雷夫·羅倫馬球 (RL) 2016 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Ralph Lauren third-quarter FY16 earnings call.

(Operator instructions)

As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Mrs.

Evren Kopelman.

Please go ahead.

Good morning, and thank you, for joining Ralph Lauren's third quarter FY16 conference call.

With me today are Stefan Larsson, the Company's President and Chief Executive Officer; Chris Peterson, President of Global Brands; and Bob Madore, Chief Financial Officer.

After the Company's prepared remarks we will open up the call for your questions, which we ask that you limit to one per caller.

During today's call we will be making some forward-looking statements within the meaning of the Federal Securities Laws, including our financial outlook.

Forward-looking statements are not guarantees and our actual results may differ materially from those expressed or implied in the forward-looking statements.

Our expectations contain many risks and uncertainties.

The principal risks and uncertainties that could cause our results to differ materially from our current expectations are detailed in our SEC filing.

And now, I'd like to turn the call over to Stefan.

Thank you, Evren, and good morning, everyone.

I am happy to be with you today.

I am here to share with you how I spent my first three months, my initial observations and a rough outline for how will build the long-term growth plan for this great Company.

Chris and Bob will then share financial results for the quarter and give you guidance going forward.

I will then come back again to conclude the presentation part of the call and open up for your questions.

Before we get going, I would like to take the opportunity to thank Ralph and Board for their partnership and trust that they have given me in leading this great Company forward.

Now, let's start with how I've spent my first three months in the role.

Over the last 90 days, I have done a lot of travels.

I have been to London, Paris, Geneva, Frankfurt, Tokyo, Hong Kong, Shanghai, Beijing and all over the US, including our distribution center in North Carolina.

I've also met with our biggest customers.

I have spent time with many influencers in the industry and I met with thousands of our team members across all functions and levels of the organization.

In many of these meetings, I received direct feedback from front line team members and customers.

The goal of the travel and meetings has been to learn as much as possible about our brand, our team, our customers and the environment we compete in.

Parallel to the traveling meetings, the Senior Management team is in the process of conducting a full and comprehensive assessment of our entire organization and every function we do.

This review goes beyond the cost-savings initiatives and brand planning processes that were underway when I joined.

It covers all the value creators in the business from brand, product, marketing, to supply chain distribution geographies, as well as customers and competitors.

The assessment and our multi-year growth strategy will be completed in the coming weeks and months and I look forward to sharing that with you in the spring.

While it's still early days in assessment, a picture is starting to develop of our strength and opportunities as well as a rough outline for how we will build our long-term growth plan.

Let me start with our strengths.

Our brand, our team and the infrastructure we are building are by far our biggest strengths.

Our brand is very strong and unique.

Ralph and the team have built the brand on a dream of an aspirational life.

In a way, it's the quintessential American dream.

But it's bigger than that.

It's a life and style that goes far beyond apparel.

It's built on authentic style, quality and specialness.

And these became the customers' dream and at it's best, is both highly aspirational and highly relatable at the same time.

Right after I came in, we did a comprehensive brand study that confirms, not surprisingly, that our customers see our brand as one of the strongest in the industry.

The strength, depth and uniqueness of our brand that Ralph created 48 years ago, is a very strong platform to build on.

Another key strength we have is our team.

Our team members, and I met many of them already, are highly dedicated, they are passionate and they care deeply about our brand.

They can't wait to get back to consistently beating our competitors and there is a hunger for change that will be critical for realizing the full potential of this Company.

Finally, the infrastructure we are investing in, like SAP and our new eCommerce platform that will enable us to have best-in-class digital capabilities.

That's especially important in the world we're living in today.

Moving to our opportunities, and here I want to start with our performance trend over the last several years.

Our recent financial performance has not been living up to the strength of our brand.

It's been very disappointing on both on the top and the bottom line level.

With this underwhelming performance, we're asking ourselves the tough questions needed to identify where the opportunities are to get back to leveraging our strengths to consistently drive high performance.

In our assessment work, we started by asking the following questions, starting with brand.

With our multiple brands, how do we increase focus on the brands where we have the biggest opportunity to win?

