Interim 2017 Burberry Group PLC Earnings Call
Nov 09, 2016 AM GMT
BRBY.L - Burberry Group PLC
Interim 2017 Burberry Group PLC Earnings Call
Nov 09, 2016 / 09:30AM GMT
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Corporate Participants
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* Christopher Bailey
Burberry Group plc - Chief Creative & CEO
* Carol Fairweather
Burberry Group plc - CFO
* Donald Kohler
Burberry Group plc - President Burberry Americas
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Conference Call Participants
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* John Guy
MainFirst Bank AG - Analyst
* Helen Brand
UBS - Analyst
* Julian Easthope
Barclays - Analyst
* Annabel Gleeson
Redburn Partners - Analyst
* Luca Solca
Exane BNP Paribas - Analyst
* Melanie Flouquet
JPMorgan - Analyst
* Rogerio Fujimori
RBC Capital Markets - Analyst
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Presentation
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Christopher Bailey, Burberry Group plc - Chief Creative & CEO [1]
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Hi there, everybody, and thank you so much for joining us. We, of course, appreciate what a busy morning it is today, so thank you for making it across London.
We're going to begin this morning by giving you an overview of our first half performance with Carol taking you through the numbers. I will then come back up and update you on the progress that we're making against our strategic plan. We'll close with a little more detail around our recent runway show and our plans for the festive season, after which we will, of course, be pleased to take your questions.
So turning to the first half, we made good strategic and operational progress in an external environment that remains challenging in several of our key markets. Against this backdrop, and with broader changes in consumer behavior shaping the future of our sector, our focus has remained on keeping near-term trading in balance with actions to secure the long-term health of our brand and business in order to deliver future value for our shareholders.
We've begun to implement the growth and productivity agenda that we shared with you in May, and continue to take further deliberate steps to elevate the brand, including in our wholesale business and our ongoing transformation in Japan. As such, we're in a period of transition as we ready ourselves for the future and this is reflected in our performance for the half, which Carol will now take you through. Over to Carol.
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Carol Fairweather, Burberry Group plc - CFO [2]
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Thank you, Christopher. I will now talk through our financial performance for the first half. Our revenue was down 4% underlying and up 5% at reported FX. Adjusted PBT was down 24% underlying and down 4% at reported FX. Adjusted EPS was down 6% on a reported basis. Our net cash position remains strong and we have declared a 3% increase in the interim dividend to 10.5p.
Now to run through the detail. Revenue was GBP1.2 billion, down 4% underlying, up 5% including FX benefit of GBP99 million. Growth in retail was offset by declines in wholesale and licensing. Our adjusted operating profit was GBP145 million, down 24% underlying and down 5% reported, including an FX benefit of GBP29 million.
Looking at retail/wholesale, profits were down 19% underlying and up 3% at reported FX. Revenue was down by 3% underlying, with growth in retail offset by a decline in wholesale. Retail revenues grew 2% underlying, with improved comparable sales in the second quarter, up 2% following a 3% decline in the first quarter.
In Q2, Mainland China was up double digit, excluding the impact of the elevation of the store portfolio in Beijing. We saw a slight improvement in Hong Kong and the Americas, and the UK was very strong, up over 30%, boosted by strong tourist inflows. As you know, we keep our pricing under regular review and, as a result, we will now be increasing UK prices in the coming days. Digital again outperformed and grew in all regions.
Wholesale revenue was down 14% underlying, reflecting cautious ordering from our customers coupled with our own actions to elevate the brand positioning in both fashion and beauty.
Moving to gross margin which was down 40 basis points to 68.3%; this included a 70 basis point positive impact from FX. Gross margins for the apparel and accessories business is unchanged on an underlying basis, with positive channel and regional mix offsetting, as a product mix, as fashion outperformed replenishment. For beauty, the margin was negatively impacted by strategic actions we took in the half.
Operating expenses were GBP649 million, with a GBP45 million adverse impact from exchange rates. On an underlying basis, operating expenses were down 1% year on year. This underlying improvement reflects ongoing tight cost controls across all discretionary costs, and positive results from rent renegotiations, some net benefit from timing impacts, and initial savings of GBP6 million associated with our cost efficiency program, with around GBP20 million still planned for the full year. These offset underlying cost pressures and investments in our growth initiatives.
Turning to licensing, revenue was down GBP13 million year on year, principally due to the planned expiry of the license in Japan. With lower operating costs, profit was down GBP11 million on a reported basis, including a GBP1 million exchange rate benefit. For the full year, total licensing revenue is still planned to be down by about GBP20 million at constant FX.
