Capri Holdings Ltd (CPRI) 2016 Q3 法說會逐字稿

Good day, everyone, and welcome to the Michael Kors Holdings Limited third-quarter 2016 conference call.

Today's conference is being recorded.

For opening remarks and introductions, I will turn the conference over to Krystyna Lack, Vice President and Treasurer.

Krystyna, please go ahead.

Thank you.

Good morning, and thank you for joining us for our third-quarter earnings call.

Presenting on today's call are John Idol, Chairman and Chief Executive Officer; and Joe Parsons, Chief Financial and Chief Operating Officer.

Before we begin, let me remind you that certain statements made on this call may constitute forward-looking statements, which are subject to risks and uncertainties that could cause actual results to differ from those that we expect.

Those risks and uncertainties are described in today's press release and in the Company's SEC filings, which are available on the Company's 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.

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

Thank you, Krystyna.

Good morning, and welcome to Michael Kors' third-quarter fiscal 2016 earnings call.

I am pleased to report that our revenues, comparable store sales, and earnings per share results for the third quarter exceeded our expectation, which speaks to the enduring strength of the Michael Kors luxury brand, in particular, during the all-important holiday season.

We know that consumers have a lot of choices when it comes to what brands they purchase, and the fact that they chose Michael Kors is a great testament to our world-class design team, strong product offering, and the lasting connection that we have fostered with our customers.

For the quarter, total revenue increased 6% on a reported basis.

In constant currency, total revenue increased 10%, driven by growth across segments and geographies.

Earnings per share increased 7%, to $1.59, on a reported basis, and on a constant-currency basis, earnings per share grew 11%.

Our retail business delivered solid results across all geographies, driven by strong double-digit sales growth in our digital flagship business, and new store openings.

On a constant-currency basis, global comparable store sales increased 2%, which was ahead of our expectations, and marked another quarter of sequential improvement.

Importantly, while mall traffic in North America declined, we saw a significant increase in conversion rates in our own retail stores, which further illustrates the strength of the Michael Kors brand.

On a constant-currency basis, comp store sales rose in the low-single digits in North America and Europe, and in the high-double digits in Japan.

While our wholesale business was roughly flat for the quarter on a reported basis, we delivered results above our expectations, despite the challenging and highly promotional retail environment.

In fact, while the North American department store channel was challenged, we believe our results continued to outpace the overall channel performance, which enabled us to further strengthen our leadership position in this channel.

Internationally, European wholesale sales grew 4% on a reported basis and almost 20% on a constant-currency basis.

And, we saw 26% growth in our Asian wholesale business.

We also achieved solid growth in our licensing business.

While the overall watch category remained challenged during the third quarter, we were excited to see favorable response to the newness that we introduced into our watch offering, as well as our jewelry assortment.

In watches, navy, sable, and black platings, as well as colored-leather straps, proved to be sought-after additions in our collection.

Customers also responded well to our updated jewelry offering, with particular strength in the padlock, hearts and disc motifs, and our watch and bracelet gift sets were strong sellers during the season.

Our fragrance collections for women, as well as men's fragrance, also proved to be great gifts, whether customers were shopping for family and friends, or looking to treat themselves to something special.

We were also pleased to see strong growth of our fragrance offering in the travel retail channel worldwide.

In addition, we continue to see very positive response to our eyewear collections, and are happy that our new partnership in this category has been such a strong success.

Turning to our product categories, we were pleased with the performance of our accessories business, where we injected new styles that contributed to strong growth and market share gains in the quarter.

Total accessory sales on a retail basis grew at a high-single-digit rate globally, and a mid-single-digit rate in North America, demonstrating our leadership in this category, especially against a difficult retail backdrop.

The demand for smaller-size bags, crossbodies, and small leather goods continued to impact AUR in the quarter.

However, we again saw a high-double-digit increase in units sold, proving that customers continue to seek out Michael Kors luxury accessories.

Footwear sales were also strong during the quarter, driven by our fashion active category.

Unfortunately, the unseasonably warm weather hurt boot sales, which negatively impacted our footwear margins and AUR.

Overall, our new merchandise assortment for holiday reflected the latest designs from Michael and our design team, and spotlighted modern glamour, easy elegance, and sport lux essentials.

The updated silhouettes, as well as our gifting assortment, resonated well with customers globally, and our #justbecause marketing campaign proved very successful in connecting our customers with just the right gift for everyone on their shopping list.

Looking ahead, we remain focused on executing our key strategic initiatives that will drive us towards our long-term growth targets.

First and foremost, we remain committed to delivering luxury products that embody fashion, design innovation, and the Michael Kors luxury brand DNA.

As we look to the spring season, we will be introducing our largest assortment of new handbag groups, created to inspire our customers with exciting new trends.

Our collections will underscore Michael's fashion leadership with an offering that reflects new color palettes, innovative materials, embellishment, mixed media, in leather, luxurious textures, and elegant silhouettes across product categories.

In footwear, the fashion active category remains one of our highest-growing areas, and we expect to leverage this trend in the spring.

We are also capturing the denim trend in our accessories and apparel assortments, which are featured in our new national advertising ad campaigns.

We have begun to evolve our advertising campaigns to reflect the glamorous destinations and inspirational moments of the modern Michael Kors customer.

Our integrated marketing programs, with compelling digital and social media campaigns, delivered through desktop and mobile devices -- as well as traditional print, billboard, and target marketing -- are designed to extend our reach, allowing us to engage consumers with our brand, immerse them in the Michael Kors lifestyle, and encourage them to shop our sites and stores.

In our retail business, we continue to develop our digital flagship strategy globally, at a rapid pace, and build upon our omni-channel capabilities.

We have digital platforms in place in the US and Canada, and we are on track to launch in 6 European countries this fall, and an additional 16 countries in Europe thereafter.

Importantly, we are working to seamlessly integrate the consumer shopping experience across all touch points.

We are taking steps to enhance our mobile shopping experience and expect to see the benefits of these measures over the coming months.

We will also begin to leverage our analytic and CRM capability to share Michael's message with consumers through various communication vehicles, and to present and tailor our styling to the individual customer.