Even though our brand is strong, how do we build on the authentic core of what we stand for and continuously evolve it?

Relating to product and assortment, how do we improve the balance in our assortment?

Do we have a systematic way of continuously strengthen our assortment?

Relating to marketing, how do we focus our resources on cutting through in today's market?

How do we evolve our brand voice in a way that makes our brand DNA stand out and excites and surprises the customer more than anyone else?

We want our customers to love us more than anyone else.

Relating to supply chain and inventory management, how do we shorten our lead times to be disruptive?

How do we optimize our inventory in relation to sales?

Relating to distribution and international expansion, how do we improve the quality of our distribution to be able to grow with higher full-price selling lower discount levels?

How do we strengthen our direct to consumer channels given where the market is going?

How do we make our online channel show off the way it should and drive ramp strength and profitable sales growth at the same time?

How do we pursue our global growth potential in a much more strategic way?

Relating to cost structure, how do we make the cost structure competitive with our best competitors?

How do we make sure that we invest in a disciplined enough way for the future to give us the highest return on investment?

Relating to customers, how do we get closer to our customers to know what their aspirations, wants and needs are?

How do we engage and build enough long-term relationships with our customers?

And finally, relating to the increasingly disruptive environment we're in, how do we strengthen the brand and develop the business model fast enough to succeed in an increasingly disruptive world?

Finding the right answers to these type of questions, putting actions in place that drive execution will be the most important work we have in front of us over the next few months.

It could be the foundation to building our growth plan.

Even though our complete plan will not be ready until the end of spring, I would like to share some thinking on where we're driving towards and how we're going to build out the plan.

We are working towards a vision centered on becoming the most admired, aspirational and high-performing style brand in the world.

And we will measure our progress towards the vision through brand strength, profitable sales growth and shareholder return.

The foundation of our plan will be our commitment and focus on developing our brand, our teams and our customers.

There will be two main parts to our plan framework.

The first will be the customer facing part of the brand, where we will evolve and strengthen the products, the marketing and the shopping experience.

The second part will be to radically strengthen the underlying business [centers].

These centers will include, developing a systematic, repeatable way of creating a stronger and stronger assortment, a more demand driven supply chain and a holistic global expansion strategy, as well as a best-in-class consumer insights capability.

Underlying all these initiatives are the strengthening of our team and the right-sizing of our cost structure.

When it comes to our costs, we just have to become more competitive.

The work we're undertaking is the work we need to do to build the Company back to high-performance and position ourselves to lead in an increasingly disruptive environment.

It's complex work that will take time.

We will show you the pacing through the plan we will present in late spring and we show progress every year.

I know how critical it is to build and maintain the trust of our shareholders.

This will require clear and consistent performance and communication going forward.

I am committed to both.

We are going to be laser focused on transitioning our business back to excellence.

And with that, I would like to turn the call over to Chris.

Thank you, Stefan, and good morning, everyone.

Revenues in the third quarter were down 1% in constant currency and down 4% on a reported basis, below our guidance of 0% to 2% reported growth.

Despite the sales shortfall, we were able to generate operating margin above our guidance range due to both better expense management and a solid gross profit rate.

The sales shortfall in the quarter was driven by our North America business due to the above average temperatures that persisted for most of the fall and holiday selling period, a significant drop in foreign tourist traffic, challenges in the Lauren brand and general macroeconomic weakness.

Our performance in international markets was much better as revenue grew 6% in constant currency outside of North America.

Let me provide you with more color on our performance by key geographies.

Starting with Europe, our revenue grew 8% in the third quarter in constant currency.

Wholesale demand was particularly strong with robust sell-throughs that drove strong reorders.

By region, Northern and Central Europe performed the best.

In Asia, third quarter revenue was up 3% in constant currency.

While this growth rate is below the high single-digit growth rate we posted in the first half of the year, it was within our expectations.

We reduced markdowns and the length of the sale period in Japan and Korea, our two key markets within Asia.

This pressured sales growth in the quarter, however, drove gross margin improvement and gross profit growth.

We believe these actions will continue to help us elevate the brand in this region.

