right strategy to do that. And I might also add we never changed our strategy in this Company since 2006, 2007.

So everything that we’ve been saying since before our IPO, during our IPO and to this day is exactly what we’re doing in terms of our pace and in terms of how we’re building out the business.

Erinn Murphy - Piper Jaffray

And just if I could just follow up on the watch business, I mean it continues to be a standout as you mentioned continued stellar productivity there. How do you think about some of the longer-term drivers and then how are you thinking about the potential iWatch launch this fall and any potential participation in that smartwatch category?

John Idol

Sure the watch business is just like the rest of our businesses, we have to have newness, we have to have excitement to stimulate the customer. We know our loyal customer has somewhere between two and three watches that they’re purchasing from us. And we’ve got to excite her to want a third and fourth and a fifth. So we think we do that well. You certainly saw with our Watch Hunger Stop campaign, I mean that was just an extraordinary success for us both the good that we’re doing around the world and the fact that people just love the whole colored dial story. So colored dials have been really, really strong for us and we see that continuing into the fall season.

And again that’s just another way of exciting her about Michael Kors watches. And we have some amazing things coming actually for spring season on that category. The eyewear business, I mean we’ve got just a brilliant partner in Luxottica. They have developed an entirely new line. By the way we had already a very sizeable eyewear business and we didn’t talk about it a lot. So it is substantial and hence why Joe mentioned the impact in our licensing area because it was a very sizeable business for us.

So we go through the transition and with the support of everything from LensCrafters to Sunglass Hut to their global distribution network and then Luxottica is turning out to be amazing partner and I think we’re going to be one of the leaders in the world in both sun and in optical due to our great partnership.


And we’ll take our next question from Simeon Siegel from Nomura Securities.

Simeon Siegel - Nomura Securities

So John, just to your point about the gross margins, I mean you guys still beat the gross margin guidance you had given. Can you talk about where the beat came from? And then can you just quantify how much retail operating margin pressure you may have felt from the preopening expenses and/or the e-commerce spend this quarter?

Joe Parsons

Again as we’ve always said the margins are going to be impacted most by markdowns. So the decrease was a markdown but the beat was primarily related to that somewhat due to the strength of our European business which as you know has a slightly higher margin. In terms of the operating margins all those items that we mentioned are going to be impacting operating margin as John mentioned, we are definitely investing in the Company. And the investments that we’re doing do have an impact in the operating margins. We feel very good about those investments, but they do as I say impact operating margins.

John Idol

And Simeon I might add we have said all along from again, the day we went public. We never believed that a 30% operating margin was a sustainable margin for the company. And by the way we don’t want that. So I want to be very clear, let no one be misunderstanding, we don’t think that’s the right way to run our business. We need more investment, we’re building this company for the long-term, we’re not here for a quarter-by-quarter situation, we’re here to build something that is very sustainable. And to do that you have to invest, we’re investing in people, you saw amazing talent that we’re bringing to this company, we have some more announcements to make that I think will even further strengthen the bench here.

We’re investing in distribution facilities, when you’re growing a staff business and putting on $800 million to $900 million a year, you need to invest in state-of-the-art distribution facilities, you need to upgrade your technology. By the way bringing in ecommerce in house, I don’t know how anyone could assume that that’s not going to impact our operating margins. Those are all the right things to do to build the business. And then lastly the impact of the development of these stores the expansions we’re going to have accelerated write-offs on these stores. That’s going to impact our D&A.

So again these are all good things that we’re doing to build this business and to build this company which I hope that you all will understand and respect. And don’t just look at the little changes and a bps here and there that’s not what drives the business, what drives the business is good strategic investment and also building your brand with the consumer which again I’ll talk about little bit more at the end of the call.


And we’ll take our next question from Faye Landes with Cowen & Company.

Faye Landes - Cowen & Company

Could you just do us a favor and go back and give us a little bit more texture on the inventory increase? Because although you have talked, you have said that in the past, inventory will grow faster than sales, this is a big percentage. So if you could just break that out a little bit more and what’s different this time than like in the previous quarters?

Joe Parsons

You are correct. It is a big increase relative to the increase in revenues however our increases in the inventory in the past have varied from our increases in sales as well. So, we are very comfortable with what happened. As we said if you kind of take the inventory increase at a revenue increase level, the amount in excess of that have about half of it relates to building up retail and building up retail commerce, another half of that relates to timing. We have accelerated production and brought goods in earlier this year and also as Europe becomes bigger, we are investing more in inventories in Europe. So, in Europe we have buildup of replenishment and Europe has transitioned as a percent of business more to accessories and therefore the inventory cost is higher as we develop the business.

