Hugo Boss' (BOSSY) CEO Mark Langer on Q2 2016 Results - Earnings Call Transcript

| About: Hugo Boss (BOSSY)

Hugo Boss AG (OTCPK:BOSSY) Q2 2016 Earnings Conference Call August 5, 2016 7:00 AM ET

Executives

Mark Langer - Chairman of the Managing Board and Chief Executive Officer

Analysts

Fred Speirs - UBS

Claire Huff - RBC

Antoine Belge - HSBC

Thomas Chauvet - Citi

John Guy - MainFirst Bank

Andreas Inderst - Macquarie

Operator

Good day, and welcome to the Hugo Boss First Half Year Results 2016 Conference Call. This call is being recorded. At this time I would like to turn the conference over to Mr. Mark Langer. Please go ahead, sir.

Mark Langer

Thank you very much and good afternoon, ladies and gentlemen. Welcome to our first half year 2016 financial results presentation.

I'm pleased to present to you in my new function as Chief Executive Officer today. However, as most of you have known me for years as the group’s Chief Financial Officer let us skip the introduction and go right into business and our performance in the last six months.

In the reporting period, adverse market conditions magnified some company specific challenges. In addition, we initiated some bold steps to make progress on our return to profitable growth, accepting a short-term negative impact on sales and profits. As a result, overall group sales declined by 2% in currency adjusted terms in the first half year.

EBITDA before special items was down 21%. In the second quarter performance was comparatively better although group sales were still down 1% excluding currency effects. Strict pricing discipline and an effective cost management curbed operating expense increase [but the] decline of EBITDA before special items was limited to 13%.

Europe was the best performing region in the second quarter and year-to-date. In the second quarter regional sales were 7% above the prior year level in currency adjusted terms. Wholesale sales benefited from a different timing of for collection deliveries. On retail sales in Europe developed positively as well supported by the contribution of new stores and takeovers.

By market, the UK continued to be the region's fastest expanding core market. Sales in the quarter were even up 14%. While this performance was helped by some timing effects in the wholesale business momentum held up well in the aftermath of the Brexit referendum. In the weeks following the leave decision, underlying retail sales even improved compared to earlier in the year and developed into positive territory year-over-year.

Performance in the rest of the region was mixed. Scandinavia and Italy developed very well. Key markets like Germany, France and the Benelux however registered declines. Here, as well as elsewhere in the region weaker tourist demand was a drag on sales.

First half year revenues in the Americas were 11% below the prior year period excluding currency effects. This was due to the US business, which was down 19% year-to-date. Double-digit growth in Canada, as well as Central and South America, was not enough to offset weakness in the region’s main market. In the US declines were driven by the wholesale channel. Beyond the effect from an overall recessionary market environment in premium apparel, around half of the sales decline in the US wholesale in the first six months was due to our deliberate decision to exit distribution formats not in line with the positioning of our brands.

Specifically, we started discontinuing business relationship with value retailers, which we had used in the past to help us clear excess inventories. In addition, we reduced the presence of the Boss core brand in multibrand spaces, for example at Lord & Taylor and Dillards. Finally, there was a consolidation effect from the shop-in-shop takeovers at Macy’s earlier in the year. These operations are accounted for as own retail now.

Own retail sales in the market continued to suffer from double-digit traffic declines, which we could not offset with an improvement on average transaction sizes. In order to turn around visitor numbers, the expansion of omni-channel and other service offerings will be key. That is why we have made click and collect available in all freestanding stores in the US now, and a few days ago we launched BOSS ON DEMAND offering customers a free pickup by Uber wherever they may be.

In the same way, we have Uber deliver package to customer homes, offices or hotel rooms. Other services include express deliveries out of our new store in the [mall] close to Wall Street, in-store stylist counseling and a program offering our most valued customers access to many events and gifts money cannot buy.

Finally, sales in Asia-Pacific recorded a 6% decrease in currency adjusted terms in the second quarter as well as year-to-date. Growth in all other major markets in the region partly compensated for declines in China. In Greater China, sales were down 14% in local currencies in the first half year negatively impacted by substantial double-digit declines in Hong Kong and Macau.

In addition, we have now started annualizing the consolidation effect from the franchise takeovers in China in April last year. In the first six months the close alignment of price levels in China with European levels meant that average selling prices in Mainland China declined by around 20% in the first six months. However, the pricing effect was largely offset by volume increases. Unit growth amounted to more than 15% year-to-date.

This underlines the improvement of our brand value proposition, which we communicated very consistently in-store and across all digital channels. We also progressed with the upgrade of our store network. In addition to several refurbishments, we closed 11 stores and shops on the Chinese mainland in the first six months. Remember, that we outlined our plans to close a total of 20 margin and image-dilutive retail locations in the market over the course of 2016.

So we are around half way through the process now. Upon completion we will run a more productive, high-quality network of stores in premium locations supporting the ambitious plans we have for the brand’s long-term future in this important market.

By distribution channel, group owned retail sales were broadly stable in the first half year. This was primarily due to the contribution from expansion and takeover activity in the prior year. On a comparable store basis however, revenues declined by 7%. In the second quarter comp store sales performance deteriorated to negative 8% against the tougher prior-year comparison base.