Looking at performance by country, Hong Kong and Macau continue to under perform due to reduced tourist traffic, while Japan and Australia continued to outperform.

As we spoke about previously, we implemented price increases in key international markets to help mitigate the negative margin impact from currency fluctuations.

I want to provide some perspective on how that has gone.

In Japan, Australia and Canada, the pricing actions we have taken have been well received by the customer and we have continued to gain market share in these markets.

In Europe, we raised prices for the cruise and spring 2016 seasons.

Early indications based on sell in are encouraging, but it is too soon to have a definitive read on the consumer response.

Moving on to the Americas, net revenue was down 4% in constant currency, below our expectations.

While we anticipated a challenging holiday season given the slow start to fall, it was even more difficult than we expected.

The silver lining is that comps were positive in store locations where domestic customers represent more of the traffic, similar to last quarter.

As a result, we are optimistic that comps can show improvement as we begin to lap the foreign tourist traffic issues this coming summer.

The sales challenges we faced in the third quarter are reflected in our operating margin guidance for the fourth quarter FY16, as we're proactively clearing end of season inventories.

We will carefully manage expenses to mitigate as much of the negative impact from these actions as possible.

Now, I'd like to turn the call over to Bob for review of additional financial results and balance sheet dynamics.

Thank you, Chris, and good morning, everyone.

Gross profit margin in the third quarter was 56.8% excluding restructuring and other charges.

This was 20 basis points lower than the prior-year period, primarily due to unfavorable foreign currency effects.

On a constant currency basis, gross margin was up 30 basis points compared to the prior year period due to benefits from the initial of phases of SKU and style rationalization, product cost negotiations and favorable mix shifts.

Operating margin in the third quarter was 13.7%, excluding restructuring and other charges, 180 basis points below the prior-year period.

This is better than the November outlook we provided of a 200 to 250 basis point decline and was due to better expense management.

The lower operating margin year-over-year was primarily attributable to negative foreign currency effects, fixed expense deleverage and incremental investments in infrastructure.

Net income for the third quarter was $193 million, or $2.27 per diluted share excluding restructuring and other charges.

This compared to reported net income of $215 million, or $2.41 per diluted share for the third quarter of FY15.

On a reported basis, net income was $131 million, or $1.54 per diluted share in the third quarter.

The effective tax rate was 25% in the third quarter, excluding restructuring and other charges, and was 28% on a reported basis.

This was lower than our guidance of 31%, due primarily to discrete items recorded in the quarter and the effective tax rate of 29% in the prior-year period.

Moving to the balance sheet, consolidated inventory was $1.3 billion at the end of the third quarter, up 5% year-over-year.

This growth reflects investments to support sales growth for existing operations, new businesses and new store openings.

At the end of the third quarter, we had 31 more directly operated stores and 85 additional concessions compared to the prior year period, which is contributing to the growth.

We ended the quarter with approximately $1.2 billion in cash and investments on the balance sheet, and $611 million in total debt.

The Company repurchased 803,000 shares of its common stock during the third quarter at a cost of $100 million.

This brought year-to-date repurchases to $380 million.

With that, I will turn the call back to Chris, who will provide guidance for the remainder of FY16 and some initial thoughts on FY17.

Thanks, Bob.

For the fourth quarter, we're taking proactive action to clear end of season inventories for fall and holiday in the US so that we start the spring selling season in a strong position.

As a result, we expect reported revenues to be flat to down 2% on a reported basis due to continued pressure from lower foreign tourist traffic as well as higher allowances in the US wholesale channel to move excess inventory.

The fourth quarter includes the 53rd week, which we estimate will contribute approximately $65 million in revenue.

We estimate the negative currency impact on sales growth in the fourth quarter to be approximately 150 basis points based on current exchange rates.

Our operating margin for the fourth quarter is expected to be approximately 400 to 450 basis points below the prior year period, due to the proactive action we are taking on inventory, in addition to infrastructure investments and negative foreign exchange impacts.

The fourth quarter tax rate is estimated at 32%.

For the full-year FY16 period, revenues are expected to decline approximately 3% on a reported basis, with 400 basis points of negative impact from currency.