Faye Landes - Cowen & Company

Okay and also just one quick question which -- on the early fall receipts, did that impact the results in June or in July? I just want to make that.

Joe Parsons

So, the receipts are really not impacting the sales. John talked a little bit about deliveries into our retail stores which did have some impact late in the quarter but the inventory receipts themselves…

Faye Landes - Cowen & Company

Not in terms of inventory, I am talking about segway -- I am talking -- and in terms of sales and margins. The fact that the early fall receipts were not as well received as you expected because of weather et cetera for whatever various issues…

John Idol

So, Faye let me explain, so we timed and planned to have those receipts in the stores in June. As I said that didn’t work for us and we took that out of stores very rapidly and so that immediately the traffic in the store et cetera, so we feel really good about moving quickly. When Joe is talking about the early receipts of merchandize, let me just explain, Faye, it’s also what’s called in-transit.

So, there is times when we have a fair amount of in-transit inventory, so the in-transit he is referring to is actually goods that we will receipt physically in the warehouse. These goods are on the water, so they are actually not in our warehouse yet.

Faye Landes - Cowen & Company

No I understand. I understood, I am just saying in terms of -- I think there is going to be a lot of focus after this call on your comments on the early fall product that did not sell-through that the way that you liked and then you moved quickly et cetera. I just want to clarify where that shows up in the numbers?

John Idol

It’s already in our guidance, Faye, it’s all done.

Faye Landes - Cowen & Company

But I am saying so it’s a July issue?

John Idol

No, some of that was in June. We did take markdowns in the store in June and we moved on and you would seen that and also I might add to that remember we have e-commerce now as well which we did not have at this time last year. So, you are going to see e-commerce showing up in our inventories for at least three quarters until the revenues really catch up with where the inventory levels are because we kind of don’t know how big the e-commerce business is. We have an idea based upon our previous relationship with Neiman Marcus but we just don’t know exactly how big that’s going to be. So, there will be some mismatching for a period of time as we get comfortable with that business.


We will take our next question from Omar Saad with ISI Group.

Omar Saad - ISI Group

A technical question, so just to be clear, you guys made a bit of a mistake this quarter on this early fall, decision to go early with fall. You’re able to cycle through it, take some markdowns, you are able to still expand gross margins in the quarter and then it sounds like you are off to a good start with the new product in the second quarter. Is that all a fair characterization?

Joe Parsons

Yes, but you should identify that to a month, the month of June which is what the question was asked earlier. So, it’s not the quarter. There was one month worth of delivery by the way that’s very similar to what we have done in the past where we had a transitioned group. We just brought in few weeks earlier and we found that the customer didn’t respond to that.

Omar Saad - ISI Group

Understood but you are able to react and respond and you are kind of back on track.

Joe Parsons


Omar Saad - ISI Group

Okay and then another kind of clarification question. I think the implied EBIT margin guidance for the full year that you gave on the last call, the fourth quarter call. I think down about 80 or 100 bps something like that. And I think today you are guiding to EBIT margins for the full year down 150 to 200, is really the biggest part of the differential, opportunities to accelerate investment to tune up to support the further growth and all the opportunities that you guys have.

Joe Parsons

Yes, that’s correct. Clearly we are -- continue to invest, we have some accelerated depreciation for the stores that we're going to change. So, yes we've developed our point of view in terms of the operating margins since fourth quarter.

Omar Saad - ISI Group

But the primary change is not some sort of fundamental change in how you view the gross margin cadence?

Joe Parsons

It is not. It is really -- as John has said we are investing in this company for the future. And that’s what’s driving that.


We’ll take our next question from Paul Lejuez from Wells Fargo.

Paul Lejuez - Wells Fargo

Hey, can you talk about the average price point of a handbag in the U.S. versus Europe versus Japan and how has that changed over the last couple of quarters, on a year-over-year basis or even years and what do you expect going forward? How should we think about average price points? Thanks.

John Idol

You know as we have said in the past really average price points have not changed dramatically in the Company, they are almost flat, average transaction is running about flat. Average price point is up just slightly a tick and that’s really more because of the consumer responding to certain higher priced handbag from us. That is not a strategic change on our part. We have -- still offer product from more or less in the $250 to $450 range that’s kind of our range of sweet spot with really $350 being the core price point for us.

