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Edited Transcript of KORS earnings conference call or presentation 6-Nov-17 1:30pm GMT

LONDON Nov 6, 2017 (Thomson StreetEvents) -- Edited Transcript of Michael Kors Holdings Ltd earnings conference call or presentation Monday, November 6, 2017 at 1:30:00pm GMT

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Corporate Participants

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* John D. Idol

* Thomas J. Edwards

Michael Kors Holdings Limited - CFO, COO, Executive VP & Treasurer

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* Oliver Chen

Cowen and Company, LLC, Research Division - MD & Senior Equity Research Analyst

* Omar Regis Saad

Evercore ISI, Research Division - Senior MD, Head of Softlines, Luxury and Dept Stores Team, and Fundamental Research Analyst

* Randal J. Konik

Nomura Securities Co. Ltd., Research Division - Senior Analyst of U.S. Specialty Retail Equity

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Operator [1]

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Good day, everyone, and welcome to the Michael Kors Second Quarter 2018 Earnings Conference Call.

Today's call is being recorded.

At this time, I would like to turn the conference over to Christina Coronios, Director of Investor Relations. Christina, please go ahead.

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Christina Coronios, [2]

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Good morning, and thank you for joining us for our Second Quarter Fiscal 2018 Earnings Call.

Presenting on today's call are John Idol, Chairman and Chief Executive Officer; and Tom Edwards, Chief Financial and 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 website. Investors should not assume that the 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.

In addition, certain financial information discussed today will be presented on a non-GAAP basis. These non-GAAP measures exclude certain items related to the company's acquisition of Jimmy Choo, restructuring and non-cash impairment charges primarily associated with underperforming retail stores and the acquisition of the Greater China licensee. You may identify these non-GAAP measures by the terms adjusted and non-GAAP. To view the corresponding GAAP measures and related reconciliation, please view the earnings release posted to our website earlier today at investors.michaelkors.com.

I will now turn the call over to Michael Kors' Chairman and Chief Executive Officer, Mr. John Idol.

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Thank you, Christina. And good morning, everyone.

We are pleased to have laid the foundation for our global fashion luxury group, Michael Kors Holdings Limited, with the recently completed acquisition of Jimmy Choo. With a rich history as a leading luxury house renowned worldwide for its glamorous and fashion-forward footwear and accessories, Jimmy Choo represents an excellent complement to the Michael Kors fashion house. We believe that bringing together these 2 iconic brands further strengthens our future growth opportunities; increases our product and geographic diversification; and importantly, creates a platform for future acquisitions.

Turning to the Michael Kors brand. While still early, we made important initial progress on our Runway 2020 strategic plan. As we have discussed in the past, Runway 2020 is centered on 3 focused areas: product innovation, brand engagement and customer experience.

Beginning with product innovation. We continued to introduce exceptional new fashion and additional layering into our fall accessories collection, resulting in an approximately 40% increase in new offerings. During the quarter, we launched Bancroft in the Michael Kors Collection line. Handcrafted in Italy, Bancroft marks a meaningful first step in our efforts to expand our collection offerings to increase fashion and luxury layering in our overall accessories assortments. From the MICHAEL Michael Kors line, we introduced Sadie, a new soft satchel that features chain inlay detailing and a cool fashion sensibility. Our Mercer and Sloan Editor collections remain favorites among consumers, and we updated these iconic shapes and luxe -- with luxe snakeskin and crocodile-embossed textures. Finally, we offered a novelty take on our Selma satchel with a limited-edition offering of handbag detailed with artful depictions of iconic cities like New York and London. Overall, consumers responded favorably to the continued fashion luxury innovation and increased layering in our accessories assortments.

The sequential improvement in our accessories' global comparative sales performance for the quarter illustrates that we are moving the brand in the right direction.

In women's footwear, we drove double-digit global comparable sales growth in the quarter. Consumers responded favorably to our fall offerings, including key styles featured in our national ad campaign, the Lori boot and Sherry studded caged sandal. Additionally, our new Alice ballet flat, which features our iconic locks charm, was among our top sellers in the quarter. Lastly, our elevated active assortments continues to resonate with consumers. The Allie sneaker, with its glamorous metallic accents and mixed materials, was a strong seller during the quarter.

Turning to women's ready to wear. We continued to make strides in growing this category as we leveraged Michael's fashion leadership and runway heritage. Global comparative sales increased double digits in this category during the quarter as consumers continued to respond to our elevated and expanded offerings, including romantic details such as florals, ruffles and lace. Embellishments such as iconic studding details were also well received. In addition, we capitalized on the strong sweater dress trend, offering an expanded array in the variety of seasonal styles and colors.

In our men's business, sportswear and luxury leather goods continued to exhibit strength in the quarter. New and unique design elements drove the largest increase in our men's sportswear category. The injection of elevated product across categories, particularly in our knitwear, lightweight sweaters and fine gauge yarns; and layering pieces such as jackets and Napa leathers were some of our best sellers. In leather goods, backpacks remain the #1 selling silhouette. Our iconic Bryant, Harrison and Odin leather collections continue to be top performers. Men's sportswear and leather goods are an important and growing category for us, and we will continue to build on the positive momentum, with the goal of reaching $1 billion in sales over time.

In the watch category, we continued to drive innovation with the introduction of our new Sofie access smartwatches during the quarter. Lightweight and feminine with a pavé bezel and a full round display, Sofie generated excitement among consumers and is now the top-selling watch in our stores. We believe that the Michael Kors brand is well positioned to be a leader in the fashion smartwatch category as we excite and engage consumers who are interested in incorporating both fashion and technology into their lives.