All regions performed in negative territory, although Europe still outperformed the rest of the world. Nonetheless, trends in the group’s home region weakened slightly compared to the first three months, explained by the strong growth in Europe we saw in the second quarter of 2015. Globally, an increase of average transaction sizes had a positive impact on own retail sales despite the significant price reductions in Asia. However, this effect was more than offset by traffic declines, most notably in the Americas but also in Europe.

This highlights the importance to improve our digital proposition to make sure we effectively lead customers into our stores. In the US, we made a lot of progress in this regard by completing the rollout of click and collect in all freestanding stores. In Europe, we launched the same service in September, starting with selected stores in Germany, Austria and the UK.

In 2017, then click and collect order from store and the convenient handling of returns across channels will be introduced in all European online markets. So while the rollout of omni-channel is progressing, the performance of our online business has been disappointing in the first half year. Channel sales declined by 5% over the period on a currency adjusted basis. First and foremost this reflects the clear priority we have placed on the insourcing of fulfillment in the last few months.

So while the insourcing of the complete order handling process from our previous partner, Arvato, was completed successfully at the beginning of May, there was not enough management attention and time spent on further improving the online store. The upcoming relaunch of the site in October will address the number of weaknesses we are currently suffering from. However, from a more structural point of view we will also have to find an answer to the challenges posed by the growing importance of mobile.

The dramatic increase of the share of traffic coming from mobile devices has started to have a meaningful negative impact on our online conversion rate, meaning that sales are down currently despite ongoing traffic increases. Turning to our physical store network, we are in the midst of shifting focus from expansion to maximizing the quality of our existing store base. This means three things. First, we continue to selectively add new stores in under-penetrated markets in weaker areas as the opening in [Leon] demonstrates.

Second, we seek to further improve successful stores through targeted renovations. Our newly renovated flagship store in Seoul is a telling example here. And third we use expiring rental contracts to discontinue operations in locations that have not lived up to our expectations.

The latter does not only apply to freestanding stores, where we closed 12 locations in the first half year, but also shop-in-shops. In the last six months, we discontinued operations in more than 30 shop-in-shop at retail partners in Germany, the Netherlands and Belgium, in particular. We did so with a view to the small contribution these operations made to our global retail business often not in sync with the management attention required in day-to-day operations.

All of these closures represent the normal course of business for our company with retail operations of our size. However, earlier in the year, we also announced 20 store closures in China and committed to a global review of underperforming retail locations. The latter performed an important part of our measures to safeguard the group’s long-term profitability.

As a result of the review, we have now decided to close around 20 freestanding stores and several shop-in-shops over the course of the next 18 months. These closures relate to loss making stores in all three group regions. Among them almost a handful of flagship locations opened in the last three years. In the financial year 2015, they diluted the group’s EBITDA margin by around 60 basis points.

While we are still in the process of negotiating the final exit conditions with landlords, the majority of stores are forecast to close either at the end of 2016 or over the course of 2017. Based on the remaining maturity of rental contracts, we expect to incur one-time expenses of €46 million predominately related to early termination payments. In addition, impairments on furniture and fittings will amount to €6 million. As a result, provisions and impairments in total amount to €52 million, which we booked in other operating expenses and income line in the second quarter and treated as special items.

The cash effect is expected to amount to a low double-digit million euro figure in 2016 with the reminder to be incurred in future years. Closing these stores is a painful exercise without a doubt. However, having had the choice between swallowing a bitter pill today and suffering from ongoing margin dilution going forward we decided for the first. While the affect on 2016 results will be marginal based on the timing of the closures, we expect the first positive impact on profits in 2017 before the realization of the full benefit in 2018.

wholesale revenues declined by 6%, excluding currency effects, in the first half year. The solid performance of our European wholesale operations supported this development, and partly offset the decline in the Americas that I discussed a few minutes ago. Channel revenues in the second quarter benefited from a higher sales share of the Fall collection compared to the prior year. This was the result of the relatively better demand among wholesale partners for some of the collection themes with earlier delivery dates.

Adjusted for this effect, second-quarter wholesale sales would have been down at a mid to high single-digit rate instead of the reported minus 1% in currency adjusted terms. Obviously, this shift will be reversed in the third quarter where we consequently forecast wholesale sales to decline more significantly again, reflecting cautious customer ordering in light of subdued market trends.

Finally, let us look at the top line development by gender. In the first half year, menswear and womenswear performed broadly in line. Boss womenswear continued its positive momentum by growing at a lower rate than in the previous year. Once more this underscores the structural health of the womenswear business, which will continue to be an important part of our group also going forward.

Nonetheless, we are placing an even higher emphasis on our key menswear business. This is true from a brand communication perspective where menswear is benefiting from a far bigger share of our communication budget again as well as from the merchandising perspective. Particularly in Europe, we have just implemented some technical changes to our retail floor space allocation.

First of all, we shifted some space to menswear formalwear, our most productive concept. Secondly, we changed the layout of some of our womenswear selling spaces, making sure that they are sufficiently intimate and detached from the rest of our offering. In the months ahead, we will concentrate on defining future brand strategy and the creative direction of our collection going forward. In this context I'm pleased to announce that [Indiscernible] will join the managing board as the group’s chief [brand] officer in less than two weeks from now.