This compares to our prior outlook of flat revenues on a reported basis and 400 basis points of foreign exchange impact.

The full-year FY16 operating margin is now estimated to be 290 to 320 basis points below the prior-year's level, which compares to our previous expectation of 180 to 230 basis point decline.

This guidance excludes restructuring and other charges that are primarily related to restructuring activities associated with our global brand reorganization and a pending customs audit.

We expect these restructuring charges to approximate $120 million to $150 million for FY16, excluding $34 million for a pending customs audit.

We recognized $42 million of this charge in the third quarter and $113 million in the first nine months of FY16.

We remain on track to deliver the $110 million of annual expense savings associated with our global brand restructuring effort.

We will get a partial benefit this year and the entirety of the benefit in FY17.

Our FY16 tax rate is expected to be 28%.

We continue to plan $400 million to $500 million in capital expenditures in FY16 to support our global direct to consumer and infrastructure investments.

Now, let me provide some initial thoughts on how we are thinking about FY17.

We recently started the planning process for FY17, which as Stefan said, will include a deep dive into all aspects of the business.

The plan will include the following key elements.

First, we plan to right-size and increase the quality of our distribution.

Second, we plan to intentionally reduce the depth of the inventory buy to decrease discount rates and promotional selling levels.

And third, we plan to take significant action to improve the Company's cost structure.

While we are still working through the details, at this point, we expect FY17 total revenues to be down versus FY16, and operating margin to be up versus FY16, excluding restructuring and other charges.

The operating margin improvement will be despite an approximate $90 million negative operating income impact from foreign currency in FY17.

We look forward to sharing more details on our outlook in late spring.

With that, let me turn the call back to Stefan for some closing remarks.

Thank you, Chris.

In closing, let me reiterate, within the Company, we see the current performance of the business as very disappointing and we have full focus across the whole organization to drive the business back to high-performance.

The challenges we are facing did not materialize overnight.

They developed over years and our solutions will take time as well.

I want to be very clear, the growth journey we set out on is not to drive results next quarter, but rather position Ralph Lauren for success and relevance over the next decade and beyond.

We have an opportunity to do something that will build Ralph Lauren stronger than ever before.

In a world where the customer is in charge, we will build everything we do around our customer's dream of a life well lived.

We will give them access to authentic style, quality and specialness in all aspects of their life and we will do this in a way that we build on what made us great and we evolve it in new and innovative ways.

I look forward to providing more specifics when we share our detailed growth plan in late spring.

One thing is clear, I've never had a stronger vision to build on.

The combined strength of the brand, of Ralph, one of the most iconic designers in the world, our talented team and my experience of driving high-performance in this industry, makes me very excited for the future ahead.

With the full support of Ralph, our Board of Directors, we will move forward to create significant shareholder value.

And with that, I would like to open up the call for your questions.

Thank you.

(Operator Instructions)

Omar Saad, Evercore ISI.

Thank you, good morning.

Stefan, I would like to ask you, obviously, there's a lot of different things on your plate, but if I could get some of your initial thoughts potentially on the complexity of the brand and is there is a need to simplify the brand's, not just from a management perspective internally but also maybe it's confusing to the consumer side as well?

And then also, do you think there is a need to right-size any of the lower end businesses like the outlet and the off-price?

Thank you.

Thank you, Omar.

Yes, you are right.

We're in the middle of the assessment, so I can give you some early reads which is, we need to focus.

I'm a big believer in my leadership approach overall to focus and that includes our brands.

So in the plan that we will come back with in late spring, I will be very detailed in terms of how I look at being focused given the multiple brands we have.

What excites me though, is that the more I learn about the brand, the more I realize the strength of the brand.

So, focusing on where we will win when it comes to the brands will be essential and I will come back and give you more details.

When it comes to the quality of our distribution, that's also something that we are looking through in detail, and as I shared in my initial remarks, we will build Ralph Lauren into a stronger position it's ever had.

That's a long-term job.

I'll be able to give you more details in May, but we are looking through every single channel.

And, I'm going to make sure that the plan that we move forward with enables us to drive ground strength and drive profitable sales growth at the same time.