Looking ahead to the 2017 holiday season. We will build on the positive momentum in our Bancroft collection, introducing new colors and textures. Additional innovation and fashion layering will be injected into the MICHAEL Michael Kors accessories assortments, where we expect to increase the level of new offerings for holiday to approximately 50%. We will introduce the Bristol group, a top-handled bag crafted from rich-pebbled leather and embellished with grommeted side ties and a removable lock-and-key detail. Bristol will be featured in our national ad campaign. In addition, we will debut our new tote group, the Voyager, which is an evolution of the iconic Jet Set tote. In footwear, holiday offerings will emphasize feminine details and embellishments, including glitter, ruffles, sequined bows and stars. Finally, in ready to wear, we are excited about the opportunity to build our significant momentum in this category. We broadened our holiday assortments with a mix of feminine and flirty party options as well as a focus on novelty embellishments and shine as our customers dress to celebrate the holiday season.

Turning to brand engagement. We continued to deepen our connection with consumers and create excitement for our brand globally. In September, Michael debuted his spring 2018 collection at New York Fashion Week to overwhelmingly positive reviews. Our front row featured a high-wattage array of global celebrities, including Nicole Kidman; Naomi Watts; and Catherine Zeta-Jones; as well as our newly appointed brand ambassador, Chinese actress Yang Mi. As our first-ever Michael Kors brand ambassador, Yang Mi is a great fit for our luxury house. She epitomizes effortless glamor. Additionally, she is one of the most influential trendsetters in China right now, with more than 70 million followers on WeiBo.

Social media is a cornerstone of our communications efforts and remains a principal focus in deepening our connection with consumers. We are pleased with the continued growth in both our total followers and engagements across all social media channels. We now have over 38 million followers across all our social channels. Looking ahead, we have an exciting collaboration plan with Google for a 360-degree marketing campaign to support access smartwatches. The campaign will feature television advertising that will run during the holiday season. This will be amplified by marketing in print, outdoor and digital channels globally. We expect this exciting global marketing campaign will further heighten the demand for our access smartwatches and ensure they are top of mind during the holiday gifting period.

Moving to customer experience. We continued to elevate our digital flagships and our store fleet. We are seeing strong momentum in our digital flagships, particularly as we add additional features and capabilities. Earlier this year, we launched our online dress shop with favorable results. In the second quarter, we continued to build on that positive momentum, driving incremental growth of ready-to-wear sales on our digital flagships. In our stores, we are in the initial stages of renovating approximately 100 locations globally as part of our Runway 2020 initiatives. Our new retail concept reflects a refined take on glamor in a modern and engaging environment. This new concept will feature salons that showcase our accessories, footwear, womenswear and menswear collections, while enhancing our sales associates' ability to provide consumers with a unique and elevated styling experience. While we have a limited number of stores that reflect this new design concept, we are pleased with the initial response. I look forward to sharing more details about our fleet renovation plans with you in the coming quarters.

Now turning to the financial highlights from the second quarter.

Our results exceeded our expectations. Total revenue was $1.15 billion, an increase of 5.4% over last year. Retail comparable sales decreased 1.8%. And adjusted earnings per share increased approximately 37% to $1.33.

In the Americas, total revenue increased approximately 1% in the quarter. Retail net sales in the region were flat, with comparable sales declining in the mid-single digits. The momentum in our digital flagships continued with a double-digit increase in comparable sales in the quarter. Our strategy to reduce promotional activity resulted in 40% fewer days on promotion, which negatively impacted our comparable sales. However, we benefited from increased AURs in our digital flagships and lifestyle stores driven by mid-single-digit growth in accessories and double-digit growth in our ready to wear. We attribute the higher AUR to strong consumer response to the elevated product newness and innovation as well as reduced promotional activity. Wholesale net sales in the Americas increased 2.3%. We saw increases in AUR across women's accessories, footwear and ready to wear driven by positive consumer response to our more elevated and layered fashion offerings; as well as 46 fewer days brand-wide promotionally, as compared to last year.

Moving to Europe. Total revenue increased 9.2%. In the retail channel, net sales grew 17.5%. Comparable sales were approximately flat on a reported basis and declined in the mid-single digits on a constant currency basis. Including e-commerce sales, comparable sales would have increased in the low single digits on a constant currency basis. This performance exceeded our expectations, as our elevated fashion offerings generated even greater excitement among consumers than we anticipated. Ready-to-wear and footwear offerings were also well received in the quarter, with comparable sales growing in the double-digit and high single-digit ranges, respectively. Europe wholesale net sales were essentially flat in the quarter, as the continued strategic reduction in shipments related to elevating our brand positioning was offset by favorable foreign exchange rates.

Turning to Asia. Net sales grew 30.4% in the quarter; with retail net sales up 31%, driven by new store openings and positive comparable sales growth. Comparable sales, which now include China, grew in the mid-single-digit range on a reported basis and in the high single-digit range on a constant currency basis. The accessories category performed well in Asia during the quarter. We continued to deepen the level of fashion and luxury layering in our accessories assortments, including the introduction of our Bancroft group from the Michael Kors Collection as well as Sadie from the MICHAEL Michael Kors line. Additionally, Mercer, Selma and Sloan collections continued to be among the most popular styles. In China, our structured crossbodies, including our Sloan Editor and Mott collections, were particularly popular among millennial consumers. Asia wholesale net sales increased 27.2%.