Overall, our digital flagship strategy is enabling us to engage consumers with our luxury lifestyle brand, and provide a best-in-class shopping experience.

As you know, we have a strong and influential online presence, as consumers turn to Michael Kors for fashion insights, and we continue to see our fan base grow across all social media platforms, further demonstrating the power of our brand.

In addition, we remain focused on expanding our global retail footprint, and we will continue to open flagship locations in key cities around the world, to drive revenues and brand recognition.

Our latest flagship opened this past November in the Ginza district in Tokyo, and we'll be opening new flagships in London, Seoul, and Singapore this coming year.

These locations not only enable us to present the most expansive collection of our fashion products, including both our collection and lifestyle offerings -- as well as men's product in select locations -- but also showcase the Michael Kors luxury DNA for consumers worldwide.

Internationally, we completed the integration of our Korean business in January, and are excited about the retail growth potential in this market.

Lastly, we continue to extend our men's presence at retail, both with stand-alone stores, as well as through the addition of our men's offering in our existing lifestyle stores in North America, Europe, and Asia.

We opened four men's locations this quarter -- in Scottsdale Fashion Square in Arizona, Memorial City in Houston, Garden State Plaza in New Jersey, and San Francisco Centre in California -- and we are pleased with the initial consumer response.

By the end of this fiscal year, we expect our full men's assortment to be available in 11 locations, and we continue to believe there is a potential for up to 500 locations worldwide.

In our wholesale channel, we expect moderately lower sales growth.

As we have stated previously, we will be managing our North American wholesale inventory to ensure that we maintain the integrity of our brand.

We see continued sales growth internationally from the expansion of our accessories, women's wear and footwear business, and the development of our men's categories.

We remain particularly excited about the expansion of our men's business in wholesale, and are on track to open 75 men's shop-in-shops globally this year.

Importantly, we continue to believe that this is a significant new category for the Company, and I am confident that we can develop this business and become a leading men's luxury brand.

In licensing, we are excited about the continued growth opportunity of our fragrance and eyewear categories, and the newness in the watch category, as we continue to introduce updated watch styles and launch our new connected fashion line later this year.

As we look at consumer trends, we believe that connected accessories will reshape the fashion watch business globally.

Michael Kors is known for being at the forefront of the fashion watch category, and we expect to quickly emerge as a leader in connected fashion as well.

Turning to our regional licenses, we remain focused on expanding our presence across Asia, which represents a significant growth opportunity for our Company.

In greater China, we continued to see an increase in brand acceptance, as evidenced by another quarter of double-digit comp-store sales growth.

As the Chinese consumers' desire for our brand builds, we are capturing this demand both in the region and as they travel globally through our airport locations worldwide, and in areas such as Japan, Korea, and Europe.

We look forward to our continued global expansion through our strong regional partnerships and growing demand for our luxury brand.

In summary, we are pleased with the success we achieved in the third quarter, with an excellent holiday season driven by a luxury fashion product assortment, strength of our digital flagships, and sequential improvement in our comparable-store sales, as well as continued success of our wholesale business.

Our results demonstrate the sustained demand for our luxury fashion products globally and the market leadership of the Michael Kors brand.

Now let me turn it over to Joe for a detailed review of our third-quarter financial results and our outlook.

Thank you, John, and good morning, everyone.

We are pleased to report financial results above our guidance for the third quarter.

Total revenue grew 6.3%, to $1.4 billion.

On a constant-currency basis, total revenue grew 9.9%, driven by increases across the Americas, Europe, and Japan of 1.4%, 29.1%, and 68% respectively.

In our retail segment, net sales increased 11.1%.

In constant currency, retail net sales increased 15.7%, driven by the opening of 114 net new stores since the third quarter of last year, and strong performance of our digital flagships.

We saw a marginal decline in comps of 0.9% on a reported basis.

On a constant-currency basis, comp-store sales increased 2%, reflecting a sequential improvement from the second quarter of our total comp, as well as our retail store comp, and outperformance versus our guidance.

The increase is attributable to positive comp-store sales in North America, Europe, and Japan, as consumers respond favorably to our luxury product offering.

Our US digital flagships sales contributed 360 basis points to our overall comp performance in the quarter on a constant-currency basis.

In our wholesale segment, net sales grew 0.3%.

On a constant-currency basis, wholesale sales increased 3%, driven primarily by our footwear category and strong growth in international markets.

In our licensing segment, revenue increased 8.4%, driven primarily by higher licensing revenues, related to sales of jewelry and eyewear, as well as higher international licensing revenue.

We opened 52 new watch and jewelry shop-in-shops during the quarter, and ended the quarter with 362 shop-in-shops globally.

Gross margin declined 140 basis points, to 59.5%, which includes a 95-basis-point foreign currency translation and transaction impact.

The decline in gross margin reflects a 310-basis-point decline in retail gross margins, primarily due to additional markdowns, a 50-basis-point decline in wholesale gross margin, primarily due to additional wholesale allowances, partially offset by higher licensing gross margin dollars.

Total operating expenses grew 10.7%.

The increase in SG&A was due to higher retail occupancy and salary costs related to new store openings, and included higher e-commerce expenses and an increase in corporate-related expenses.

The increase in depreciation expense was primarily due to the opening of retail stores, new shop-in-shops, an increase in lease rights related to our new European stores, and investments in our corporate facilities and IT infrastructure.

As a percent of total revenue, total operating expenses increased 120 basis points, to 30.2%.

This was below the 200 to 240 basis points of deleverage in our guidance, primarily due to better-than-expected sales in the quarter.

Income from operations was $409.3 million, or 29.3% of total revenue, as compared to 31.8% of total revenue in the same period last year.

Retail operating margin declined 340 basis points, due to the decline of retail gross margins, as discussed earlier, and a 30-basis-point increase in operating expenses attributed to higher store-related costs and depreciation expense, largely offset by lower distribution and general expenses.

Wholesale operating margin declined 180 basis points, due to the decline in wholesale gross margin, as discussed earlier, and a 130-basis-point increase in operating expenses attributed to increased distribution costs, selling costs, and depreciation expense, partially offset by lower general expenses.