And then in SLGs again that average is ticking up a little bit there because of cross bodies being a picture percentage of our small leather goods business but we don’t really view anything there as being different.

And then of course, in Europe our product is more expensive due to VAT and our operating expense is bit more or bit higher in Europe as a percent to total. So therefore we run the product at a higher price. And then in Asia it’s obviously the most expensive and again that’s really driven from real estate costs and what a cost to operate in department stores in certain markets where we have confessions and to our freestanding stores which have typically higher rents in particular than North America and in some cases even in Europe.

Paul Lejuez - Wells Fargo

And the steady price points that you've talked about, you are seeing that across geographies? You are not seeing the average price point to be higher in Europe and Japan relative to themselves?

John Idol

No. It’s all runs pretty much about the same.

Paul Lejuez - Wells Fargo

And we shouldn't expect any change in the future in that number as well?

John Idol



We will take our next question from Adrienne Tennant with Janney Capital Markets.

Adrienne Tennant - Janney Capital Markets

I guess my question is, from a longer-term perspective, if 30% is not the sort of right op margin number that we should be thinking about, how long should the investment phase last? And where should we think about those margins settling in?

And then really quickly, the mid-teen comp assumption for the year would assume ongoing deceleration? I am just wondering why that might be. Thank you very much.

John Idol

Okay. So two things, let me just discuss the comp first and then the operating margin. I think you have seen us give guidance before and I think fortunately we have been able to do better than the guidance. And as we said to you in the past we like to guide with what we know that we can deliver.

And then if the consumer is there as she has been and demanding our product, we’ve been able through our factory relationships and other situations with the way we (book) [ph] product, be able to achieve those comp stores.

So I think we’re planning as we had from the beginning of the year. And if the product continues to have the strong results that we’re seeing than you might see us do better, but so we view our double-digit comp store growth as still being best in class. I don’t think there is any other luxury retailer in the world who is delivering the kind of comp store results that we are.

And I think you all and the investment community needs to look at that as a very positive sign for the strengths of the business. Let me just point out something on that note and then we’ll come to operating margin. There’s a number of people who are picking and choosing little spot to discuss trends in the business and we can’t come out and respond to every single piece of information like that.

But I will tell you the traffic to our website with us by the way backing off of marketing as we were transitioning is up 26%. Our CRM database went up 69% in the quarter. Our Facebook fans went up 160% in the quarter. Our Instagram fans went up 155%. Our Twitter fans went up 58% and that’s on a like-for-like quarter. So I think Michael Kors is still feeling a very, very strong momentum both domestically and globally.

And even in search for Michael Kors as the name was up over 20% in the quarter. So I think that just resonates to the brand and what the potentials are if the consumer continues to response that way, but we’re always going to plan where we think we can deliver on and then hopefully exceed that.

Secondly as it relates to the operating margins, I would tell you that we think that 28% to 29% range is a more sustainable range for us. Investment will go on forever. That’s the right place to be in, by the way that’s still by all metrics that we look at still incredibly best in class in terms of operating margins.

So again I hope that you all -- I know you love to all look at sequential deceleration, but remember it is the fact that we’re going to deliver 30% top line and 25% bottom line this year and we’ve said that we’re going to continue to have double-digit top line and bottom line growth in this Company.

Again I don’t see many luxury retail companies out forecasting that type of growth.


And we’ll take our next question from Dana Telsey from TAG.

Dana Telsey - TAG

As you look at -- just a couple quick questions. How did ticket perform in the quarter and any other timing changes in the second half of the calendar year that we should look to in terms of the timing of bringing in goods? And lastly, just the SoHo store opening, when do you expect that to open and how is the impact of those costs on overall operating expenses?

John Idol

Tickets exactly the same, from 2007 to where we’re today it’s almost identical also little bit it’s been climbing ahead but nothing to really call significant at all. Average transaction, UPT has gone up and I had mentioned that to you for the past year or so and that was really driven by jewelry but more people coming in and buy more product in total. So we feel good about that. The timing thing, let me just explain this again the reason why we try to do this the fall delivery is a good example is, because we don’t want to compete in the markdown arena.

Again both in our wholesale business and in our retail business we remain on the same cadence. So every day of the week we try to think about how to sell more full priced product. I saw an analyst wrote a note about the unmentioned 500 stores, which by the way is exactly -- we've been in all those department stores since we’ve been operating in this company. We’ve been upsizing those shop-in-shops. And guess what? They sell mostly full priced product.