Moving down the income statement, the adjusting items of GBP44 million compares to an income of GBP2 million last year. This charge consists of four items.
Firstly, a charge of GBP26 million relating to the beauty intangible. As a result of actions we took in the half to improve the category's positioning, our expectations for beauty revenues through to December 2017 are now lower than previously planned. Therefore, in addition to the regular amortization charge of GBP7.5 million, an additional [GBP18.6 million] has been recognized, bringing forward the planned amortization to December 2017.
The second item is a restructuring charge of GBP13 million associated with our cost and efficiency program, and we expect the charge for the full year to be around GBP20 million.
Thirdly, a charge of GBP1 million for movements in the China put option calculation up to August 1 when we exercise our call option and acquire the remaining 15% of our business in China.
And finally, a charge of GBP4 million, recognizing movements in future payment relating to the purchase of the non-controlling interest in Burberry Middle East.
Moving to tax; the effective tax rate for the year is now estimated to be around 25%, 1% higher than originally guided due to a change in the transfer pricing methodology of an overseas tax authority.
Our business remains highly cash generative with GBP182 million inflow from operations. Depreciation was GBP69 million. With sales below our original expectation, inventory was up 10% on an underlying basis, but we are comfortable with both the quality and the aging.
This chart shows the major cash outflows in the first half. Tax was GBP65 million; capital expenditure of GBP43 million with over half in retail, balanced across new stores and refurbishments. Due to timing shifts, we now expect capital expenditure of around GBP130 million for the full year, about GBP20 million lower than our previous guidance.
In addition, a payment of GBP69 million for the purchase of non-controlling interests in China and Burberry Middle East for GBP54 million and GBP15 million respectively.
The final dividend was GBP119 million and share buybacks were GBP32 million. We finished the half with GBP529 million of cash and, once you adjust for our leases, this is equivalent to about GBP600 million of net debt, up around GBP50 million on last September.
We have declared a 3% increase in the interim dividend to 10.5p a share. In terms of the share buyback, we will commence the next GBP50 million once we have completed the initial GBP100 million which we started in July.
The slide in your pack is our normal guidance for the balance of the year and, on an underlying basis, there is no change today in our expectations for full-year adjusted PBT. We remain very focused on both driving the business through this all important second half, and on executing the initiatives underpinning our growth and productivity agenda.
I'll now hand back to Christopher, who will talk you through the specific progress we have made on these initiatives in the half and on our plans for the future.
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Christopher Bailey, Burberry Group plc - Chief Creative & CEO [3]
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Thanks very much, Carol. So as Carol just said, I'm now going to turn to the plans that we shared with you in May, and the good early progress we're making with their implementation. As you'll have seen from today's statement, we have distilled these plans into five key strategies that will be how we talk about the business, going forward; product focus, productive space, e-commerce leadership, operational excellence, and finally, inspired people. A new strategy covering our culture and the changes to our ways of working that will be a critical enabler for all of our plans in the future.
Since May, we've been focused on developing the detailed plans underpinning each of these strategies, which we are now beginning to execute. As a reminder, these strategies are being informed by a number of external factors; a more subdued luxury growth environment, a shaping force of digital technology, rapid changes in consumer behavior, and significant demographic shifts, including the increasing importance of cities and the maturing of millennials.
I'll now share some of the details of these plans and, importantly, some initial results from each area because, while we are still early in this process, we are making good progress in laying the foundations for future outperformance. All of which gives us confidence we will achieve our significant growth and productivity ambitions which we're currently on track to deliver.
So turning to the five strategies, I'll begin with our plan to move towards greater product focus, by simplifying our offer, reducing our assortment and allowing innovation and newness to come through more strongly than before. As with all our areas of strategic focus, we expect the benefits of actions here to build, over time. But I am pleased to say progress over the past six months has been significant. Let me give you a couple of examples.
First, the strong performance of bags as we start to reorganize this category around a new pillar and shape strategy. We saw mid-single-digit growth from this category in the half, with an acceleration to double-digit growth through the second quarter. This included standout results from existing styles that we're focused on building for the future, notably the Banner bag, as well as newer introductions including the rucksack, the Buckle family, and most recently the Runway bridle. This is already our third best-selling style globally following its introduction in the September collection a couple of months ago.