We continued to see strong performance in Mainland China and Japan. Hong Kong and Macau remained challenged but began to show signs of improvements in the quarter, while South Korea continued to be impacted by the decline in Mainland Chinese tourists. Overall, we are pleased with the performance of our Asia business and continue to invest in our retail network as we build on the positive momentum in this growing region.

Finally, in our licensing business revenue decreased approximately 2% in the quarter. Access smartwatches continued to perform well, particularly the introduction of our new style Sofie. However, the fashion watch category continues to be challenging, and we expect continued sales declines through the fiscal year in our total watch category. In the -- in fragrance, we expanded our successful business with the global launch of our new fragrance pillar Sexy Ruby. Finally, in eyewear, we continued to focus on developing our optical collection with a fashion point of view. Sleek metal designs and fresh, modern shapes continued to generate excitement among consumers. In sunglasses, mirrored lenses continued to be top performers across a variety of shapes, including our iconic aviators. We also saw a positive response to an expanded array of shapes, including glamorous oversized squares and cat eyes.

In conclusion, our second quarter results reflect the traction we are gaining on our Runway 2020 strategic plan. However, fiscal 2018 remains a year of transition for the Michael Kors brand, as we are still in the early stages of executing our initiatives. And we look forward to providing you with updates on our progress in the coming quarters.

With that, I will turn the call over to Tom.

Thomas J. Edwards, Michael Kors Holdings Limited - CFO, COO, Executive VP & Treasurer [4]

Thank you, John. And good morning.

I will begin by providing details on our second quarter performance, followed by our outlook for the third quarter and full year, which incorporates the impact of the Jimmy Choo acquisition.

Starting with the second quarter. Results exceeded our expectation with adjusted net income of $204.5 million or $1.33 per diluted share, an increase of 37%. The better-than-expected performance was due to higher retail and wholesale net sales combined with lower operating expense, which was largely related to timing. Total second quarter revenue of $1.15 billion increased 5.4% compared to last year. Retail net sales increased 8%, largely driven by 56 net new store openings since the end of last year's second quarter, along with the benefit of Europe and Asia e-commerce. This was partially offset by a comparable sales decline of 1.8% or a 2.5% decline in constant currency. North America e-commerce benefited comparable sales by 260 basis points. Wholesale net sales increased 2.5% compared to last year.

During the quarter, seasonal replenishment orders in our accessories and footwear categories were higher than anticipated, reflecting better full-price sell-throughs. Licensing revenue decreased 2.1% primarily due to declines in fashion watches and jewelry, partially offset by growth in access smartwatches. While we are pleased with the continued growth of access smartwatches, the fashion watch business remains challenging. And we expect sales in this category to decline through the second half of this fiscal year.

Gross margin for the quarter was 60.2% compared to 59.2% last year. Retail gross margin increased 160 basis points, benefiting from an increase in international sales as a percentage of the total as well as lower cost of goods. Wholesale gross margin was roughly flat year-over-year. Total adjusted operating expense increased $17.3 million, reflecting continued investments in our digital flagships and marketing initiatives as well as new store openings. As a percentage of revenue, adjusted operating expense declined to 39.5% from 40.1% in the prior year, reflecting leverage on higher sales. Consolidated adjusted operating margin was 20.7% compared to 19.2% in the prior year. Adjusted retail operating margin was 15.4% compared to 12.5% in the second quarter of fiscal 2017. This year-over-year increase was driven by the expansion in gross margin and leverage on higher net sales. Adjusted wholesale operating margin was 27.3% compared to 27.0% in the prior year.

Turning to our Runway 2020 fleet optimization initiative. During the second quarter, we recorded a restructuring charge of $5.9 million related to store closures, as well as a noncash charge of $16.3 million for store impairments primarily related to underperforming stores and additional stores we have identified for closure.

Capital expenditures for the quarter totaled $43.1 million and were related to retail store openings and renovations as well as continued investments in information system enhancements.

Turning to the balance sheet. We ended the quarter with $178.2 million in cash and cash equivalents and no debt.

Now turning to our guidance. The numbers we are providing today reflect our expectations for our global fashion luxury group including Jimmy Choo, which will be incorporated into our results beginning November 1. Before turning to our outlook: As we have stated, we made the strategic decision to reduce promotional activity around the Michael Kors brand to drive higher AUR and higher full-price sell-through and to protect the long-term image of our brands. I would like to note that, in the third quarter, we will be anniversary-ing the highest level of promotional activity in the prior year. In retail, our new promotional strategy will result in a 66% reduction in promotional days in our digital flagships and lifestyle stores compared to the prior year. We anticipate that will be a significant headwind to retail comparable sales. In wholesale, we expect to have 67 fewer promotional days than last year. And as a result, we anticipate that sales will decrease more than our full year expectation of a low-teens decline, and wholesale gross margin will decline more than in previous quarters.

Taking this into account, we expect the following for the third quarter on an adjusted basis: total revenue to be between $1.355 billion and $1.385 billion, including between $105 million and $110 million of revenue from Jimmy Choo; comparable sales for the Michael Kors brand to decline in the high single digits; gross margin of approximately 60.5%; operating expense of approximately 43.0% of total revenue, including the impact of a shift in timing of expenses from the second quarter into the second half of the year; an operating margin of approximately 17.5%; a tax rate of approximately 17.5%; and weighted average shares outstanding of 155 million; and lastly, diluted earnings per share in the range of $1.22 to $1.27, including anticipated dilution from Jimmy Choo of approximately $0.04.