Michael Binetti, UBS Investment Research.

(Technical Difficulties) -- for next year.

That's going to be fairly hard for us to pencil out with any kind of clarity in our models.

Just maybe directionally how you're thinking about -- I know it's early, but directionally how you're thinking about magnitude, particularly on the revenue line just to help us with our longer-range thinking?

And if we could go back to try and connect some of the comments you made today to some of the investment buckets that we're used to hearing about from you over the last few years and maybe how much leverage we can think about for FY17 in terms of the buckets you've given?

One, the retail strategy; two, the SAP and e-commerce; and then three, the cost restructuring.

Chris, it sounded like from your deep dive comments that there could be something you guys are looking at that's incremental to the original plan that's led to about $110 million in cost savings.

Thanks

Yes, thanks Michael.

I think the answer to that is, what Stefan started with, which is we are in an assessment phase on all aspects of the business.

And we are working through to create a strategic and financial plan that can drive shareholder value, can drive profitable sales growth and can strengthen the brand over the mid-term.

We plan to share that plan in more detail in late spring.

And so, we are not yet at the point where we are ready to quantify the elements of the guidance for FY17 beyond what we shared in the script this morning.

But I can say, but on the buckets, is that particularly, we shared I think on the call, the FX impact that we expect next year.

We remain on track on the infrastructure on both SAP and e-commerce to complete the SAP European implementation next year, as well as the e-commerce replatforming next year.

And we remain on track, as I mentioned, to deliver the $110 million of cost savings from the initial global brand restructure.

But we are in the assessment phase and we'll share more details in late spring.

Matthew Boss, JPMorgan.

Good morning.

I guess if we piece this together and think about multi-year constant currency revenues, beyond the impact of FX today, what's the best way to think about wholesale and retail constraints today, both here and also abroad versus, Stefan, potentially the opportunity you see for a return to growth?

Some of things that may be impacting you next year, versus some of the opportunities that you see?

And with that, if you broke down into the product, Polo versus Lauren, just from a pricing perspective, do you think that you're appropriately set or do you think that there's changes that need to be made to the core infrastructure of the price that is going out the door to the customer today?

Yes, thank you, Matt.

So starting with the pricing, it's going to be an important part and it is an important part of our assessment to look through our whole offering to our customers.

So, given the recent very disappointing performance, we are asking, and I'm driving that we are asking the tough questions in every single area of the business.

Because, what I'm determined to do with the team and with the support of Ralph, is to mask the business performance with the strength of the brand.

So when I look at the brand, it's one of the strongest in the industry.

And when I looked at our performance over the last couple of years, including the recent quarters, it's very disappointing.

So I see a significant untapped value in both the idea behind the brand, and as well as how we drive the business.

And therefore, in the way I outlined the way we approach building the growth plan for the future, there will be a customer facing component, which is about evolving the brand, evolving our product, marketing, shopping experience, and then radically improve some of our business engines.

And I believe that driving brand strength for the future and driving consistent profitable sales growth and in turn, giving high shareholder return, is to strengthen both those components.

Both the customer facing part and the underlying engines and have them play together.

That's also what I have experience of doing from my two previous brands.

Kate McShane, Citi Research.

Hello, thank you.

Good morning.

My question is just with regards to the brand.

Stefan, you said you had done a lot of work on discussing the brand and just in some of the questions you have just answered, you again attested to the strength of the brand.

Could you let us know a little bit more detail about maybe what some of those strengths are?

What is so appealing about the brand to the consumer and what can you leverage over time?

Yes, absolutely.

Thanks, Kate.

When it comes to the brand, what excites me is that Ralph original idea behind the brand when he created it, it was much bigger than apparel and it was much bigger than product.

It was about inviting the customers into an aspirational life, their aspirational life and being very consistent in offering authentic style, high-quality and deliver specialness in the experience.

If you look at the disruptive market today, I believe that's exactly what you need to do to win, you need to be special.

You need to develop -- deliver a value that goes beyond apparel and if you look at the customer, the customer is now in charge and the customer is living a busy life.

What excites me about the original brand dish and then building that out, and why I see so much potential in it, is that we should deliver style to the customer.