The exceptional performance of these styles is an early indication of the benefits we believe will flow from our new approach in both new and existing styles. For example, we're introducing more novelty through fabrications and personalization. We're elevating price points, where appropriate, reflecting enhanced design and construction, and already being reflected in higher AURs. We have much more focused marketing, heroing our products every bit as much as our brand.
And finally, we've introduced a more elevated approach to selling and visual merchandising in our stores. With phased plans now in place in several other key categories, we expect not only to build further on this early success in bags, but also to replicate it in other areas, over time. And we will update you on these in due course.
The second area of progress I'd highlight in product is that we are reducing our assortment in line with our targets, with a further 15% to 20% reduction for our November market, building on a similar reduction we made in May. This, together with our move to one label, fully implemented across our retail network this month, will greatly improve our customers' experience, whilst significantly decreasing internal complexity.
Reducing our assortment is also helping to give greater visibility to the fashion and newness in our collections, which is a major area of focus, with fashion again outperforming replenishment in the half. Within this, we saw strong results at both ends of our pricing architecture, in line with the opportunity that we highlighted to you in May, including the outperformance of Runway apparel and accessories at the top end, and strong results from new products at the opening price points in our core categories.
Finally then, under our product focus strategy, I'd highlight that we're getting on with simplifying how we work and ensuring true accountability for the results. Actions here include the evolution of our merchandising process, and the introduction of end-to-end category management, with new roles, responsibilities and ways of working, starting to be put in place for this November market downstairs.
Just before I move on from product, I'd like to say a few words on our beauty business, given the impact of our reported numbers. As you know, since buying back beauty in April 2013, we've been focused on rebuilding it around key fragrance pillars, including Brit, My Burberry, and Mr. Burberry, as well as growing our more nascent makeup business. And as the success of our recent fragrance launches has shown, this strategy is working to drive market share gains and elevate perception of the brand in this category globally.
This has been supported by ongoing improvements to distribution, not least here in the UK, and an integrated approach to fashion and beauty marketing, with the results that the business today is much better aligned with our overall brand positioning in key markets. But we do still have a lot further to go to unlock its full potential. So back in July, we said that we would review this category, building on the work that we did in our fashion business.
As a result, we are now accelerating the elevation of our fragrance business, including through upcoming launches within our key pillars, and further elevating their distribution, whilst significantly reducing activity on older lines, most notably in the secondary channel. This will ensure an overall focus on sustainable, profitable growth, underpinned by our full commitment to the future success of this category.
Turning now to our second strategy for the future, productive space. This is all about taking the footprint that we've established in recent years, and realizing the significant opportunity that we have to make it much more productive, including by better targeting the local customer in key cities. The initial focus here is our multiyear retail excellence program but other areas will follow, over time, most notably the further evolution of our wholesale business globally, including in the US, where we are working closely with our partners to elevate our presence, consistent with our luxury brand positioning, single-label strategy and overall objectives for the region.
Our retail excellence program is a truly global, cross-functional effort covering product, service, client engagement and operations. And we're already seeing results across all of these areas as we sharpen our focus on driving the business in a lower traffic environment. Actions in the half have included increased investment in training, the expansion of our CVM program, and Burberry private clients team, and an emphasis on creating more compelling content for events and appointments, with particular success on those linked to the design and craftsmanship of our products.
All of this has helped to drive an overall uplift in conversion across our key markets, as well as improved average transaction values in mainline and improved customer retention with a double-digit increase in spend from returning top customers. We expect the benefits to build as other retail excellence initiatives go live in the second half. Within product, as I mentioned, this will include the full rollout of our one-label strategy this month. We're particularly excited about this, given the very positive feedback from customers and partners to its staged introduction over recent months.
And this month will also see the full deployment of our new store profiling model at our November market which, as I said, we're just setting up in our showrooms downstairs. This means we'll be taking a more scientific approach to merchandising, ensuring assortments are better tailored to the specific needs and preferences of customers in different locations.
In service and client engagement, we will roll out a new customer feedback tool based on net promoter scores for the first time. Following six months of planning, and a successful pilot, this will provide invaluable insights for our retail teams and will allow us to become much more responsive in how we manage our customers' experiences. Early results suggest this will be a particular benefit as we seek to drive loyalty and stronger relationships with local customers, both key aspects of our overall retail excellence program.
And, finally, in operations we're prioritizing how we support our wider omnichannel plans, building on the 7% increase in online stock availability that we've achieved through the initial rollout of single pool of inventory. And we're also laying the foundations for shipping e-commerce orders directly from our stores.