For the full year, we now expect the following, all on an adjusted basis: total revenue of approximately $4.59 billion, including between $215 million and $225 million of revenue from Jimmy Choo; comparable sales for the Michael Kors brand to decline in the mid-single digits; gross margin of approximately 60.0%; operating expense of roughly 44.0% of total revenue, including the impact of a shift in timing of expenses from the second quarter into the second half of the year; an operating margin of approximately 16.0%; a tax rate of approximately 17.0%; and weighted average shares outstanding of 156 million; and finally, diluted earnings per share in a range of $3.85 to $3.95, including anticipated dilution from Jimmy Choo of approximately $0.08.

We anticipate capital expenditures for Michael Kors Holdings Limited of approximately $200 million, including Jimmy Choo, which will be focused on select new store openings, renovations to our retail store fleet and investments in information systems enhancements. For the full fiscal year 2018, we now expect to close between 40 and 50 stores, with a total expense of $40 million to $60 million. We expect transaction costs related to the acquisition of Jimmy Choo to be approximately $50 million and transition costs to be between $15 million and $20 million as we integrate Jimmy Choo into the broader group.

Overall, we were pleased with our second quarter performance and believe we are on track with our Runway 2020 strategic plans. We remain excited about our long-term prospects and also look forward to working with the Jimmy Choo team as we grow our global fashion luxury group.

Now I will turn the call back over to John for closing remarks.

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John D. Idol, Michael Kors Holdings Limited - Chairman & CEO [5]

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In conclusion, we are pleased to have established our global fashion luxury group Michael Kors Holdings Limited with our recently completed acquisition of Jimmy Choo. We look forward to capitalizing on the great opportunities that lie ahead for our brands as we begin partnering with the talented Jimmy Choo team and continue to execute on our strategic growth plans with the Michael Kors brand. We are pleased with the positive signs that we are seeing in the Michael Kors business, which illustrate progress on our Runway 2020 plan. Overall, we believe that the Michael Kors Holdings Limited is well positioned to drive long-term growth as we expand our global luxury fashion group.

With that, I would like to open up the call for questions.

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Operator [1]

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(Operator Instructions) We'll go first today to Lindsay Drucker Mann with Goldman Sachs.

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Lindsay Drucker Mann, Goldman Sachs Group Inc., Research Division - MD [2]

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I wanted to ask just if you could give any more details on the Jimmy Choo sort of time line, integration, synergies, revenue opportunities, anything more specific you could give us on what you hope to do with this new asset.

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John D. Idol, Michael Kors Holdings Limited - Chairman & CEO [3]

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Great. Thank you, Lindsay. Needless to say, we're really excited about the acquisition of Jimmy Choo. We've had an opportunity to spend a fair amount of time with the management team led by Pierre Denis, who is the CEO; and Sandra Choi, who is the Creative Director. And as you may know, Sandra has actually been with the company and helped found the company 20 years ago. So we've got a great team in place as well as their entire executive team around the world, so we go into this feeling very, very strong about the management. We feel very strong about the brand. As you know, they are the -- one of the leaders in luxury footwear in the world and really hold an iconic positioning there. So we believe we have a few different areas of opportunity. We've stated that we're going to grow that business to over $1 billion, and we think we've got a relatively -- a clear vision on that. Number one, there is an opportunity to open additional stores, and those will be predominantly in Europe and in Asia. Along with that, the e-commerce platform in the business is growing very rapidly, and we see a great opportunity to further enhance that with the team. So that's the first opportunity for us. The second opportunity is to take advantage of the accessories momentum that they already have and really build that out to a much greater degree. Jimmy Choo has a very, very engaged customer who finds a place in her wardrobe for that product and for the vision of the brand, so you can look to us really over the next 24 months to make a major commitment to the accessories business with Jimmy Choo as we expand that category with them. And third, the men's business is also growing very rapidly inside the Jimmy Choo company, and we see that as a great opportunity to accelerate. They're already doing an outstanding job with that, and we're just going to work together to continue to build on that. So those are the 3 key areas for us that we're -- we feel very comfortable and I would say that the management team at Jimmy Choo feels very comfortable in executing. With our new-formed alliance, they'll be able to move a little quicker on some of these initiatives than they were previously able to, so that's really one of the major advantages to being strategically aligned with us. And of course, we have a pretty deep history in the accessories business, so we think we can bring some knowledge there...

Lindsay Drucker Mann, Goldman Sachs Group Inc., Research Division - MD [4]

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Is -- sorry. Go ahead.

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John D. Idol, Michael Kors Holdings Limited - Chairman & CEO [5]

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Let me just finish what I just said. There really will be very little synergies, as we've stated previously. The Jimmy Choo business is a very different business in terms of where the product is manufactured and how they're structured internally, so I would expect no -- little to no synergies on that situation.

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Lindsay Drucker Mann, Goldman Sachs Group Inc., Research Division - MD [6]

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Great. And just to clarify, the reasons why the team will be able to move more quickly, as you mentioned, is that just because they'll be able to leverage the capabilities you already have? Or is there something else that would allow them to be more agile?

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John D. Idol, Michael Kors Holdings Limited - Chairman & CEO [7]

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It's really financial. And what we've said when we bought the company is Jimmy Choo will be dilutive for the next couple of years, and really that's a twofold basis. Number one, part of that is because of the debt that we took on, which we intend on paying back very, very rapidly. And secondly, we're going to invest. So we've had that dialogue with the management team. We've had that dialogue internally. And so that we're going to take advantage of this opportunity to really set some incredible roots in the ground for what we think is going to be a major strategic addition to the company. And that is driven off of the accessories and then deeper commitments to the men's business as well. Thank you very much, Lindsay.

