Capri Holdings Limited (CPRI) Earnings Call Transcript & Summary

Thank you. Jimmy Choo is a company. And when we first started our decision to move into the luxury space, literally, it must have been 90 days after our Board meeting, and all of a sudden, Jimmy Choo became available. And so we made a very quick decision to acquire this brand. And I might add -- I know that many people in the financial industry think that we've overpaid for Versace and Jimmy Choo. And I would contest that. And while we paid approximately a 20x multiple and approximately 2x sales, there's a lot of evidence in the industry of those acquisitions being made and in particular, by the largest competitor in the luxury space, who's done extraordinarily well with acquisitions at those type of levels. So again, we feel very comfortable in how and the prices that we acquired these companies. Jimmy Choo is going to be 25 years old next year, which we're excited about, very iconic brand. And as you know, it's a predominantly footwear company. It, at one point in time, had quite a sizable accessories business. And over the years, just -- I don't think it was the company's priority. And the company also never had a logo to drive off of. And today, again, as I've made clear, every luxury company that is very successful. There's one that kind of is famous today that doesn't have it. But everyone basically has something that identifies. When you've paid the kind of prices that you paid for this product that you have an identification. And so we very quickly came up with the JC logo that you've seen on our VARENNE accessories collection and on many of our footwear styles. And that's taken off quite nicely for us. So we're very pleased with it. You're going to see a very robust expansion of that program. Just got of phone with our design teams a couple of days ago. But I'm smiling, it's because I really think they hit it. We're in a really good place. And we'll be accelerating that quite significantly. And so that's going to be, over time, up to 50% of this company's business. And again, there's other examples of companies that have been able to do that. And again, this will be a little bit more challenging than Versace. Versace, obviously has a very powerful voice, has incredible brand awareness. Interesting enough, Jimmy Choo has a similar outweighed brand awareness versus the size of its company. And what gives us great confidence is that we're already in her closet. When you talk to luxury customers, probably about 60% of them plus have Jimmy Choo in their closet. So what we need to do is to work harder to get them to our website to understand that we offer more than shoes. And we have a very sizable fragrance and eyewear business. We need to do more to get her engaged. And that's, I think, something the new management team, led by Hannah Colman, will really be focused on, is engaging storytelling. Because it's a luxury brand, you have to storytell. And the other thing that we'll be really pushing on is our heritage as being a London luxury company. So -- and then the last thing is Jimmy Choo, and I've talked about it before the pandemic. The dress shoe business has been challenged. And as we've mentioned, the sneaker or active business in the luxury world has become very sizable. And we need to do a better job to compete in that. And we're doing that now. We were a little bit behind. We're not quite where we want to be yet, but we're moving rapidly and active is continuing to grow in penetration to the total. And in fact, one of our active styles called HAWAII is our bestselling item in the company. So we're making that move, and we're really pushing forward with our accessories. And again, we were all -- we were touching on $600 million. Jimmy Choo for 23 years, not this past year. But for 23 years, grew every single year. And so we don't need tremendous compounded growth there. We need kind of that 10% to 15% compounded growth. And I think we're going to reach the $1 billion relatively, I don't want to say, easily, but it's consistently, given the company's history and heritage. And again, both of these companies, Versace and Jimmy Choo, we believe we can attain mid-single-digit operating -- mid-teens operating margins. And Jimmy Choo was around 11% when we bought it. So for us, to get to 15% and above is not really going to be a huge leap of effort for us. And Versace was around 8% or 9%. So again -- and those are not best-in-class operating margins. So imagine if we could actually get to best-in-class operating margins, which is north of 20%. I think we'd rather be a little bit conservative in our own internal planning and hopefully see the upside to that.

Great. And then maybe lastly on the Michael Kors brand. So you now see the brand is a $4 billion brand longer term. I think that's down from $5 billion prior projection. What drove the $1 billion reduction in your view of that long-term size for the Michael Kors brand?