Licensing margin increased 60 basis points, due to lower operating expenses including advertising costs, partially offset by higher costs associated with intellectual property protection, as we take action against counterfeit activity globally.

Income taxes were $114.4 million in the quarter, and our effective tax rate was 28%, as compared to 27.2% in the same period last year.

The increase in our effective tax rate was primarily due to the absence of the prior-year favorable settlement of certain instruments, in connection with our international structuring, partly offset by the increase in taxable income in certain non-US subsidiaries, which are subject to lower tax rates.

Net income was $294.6 million for the third quarter, and diluted earnings per share were $1.59.

The unfavorable currency impact on EPS was $0.06 per share.

Turning to the balance sheet, at the end of the quarter, cash and cash equivalents were $696.8 million.

During the quarter, we repurchased approximately 4.7 million shares totaling $200 million under our share repurchase program, and we have another $558.1 million of availability remaining.

There are no outstanding borrowings under our credit facility at the end of the quarter in either year.

Inventory increased 9.5% versus last year, slightly ahead of revenue growth and in line with our expectation.

As discussed in our last call, the change in foreign exchange rates continue to impact our European inventory, and we are now recording incremental inventory related to the consolidation of MK Panama.

We expect our growth in inventory to continue to outpace our growth in sales, as we open new retail stores and shop-in-shops, expand our digital flagships, and further develop our men's business.

We also expect the exchange rate differential and the MK Panama consolidation, in addition to the transition of the Korean business in-house, to continue to impact inventory levels until we anniversary these events.

Capital expenditures for the quarter totaled $96.8 million and were related to the build-out of new retail stores and shop-in-shops, as well as investments in our distribution facilities, our corporate offices, and other infrastructure improvements.

We added 34 new stores in the third quarter: 15 in the Americas, 16 in Europe, and 3 in Japan.

In addition, we expanded or relocated 8 stores, and converted 79 wholesale doors into shop-in-shops globally.

Turning to our outlook for the fourth quarter, we expect total revenue to be between $1.13 billion and $1.15 billion, which includes approximately $36 million of additional sales, due to our 53rd week.

On a constant-currency basis, total revenue is expected to increase in the high-single-digit range, assuming an impact of approximately $20 million from the change in foreign currency rates.

We expect comp-store sales to be flat on a reported basis and to increase in the low-single digits in constant currency, driven by growth of our US digital sales, the introduction of new innovative product offerings for spring 2016, and diminishing FX headwinds.

However, we anticipate lower revenues in our licensing business during the quarter, due to lower watch sales, and a decrease in revenue related to eyewear, as we anniversary our launch with Luxottica and the final quarter of shipments from Marchon last year.

We expect international gross margin to remain under pressure in the fourth quarter, as favorable hedging contracts we entered into last year expire.

Operating expense as a percentage of total revenue is expected to increase 190 basis points to 220 basis points.

We expect diluted earnings per share to be in the range of $0.93 to $0.97, assuming a tax rate of approximately 27.5% and 182.5 million shares outstanding.

We expect foreign currency to impact net income by approximately $3 million and EPS by approximately $0.02 for the fourth quarter.

For the full fiscal year, our outlook for revenue and EPS remains unchanged.

We expect revenue of approximately $4.65 billion on a reported basis.

On a constant-currency basis, total revenue is expected to increase in the low-double-digit range, assuming an impact of approximately $180 million from the change in foreign currency rates.

We expect a mid-single-digit comp-store decrease on a reported basis, and a low-single-digit decrease in constant currency.

Operating expense as a percentage of total revenue is expected to increase by approximately 230 basis points for the year.

We expect diluted earnings per share to be in the range of $4.38 to $4.42 for the year, assuming a tax rate of approximately 28.5% and 190 million shares outstanding.

We expect foreign currency to impact net income by approximately $38 million and EPS by approximately $0.20 for the year.

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

Thank you, Joe.

We are pleased to have exceeded our third-quarter sales and earnings per share expectations.

Our results demonstrate the sustained strength of the Michael Kors brand, as our luxury product continues to resonate with consumers around the world.

We are on track to deliver solid financial performance in the fourth quarter, as comp-store sales continue to show sequential improvement and we capture additional market share in the luxury fashion accessories category globally.

Looking beyond fiscal 2016, we will continue to leverage our market leadership position and strong management team as we move forward with multiple strategic initiatives we have in place to drive sales and earnings-per-share growth for the long term.

I will now open up the call for questions.

(Operator Instructions) Kimberly Greenberger with Morgan Stanley.

Good morning and a very nice print today.

Congratulations on that.

John, I'm wondering if you can talk about e-commerce.

I guess the surprise here is that, as you have anniversaried ownership of that business, it sounds like it is still having a very outsized positive impact on your sales growth rate.

I just expected we would actually see a little bit of more deceleration at this point.

So maybe you can just talk about some of the drivers there.

And then Europe, also, I think a little bit of a positive surprise, just given what we have heard from others, the fact that it is still running positive on a constant currency basis.

Are you seeing disparate results across various countries in Europe?

And maybe you can talk in particular about the wholesale piece, which was a real source, I think, of upside surprise.

Thank you.

Sure.

Thank you, and good morning, Kimberly.

First starting with e-commerce, we were very pleased in the quarter with the results that we saw for e-commerce, and those were driven by first, traffic, and second, conversion.

Again, what we see happening is customers are starting their shopping experience, as you all know, digitally or mobilely first, and so the mobile traffic that we are getting to the site, it just keeps accelerating every single month.

And we think we've got some real opportunities to even take that to another level, so we are extremely pleased with the traffic that we saw there.

And we are also just pleased with the fact that certain categories, and I might add, footwear in particular, is seeing a huge lift on e-commerce.

Again, we are able to represent a much greater assortment of product then we are actually in many of our own stores, which has been a really interesting finding for us, and is leading us to look at our stores today currently, and we are going to be expanding the footwear areas inside of our own stores to capitalize on what the consumer is really telling us, given what she has seen online.

Again, we like what's happening there, and we think that's just going to continue to grow.