Operator [8]

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We'll go next to Omar Saad with Evercore ISI.

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Omar Regis Saad, Evercore ISI, Research Division - Senior MD, Head of Softlines, Luxury and Dept Stores Team, and Fundamental Research Analyst [9]

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John, I was wondering if you could give us a little bit more detail on what you're seeing around the product trends more broadly speaking, kind of especially the handbags categories versus some of the other ones. I noticed you guys are doing really well in footwear and ready to wear, what you're seeing in terms of the evolution of the handbag category. Obviously, there's been strength at certain high-end brands. And you guys have momentum in certain pockets there, but a broader perspective, I think, would be helpful for us.

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John D. Idol, Michael Kors Holdings Limited - Chairman & CEO [10]

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Sure. Thank you, Omar. As you noted, our women's ready-to-wear business is absolutely -- it's really, really strong right now, so we're very pleased. And that's led by product innovation, which is you clearly see it in -- if you're following us on Instagram or if you're looking at our e-mails on a daily basis, I think you could -- you've seen a marked difference in the way that the company is communicating to consumers. And I want to say we're leading a little bit more with what we call Kors Style. So Michael is a runway designer. Michael has got many, many years of leading the consumer in terms of a fashion statement. And we're taking advantage of that positioning in our company, and so Kors Style is really the cornerstone of our communication to the customers. And then of course, we've got a very large footwear business that we don't talk a lot about, but it's growing very nicely. And we see that as a way to really head-to-toe dress our customer, and that's giving a lot of additional opportunity for our sales associates inside the stores to reach out and talk to our consumers. And of course, you're going to see that in some of the new stores that we're building out where we're taking a much more lifestyle approach to the brand and really highlighting those other strengths inside of our company. In terms of the handbag or accessories business, I don't think there's any secret. In Asia, the business is very, very strong. So I'm going to start from the East and go to the West. And that's not only in the Michael Kors business, but that's in the -- in obviously the luxury players that are in the marketplace. So very strong reception to the category in that marketplace driven by, I would say, younger millennials and slightly older who are really continuing to find luxury and aspirational luxury for many different companies. So we're extremely pleased with how the category is developing in that marketplace. I would say Europe got a little more solid over the last quarter, driven again by, I would say, tourists. We saw a significant return -- or elevation, I would say, in the Chinese tourists traveling to Europe. And there has been a return in certain categories of tourists who had declined -- who are starting to come back to Europe. So we're feeling more confident, and you can see that in our results in Europe. I would say the American marketplace remains relatively muted in the category, if not slightly down. And we've taken the position that the American market, we actually want to shrink in terms of accessories; and we've done that through 2 ways. Number one, we are shipping less product into our department store partners as well as our own stores in the accessories category. And as a result, we're also less promotional significantly, as you can see by the amount of days. And again, in Q3, it's going to be very, very dramatic reduction, even beyond what we've done so far. And we think that's the right thing for the brand. So again, the customer is going -- it's going to be a little more difficult for them to find Michael Kors product on sale in the accessories category, and we think that will mute the trend in that marketplace. Again, small bags continue to drive the business, smaller bags; also smaller wallets, which affect the AURs. So we're particularly pleased to see the AUR increase we have in the continued light of smaller bags and smaller wallets driving the business. And by the way, that trend is not a North American trend. That trend is a global trend, so that's still a headwind for us as the consumer continues to see that as the fashion quotient and not necessarily about price. Thank you, Omar.

Operator [11]

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We'll go next to Oliver Chen with Cowen and Company.

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Oliver Chen, Cowen and Company, LLC, Research Division - MD & Senior Equity Research Analyst [12]

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John, what's your -- what are your thoughts regarding partnerships in the industry with Amazon and Google and how these will evolve as you continue to develop a foundation for a larger platform? Just curious on your thoughts about distribution and what modern luxury should pursue in terms of customer relationship management and digital and reach. And Tom, just a modeling question. The merchandise margins, how are they in the U.S.? And what should we think about in terms of the forecast there?

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John D. Idol, Michael Kors Holdings Limited - Chairman & CEO [13]

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Thank you. Oliver, I think as -- we've been using this terminology in our calls, digital flagships. And I remembered when we first started, that there was a few people who were a little confused by why we were referring to it as a flagship. And we believe that, today, the #1 place that a consumer engages with your brand usually initially is online and usually through your own website. And they may not ultimately transact there because certainly brick-and-mortar stores are very important. And we believe in brick-and-mortar. And we believe that the consumer will shop in multiple places for their merchandise, but what we need to remain committed to as a company is our own digital flagships and that being the cornerstone of how we're engaging with the customer and how we are going to move the brand continually forward. It's too early to ascertain whether -- what the future is with Amazon or any other platform. Right now our position is that we're focused on our own digital communications with the consumer. And we think that's the right place for us to be, and certainly we're showing a strong double-digit growth by doing that. And we've got a long way to go till we consider ourselves to be best in class, but you can see by some of the ratings that have come out about L2 -- from L2 about our brand and -- that we are committed. And we believe that we will continue to move forward and ultimately become one of the best-in-class luxury companies really operating our own digital flagships. And I'll turn it over to Tom for the second part of the question.