I'm sure that his arrival earlier than initially planned will be instrumental in driving progress in this important part of our business. Ladies and gentlemen, I hope that I have been able to convey the different sources of top line pressures in the first half year. Some of them were market related, others company specific. Some of the pressures we were not able to avoid, others we accepted in order to strengthen our base for future growth.

So while we cannot and we are not satisfied with the group’s current top line momentum, we have been able to limit the effect on operating profit as far as possible. In the second quarter, gross profit margin improved by more than 100 basis points meaning that we almost reversed the declines of the first quarter, where gross margin had suffered from higher rebates and some scrapping of old merchandize in China.

In the second quarter, we even reduced rebates compared to the prior year despite an overall still highly promotional market environment. In doing so, we sacrificed sales for the sake of brand protection. Even more importantly, however, we benefited from a positive channel mix effect as well as tighter inventory management compared to the previous year.

In addition, some price increases in other markets, most notably in Russia, limited the negative effect from the price reductions in Asia. Below the gross profit line, the efficiency program announced a few months ago has clearly started to taking effect. This was true for selling and distribution expenses, where successful rent renegotiations particularly in Asia limited cost growth.

However, the effect was even larger in the G&A line where tight operating overhead cost management, meant that cost remained stable versus the prior year. Nonetheless, we took great care not to touch expenses vital to reaccelerate brand momentum. Marketing expenditures, for example, remained on the prior year level. Despite the measures to protect profitability, EBITDA was down 21% compared to the prior year.

As a consequence of special items and higher depreciation and amortization expenditures, the group’s EBIT and net income declined even more significantly. From a regional perspective profitability held up reasonably well in Europe. In the Americas, operating deleverage from the severe decline of sales as well as somewhat higher rebates lead to margin contraction.

In Asia, the profitability decline was largely due to the lowering of selling prices in China, in some other markets at the beginning of the year, which was only partially offset by tighter overhead cost management.

Let us turn to the balance sheet, at the end of the first half year trade networking capital was up 1% in currency adjusted terms, but down by the same rate in reported terms. Relative to sales, this represents an improvement of 20 basis points compared to the prior year period.

Inventory growth continued to be well contained. The risk factor was a negative top line development. At the end of June, inventories rose 2% excluding exchange rate effects. Increases were entirely due to the growth in Europe. In the two other regions, the inventory position decreased substantially.

In line with our guidance, investments were down compared to the prior year and amounted to €79 million in the period. The decline was primarily a result of the non-recurrence of last year’s one-time investment related to the relocation of our New York City showroom.

Overall own retail expenditures remained virtually unchanged. However, while store renovation expenditures increased, spending for new openings declined, a pattern, we also project for the rest of the year. Lower Capex and trade net working capital improvement were not sufficient though to compensate for the earnings shortfall, so that free cash flow declined to €54 million year-to-date.

As a consequence, net debt was above the prior year level at the end of the period. In the full year of 2016, we now expect group sales to develop weaker than originally expected. This is due to a weaker than expected sales performance in own retail in the first half year. In addition, we have decided to accelerate the structural changes in our US wholesale business. As discussed earlier, we started reducing the Boss brand exposure to off-price distribution formats in the first half year. In the second half year, the cleanup will be even more comprehensive than initially planned. As a result, we reduced our full year sales outlook for the wholesale business and now expect a decline of up to 10% in currency adjusted terms.

In our own retail business, we are obviously working towards an improvement of like for like sales in the second half year. For us the comparison base will ease significantly in all three regions. Second, we are adjusting our merchandise offering in China to better cater to the demand that our price adjustments have created, and third we will continue to drive the group’s digital transformation by rolling out omni-channel services also in Europe.

However, we expect an ongoing difficult and volatile market environment in the remainder of 2016. As a consequence, our visibility on any potential improvement on trading and own retail remains low. We hence assume a second half year comp store sales performance equal or better compared to the first half year’s level.

As a result, overall group sales are now projected to decrease by up to 3% on a currency adjusted basis. A stable gross margin development in the full year and disciplined cost management should continue limiting the operating deleverage from a flat to decreasing sales trend. Consequently, we expect EBITDA before special items to decrease between 17% and 23% in 2016. Unchanged to our previous communication, investment should amount to between €160 million and €180 million.

Following the adjustment of our sales outlook; however, we now expect a slightly smaller cash contribution from working capital improvement. As a result, free cash flow is projected to decline slightly compared to the prior year levels.

Ladies and gentlemen, we have initiated a number of measures to address our current challenges. We cut down on cost growth. We adjusted prices in Asia to improve the consistency of global brand presentation. We initiated far-reaching steps to improve our distribution in the US wholesale channel in particular, and we decided to right-size our stores network by discontinuing operations in underperforming locations.

These decisions are painful in the short-term, but they had to be taken because they are right for the long-term. There will be more work to do of course. Irrespective of the prevailing market environment, we need to further strengthen our brands and our business model. We will have to become more customer-centric, faster and more flexible. These attributes will guide our definition of future strategy [Indiscernible].

I'm excited about what this will mean for the future of Hugo Boss. While it is too early to go into detail today, I look forward to sharing our medium and long-term plans with you when we will meet you for our investor day on November 16th in London. But before this I'm pleased to answer your questions on today's set of results and our outlook for the remainder of 2016.

Question-and-Answer Session

Operator

[Operator Instructions] We will now take over first question from Fred Speirs from UBS. Please go ahead.