And again sequentially that will not grow as fast as you've seen over the past year or so, but the sheer dollar number is quite impressive.

I might also add that even with the lift in e-commerce, we actually saw a sequential improvement in comp stores in just the stores themselves in sales.

Again, that was driven, as I said earlier, by conversion.

The conversion rates are getting very, very high inside the stores.

And I want to give a very big New York shout-out to our thousands of sales associates all over the world, who I think did an amazing job.

We had a great holiday season.

First and foremost because of Michael, the design teams, and the product that they put together, but we've got thousands and thousands of people who have jet-set training and continue, even with declining traffic in shopping malls, to really deliver for us and for the consumers that they serve, so real kudos to them.

In terms of Europe, we were generally pleased with the quarter.

I have to be honest with you, there was a couple of areas of softness, as you can be well aware, and France was a very difficult market for us, after the events that happened there.

And again the whole -- it wasn't just Paris, that was affected.

Remember, we are very strong brand across many of the areas, and people were really not in a mood to shop.

We were affected in Belgium as well.

And then the other place that we felt some softness is in the UK, and we've been feeling that, we've been talking about that really since last year, and that has been the Euro-dollar exchange, and also the Russians not coming there as much as they did, and some of the Middle Easterners as well.

So that market has been a little more challenged for us.

That all being said, we are seeing an actual acceleration in the business as we kick off the fourth quarter, which we are very excited about, and we think that's some of the new product reads.

We told you that in the last quarter, as we saw some of the new products hitting the stores, the reaction was quite strong.

And again, the other thing that we're seeing happen in Europe, like we saw in America three years ago, some of the e-commerce penetrations with our partners, whether that is Harrods or Selfridges or other accounts in the marketplace, is really accelerating very quickly, and so we're very pleased with what's happening in the European market, and continue to see lots of growth there.

Thank you, Kimberly.

Great, thanks.

Omar Saad with Evercore ISI.

A really nice quarter, guys.

Wanted to ask my first question, dive a little bit more on conversion, John.

I think it is something new that you are calling out.

You touched on it in response to Kimberly's question and the prepared remarks, but is it a new phenomenon, this accelerating conversion?

Do you feel like it is firmly tied to the development of the digital platform, in-store training, are there other factors driving this?

Because you've got exposure to these channels that a lot of other companies and retailers are struggling, tourist markets, mall channel, outlets, et cetera.

Maybe we can dive in a little bit deeper and understand what's driving that conversion, and how much more opportunity there is to use conversion to drive the comps.

Omar, we believe, and I'm going to focus this on North America for the moment.

We believe that mall traffic in North America is going to continue to decline.

And the reason for that is, again, we think that people in North America are a bit more savvy when it comes to digital shopping.

It's just been more cultural here for a longer period of time, and you have big companies who are quite strong at it.

And we've seen that, both in our own stores, and you can see that through our wholesale partners, as well, where digital is just becoming a bigger piece of business.

We haven't seen that yet in Asia, where mall traffic continues to be still pretty good, and Europe, I would say mall traffic is average.

We haven't seen the deceleration that we saw in the United States.

And in the United States again, we attribute it primarily to digital shopping for people.

The reason why the conversion is climbing, I think, is twofold.

Number one, just as a percent to total, obviously if your traffic is down and your sales are trending up, it's going to come usually through conversion, not necessarily through ticket climbing so high.

But the second thing is, we have really worked hard with our teams inside the stores, we told you in our prepared remarks, that the smaller bags and the AURs, that is a reality of fashion.

We were one of the first people that jumped on that, and we believe that the global market for luxury handbags is approximately flat, but in unit sales, we are up in the very strong double digits.

So what does that tell you?

That tells you that there are more customers actually buying Michael Kors product than what you look at in the comp store sales.

You are comparing comp store sales in dollars, which is obviously how we all earn EPS, but in actual units, there is a lot more people buying Michael Kors product than probably some of our other competitors, than you are actually seeing.

So the category in dollars is roughly flat, but actually in units is quite strong.

So how do you go after that?

We believe that when somebody is coming in and interested in a crossbody, they need a new wallet, because the wallet size is smaller in a crossbody versus a midsize handbag, where it might be a zip-around Continental or things like that.

So the market is changing very, very rapidly as the consumer's fashion taste is changing, and we see our opportunity really being in upsell with the customer, or in trying to take advantage of trend.

That's the second thing I think we have done a very good job on, again, whether it was backpacks, whether it was crossbodies, saddlebags.

We also did great job with our active footwear.

It is no secret, some of the big athletic companies are doing very, very well, and we've been on that trend for the last two years, and that category is growing significantly for us.

So I think what our customers are responding to is we have got the right fashion for them at the right time.

We've got really well-trained associates, and these associates, quite frankly, know how to upsell in terms of multiple items, to get that transaction value up, which is helping in our total conversion rate inside the store.

Thank you.

That's super helpful John.

Can I ask another question on the -- maybe a little bit more detail, on the decision to continue to destock the wholesale channel?

It's a channel generally the market's worried about, what you are seeing there.

It's obviously a channel you are also committed to, and how should we think about that, and the thought process behind it, and the evolution of it?

Sure.

First off, we love our partners, whether it is Macy's or Dillard's or Lord & Taylor or Bloomingdale's or Saks or Neiman's or Harrods or Selfridges or Takashimaya or, whatever.

The wholesale channel is phenomenal.

The department stores are phenomenal.

They carry amazing brands inside these channels, and I think that the theory that this channel is a channel that's going away is not a very well thought-out theory.

That channel is like every channel in retail today.

It is being challenged, because the consumer is shopping differently.

And as they shop differently, quite frankly, they are smarter.

They have the ability to see things online, a lot more assortment, a lot more selection, they can compare side-by-side, they can compare pricing online.

So what we just believe is that channel is going to figure out how to manage its growth over the next 12 to 24 months, as many of us are.

And we think it's better to have less inventory in there, to have less promotions, which will keep the brand integrity at a higher level, and our partners are very supportive of this.

We also want to turn our inventories faster for them and for us, and we think the better we look to our end consumer, and not confusing them with different promotional activities at different levels, the better it is for the brand, long term.