And we can do that and we are known to do that and why we're so loved is because we have been so consistent in delivering authentic style, quality and specialness.

Lindsay Drucker Mann, Goldman Sachs

(Technical Difficulty) -- and the brand has a number of different avenues of distribution; wholesale, off-price, full price retail, outlet.

Can you just talk a little bit about what areas you view as quality and what function each of those avenues of distribution serve?

And then a quick follow-up for Chris, I'm curious what gives you visibility to margin improvement year-over-year in light of the potential deleverage on the sales shortfall and some of the other puts and takes that you talked about?

Thanks.

Okay, thanks.

Let me start, it's Stefan.

Quality of distribution for me is any channel that gives us an ability to strengthen our brand and drive profitable sales growth at the same time.

So, we'll come back in late spring and give you more details on how we see output folio of distribution going forward.

And relative to the operating margin visibility for FY17, I think the thing that gives us visibility into that from the initial planning phase, is a number of factors, including, the full-year impact of the cost savings that we've generated from the global brand restructuring.

The full-year impact of the pricing that we've taken in devaluation markets that should kick in next year.

The cost savings that we're going after through the SKU and style rationalization.

And, the work that we are beginning on right-sizing the Company's cost structure for next year as part of the planning process, which we will share more detail on in late spring when we come back with the plan.

And I think, all of those things taken in aggregate, we have visibility to suggest that is going to result in operating margin being up versus the drag of foreign exchange that we have for next year.

And fixed expense deleverage.

Rick Patel, Stephens Inc.

Thank you and good morning, everyone.

Stefan, we would like to hear your thoughts on the product and concept pipeline.

Over the past several quarters, we have heard the Company introducing Woman's Polo, Polo retail, they reintroduced Polo Sport.

As we think about the medium-term, should we expect the primary drivers of organic growth to be the ramp-up of these newly introduced areas?

Or are there new sub-brands and concepts that we may be hearing about in the future as you do your assessment of all the brands?

Great.

Thank you, Rick.

Well, I come back to that it's a part of the assessment.

I will give you detailed outline of how I think about these questions in May.

But just initial thoughts is that my experience of driving high-performance in this industry is very much connected to finding a systemic repeatable way of creating a stronger and stronger assortment.

It's still early days, but I see big untapped value potential there.

When it comes to evolving assortment in terms of the balance of the assortment and in terms of sports and catering to the customer's different needs, I'm coming back to why I believe in the brand.

I believe that we should give our customer access to a life and style better than anyone else.

And that means mirroring what their need is and how they build up their wardrobe.

We can do that more authentic, with higher quality and with more specialness than anybody else.

And we can also -- we should think in new ways and innovative ways of how we can utilize the disruptive world we are in to actually deliver that specialness to the customer in a way that excites and delights them, but also that makes it convenient for them.

And I will come back in late spring with more details.

Dave Weiner, Deutsche Bank.

Good morning.

I just had two quick questions.

Number one, just a follow-up on the prior one, could you talk a little bit about your early reads that have seen so far on the Polo Sport business and the inclusion there in Dick's and some other wholesale partners?

And then also, maybe a little bit about Europe?

You gave some commentary on your own business by geography, but could you maybe talk about whether you saw any incremental weakness due to the terrorist attack in Paris or if you feel any shift in cadence among local consumers just broadly there relative to maybe the back half of -- or earlier in 2015?

Thanks.

Let me start with Europe and then I will turn to Stefan for Polo.

In Europe, we delivered constant currency growth in the third quarter of 8%, so it was a pretty strong performance from a revenue standpoint.

We were disrupted from the terrorist attack in Paris.

We actually had a number of our stores shut down both in France and the UK for a few days and we saw the shopping pullback.

But, it returned relatively quickly after that and so, that's how we were able to deliver a relatively strong result of the 8% constant currency top line growth despite that short-term disruption.

Yes, and when it comes to the Polo Sport question, I tie it to getting closer to our customers.

Given that we are about style and we are going to be the customer's preferred supplier for aspirational style to their wardrobe, it's about getting as close as we can to them.