Very good question. We thought it was important, at a recent conference that we spoke at, to reset the expectation of the Michael Kors House. And it was really driven by 2 things. First and foremost, our wholesale business is going to decline, and we've talked about that. And I know that many of the people on this call are excited to hear that. We've always said and been consistent that we're very proud and enthusiastic and we think our wholesale partners are spectacular. So whether it's Selfridges and Harrods and Gallery Lafayette or whether it's Neimans and Zacks and Macy's and Dillard's, these are great partners. They've been terrific with us. We think they represent and present the brand in an outstanding way. That being said, we'll start with North America. North America, we have seen many of our partners closing door locations. So that's going to impact us. And I've had the question asked by me, how much of that transfers back into the e-commerce channel or to another store? We see it predominantly transferred to the e-commerce channel. And most of our North American department store partners are actually -- we're doing north of 40% of our business, and in some cases, 50% of our business online today. So it's not that those doors aren't important. They are. But as those stores close, we don't know where the volume goes. We see about 25% of it come back to e-commerce, the rest of it we don't actually understand where it goes. And so that volume will go away. So we expect about $500 million of that $1 billion kind of reset will have come from wholesale. The second part of wholesale will also be lower -- again, until the travel retail business comes back, that's a significant number for us on a global basis. And as I've mentioned before, again, many people think of us only as a North American wholesale business. That's actually not correct. We do a very significant part of our business in North American wholesale. But our second -- second biggest part of our business is actually Europe wholesale, which that will also see a decline. Many of our specialty stores are closing there for obvious reasons, everything from a powerful e-commerce only players to what's happening in this crisis and some of disintermediation. And our third largest business is the tourist business, where we have close to 200 locations around the world that are operated by other partners and those are for all intents and purposes shut down. And we don't expect the travel retail business to come back for 24 months. Now it will ease back up to a level. But we don't know what that level is actually going to look like in the future. So we felt it was prudent to share with the financial community, the reduction in what we think is the wholesale business. And lastly, I forgot to mention, there have been quite a few bankruptcies that have seen some of our partners go out of business. And so that's an impact as well. The other $0.5 billion comes from our retail business. First piece of it is the 150 stores that we recently announced that we're going to close over a 24-month period of time. Those stores on average do about $1 million. So you can figure that number out pretty quickly. And again, while we are going to lose the revenue, we'll actually increase in profitability because all those stores are unprofitable today. And as you recall, we've said that in the Michael Kors brand, we will actually see operating margin expansion over the next couple of years from its kind of historic 20% levels to something north of that, maybe as high as 25% over the next couple of years. And part of that is going to be based upon our fleet-optimization program. And the balance of that is just us taking a more prudent view of the North American market. It will still grow for us in retail. We just think it's going to be a little bit slower than we had anticipated. And then lastly, the European market, which we believe is going to be, as I said, 18 months minimum until that gets back to a level that we think is appropriate. So that again brings us back to that comment that I made earlier that, if you think of Michael Kors as a $4 billion business and Versace and Jimmy Choo as $2 billion and $1 billion. So you're going to be dealing with well north of 1/3 of our revenues coming from the luxury category. And then about 1/3 of the operating profits will come from that world. And as I've also said, while we believe next year, we won't reach pre-pandemic earnings per share, we believe that post next year we will exceed pre-pandemic earnings per share, and that's based upon the reshaping of the business and the way we're looking at it going forward.

Great. John, one of the more interesting things recently has been average unit retail, AUR. So what inning do you think you're in, in increasing AUR at the Michael Kors brand? And do you believe AUR can continue to increase multiyear? And if so, what gives you the confidence in that?

Sure. First, I'll just go through the 3 houses of the first one or the 2 will be quick. Versace, we are where we want to be in pricing. I think that one of the greatest things that pandemic has taught us is we can do a lot -- we can do almost the same amount of business. And in the case of Versace, we're actually doing more in our own retail stores with line sizes that are 30-plus-percent smaller. So that's going to raise gross margin at Jimmy Choo -- sorry, at Versace over time. We're very excited about the results that we're seeing there. At Jimmy Choo, which is very much like Michael Kors, we've always had this philosophy that we should be slightly below the marketplace. And Jimmy Choo is underpriced versus our luxury peers by a considerable amount. And so we are -- we started the price increases in September. We've seen very little, if any, pushback from that. There will be more price increases through the balance of the year, and we will end those price increases by the end of next calendar year. Most of it will be complete by September. And again, those prices are going to go up similarly to Michael Kors, 10%, 15%. And again, we're just going to get to competitive levels, which really -- first thing that our new CEO asked me was, is this a strategy that you would endorse? I said, absolutely, this makes all the sense in the world. And again, Jimmy Choo has, I believe, a powerful enough brand that the consumer wants our product. Interesting enough, not only for design, but we have one of the best fits in footwear in the luxury business. So we feel good about that. In Michael Kors, as I said, we've been raising prices for about a year. You'll see more significant price increases starting in January through the end of calendar year. Again, it will only get us to competitive pricing over time, we could possibly be the most expensive player in this world. Again, we are led by I think the greatest American designer in Michael Kors. He continues to demonstrate his talent and his drive for growing this company. He is, as I said to you, he has been -- he was the first one calling me asking us to go back to work during the pandemic. And Michael has been here, we're open generally around 3 days a week, and Michael is here with the design teams. And he's never stopped driving this company and all of our talented teams for great success and for innovation and for excitement for the customer. And so when you look at how our accessories business, which is our lead category for the company and while revenues were down for the Michael Kors brand, about 27%, accessories were significantly better than that and it was -- also, when I look at the -- our Michael Kors Signature business, it's been extraordinary. And you know 2 years ago, I set out on fixing something that I had personally made a mistake on and really walking away from that category and deemphasizing it for the company, and I believe it was an impact on us. We've done exactly the opposite. And now we're really leading and the sell-throughs are great, not only in our own stores, but our wholesale partners, online. And so that -- and in the midst of us taking price increases. So I feel really good about what we're doing. And again, I don't think it's hugely going to kind of put us in a position where we're not competitive, in fact, it will position us quite frankly, competitive. And again, that's going to be part of the margin-expansion story that you're seeing happening. And we believe that margin-expansion story is not only for this year, but it's going to be multiyear. And so the impact is exciting, and our teams are behind it. So by the end of next year, we should be complete with that price increase strategy.