So as I said in our prepared remarks, we believe that channel is going to be down on a go-forward basis for us.

And we will make that up more so in our own retail stores, our e-commerce, expansions in certain marketplaces.

And then ultimately long-term as we said in the past, we're looking at certain other licenses that we may or may not bring in-house.

Our men's business growth.

So we have plenty of opportunity for us to grow.

It doesn't all have to be pushed, and that is what we're afraid of.

We don't want to push too hard, because we think that could damage the brand long term.

Thank you.

Great job.

Thanks.

Matthew Boss with JPMorgan.

Congrats on a nice quarter.

So as we think about the handbag category, do you see this AUR pressure as entirely fashion-related?

Is any of this promotionally driven?

And when did you really see the AUR pressure start?

I guess my question is, do you think we've seen the peak, and what is the right stable state balance between the unit growth that you are seeing and the right level of AUR?

Good morning, Matt.

It's a great question.

I don't have the exact percentage in here for you, but it is definitively much more driven by bag size than it is by promotional activity.

And I think I said in the last quarterly call that we are hoping, believe, think, wish, whatever you want to say, that we start to lap this in June, July, August of next year.

We saw this small bag trend happening.

It really started happening two years ago.

We think we are a bit more up against that, or there will be less of a headwind for us.

There is no guarantees on that.

Again, it is just going to depend on the trends that are happening.

You're even seeing money pieces now are getting smaller, because again, people are -- as more things end up on your phone, you need less things in your wallet.

So that is just a fact, so actually our much smaller money pieces are accelerating even faster than our larger money pieces.

So we're seeing it across the board.

In terms of promotional activity, there is no question that our third quarter, or the retailer fourth quarter had more promotional activity inside of it.

I wouldn't say there was more events.

I would just say there was a lot more markdowns related to clearing inventories, as everyone wanted to be clean to start the year.

We had terribly unseasonably warm weather, which really affected everyone in the business, and not just things like boots and coats, which everybody talks about, but when people aren't going to the stores because it's 60 degrees outside on the day before Christmas, it has just got a psychological halo that we really think affected the business in North America.

So I think people got healthy with inventories, and I think that was a very good thing for us to start out the spring season.

Thanks.

Great.

And then just a follow-up.

What was the run rate of watches in the quarter, and when do you anticipate a level of stabilization here, and potential return to growth in that segment?

Yes, first off, we don't disclose the various categories in detail like that.

The watch business remained difficult during the quarter.

I would say that, as in the prepared remarks, we really saw something very interesting.

We saw, when we put newness on the table, the customer responded very positively.

So you are going to see something from us in spring.

We have one of the largest new assortments of watches coming in our history, and that is going to be led by slim watches.

We think there is a very, very big fashion trend towards slim, so Michael Kors will be pushing that in a very significant way.

And we think that is one of the key issues, we probably didn't have enough newness out there.

I told you that in previous calls.

We think we've addressed that this spring season.

And secondly, clearly consumers are just wearing less watches, because of what a smartphone will do for you, and the fact that people are glued to their phone.

And they use that for more of a timepiece.

I think, and I believe Kosta Kartsotis at Fossil thinks as well, that the smart watch technology is actually going to revolutionize the fashion watch business.

I think over the next 5 to 10 years, most fashion watches will be sold with some type of smart watch technology, and so we're super excited.

We will be announcing our whole program at Basel in March, with a launch in-store in August.

And watch out.

We are a very competitive group, Fossil and Michael Kors, and we see big opportunity in a category that is today in the billions of dollars, that being not only smart watches, but other connected accessories as well, and we intend on competing, and competing at a very high level.

Thank you, Matt.

That's great.

Good luck.

Oliver Chen with Cowen and Company.

Congrats on the solid product and execution.

John, we had a question on the longer-term margin profile.

As you look ahead, what are your thoughts as it interplays with product mix or AUR in your opportunities?

It is a question we get from investors.

Also, you had such a strong performance in earnings growth, ahead of your expectations this quarter.

Why wasn't there necessarily an opportunity to raise your full year?

I'm just curious about that.

Thank you.

Oliver, I will let Joe answer those questions.

Thanks, Oliver.

So in terms of margin, obviously, we've talked some time about normalization of gross margin.

We are not giving guidance further than the current year until our next quarter call.

That being said we are thinking that gross margins have approximately normalized, and that we can continue forward with the margins in the zone where we are at.

In terms of EPS, we think that we can continue to grow EPS into the future.

And in terms of operating margin, we discussed recently what we thought operating margins could be on a sustainable basis, and we continue with that.

In terms of the full year, we are actually very pleased that we are sustaining the projections for the full year for both revenue and EPS.

We're obviously in a difficult market; we talked about that in the conference call.

We are reflecting what we are seeing, plus some timing differences in the fourth quarter, and that is why at the end of the day, we did not increase the full year.

But again, we are feeling very good about the full year, and very pleased that we held the previous guidance.

In the largest assortment ahead, could you just characterize the mix of price points?

If there is major distinctions we should be aware of as we evaluate and look at that product?

And does that -- the assortment size, does it also get some space growth in terms of how it will be shown, and any details we should know about as you launch it across your channels?

Thank you so much.

Oliver, it's a very good question.

The AUR is going to move up a little bit in product, because as we add materialization, and as we add embellishment, and as we do different things to the product to enhance it, we actually want to move the AUR up a little bit.

Michael and I were talking last night, it's so funny, that when a customer sees amazing design and understands that is something that is different, we don't have any problem with selling the pricing of it.

And I think as an industry, we probably got a little too focused on the $300 handbag price point.

So again, it's not that we're jumping into saying that our business is now going to be $700, which by the way, we have that category today in our stores, because we have our Michael Kors collection bags in the stores.

But we think that the customer is looking, just like we said in watches.

They are looking for something that's more exciting, and that's why we've invited you all to come up to the showrooms in the next couple of weeks to see the product.

Because Oliver, if I may say, when I read a lot of the reports, everyone has said that Michael Kors is ubiquitous.