That's why as one of the underlying business engine that we are going to develop is a consumer insights capability that gives us the possibility to reflect.

If the customer builds their wardrobe on more of an at leisure and sport component, our offering should reflect that.

And it also makes me think about how Ralph has been 10 or 15 years ahead of many macro trends because we were one of the first in the industry several years back, in thinking about sports.

And what we had come to do now is we have to get close to the customer, we have to evolve our offering so we reflect how they want to build their wardrobe.

Laurent Vasilescu, Macquarie Capital.

Good morning, thanks for taking my question.

Gross margin was up 30 basis points on a constant FX basis compared to 90 basis points last quarter, was the difference due to lower benefits from sourcing SKU rationalization in product mix, or were there additional factors we should consider?

How should we think about that for the fourth quarter?

And then lastly, last February, it was noted that your hedges for inventory purchases is six to nine months out with 70% exposure rate.

Has those factors changed over the last year as we think about FY17?

Yes, let me address those.

The gross margin performance in the third quarter was impacted largely by the US market versus the second quarter, because in the US market, we saw a difficult, as we mentioned in our prepared remarks, fall holiday selling period.

In our fourth quarter guidance, is reflected on the gross margin rate, a plan to increase markdown monies and allowances to clear excess fall and holiday inventory so that we start the spring selling season strong.

I would say, that's really the driver in the gross margin trend in Q3 and Q4.

With regard to FX and hedging, our hedging policy has not changed.

It is consistent and so, we expect at current exchange rates to have a very small to nominal impact on translation next year in FY17, but we will have a transactional impact as we mentioned in the prepared remarks.

The combination of those two, we expect to impact the results by about $90 million negatively as the favorable hedges -- we lap the favorable hedge benefit this year going into next year.

John Kernan, Cowen and Company

Good morning, everyone.

Thanks for taking my question.

Stefan, you talked a lot about disruption.

You used the word several times.

Can you help us understand what you see is the most disruptive factor to the apparel category in general right now?

Okay, good morning, John.

Yes.

When it comes to the disruption, I'm a firm believer that we're just seeing the beginning.

I believe that the biggest disruption is that the customer is now in charge.

The customer has better visibility and better choices than ever before.

So, any company that's in the business of providing generic products or don't have any real value add beyond the lower and lower price or who, more importantly, is not close enough to the customer, will be in trouble.

So that's why we are building on the strength that's made us great and we are adding an even closer focus to what's going on in the market and what's going on with the customer.

David Glick, Buckingham Research Group.

Think you.

Just a follow-up question on some of the channels you're reevaluating.

The department store channel, obviously, has been very, very important in the US, for the development of the brand.

And it's evolved over the years certainly, the shops are very brand enhancing but obviously, there has been a lot of promotional activity, a lot of focus on key items selling at a discount.

Is that an example of one of the channels you are taking a closer look at to perhaps shorten lead times and improve the quality of sales?

And can you still maintain the same space in those department stores if you end up shipping less into that channel?

Yes, thank you, David.

So when it comes to department stores, they have been very important, you're right, to what has made us great from a business performance historically, and they will continue to be important to us.

And yes, we are focusing in the plan we are building and coming back with the details in late spring, we are focusing on some of the underlying business engines, the [licensee].

Yes, it's early days, but I already see based on my experience that we have a lot of value unlock to do.

So one is how we systematically and repeatable build -- how we in a systematic and repeatable way build assortment stronger and stronger.

The results of our supply chain and inventory management component which is, to become much better at balancing supply and demand.

And the results from an expansion strategy, which is to say, how do we grow with quality in all the different channels we have because I believe in that department stores, direct to consumer, are going to play together.

And offline and online are going to play together.

And again, coming back to my own experience, what I have experienced of this to drive a highly profitable global growth strategy.

And, I believe we have opportunities in taking of holistic expansion approach to our brand and our business.

And by doing that, unlock even more brand strength and unlock even more value in terms of driving profitable sales growth.

Okay, thank you all for joining us this morning, and as always, we will be available for follow-up questions after the call.

Thank you.

Ladies and gentlemen, this does conclude your conference for today.

Thank you for your participation.

You may now disconnect.