Fred Speirs

Hi, good afternoon Mark. It is Fred Speirs from UBS. I have got three questions please. The first is on the 20 retail store closures, given your indication these were a 60 basis points strike on growth EBITDA and margin, would it be fair to assume they are about a mid to high single-digit euro million drag on FY ’15 EBITDA. Secondly linked to that, how are you now thinking about the overall net change in free standing stores for 2017 at this stage, and then lastly on the free cash flow you are talking about only a slight reduction in free cash flow year-on-year, does that mean you still think you can keep it above €200 million this year, and how is that outlook shaping your latest thinking around the dividend? Thank you.

Mark Langer

Thanks Fred. Let me start with the US closures. I think the number is slightly higher than you calculated. I mean, we are deliberately not giving an indication on the 2016 numbers because as we said the impact of the closures will be more felt in 2017 and beyond because we have now intensified our discussion with the landlords on the exact timing and the amounts to close these stores.

What we have done and this is the indication of the 60 basis points that I mentioned in my call as what if – what would have been the performance in 2015 excluding the now identified stores for closures, and here we calculated 60 basis points improvement. So from that you can calculate backward the impact on the full year 2015 from the closures.

As we explained on previous occasions, we have started to slow down our opening plans going forward, shifted our attention far more in improving performance in existing stores, without giving you an exact guidance on our 2017 expansion plan in the US. There will be selective additions to the network as I said, [Leon] was an example, now in the second quarter, I think exactly the right expansion work where we still see wide spaces, but the number of new stores added to our network of future takeovers will be significantly lower than the rate you have seen in previous years.

I think we need to spend some time to explain our now lowered guidance on free cash flow, which we now guided to be slightly below previous year’s levels. I think it is too early to be more specific on that one but it doesn't change also avoiding all the dividend proposal. Both elements will be truthful going forward, we speak to our dividend policy of paying out 60% to 80% on net income. And as we highlighted at the Analyst Conference we will also take our performance and outlook on free cash flow generation in 2016, '17, into consideration when it comes to facing our dividend proposal. So, no change to our dividend policy from this perspect.

Fred Speirs

Okay, thanks.

Mark Langer

Thanks, Fred.

Operator

We will now take our next question from Claire Huff from RBC. Please go ahead.

Claire Huff

Yes. Hi, Mark. Thanks for taking my question. Two please. The first one, just wondering if you could possibly comment on trading in July and whether any of the markets are worse since Q2 which led you to reduce the sale guidance for the full-year. And that'd be the first question. And then second one, I think you mentioned the full-year results for you were hoping to rebalance or try to rebalance the offer between luxury and premium. And so, just wondering whether there's been any change to the merchandizing or pricing architecture here also.

Mark Langer

Okay. Let me just clarify on sales outlook. So, this was predominantly driven by a weaker like life performance than we initially got the market to expect when we gave our initial guidance for the year with the Analyst Conference. Back then, we guided the market for the full-year on a basically flat like or like development. We now expect to be the full year development more or less in line with the development we have seen in the first half year. So, we have to expect -- we have to accept that the retail like active development is weaker and probably hapful. We have to pay so continuous volatile environment, also retail for the second half of the year.

In addition, I think that's important, it's not only the retail part of our business, we also decreased our wholesale guidance for the full year with the repercussion on the topline guidance because we have now taken more stricter measures to cut off distribution off strategy of price chance in the US. You probably have noticed that we increased, all right decreased our guidance for the wholesale business for the full year now up to 10% decline for the full year. And this is predominant and driven by the measures that we have taken in the US which will also take, be more effect in the second half of the year.

In terms of merchandizing and price positioning, there are a couple of measures that we take into consideration. One is we have adjusted already for the second half of this year, our merchandising offer in particular in Mainland China where we now operate at different price points and this has to be reflected out in our buying behavior. So, merchandising teams in Hong Kong has worked very closely with headquarter functions to make sure that we have now optimized our buying decision for winter and pre-spring '17 which will both effect our 2016 performance in China in the light of the new buying behavior. As I mentioned, we have seen strong uplift in terms of volume sales and we want to make sure that we are not missing on this volume opportunities in China.

In Europe, we have taken with some more technical decisions between product categories and also between branch and the lines to maximize retail productivity, in some cases that has meant to shift more attention into menswear or to shift more attention into Formal wear but basically working with the spring, therefore Winter collection would as it was defined and presented in January/February. Going forward, we do expect rebalancing and a stronger focus of our collection to price positioning of the brand but we continue and we see positive results also in our premium or highest price offering that's our full tailored and made to measure offering. So, we'll continue to be present and presume market opportunity also is the higher end of our product offering.

Claire Huff

Okay, brilliant. Thanks very much.

Operator

We will now take our next question from Antoine Belge from HSBC. Please go ahead.

Antoine Belge

Yes, hi. Good afternoon, it's Antoine Belge, HSBC. And three questions. First of all regarding the gross margin. I think you've mentioned a lot of moving parts. I've noted less rebates, sort of so positive new channel mix also positive, price reduction on the whole, negative. So, any sort of quantification would be welcome also. I would be surprised that given the H1 evolution which is sort of flattish, you're not expecting more bullish or two for the second half. So, we are within the positive of Q2, officially less rebates on channel mix, are you expecting some of them to be nonrecurring in the second half.