Thomas J. Edwards, Michael Kors Holdings Limited - CFO, COO, Executive VP & Treasurer [14]

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So thanks, John. And Oliver, with regard to margins in the U.S., maybe just take a little step back here and talk about our Q2 margin overall, which we are really pleased with. That margin is up for the quarter, and we continue to forecast a growth in margin for the full year. As we noted, retail margin overall is benefiting by mix. And wholesale margin, while flat for the quarter as we noted, we'd expect to be lower in Q3, along the lines of Q1 activity with lower volume.

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Oliver Chen, Cowen and Company, LLC, Research Division - MD & Senior Equity Research Analyst [15]

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Okay. And John, just a quick one on the handbag at-large. The larger totes and the pricing that you're achieving there, could you just brief us on the strategy and what we should monitor? That looks like there's a lot of elevation. And I'm just curious about how that will manifest in light of different things happening and what you're thinking about where you want to take your higher-priced larger handbag assortment.

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John D. Idol, Michael Kors Holdings Limited - Chairman & CEO [16]

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Sure. And that's a very good and relevant question, Oliver. Number one, we haven't really talked about it in this call at all, but just as a macro trend issue kind of related back to what Omar was asking, as you probably are aware from walking the streets et cetera, backpacks are very, very strong. And it's one of our fastest-growing classifications. And we're really pleased about that because of the AUR in backpacks is high, which is good for us. So there is actually little decline in the tote business because it's really shifting to backpacks because of the fashion trend, but that being said, what we're doing is we're really elevating. And you're going to see a whole elevation of totes from us over the next kind of 6 months, where we think there is a fashion statement to be made there. It was a bit more utilitarian previously, and now that you've got a lot of people or women coming to work in sneakers and/or trainers, there's just a little less utilitarian use for the tote. So we're trying to make it much more about fashion, and I think you're going to see a lot of that coming in the coming quarters. And again, what we're seeing is the more innovation that we're delivering on our accessories, on our ready to wear and on our footwear, the more the customer is responding. Again, Michael's got 30 years of leading with fashion runway design; and we're going to use that as a real cornerstone of how we're communicating with the customer, in particular through Kors Style. So thank you very much, Oliver.

Operator [17]

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We'll go next to Simeon Siegel with Nomura Instinet.

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Simeon Avram Siegel, Nomura Securities Co. Ltd., Research Division - Senior Analyst of U.S. Specialty Retail Equity [18]

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So among other things, really nice growth within Americas wholesale. As you lap the last double -- last year's double-digit declines, just can you talk to where you think you are, in maybe what inning or however you want to frame it, in terms of that wholesale reset? How much further top line deceleration do you think you see before we start returning to growth there?

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John D. Idol, Michael Kors Holdings Limited - Chairman & CEO [19]

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Sure. Thanks, Simeon. So Simeon, I want to first point out that we mentioned a few calls ago that we had taken a point of view to be less promotional. We thought that was the right thing to do for the image of our brand, number one. Number two, we also focused on some iconic groups where we really made sure that they were very, very key in terms of their price points. And that was our Mercer, our Selma, our Hamilton, our Cynthia, our Savannah. They were the 5 core groups for us that we really -- we wanted to make sure that when the customer came in the store, whether they were on sale or not, it didn't matter. The value was tremendous not only in terms of the design but also the price-value relationship. And that's really turned out to be a very good strategy for us. And in fact, that's one of the reasons why you saw the wholesale business deliver better than we had anticipated, and that was just based upon our replenishment and what we saw happening there. And then you layer on top of that what's happening with some of the new groups that we've added into the category. And so what I would say to you is that our partners in the department store community are, I think, very pleased with how our strategy has turned out. I must say to you that, in our second quarter, we saw some nice trends happening in the department store environment. So we were very pleased, and I think they were pleased also, to see we can sell product at a higher price, we can sell product that isn't on sale and that the customer is excited about newness and elevation. So that's working well for us. We're very cautious about Q3. I know everyone is concerned about the deceleration between Q2 and Q3 in the way that we're guiding for comparable store sales growth. We're being very cautious because, as Tom pointed out, in our own stores it's about 66% less promotional activity. That's a tremendous amount. So I can't say to you which inning we're in, but what I can say to you is that the initial indications from both product and from our reduction in promotional cadence is going well. So I would tell you that we're pleased. This is going to carry on all the way through Q4. Even though we will "lap" in the second half of Q4, there's still going to be settlement that has to happen in terms of where the inventories end up arriving. And I remember I mentioned this in one of the other calls. We will still have a decline as you look forward. It'll flatten out somewhat in 2019 fiscal, but there'll still be some decline heading into the first part of that because, as we sell at a higher AUR, you need less inventory in there to mark down. And again, that's all good. That's all very healthy for the business. So we view -- I think we'll be able to have a better assessment on where we are coming out of Q3/sort of midway through Q4, and hopefully, we'll be reporting to you that we're continuing to make progress.

Simeon Avram Siegel, Nomura Securities Co. Ltd., Research Division - Senior Analyst of U.S. Specialty Retail Equity [20]

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Great. And then if I can just, a quick follow-up. So on the retail side, so on your own business that you're -- I mean we can see the strength there. We can see the recovery on the margin. Any thought there in terms of the long-term EBIT opportunity?

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John D. Idol, Michael Kors Holdings Limited - Chairman & CEO [21]

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It's -- it remains -- the biggest challenge in retail for us remains the shift between e-commerce and the brick-and-mortar part of the business. We're working really, really hard: again, cornerstone of Kors Style and some additional styling tools that we'll be adding to the stores for our sales associates. We are committed to turning around our brick-and-mortar comp. And we know that's challenged to some degree by e-commerce, to some degree by traffic, but until we can get some turnaround on that, which again will not be this year, we're obviously hoping to see that -- to be in a better place for next year, that will be when we can create more of that EBIT leverage in the retail business. Thank you, Simeon.