Michael Kors is over-distributed.

Michael Kors is this, that, and the other thing.

The truth is that we keep growing, and the customer keeps responding, and the customer is voting not only yes in dollars, but she is voting yes in units.

So what we are going to stay committed to is great design.

There's going to be some elevation in the AUR.

In terms of additional space in the store, no, what we are probably going to do is take a little less of our basics and probably wind -- pull those back a little bit and increase fashion a little bit more, which again, the customer's saying yes.

She wants something new, not only from us, it's from our competitors, as well.

I'm talking from the luxury European competitors, are seeing the exact same thing.

It is right for trend.

It is right for the business, and it is right for inspiring our customer.

Thanks, Oliver.

Thanks, John and Joe.

Joan Payson with Barclays.

Could you talk a little bit, John, about how you have been investing in the business?

Maybe what inning you are in with some of the recent investments, whether it is supply chain, marketing, e-commerce, flagships?

And which of those are driving the most OpEx growth?

And then Joe, could you quickly touch on, I think you mentioned some of the favorable hedges that are rolling off soon.

Maybe how those will potentially impact fiscal 2017?

Good morning Joan, and a very good question.

As you can see when you really look at our income statement, the revenues continue to grow inside the Company.

We're making sequential improvement in comp store sales, so hopefully a bit of the nay-sayers who say that our brand is ubiquitous, over distributed, et cetera, some of that hopefully, you'll get comfortable with the fact the Michael Kors brand still very strong, growing and developing, both in North America and globally.

That being said, our expense, our SG&A is actually rising slightly quicker than our sales, which is something that we are working on.

And that is being driven by a number of different projects, as you know, that we were investing in.

And also, we had anticipated a much higher top line, in particular, because of the FX change.

So in terms of -- we are about halfway through the development of our Venlo project which is a very expensive endeavor for us, a million square foot facility in the Netherlands to support our $1 billion-plus business in Europe, and the fact that we're going to be launching ultimately in 22 countries our online.

We want to really have the best-in-class facility to be able to handle that, and not have to keep upsizing the way that we did in Los Angeles, which was a bit painful for us.

So that project will be finished somewhere around August, September, October, and we really won't get leverage from that in the first year.

Actually, that will go against us, as we learn to operate the facility, et cetera.

But again, as we've told you, we are luxury business investing for the future.

So if we don't make these investments, we're not going to have a Company that's going to be sustainable long-term.

That's the first big investment.

Secondly, as we bring up e-commerce around the world, and quite frankly, move sales from brick and mortar to e-commerce, we have the expense of bringing up e-commerce.

All the systemic issues.

We are hiring staff well in advance of having any revenues.

So all these are going as negative headwinds.

And then, unfortunately, today, e-commerce generates a lower operating profit for us than four-wall brick-and-mortar.

We think over time that will reverse itself, but as you know, when the consumer requires free delivery, free return, wonderful packaging, plus there is a new trend that people are buying multiple sizes of things to try them at home and then return them, that all is a negative headwind for us.

So I would say that we are again about halfway through our investment to be able to have our entire network built out, in terms of global e-commerce.

And then, we are here finishing out our corporate headquarters, which again you will see in a couple of weeks, which was a very significant project for us.

We said that we wanted to look, feel, and act like a digital company.

I think you're going to be very impressed when you see what we've done here.

It's great for recruiting the best in the industry.

It is great for employee retention.

And I think we did it in a way that was very reasonable given where we are in our building, and how we were able to execute that.

So those are the three big projects.

We've got some minor things as you know that are headwinds for us.

We brought Korea in-house, that's going to be negative for the first couple of years.

We've got our joint venture in South America that unfortunately will be negative for us as we deal with some of the headwinds down there.

And men's will be negative for us for the next couple of years.

Again if we don't make these investments, we're not going to build a long-term Company and have it sustainable.

We believe that going forward, SG&A still will slightly outpace sales, and we hope to get that probably turned around in our fiscal 2018, but it will not be in fiscal 2017, at this point.

Hopefully that gives you some color on that question.

And then, again I would add to John's comments, and we didn't discuss this in this call, and we're not giving guidance for next year.

However, when you think about CapEx, our $400 million CapEx for the current fiscal year is a peak CapEx, and we will be thinking in terms of decreasing that CapEx spend significantly, going forward.

In terms of the hedges, I can't give you any definitive answer to that.

Our hedges are typically nine months to a year out.

They relate to operations that we operate in non-US currencies, where our purchasing of inventory in US dollars.

And we talked about that in prior quarters.

As those hedges roll off, we of course are entering new hedges but they will be more of the spot rate when they roll off, and so that is just contributing to -- that will increase inventory costs and therefore have a headwind in terms of gross margin.

Great.

Thank you both.

Erinn Murphy with Piper Jaffray.

I was hoping, John, you could talk a little bit more about the men's opportunity in the wholesale channel.

I think you talked about 75 shop-in-shops being rolled out.

Where do you see the longer-term opportunity at wholesale in particular for men's?

And then during the quarter, I do believe Mark Brashear, he left to go to John Varvatos.

Can you talk about where the leadership team is now at men's, and did that departure change any of your near-term rollout plans?

Thanks.

Sure.

Mark Brashear, by the way, was terrific.

We really enjoyed his leadership there.

I guess we did a switch with John Varvatos.

Mark went to John Varvatos and Don Witkowski came from John Varvatos to come over here to run men's.

You may not know this, but actually Don ran men's here, many, many years ago when we first started it.

Don was with me at Donna Karan, as well.

So Don is somebody who walks in the door, hits the ground running, doesn't miss a beat, has great leadership and merchant qualities, and so as far as we are concerned, really nothing has changed at all.

And as you know, we are really excited about Marcel Ostwald joining the Company, and I can't tell you how thrilled you're going to be to see the men's product when you walk in the door, and I'm very excited for when you all come visit, because for the first time -- normally it is always the female analysts who are oohing and aahing.

This time we're going to have hopefully a few men oohing and aahing at our walk-through.

So we feel -- the men's business, we've said before, is a $1 billion opportunity for the Company.