My second question is on the management changes, I think you've spoke about one of the changes. Are there any other such as in terms of turn-ins especially in terms of branding or retail. So, what about this year for position going forward? And on finally, regarding womenswear, I think there is a bit of a debate or at least uncertainty amongst investors regarding your commitment to womenswear, so, would you say that you will be the emphasizing womenswear or is it just that you probably be reallocating your marketing budget which had been as to what woman's wear in recent years. Thank you.

Mark Langer

Now, let me start with your question womenswear first. We continue to be fully committed to our womenswear offering across our Boss and Hugo brand lines. And as I said, we are have seen a difficult market environment also in the second quarter to continue momentum with all core womenswear offering and other Boss Black label. I think we all agree that we have overinvested in terms of marketing, in some cases also in terms of merchandizing space allocation to all womenswear business over the last couple of quarters. And what is happening right now and this should be beneficial for the overall performance that we are smart in allocating these resources to our biggest profit contributor and this continues to be Boss Menswear.

So, it's not a tactical adjustment, in growth market condition, where we have to make sure that our core business is sufficiently protected by marketing measures that we have to take to protect the menswear but you can see all upcoming show at the New York Fashion Week again with Boss womenswear. As a clear commitment that we are in the long term participant in the and important in for us was a high strategic relevance womenswear apparel market. In terms of gross margin development, I think was your first question, I think I highlighted some of the positive things that I was happy about in the second quarter. Tough trading conditions, however, the market managed to even reduce rebates overall in the second quarter. We run relatively not perfect but relative clean ship on when it comes to our inventory situation.

But as you can see from our retail sales outlook, we do not expect any significant support from the market in the second half of the year. So, overall we're comfortable with outlook on the gross margin projection for the full year. If we see a positive surprise in the third quarter, I would be happy to report on that but also the earlier question as Claire asked us about, first trading trends in the third quarter. We might have seen a slight improvement in the third quarter but the general trends in terms of tourism flow, high promotional activities in US has not changed with the start of the third quarter. In terms of management changes, I think the key message were not that we were successful to achieve that in both will, already start in August. I'm very happy about this not earlier than initially planned starting date.

There will clearly be a lot of work ahead of us. Now that we have the full boat with Bernd Hake with myself. We are in the midst of preparation for the Investor Day in November. The decision to fil the CFO position again is not for me to take alone, if from the June governance system, something that involves the Supervisory Board. So, I will not preempt any decision to be taken from the supervisory board.

Antoine Belge

Thank you, very much.

Mark Langer

Thanks, Antoine.

Operator

We will now take our next question from Thomas Chauvet from Citi. Please go on.

Thomas Chauvet

Good afternoon, Mark. I have two question, please. The first one, follow-up on you refocus on Menswear. One of the initiatives if I recall was to reallocate marketing spends from womenswear to menswear. So, how much was in P/E dedicated to Menswear in the first half of '16. I think you said in the last two years, 70% of the budget was dedicated to womenswear. So, how much has it fallen, in other words. And secondly, on ecommerce online was down high single digits in the second quarter, I guess, bit below. You're expectations despite the insourcing of fulfillment operations. So, what were really the main hurdles you faced and how quickly you think that's fixable? Do you need to invest more than the original plan you presented last November to turn around the business. Thank you.

Mark Langer

Yes. Let's take your first question on the composition of marking plans. Clearly, in the second quarter we were not able to completely reverse some of the already at the beginning of the year taking decision on media booking for the first half year. We have seen only marginal trends in composition between menswear and womenswear. For the second half of the year is that it's far more balanced with the Menswear side, I can't give you a precise number right now because we're negotiating this rebalancing of advertising be and that feed on print with our partners. But I expect this to be far more evenly balanced between menswear and womenswear in the second half of the year. And we are currently working as part of our strategic review.

In terms of media channels, in terms of composition between menswear and womenswear between or brand line up, we're to see optimal marketing media plan for our brands going forward. On ecommerce we are clearly disappointed by the slowdown in the second quarter. So, on the one hand we were quite successful in insourcing, however as I said in the core, we have not upgraded our site in terms of functionality and other services as this is happening right now in a fast moving competitive environment. One of the challenges that where we have to find the right answers that increasing the traffic or site is not coming from desktop anymore but mobile devices, smartphones, tablets. And here our site is not operating with the same converted rate.

So, we have to improve the ease of use navigation to this small increasing becomes standard way of accessing our mobile sale side. Important step to ours this direction will be the relaunch of our website in particular addressing these shortcomings which unfortunately will only happen till the end of the third quarter. And the other element here we known some initiative finally taking place also at Hugo Boss, in particular in the US and key European online market that we would bring to life, introduce omni-channel services which are desperately needed to connect our online to our offline offering. So, on the omni-channel measures, I 'm confident I will have hopefully some positive impact to report back to you in the course of the third quarter. In terms of site improvement, I expect the vast majority of improvement to happen post the relaunch of the site end of September, beginning of October.

Thomas Chauvet

Thank you, Mark.

Mark Langer

Thanks, Thomas.

Operator

We will now take our next question from John Guy from MainFirst Bank. Please go ahead.