Operator [22]

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We'll go next to Kimberly Greenberger with Morgan Stanley.

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Kimberly Conroy Greenberger, Morgan Stanley, Research Division - MD [23]

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The numbers here in the second quarter were better on a number of fronts than we had been looking for, and the area in particular I wanted to dig into is the wholesale. That looked to be the largest departure, John, I think, from what you had expected. You talked about better full-price sell-through in wholesale, but I think you also mentioned that wholesale gross margin was flat. Were there any changes in wholesale partners? Or maybe you can just help us understand a little bit better the material beat on the wholesale line. And then we're just, in your discussion with Simeon, struggling with somewhat the same thing: understanding what happened in the second quarter and the very strong results in the second quarter and how that leads to such a conservative third quarter guide. Maybe you can just touch on the reduction in promotional days both in wholesale and retail in the second quarter and how that compares to the third quarter. It did -- it sounded like there were the -- a greater reduction in Q3 but not materially enough for such a differential in the sales results. Is it just that, during the holiday season, when you're less promotional, there's a greater negative impact on sales because everybody else is so promotional? Maybe you could just help us understand a little bit better.

John D. Idol, Michael Kors Holdings Limited - Chairman & CEO [24]

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Sure. And Kimberly, I'm going to answer half of that, and then I'm going to turn it over to Tom. Let me start out by reiterating to everyone that we have raised our guidance for the year. So I want to compliment our company, that we are flowing through a significant part of the beat in Q2 for the year. The second thing is -- and Tom will talk about this in a little bit, but part of what you're seeing in the Q2 guidance is expenses that have shifted from -- that Tom spoke about in his prepared remarks, from Q2 to Q3. So that's impacting some of the EPS, but overall for the year, as you can see, we're still taking the year up for the company. We always knew internally that we would be at a higher comp store decline in Q3 than any other quarter. I know that some of the models that are out there didn't indicate that, but we knew because, again as you can see for the year, we're guiding for overall mid-single-digit comp store decline for the year. And so we'll have a little worse in Q3 and we'll have a little better in Q4, if you look at the model. So for -- and by the way, the -- our stores are not trending a whole lot different from what we're seeing in the department store environment. The reason why you're seeing the delta so high in Q3 is, number one, it was the most amount of days we were on promotion of any of the 4 quarters. And secondly, it is the largest dollar volume quarter. So because when you have those 2 things happening at retail, you're going to have the largest impact to all of the factors that are happening around in the business. So as I said to you before, we actually had a very nice Q2 with our department store partners here in North America. And I think we were all pleased, they were and we were, by the performance that we saw relative to our sales plans and relative to the fact that we were ahead of our mutually agreed-to sales plans. Again, we are trying to take the business down at retail in our Q3, and that's because we want less product out there to be not only on promotion, with less promotional days, but then marked down at the end of the season. Because we're dealing with that situation in Europe which we've talked about. We want to end the season with less promotional product for the customer when we begin our final sale periods of time. So again, we think this is all going exactly according to plan and maybe slightly better. We hope that we'll have a good holiday season. And if we do -- again, we might do better than what we have guided to if we do have a better-than-anticipated holiday season, but that being case, I think we're taking a very prudent view of the environment and in particular our promotional policy. So remember it's the largest amount of days of all the quarters. And secondly, it is the biggest of the 4 quarters that we have in terms of retail sales, but let me turn it over to Tom so he can talk to you a little bit about the expense movement which affects the modeling.

Thomas J. Edwards, Michael Kors Holdings Limited - CFO, COO, Executive VP & Treasurer [25]

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Sure. And looking at, as John mentioned, the full year, we've raised guidance and on a Michael Kors brand basis really flowed through all of the upside and beat in Q2 from a revenue perspective. So we see that coming through as a full year increase in our overall guidance. On the expense side, we will see some expenses moving into the second half across various items and areas. So that part, we did not flow through to the full year. The other addition was the expected dilution from Jimmy Choo of around $0.08. So that in total is how we were looking at it. And as John mentioned, Q3 a little more conservative based on the reduction in promotional days, but overall this is very much in line with our prior guidance of mid-single-digit declines in comp sales across the year and in line with that thinking.

John D. Idol, Michael Kors Holdings Limited - Chairman & CEO [26]

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Yes. And Kimberly, I want to add one last thing too. Please take note of the higher AURs. I think that's a very strong indicator that the customer is buying product from us at a higher price than what she was paying for it before. And that's really being driven by the design and innovation that we're creating in the design. So we think that's a very strong lead indicator that we're heading in the right direction with the strategy that we put in place around Runway 2020. Thanks, Kimberly.

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Operator [27]

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We'll go next to Randy Konik with Jefferies.

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Randal J. Konik, Jefferies LLC, Research Division - Equity Analyst [28]

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John, I want to just follow up on the AUR side. So we're now in this -- a couple quarters through, a few quarters through of this AUR inflection, so maybe it would be helpful if you gave us some perspective on, if we look at current AUR today, how far below is it from peak AUR? And what's the realistic, in your view, recapture rate on AUR to go back up because of, a, small bag size is stabilizing or price is going up within that category; b, less promotions; or C, mix from higher average unit retail offerings, like the Bancroft collection? So I'm just curious there. And then if, Tom, could you give us some perspective on putting the gross margin for the third quarter and beyond. Given the less promotionalities, simply the gross margin pull back a little bit even though it's going to be up. Is that from the inclusion of Jimmy Choo in the model on the gross margin side? So I was just curious there.