And we've said about a third of that roughly will come from men's sportswear, about a third of that will come from men's leather, and about a third of that will come from watches.

Maybe a little less from watches, but we broke that down in that area.

The watches we obviously won't report the revenue inside of our Company, but we will report the royalties that generates.

We are well on track with all of our North American partners in constructing shops, so we will be in all the best stores, again whether that is Saks, Bloomingdale's, Macy's, Dillard's, Lord & Taylor, they are either up or under construction, or going forward.

I have to say that some of the new product has just hit retail in the last week.

Marcel was just barely able to touch some of that, and the sell-throughs have been terrific, and where you are really going to see the big impact is come fall season.

We are also in 150-plus stores today already in Europe, so the distribution is there.

We have beautiful shops in Harrods and Selfridges and at Peek & Cloppenburg and in El Corte Ingles, etc.

And the European community is really supportive of that.

I just came back from Asia two weeks ago.

We have some very significant plans about rolling that business out.

Again, that will be a department store driven business, but with shop-in-shops that we'll actually count those as stores.

Remember, we count concessions in our store count, so when I give you that 500 store count globally, that includes concessions, as well, inside that number.

So internally inside the Company, we are really excited about it.

Big opportunity.

And there really hasn't been a major new menswear business launched in 20 years in terms of significant, across all categories, that I think our wholesale partners can get behind in a big way.

So we are excited to be a part of that.

And then we have the freestanding store opportunities/stores, that will be connected to our existing stores.

And we think that's going to be a big opportunity.

One last call out, I will tell you that in our stores over the holiday season, what really surprised us is leather accounted for close to 40% of the sales inside the stores that opened.

Again, they've only been open for a couple of months and it was during the holiday season, but we were really shocked by the strength of our business in leather, and really bodes well for the development of that category.

Great.

Thanks for all the color, and best of luck.

Simeon Siegel with Nomura Securities.

Congrats on the quarter.

John, any thoughts on the jewelry opportunity, how large you can see that category reaching?

And then Joe, just given your commentary on advertising earlier in the call, is there targeted marketing as a percent of sales to keep in mind?

Thanks.

Good morning Simeon.

The jewelry category, again, has been continuing to expand and grow, so while unfortunately we've seen the watch category decline, we are seeing the jewelry category increase.

One of the things that we're going to do in our own stores for the spring of 2017, and you've heard me talk about this last year more, that while we loved introducing the jewelry category, unfortunately that drove the AUR of the total jewelry and watch category down for us, because we were selling a $150 bracelet or an $85 pair of earrings versus a $225 watch.

So that really hurt us.

Again, I think sometimes when people are looking at the business, they think it's all handbags that's driving the comp up and down, but in a lot of cases, that's not really actually the issue.

So we hurt ourselves a little bit with that.

So what we are going to do is, we will exit most of the fashion jewelry line in the spring of 2017 from our own stores, and we will introduce a more fine jewelry line inside of our own stores, really bringing it closer to the watch AUR.

Not completely, but it will be -- we will have gold.

We will have silver.

We will have plated materials as well, 18 karat plated, et cetera, and we will really elevate that whole category inside of our store.

And there will be select retail partners that we will allow also to carry that, but it's going to be very limited distribution, and we think it's a big opportunity for us to trade up the AURs in the store.

Going back to the original question that Kimberly and Omar were talking about, is as traffic declines in these stores, we all have to be focused on conversion, and how can we -- we're not going to raise our AURs by 25% and 30% and 40%, but if you can get your AUR up 5% or 10%, that's going to make a big difference.

And we're going to be doing that not only in our own stores, but looking at the department store channel as well, and the specialty store channel, and really take advantage of that.

The second question you asked, we don't break out the percentage of -- for advertising.

The only thing I can tell you is that we will continue to support that part of our business.

As you know, we have, first off, the greatest voice in the fashion industry with Michael himself.

We have the greatest PR, marketing, and digital team we think in the industry.

I said in the prepared remarks, every single channel, social channel we increased, whether it is fans, followers, et cetera.

That really speaks volumes to what's happening with our advertising and marketing and the way that our teams are handling that.

And again, we are going to be very proactive not only on existing channels, but as we've done in the past, we've been really a leader in looking at new channels as they emerge, and how we can have a voice in there.

Great; thanks a lot, guys.

Best of luck.

Lindsay Drucker Mann with Goldman Sachs.

I wanted to ask a question about your plans for stores in calendar 2016.

Can you give us a sense on what you're planning to do as far as in North America, your store expansions, your full price store openings, your outlet store openings?

Any detail on how you are planning to grow that distribution would be great.

Thanks.

Sure Lindsay.

We don't give guidance on that, yet.

We will do that in June.

But we have between our licensed partners and ourselves, we have about 860 stores worldwide.

And out of that 860 stores, in the Americas we have about 400 stores.

That includes Canada, Latin America, the United States et cetera.

So we are getting build and finished with our store rollout.

In North America in particular, it's going to be very few stores.

We told you many years ago, and I know many people have not loved the fact that I've held very steadfast to the number.

We told you we were going to build 400 stores in North America, and many people have asked me over and over again, why are you doing that?

We said we're going to keep building 400 stores in North America, and we will finish that build out.

The Americas got a little bit larger as a number because it now includes Latin America, so maybe it will be 425 or 430 or something like that.

Whatever it is, we are pretty much done with our build out in this region of the world.

Europe will continue to accelerate.

In that marketplace we have 171 of our own stores, and then we have a number with -- in Russia et cetera.

And again, we believe that marketplace will have in excess of 200 stores, we've said that in the past.

And then Asia is a place where we think we have a lot of opportunity.

So all in all, we've said it, about 1,000 stores is where we think we will be as a Company, and that includes our licensed partners.

So we have 150 or so to go.

That does not include men's.

We said that men's will be something that will be a plus for us.

So again and the last thing I want to say is, again I believe we make a lot of money in four-wall in stores.

We also believe that while e-commerce one day will end up being 20% or 30% of our business, it's not going to be 100%.

So stores aren't going away, they are not dying, and we need stores to service communities and people.

And that also, I think as you become omni, you really have a distinct advantage in having stores.