These are just a couple of examples of progress from a program that is genuinely galvanizing our whole organization to think and work differently in order to put our customers first. As we said in May, we expect half of our growth through to 2019 to come from improving mainline retail productivity, so its significance and potential for our business should not be underestimated.
Turning now to our third strategy, e-commerce leadership. Our focus here is on translating the strong digital capabilities that we've established into greater sales growth across our own and partner platforms, as well as developing a deeper relationship with our existing digital audiences while, of course, attracting new customers to the brand. As we said in May, we believe Burberry is uniquely positioned to lead the sector in this, its fastest growing channel.
From digital customer acquisition and retention to developing omnichannel journeys, we are using skills we believed in and developed early on and which, today, are core to our DNA. We have a detailed set of initiatives planned to achieve our e-commerce ambitions and we are investing behind all of these, from people to capabilities to technology, to ensure that we stay ahead.
And we made good progress in the half just gone as digital, once again, outperformed and grew in all of our regions. Traffic to our website increased year on year and conversion improved across platforms. Mobile accelerated to more than 50% of our mix, reflecting sustained investment. And we began to realize the benefits of our investments in the significant commercial opportunity we see in Asia with our newly configured site driving a strong sales uplift in China.
I'd also highlight the strong growth we saw in sales on third-party platforms, which now represent a significant proportion of e-commerce retail revenues. A number of initiatives delivered or developed in the half will underpin further progress in our e-commerce leadership strategy, going forward.
First, our new website, which launched on desktop in September, now a much better representation of our brand and a greatly improved customer experience. Very much a living platform, we will continue to improve and evolve the site, over time, and look forward to its mobile launch in the coming months.
Second, we are just finalizing a new customer app which will create a more personalized shopping experience, connecting our customers more effectively to our stores and associates, delivering seamless mobile commerce and a platform for interactive storytelling. This app will launch in the coming weeks.
Third, and, finally, we are continuing to build relationships and drive innovation with partners in the digital space; such is our collaboration with Barneys and WeChat for the September show. This partnership approach will be critical to building reach, brand consistency, and keeping pace with customer expectations for the future.
Our fourth strategy, operational excellence, covers the majority of the plans for greater efficiencies that we shared with you in May, with a focus on systems, processes and balancing cost reductions with investment.
We're making progress across all of our areas here, not least in respect of cost efficiency, with our plans on track to deliver around GBP20 million of savings this year, and at least GBP100 million annualized by 2019, supported by actions in the half, including supplier renegotiations where we saw double-digit reductions in the cost of numerous large contracts; improved marketing efficiency with investments in digital marketing capability, allowing us to reduce the cost of each view of our content by 20%; and the cost benefits flowing from changes to our ways of working.
Beyond this program, we're keeping a tight control on all other operating expenses, as you'd expect. This includes the renegotiation of lease agreements, most notably in Hong Kong, and continued rigorous control of other areas of discretionary spend, all of which resulted in meaningful savings in the half and underlines our confidence in our planned full-year savings.
In addition to these cost efficiency measures, we're taking action to simplify the most critical processes across our organization, and to introduce new technology solutions to support improvement in how we operate. For example, in procurement we're implementing a technology called [RIBA], which will halve the effort involved in processing our supplier payments.
In product development, we will roll out a new system to simplify how we manage the product lifecycle between design, merchandising, planning and supply chain. And we're taking steps to optimize our management of stock with the single pool of inventory improvements that I mentioned earlier.
And, finally, we have established a new transformation management office reporting to John Smith today and then to Julie Brown, after she arrives in January, to partner with the business to ensure the delivery of all of our strategy priorities. Together, these actions position us to realize benefits that will build, over time, as we embed greater efficiency into the processes that form the backbone of how we do our business.
Overall, I'm pleased with the progress in our operational excellence strategy; we've made a good start, but we've lots more still to do. These changes to how we operate will be complemented by an evolution of our ways of working, which form a critical part of our fifth and final strategy, inspired people. Underpinning this is our commitment to reducing complexity in our organization, making us more agile and reducing duplication, as well as driving greater consistency globally while also improving insight locally. All of which will allow us to get design and creativity to the customer much more effectively, and serve their needs so much better.
As we said in May, this is partly structural and we've already begun to make a lot of changes in the half. For example, we've started to implement category management, as I mentioned earlier, and we're simplifying our shared services globally, including introducing more common processes in areas like finance and HR.