John Guy

Yes. Good afternoon, Mark. I got a four questions, that pretty brief. Could you please confirm on the €50 million of cost savings that you articulated back in first quarter? Does that include any savings that you'll get with the change in fulfilment online, obviously now starting with Arvato and also could you confirm within a 12 months period the savings that you get and having to terminate your agreement with Arvato will be around €15 million. So, that's the first two. Then just sticking with the cost savings, when we look at selling and distribution costs growth over the first half is running around 5%. Should we think that's a reasonable run rate over the course of the year? And also think about 2017 with regards to some of the store closures and the transformations that you're making. Where else could we considerably see opportunities for further cost savings?

And then finally, just with regards to these sales contribution from Space going forward. What should we be thinking given the fact that the first half looks like it's a mid to high single digit, close to high single digit sales contribution from Space. Thank you.

Mark Langer

All right, thanks John. Well, the saving from the and talking on the online business, even though we have never given the exact amount on the saving but we announced it to be significant compared to the service fee that we pay to Arvato was up -- already included on initial guidance for the 2016 because it was part of the agreement that we, when we did the business case on in-sourcing and I can confirm that the handling cost per piece have now been inline or below our initial expectation from doing the in-sourcing.

The $50 million cost optimization that we announced once again our original cost plans for 2016 which we have been regularly reviewing and I would like to highlight to use the decrease in quarterly run-rate in G&A expenses over the last three quarters which has fallen from the high single digit rate now if you look at G&A cost alone to flat within less than six months. We are not giving cost line guidance for the remainder of the year, but we can confirm that our full year outlook will continue to see a rigorous review and cost analysis on anything that's not needed as necessarily investment in terms of digital competencies or the impact from full year effects retail expansion.

Retail and I think was your last question on the impact from new space addition so we still have the impact on further addition at a much smaller scale in 2016 but also the full year fact from take over that happened over the last 12 months will have a cost impact well of course marginal top line impact, but we expect I think this question was early asked also from threat that the impact in terms of sales contribution from new spaces in 2017 will be further declining. Areas of further cost optimization will come part of as we go into our budget process 2017 that we will now reduce the momentum of cost development in most areas. We continue to see or continue to hold cautious outlook on the market recovery for the next couple of quarters so we will not give you specific fixed cost guidance of the next 12 months but as you seen from our outlook in terms of OpEx development for the remainder of the year we expect the second half of the year to be in line or below the cost development that we are able to achieve at the run rate after six months in 2016.

John Guy

Okay, great. And maybe just one follow-up with regards to the strategic highs and personal within the organization, I mean given the additional emphasis now that you are putting back into menswear, do you think you need a start sort of fashion designers that were to get to you to push the woman's wear product. Is this something that you are going to continue with or are you going to de-emphasize that as well?

Mark Langer

No, I can confirm that [indiscernible] are very happy first and foremost in joining us much earlier than planned so they will have clearly touch on upcoming collection and he will the master mind behind our menswear collection going forward and he will work very closely with Jason to keep the momentum on the women's wear so there is no need to have a somebody added to our team that clearly hits home turf and I am very confident that he will do exactly what is needed to further accelerate our menswear business going forward.

John Guy

That's great. Many thanks, Mark.

Mark Langer

Thanks.

Operator

We will now take next question from [indiscernible] from Jefferies. Please go ahead.

Unidentified Analyst

Hi Mark. Thanks for taking my question. I have three pieces, I think and first on space can you, given the store closure can you, are you able to tell us a space will decline or it would flat in margin rate growing. Second question is, I was just wondering if you are able to give us the full price sales penetration as it is now and how it has developed and also that one is on the price increases and Russia to what extent has that happened if you can quantify please? Thank you.

Mark Langer

Well, let me start with the third one the price adjustment that we did on Russia was basically the reversal from significant exchange rate impact that we have seen over the last 12 months. So we are still, if we take state price in Ruben convert back in Euro we are significantly below the level that we had two years ago but we brought have the price differences in Russia which was I think like six months ago even in-line or below or the German prices with respect to price levels that are more in sync to competitive pricing of the Russian market which has a positive impact now in the second quarter. The space growth for this year we can confirm that we will benefit from space growth for the full year as I said the as I said the closures that we announced today where we also booked significant restructuring charges we are in the majority only the fact in the course of 2017 and I would ask you to bear with us that we can't give you an impact on sales development in 2017 from space contribution at this point in time, but we continue to expect that in the 2016, we will have a mid to high single digit impact from new spaces. I would expect that it can we will also benefit from space additions going forward but we can't give you more précised number for 2017 at this point in time. Of course depending on our expansion plans and take-over plans for 2017 which are not finalized in the exact timing of closures which we announced today where we booked the restructuring charges but in the midst of process of negotiating the exact timing of the stores.

Did I answer your question, okay.

Unidentified Analyst

Yes. Okay. Thank you and the full price penetration?

Mark Langer

Sorry, I didn't get what was your question on the full price penetration?

Unidentified Analyst

Sorry. Yes. I was wondering what these full price sales penetration is at the group now?

Mark Langer

You mean, the split between full price and off price and on the regional part of our business?

Unidentified Analyst

Yes.

Mark Langer

Well, this hasn't changed dramatically because the up price changes that I mentioned wasn't more the wholesale side where we used up price channels in specific deal on the newer part of the business where we have discontinued the relationship with almost all of these partners, so significant part of our wholesale decline the -- related to the discontinuation to that. On the retail side of our business I think you have seen some of the momentum we parted in US and shop-in-shops where the factory outlets this composition hasn't changed significantly between both sales channel.