John D. Idol, Michael Kors Holdings Limited - Chairman & CEO [29]

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Thanks, Randy. Randy, on the AUR side, we don't report how much it has gone down from the -- its peak, but it is down, for sure. And part of that was self inflicted a couple years ago when we were looking for higher units per transaction and therefore we went after categories like jewelry and et cetera to bring up that and that started to lower some of the AUR. And then we saw originally some of the bag sizing shifts, which wasn't something that we had anticipated. To be honest with you, we've set an internal goal, don't know whether we'll achieve it or not, but we've kind of used the number 10%. That's what we're just shooting for as a benchmark. And again, we're not going to report on that on a quarterly basis. I'm just telling you, giving you some color that, that's a number that we've picked out and said we want to try and achieve that over time. So -- and that's -- for us, when we look at that, remember that's aggregated between accessories and women's ready to wear and footwear, so we're looking at that as an overall. I would almost say it's to our average transaction and AUR as well. So that'll drift up and down in categories, depending on different things that we're doing at different times in the various categories. So as a good example, in the bootie category in footwear, we sharpened our price points in booties, and that's really helped our business tremendously. It's affected our average AUR at this point in time during the year, which because booties obviously are fairly significant, but it's helped our sell-throughs dramatically. So there's going to be different things we're going to do during the quarters, but overall we know that from the pullback in promotional activity we're going to sell less units. And therefore, we're going to need to take our AUR up, and obviously that's a very important part of our long-term success for returning to comp store sales. I'll turn it over to Tom for the second part of the question.

Thomas J. Edwards, Michael Kors Holdings Limited - CFO, COO, Executive VP & Treasurer [30]

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Randy, with regard to gross margin in Q3 and beyond, the first thing I'd say is overall we expect it to grow, as we've indicated in our guidance. And that's consistent with our full year outlook and unchanged from how we've been looking at it over the course of the last couple of quarters. From a first half to second half, directionally I'd say that we'll be consistent with -- we've seen growth on the retail side. And we mentioned in the prepared remarks, wholesale, we'd expect the wholesale gross margin to be a little lower than what we've seen in the first half really just due to the lower volume that we've discussed. With regard to Jimmy Choo: Jimmy Choo runs a slightly higher gross margin, so within our guidance that is included. And for the portion of the year that they're with us, that is a slight benefit to the gross margin. And as we get into our full year guidance next year, when we provide it, we'll -- and talk about Jimmy Choo results more directly as we move forward, we'll look forward to talking more about their margins and their great growth prospects.

Operator [31]

We'll take our next question from Brian Tunick with Royal Bank of Canada.

Brian Jay Tunick, RBC Capital Markets, LLC, Research Division - MD and Analyst [32]

I guess 2 questions. When we think about the return, I guess, to growth in your profitability, what kind of sales growth would you need for OpEx leverage? And then on the fashion watch side of the business, what kind of impact did it have on the comp either in this quarter or the first half of the year so far? And when would you expect the fashion watch impact to lessen as we go forward?

John D. Idol, Michael Kors Holdings Limited - Chairman & CEO [33]

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Thanks, Brian. Brian, as Tom presented in our Investor Day, we have said and we continue to believe that 2019 fiscal will be your growth in revenue and in earnings per share. I think we further view that our operating income is going to be returning to growth as well. So I think that's a very important inflection point for the company, because we know that over the last couple years our operating income has declined. And we're vigorous about our opportunity to turn that around both from the Michael Kors brand standpoint. And also, don't forget that, that's going to be impacted by Jimmy Choo, at least on the operating income, which will be very nicely positive for the company. So we are also looking at all the different levers inside the company as we're kind of rebalancing the organization. We have a fleet optimization program that's going on. And we look to as we close these approximately 100 stores over the next 2 years, but that will have an impact on our operating margin as well and create some leverage on the OpEx line. So again, we're very encouraged about what the future lies ahead for us, good indications for Runway 2020. We're kind of -- believe that we're seeing the initial results that we had hoped. And if those continue to flow through, we think our objectives for 2019 will be very much in our sights, and our ability to deliver on that. Secondly, in terms of the fashion watch business, it was a fairly sizable impact to our comp store sales. We don't break that out, but it was very sizable. It -- so we do not see that turning around, as we said in the prepared remarks, for the balance of the year. The smartwatch business is mitigating that to some degree but not enough to offset the decline in the fashion watch business. We -- so therefore, that's one of the reasons, and we've said that to you some months ago, at the Investor Day, we are very focused on our footwear business and our women's ready-to-wear business as categories to offset that decline. And as the accessories business stabilizes, that will really be the balance that will begin to return us to positive comp store sales. Thank you, Brian.

Operator [34]

Ladies and gentlemen, that concludes our question-and-answer portion of today's call. I'll turn the conference back over to John Idol for closing remarks.

John D. Idol, Michael Kors Holdings Limited - Chairman & CEO [35]

Again, we want to tell you how excited we are about concluding our acquisition of Jimmy Choo and how that really is positioning us for the long term for our luxury group and gives us the platform also to look at future acquisitions. Secondly, we're very pleased with the progress that we've made on Runway 2020 with the Michael Kors brand, and we look forward to reporting to you our future progress in upcoming calls.

Thank you very much.

Operator [36]

Ladies and gentlemen, thank you for your participation. This concludes today's conference. You may now disconnect.


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