So I'll give you a good example.

Our return rates on e-commerce are running very low, but a number of those returns are coming back to stores.

And it actually gives us an opportunity to interact with the customer, and we have seen evidence where we are actually not only taking the return but trading the customer up and creating even a better experience with the customer.

So again, we embrace omni, we embrace our retail flagships and our retail fleet that we have today, and we will finish the build out and get ourselves to the approximately 1,000 stores.

Will you be expanding stores in North America?

I know a number of them are still pretty store in full price and in outlet.

Lindsay, if you asked me that two years ago, I would have said yes.

I think that's a little bit off the table.

We've got a handful of stores that we did expand already.

I don't have the exact number in front of me, but it's probably in the 30-plus or 40-plus range.

Those, we're pleased with what happened with the stores.

What we need to see is, we are going to reconfigure a number of existing stores, as I mentioned earlier, to increase the footwear space inside those stores.

We're really happy with what's happening with footwear.

And we think it's another reason for the customer to come in and shop with us, et cetera.

So we've got to see how that plays out.

I want to remind everyone that as we increase our women's ready to wear and our women's footwear business, both in wholesale and in retail, that has an impact on our margin, for two reasons.

Number one, we have lower margins going in, and number two, they are size businesses, and when you have size business, you have markdowns that are greater than what you have run in -- handbags aren't really sized and watches aren't really sized.

So it will help us grow the top line.

And ultimately, we think it will help us grow the consumer experience.

But as Joe indicated before, gross margins are going to be flattish in the zone of where they are today, looking out going forward.

Impacted a little bit by with what's going to happen with shoes and bags, and even menswear has lower gross margins as well.

Great, thanks so much.

Brian Tunick with the Royal Bank of Canada.

I'll add my congrats, again, to you guys in a pretty tough environment.

Last quarter you guys took on an additional line of credit, and I guess clients are asking about the potential of buying in maybe the China license, given the ongoing positive comments you have been making about China, despite some of the issues there.

Maybe curious about your thoughts there John?

And secondarily, on your beat to your guidance, can you talk about in North America, was there upside coming from the malls, or was it coming from the outlet stores?

Just trying to get an understanding of where the upside came from bricks and mortar.

Thanks so much.

Sure.

Brian, first off, and I will let Joe speak at the end here also about our balance sheet.

But as we have said in the past, we are a Company that has an amazing operating model.

We have, I think the second or third highest operating margins in the world in luxury compared to the European luxury operators et cetera.

We're going to end this year somewhere around 25% operating margins, which really is extraordinary.

We generate a lot of cash, and we have been very aggressive about buying back stock, because we feel that the market, if I may say that, has misunderstood our story and our potential and our long-term vision, and our success, quite frankly.

We are going to continue to be very aggressive, given what we think is a dislocation of where our multiple is versus the rest of the industry, and I might remind everyone that we will end the year with top line growth and bottom line growth, which is very unusual for many, many players in the luxury industry.

Pardon me if I bang the drum for Michael Kors for a minute.

The line of credit is there for a number of different reasons.

First, it is there again, if we continue to see dislocation, we may or may not decide to even get more aggressive with our buyback purchases.

As Joe said before, we have $580 million left on our authorization, but our Board feels very strongly in making sure that we continue to return value to shareholders.

Secondly, the line is there to look at potential licenses.

We have a number of them that could be brought back in-house.

Again, when we think those are in a strategic place for us or are going to be accretive for us, we will act upon that.

As you said before, we are very pleased with what's happening in China for us.

And even though Hong Kong and Macau remain difficult, we had double-digit comp store increases even with Hong Kong and Macau being difficult.

What does that tell you about the brand?

The brand is strong, resonating, customers are very, very excited about what's happening with our product in that marketplace.

So we like that, and as we said in the prepared comments, she's shopping around the world with us not just in the mainland China marketplace, and as you know, well over 50% of luxury goods is purchased outside of the mainland.

And the third purpose for the line is, and we said in our last call, is when and if a strategic acquisition is something that we think fits with our Company's short-term and/or long-term objectives we may very well act.

So we have an incredible balance sheet.

We have an incredible cash flow generation.

And we have the ammunition to do a lot of different things to continue to generate revenue and earnings per share growth for the long term.

Joe, do you want to add anything about the balance sheet?

No, you know in general our balance sheet is very strong.

We talked about inventory.

We're in a very good position to do the things that John talked about.

So we're feeling very good about the balance sheet.

And then lastly Brian, we really saw acceleration coming in the fourth -- third-quarter, fourth retailer quarter.

Our third quarter.

November and December just got better for us as we went through the quarter.

And we saw -- what we really were pleased about was our full priced stores.

She came in, she shopped, she shopped for gifts, and I said to you earlier that we saw sequential improvement.

She liked what product we were offering her, and she had a lot of choices out there in the marketplace.

And not only did she have a lot of choices, she had a lot of choices at a lot of prices.

So we were particularly pleased with that.

And again, we spend so much time talking about North America, North America.

We're doing 30% of our business now, approximately internationally, and we really liked what we saw happening in Europe, and Asia is continuing to just build momentum.

So as you think of this Company long-term, and this will be my concluding remarks, we always knew that North America would be a marketplace that ultimately would reach a point where it would have lower growth.

That is where we are today.

We're still growing in the marketplace, and we're still taking market share which again, I hope you recognize, given our results.

We think that really resonates for the brand well.

Europe, still good opportunity for us to develop stores, wholesale shop-in-shops there, and many marketplaces where we are still underpenetrated.

Asia is wide open for us.

We still are super underpenetrated in Korea, Japan, China and in certain places in Southeast Asia.

So when you think about Michael Kors, think about growth.

It is not going to be double-digit growth.

Those days are behind us, but we are going to have solid growth going forward.

And in the luxury industry today, I think there's not a lot of companies that can stand up and say that, and keep delivering on that quarter after quarter.

I want to thank you all for taking the time to be with us today, look forward to updating you on our results in our next conference call.

Thank you.

Ladies and gentlemen, thank you for your participation.

This does conclude today's conference.