Unidentified Analyst

Okay. Thank you.

Mark Langer

Thank you.

Operator

We will now take our next question from Andreas Inderst from Macquarie, please go ahead.

Andreas Inderst

Yes, hello. Yes. First of all congratulations. My question is the first one how far are you actually in cleaning up US district institution channel to get a feeling on the roadmap here? Have you just begun half way through so maybe here you can elaborate a bit more? Second question on the store closures overall of the 23 spending stores but also on the stores, you already closed could you give us a bit more insight to how much sales you expect to lose related to this store closures? And my final question just to clarify on the dividend. Do you mean 60% to 80% payout ratio on adjusted profits or in reported profits? Thank you.

Mark Langer

Well, let's start with the last one, we always talked when we talk about net profits as reported, we never give the market adjusted in the profit number but we also as part of our dividend guidance or policy for the year 2016 commitment that we also taking consideration to additional factors one is free cash flow development for the full year 2016 but also our financial outlook on the year 2017. So it's too early to comment on the later on but the core of our dividend policy to payout between 60% and 80% of consolidated net income I can't confirm today.

In terms of the wholesale clean up in the US we have been – we are well advance in most cases we have completed the exercise to discontinue the collaboration with third-party of price channel peer place, so this has been already completed to a very vast degree and the first six months of 2016. I think as part of the speech I gave you in update on where we are working with our full price all time partners to deepen our relationship in some cases we will include the decision to move into shop-in-shops concessions as have done in Europe here which is most prominent examples and [indiscernible] these were the two major networks where we have now taken over full responsibility in these spaces and what I mention with dealers in North that we have found an agreement with these partners to limit the distribution where we are talking about full price distribution but whereas brand environment is more in sync with a lower price brand like Hugo and Black Orange, we will prefer it to shift distribution from our Boss like core brand lines to be more in sync with brand environment.

So the later we will continue we are also in very close discussions with other wholesale partners in US even so we have -- in specific agreements yet to further enhance our presentation be in upgrade and stuff space be it in respect to pricing and promotion activity so you can be assured that we have the mutual interest of wholesale partners in the US and Hugo Boss to protect brand equity and sales and we will do this in mutual action steps, but on across all three dimensions which define our wholesale business in US. I am happy with the progress we have achieved.

On the store closures we announced earlier this year that out of this total portfolio of stores that we have taken all the former franchise partners in China we will take advantage of the expiration of certain rental contract. This was also 20 stores in China of which we have now already exited around half of them with the new at the end of the second quarter and now global store portfolio review we will have in addition 23 standing stores in a number of shop-in-shops that will be now disclosed based on performance and their diluted impact on the performance. So this has been announced by us at the analyst conference. We’ve come with the exercise even so the majority of these stores are not closed yet. We are in advance negotiation with the landlord and we will update you on the exact closure expenditures and the timing and that also the sales impact but today from today's perspective we expect only a marginal impact in terms of top line and profitability improvement in the current fiscal year.

Andreas Inderst

Okay and you can't give rough indication how much sales you will lose from the 20 stores you intent to close by end 2017-2018?

Mark Langer

Honest answer to that I mean, it will be low double digit number but it really depends on the concrete timing to that it will be not felt over the course of we are talking about 24 months, which I think is a realistic timing but if you want to have a ballpark number it will certainly be less than 50 million Euro related to these store closures.

Andreas Inderst

Okay. Very good and then final question on your transition in Germany by dividing certain wholesale spaces giving some space to Hugo versus the Boss core label how has been the overall reception by retailers and of course most importantly by consumers? I see that sales were down in the second quarter but overall what’s the feedback here?

Mark Langer

We received very positive feedback from our wholesale partners which confirms that it was the right move for our Boss core brand to become more exclusive and it has the right environment so our Boss core brand is not only presented at third party distribution in branded spaces and please keep in mind that in particular Hugo as it is the second best selling brand at some wholesale partners Hugo was already ahead of both in terms of in certain categories so this was not a new brand introduced to most wholesale partners in consumer but a well known brand which has picked up sales momentum very well from our perspective. The wholesale weakness I think that's important comes predominantly from the US market and not from European wholesale market.

Andreas Inderst

Okay. Thank you very much.

Mark Langer

Thank you.

Operator

We will now take our next question from [indiscernible] please go ahead.

Unidentified Analyst

Hello gentlemen. First question on your online strategy as a novel observation is it that consumer size using more and more fashion online portal instead of surfing through the mono-brand online stores so what is your strategy in order to gain customer traffic and frequencies on your online store and what page and second question on your comp store sales minus 8% in the second quarter could you give us a split by regions here please and I put it just if you have to repeat yourself as I was dropped out for while out of the call. And last question would be on the one offs could you provide here a rough split of the 50 million second quarter and how much of the planned restructuring measures are already implemented and perhaps the kind of guidance what amount of one offs you should take into account for second half also here I mean as a rough guess from your side in order to help – to be on the same page when calculating the rest of the year? Thank you.