Perfect. And another great segue. So on the margin front, can you break down your long-term EBIT margin targets? It's mid-teens for Versace and Jimmy Choo, and then more than 20% for Michael Kors. Just the drivers and the time line you think is reasonable to get there?

I'm going to turn that question over to Tom.

Thanks, John and thanks, Matt. So I'd like to start with Versace and Jimmy Choo, because there are some consistent drivers across both brands to get to a mid-teens operating margin. As John mentioned, that's not far from where they were historically and compared to peers, it's very reasonable and realistic target as peers could be significantly higher, 22% up to 40% in the luxury market. But the first thing is to grow in the accessories business. Now that is a critical part of both the businesses' strategies going forward. We have already begun to work on both of them and have seen traction. As that business grows, it comes with a higher gross margin. And a lot of other efficiencies associated with it. So we think that, that's an important and critical to our growth profile and margin story. The second piece is really improving store productivity. And there are a number of components to this. At the core of it is product. And as John mentioned, it's increasing, for instance, the penetration of sneakers or increasing the breadth of a core offering across both businesses, and that will improve our productivity. The second is the build-out in omnichannel capability. Jimmy Choo is fairly advanced in this. But Versace is in the process right now of launching in Europe and soon to be in the U.S. So there's a lot of opportunity here to continue to build that out. And linked to that is clientele, which we're building out, of course, across all our brands, but will certainly help in the luxury market. And pricing for Jimmy Choo, as John mentioned as well, will help increase productivity. Above all of this is the database size and the extensive brand awareness for both brands, which are very large and frankly, outsized for the size of their business compared to peers. So we think we'll be able to leverage this and build on that extensive awareness and engagement with our consumers. As that occurs, we'll leverage sales growth on SG&A. So we expect to see SG&A leverage over time and normalized investments as we've made a number of investments and changes in the businesses and cleaned up, so to speak, some of the things that we wanted to work on already. So we'll see that benefit. And we'd expect to see this improve over the course of the next several years. So expect year-over-year improvement for both brands. When we turn to Michael Kors. Michael Kors' gross margins were 20% last year. We expect to be at that level or above, up to 25% over time. And when you look at the components, the first piece is gross margin. As John mentioned just before this, we do expect to see a multiyear progression in gross margin. But it starts with AUR, led by pricing as well as higher full price sell-throughs, which is led by better inventory management and lower SKUs as we really turn inventory a little faster and manage the overall business with a lower number of product out there. The second is manufacturing efficiencies. So we expect to see this as we have in the past, but we'll continue to see it in the future and procurement savings around raw materials and weather procurement as we're one of the largest procurement and buyers of these products across the globe in the luxury space. So in gross margin, expect to see a multiyear expansion. When we look at costs, we've already streamlined the organization. And prior to COVID, Michael Kors was seeing a year-over-year decline in SG&A, we would expect that to continue. In terms of managing our SG&A, adding to that is the additional fleet optimization of closing the 150 unprofitable stores. And finally, for Michael Kors, growth in Asia. And this will benefit all 3 of our brands. But in Michael Kors, Asia is a higher gross margin, higher operating margin business, and that's going to be a structural tailwind over the next several years, both for that brand, for Versace, Jimmy Choo and the overall Capri Holdings. And in terms of time line for Michael Kors, since we've been there as last year, we expect that, that will be a little faster time line than the other brands. But overall, expect to see margin expansion year-over-year over the next several years.

Great. And then maybe lastly to close. From a balance sheet perspective, could you just update us on your capital allocation priorities? How we should think about the pace of debt paydown from here?

Sure. Happy to do that, Matt. First, I'll start with our free cash flow generation. And it's -- we've been robust in the past, over $600 million. And over the course of COVID in the first half of this year, we've been free cash flow positive in both quarters. And we would expect to see the pace of that increase in the back half of this year and then expand even further as recovery pace out of COVID accelerates into next year. Our first priority is always to invest in our current business. So invest in the plans, the capital, marketing and other activities to support the business and execute our carrying growth plans. Second priority is to pay down debt. And as we get into the back half of this year with higher free cash flow, we would expect to pay down even more debt. And next year with that continued progression, we'll be positioned to pay down even more. So that's the second priority. The third is share repurchase. Let's return cash to shareholders. It certainly supports and demonstrates in the past our strong free cash flow generation. And in the past, we've also clearly been able to generate cash, pay down debt and return cash to shareholders at the same time. Longer term, we will be open to another luxury acquisition. And certainly, after COVID and integrating Versace, Jimmy Choo and paying down some debt. But that was definitely something that could be added to the platform and we consider it in the future.

Great. Well, look, I think this is a perfect way to -- and a place to close it. John, Tom, thanks, again, for your time and transparency. Stay safe and best of luck navigating this continued changing dynamic across the board.

Thank you very much, Matt, and thank you for hosting us.