So again I think there has been a little misdirection that needs to be looked at and again what we’re trying to do is we’re trying to sell more full priced products. So we’re going to push the envelope, we’re going to try and get new fashion in stores earlier. And are we going to make some mistakes at times? Absolutely that’s what fashion is about. And so that timing issue for us -- same thing we do by the way and the holiday season, in January we tried to get out of the sale product as quickly as possible and we try to bring spring product into our stores in January. Sometimes that works, sometimes that doesn’t work depending on how the weather is outside, depending on what the season was before.

But again I want you to know we are not going to back off being a fashion company trying to deliver newness and trying to excite our customer. That is our competitive edge period, end of story, that’s why we’re winning around globe.

And in terms of SoHo store that timing has now moved to October sadly, it is going to be spectacular and I do want to tell you we’re going to hold an analyst day at the store when it is completed and we’re going to invite you all in and talk about the future direction of this company in particular we’re going to walk you through the men’s line and what we’re doing there and some of the exciting developments we have.

But it’s really going to be a corner stone project for us. And as I also mentioned there will be a couple more of those level stores that we’re working on. Again that’s not a real strategy. Our real strategy is to go to the 5,000 foot stores going from 2,500 to 5,000. But there are a few locations globally where we think we could have a slightly larger flagship store and incorporate men’s, women’s together. But as we said in the call earlier most of the men’s projects will be free standing stores that we’re working on and quite frankly have a few locations already identified.


And we’ll take our final question from Camilo Lyon with Canaccord Genuity.

Camilo Lyon - Canaccord Genuity

I just wanted one final clarification on this gross margin concern as I think that’s going to be a highly debated topic. As you think about the guidance that you spoke about, down 50 basis points for the year, it seems like a lot of the markdowns on the fall lines have already been taken, maybe a little bit seeps into Q2.

How are you approaching the promotional landscape around back to school and holiday and more importantly, how are you viewing your relationships with your wholesale partners and how they are planning their business from a markdown cadence perspective?

John Idol

So again I want to reiterate, I think 0.5% of gross margin movement off of a very high gross margin is, I wouldn’t view that as -- you may view that as highly debatable we will take the position that that’s not given the fact that we’re a luxury goods company growing our business.

But we are going to take the exact same point of view that we have always taken; we are not going to become more promotional that is not what we’ve built this company on. And I think our consumer has responded to that.

By the way we don’t participate in a back to school promotional cadence, never have, never will. What we will do is we’ll introduce great new product. For example bag packs are becoming quite strong, today and those are leather bag packs as well.

And so we’ve got a whole collection of those that happen to be retailing quite strong for us. So we will do things like that, we’ll increase our assortment of flats that way we can take advantage of some of the younger customer who might go -- up for back to school, again we are focused on trying to excite customers with fashion, not with price. That’s not how we are going to win as a luxury company.

Camilo Lyon - Canaccord Genuity

Thank you for that clarity and gives you just one more point on that. Could you just clarify then what is the main driver for the gross margin decline expectation?

John Idol

Sure as we have said earlier on the call, we believe that there is just some more normalized selling rates that are happening inside the store. Those were unsustainable gross margin. We told everyone that for multiple quarters. We also told everyone that the operating margins were not sustainable and we have had planned them to come down, so I said that to you guys in previous conversations.

I think the shock and the reality of seeing that has everyone a bit unfocused in my opinion because you are not focusing on what is the true development of this business. We put on 20 plus percent comp store growth. We had 43% top-line sales. We are adding stores. We are growing the business to a $1.5 billion in Europe and when you are focused on only one little detail that’s not the whole picture of the company. And the other thing that I want to end on though is remember we don’t compete with one company in the world and I believe that many and I am going to say this, many analysts are just focused on that, I think it’s wrong.

I think you need to focus on the fact that there are a lot of luxury goods companies in the world. There is a very large luxury market in the world and we don’t compete in just one category as we said earlier. 70% of our business is coming from handbags and small leather goods, 30% is coming from other categories and those categories are growing very, very quickly for us. So, look at some of the other luxury players and what percentages they run in some of those categories. And I think you might see opportunity for Michael Kors in its growth and development.

I want to thank everyone for participating in the call today. Look forward to speaking to you all and hopefully on the next call that we are all together. Thank you very much.


This concludes today’s conference. Thank you for your participation.

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