Mark Langer

Alright. Let me start with the last one. As we clearly highlighted this has been the full review of restructuring for Hugo Boss period. So of course there will be as a normal course of business in future quarters store closures where we will not expand an existing renter contract or we will relocate but this will be always be booked as part of the normal course of the business. The roughly 55 million that we book now is predominantly due to the expenses that we have to book in the context of early termination of the renter contract and you can be sure that we do whatever we can to minimize the impact via negotiating exit solutions that are beneficial of Hugo Boss and there is roughly 6 million charge due to the earlier write off in those inventories and pictures related to this operations. But we do not expect anything of significant amounts in the second half of 2016.

Unidentified Analyst

Okay.

Mark Langer

On the comp store development for the -- by region that we do not disclose comp store development by markets or regions but again despite the fact it was a negative territory performed much better than the other two regions. The two markets which clearly have been disappointing were in Asia-Pacific in particular Hong Kong and Macau where the second quarter continued to be a very difficult one in the US market. And both of these markets were clearly affected by a very high number of declines in traffics and to our stores, which we are not able to compensate by better conversion rates and value per transaction.

And this leads to your fourth question of course online is of importance but we think it's a combination it's not a separate faced channel as much has started we are in a very good position to benefit from this changes in consumer behavior when it comes to exploring brands and also to purchase from them so it's not either or it's a combination of integrating omnichannel services and then into our store network but also referring to us around physical stores via the internet. Here we will see as we announced already in the third quarter the introduction of new services which should be mutual beneficial both to our physical retail and our online business. I think I mentioned earlier that we need to improve our conversion rate when it comes to visitors that come to our store via mobile devices. This has become the prime channel of visitors to our site and we are not yet at the same conversion rates for these visitors compare to people who hit more historic years come to our site by desktop solution. And I also would say it's not either or in the digital world mono-brand were market brand. That we are quite successful operating the most markets in mutli-brand environments where we are more all cases are the strongest menswear brand and we are able to operate very successfully retail brands take the UK as a very good in telling example but that's true almost like every core market that we operate and I think that's the same rational will held true when it comes to online distribution online presence which should be leading the industry in terms of capabilities and efficiency.

It's a good combination which wholesale online distribution. We just have to make sure that the treatment of the brands, the presentation and multi-brand online presentation is in sync to what we do in the physical world where that's the case we are very happy to work with these partners like we do with many of our wholesale partners who have built also quite successful online businesses now.

Unidentified Analyst

Okay. Thank you.

Mark Langer

Thank you.

Operator

We will now take our next question from Philips [indiscernible] Research. Your line is open. Please go ahead.

Unidentified Analyst

Yes, hello gentlemen. First of all on while you elaborated in the past about several measures that you plan for improving your retail like-for-like you mentioned in the quarter to mix rate location and then merchandise planning etcetera to what extend does the first half of performance reflect the full impact already of measures or how much potential do we have in the next couple of quarters from these measures. It's the first one.

Secondly in terms of renter contract when you currently prolonging contracts do you see a general willingness of retailers to reflect the declining frequency in lower rental payment or some color on that one?

And thirdly, technical question while depreciated by impaired some of your stores and as far as I remember you usually have a larger chunk of impairments for under-performing stores particularly in Q4. Would it be reasonable to expect a lower charge from debt side in the current year in Q4?

Mark Langer

Let me take the question first you are right. As procedures, we will review our total retail network at the end of the fiscal year. The measures of that is much described in our annual report so we treat each store as the cash generating unit. It has to be evaluated whether the assets most cases that's the fixtures, the build out expenses being supported by the future cash flow generated by these stores. Typically these stores as we the amount that we do expect it's too early to speculate on that but I would not assume based on the 6 million charges that we have now taken sort of our restructuring were significantly lower our full year impairment cost as we go through the regular exercise because these efforts are completed independent to each other. The additional charge that they would book now because more to which is the fact that we have now included also some expense of flagship location with long lasting contract so it will have only marginal impact on the full year restructuring impairment charges that we booked in the last fiscal year in part of our full year numbers.

What we can confirm is that rental consideration many cases it's half declined over the last couple of months and quarters. Unfortunately that makes our intention to sublet some of these loss makers not any easier. But we are also on the other hand benefiting from that where in some cases where we have now much better bargaining power to secure more flexible lower rental agreements in these cases and as I mentioned as part of our OpEx development the first six months where this was ceaseable, we have aggressively persuade opportunities to renegotiate rental obligations for the group.

For the improvement of retail business coming from merchandising yes we have seen already some measures to be effective in the first half year. However the selection as such the buying decisions were already taking prior to the start of our restructuring program that we started end of February and beginning of March. So some of the measures in particularly in the buying decisions in the merchandising decision the allocation decisions were only become fully affected globally as we move in the second half of 2016 when it comes to the collection most of where we have started to re-balance our offering between entry and upper range prices will only become full affected at the end of 2016 so I expect the continuous support from much better retail execution over the six months not only from short term reallocation of budget and brand underline but also more thorough review of our planning and buying decision compared to the past.

Unidentified Analyst

Thanks a lot.

Mark Langer

Thank you. I think this will conclude our conference call for today. Thank you very much for your interest and on numbers. As I said please ear-mark our investor day in London mid of November where we will be able to give you far more details. Now midterm strategy going forward, if there anything you would like to follow-up on [indiscernible] is ready to take your questions also after the call. Thank you very much and have a good day.

Operator

Thank you. That will conclude today's conference call. Thank you for your participation ladies and gentlemen. You may now disconnect.

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