Beyond this structural evolution, we're ensuring everyone is adding maximum value to the product and the customer in their role to support our overall ambition. This, of course, includes the changes that I'm making myself to my own role here at Burberry. And I'm excited about the partnership I'm going to have with Marco Gobbetti when he joins us as our CEO next year.
And it's true right through the organization, where actions range from streamlining how we make decisions, and being clearer who is accountable for what, to bringing in additional skills to complement our brilliant existing teams because our talent will, as ever, be the key to our success.
Meanwhile, alongside these changes to how we work, we're redoubling our efforts to nurture and build Burberry's unique culture for the future, with an enhanced emphasis on our values and responsibility agenda, and we'll be talking to you more about this is due course.
So in summary, we're making good progress on the strategic plans we shared with you in May, with some early results already feeding through to performance and more to follow, consistent with our commitment to outperform sector growth, accelerating over time.
With that, before closing with some insight into our September show and upcoming festive plans, I'd like to share a short video with a couple of highlights from the first half of this year.
(Video playing)
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Christopher Bailey, Burberry Group plc - Chief Creative & CEO [4]
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Now then, just before we close this morning's presentations and move to questions, I'd like to reflect briefly on two incredibly important moments; our show in September, some highlights of which you just saw in the video, and the festive season that we have ahead of us. This is partly because how we've approached these brings to life so much of the strategic agenda that I've just been talking about.
But it's also because they embody the spirit of our brand, and that remains our most precious asset and most important priority (technical difficulty) and our founder, Thomas Burberry, best when testing boundaries, pushing established practices and challenging norms, while always remaining true to where we come from.
And for me, that's what made our September show so significant. It demonstrated our agility, making the straight-to-consumer concept a reality in just eight months from announcement; it was online and with representation in every one of our stores globally. It showed our passion for product and our commitment to creativity and to our roots, from the collection itself to the week-long craftsmanship installations at the venue. And, of course, to the digital collaborations that connected global audiences with the excitement of our show. And above all, it reinforced our belief that the needs of the customer must always be our priority, above all else.
Ultimately, I believe this change was the right thing to do as customer behaviors evolve. It's a significant moment for our brand, positioning us at the forefront of an industry changing paradigm. We're proud of that achievement and excited about what it means for the future, particularly because the September show exceeded our expectations across all measures.
We've seen a great response to the collection from the press, from our partners and, most importantly, from our customers, with particularly strong sales in areas of strategic focus including outerwear with military cavalry jackets becoming a seasonal trend, and bags with the Runway bridle, as I've already mentioned, already our third best-selling style globally. We've also seen a strong reaction to the more commercial pieces inspired by the Runway collection, and made available shortly after; all part of our commitment to greater newness and innovation across categories and price points.
We also saw record reach across PR and social media, and over 15 million views of our show on our owned and partner platforms. As always, this was driven in part by new and innovative ways to engage consumers, the experience including through partnerships with Facebook Live and Messenger, Snapchat, WeChat, YouTube, and our spend was more efficient than ever, consistent with our broader commitments here.
And finally, more than 20,000 people visited our venue, Makers House, in just one week. This showcased the collection alongside some of the work of some of the UK's finest craftspeople through a series of installations and events. Inspired by this success, we're currently looking at how we can extend elements of this experience into our own retail on an ongoing basis. All of which is continuing to build our brand momentum, as shown by our strong unaided awareness versus peers, with Burberry in the top five luxury brands across all of our key markets.
We now intend to leverage this momentum as we enter the all-important festive season. As many of you will already have seen, I hope, we launched our festive campaign last week inspired by the life of Thomas Burberry. Ending a year that's been all about positioning ourselves for the future, it felt natural to us to do something linked strongly to our past because, as I said, our heritage and the spirit of our remarkable founder remain our inspiration today, and we wanted to celebrate that as we embark on this, our next chapter.
Alongside this celebration of our past, our festive plans highlight our renewed commitment to product and to the customer experience, all linking back to our central theme. Let me give you a couple of examples. In product, we have made gifts a more significant proportion of our overall assortment, and introduced our widest selection of monogramable items to date.
And this commitment to personalization extends beyond products themselves into all of our communication with customers. For example, our top customers globally will receive a customized book of gifts that features their own monogram on the products throughout the book. And we're launching further real-time personalization innovations across email, banner advertising, and digital out-of-home sites globally.
We're also planning an ambitious and immersive program of events, all linked to hero products and their craftsmanship stories and closely aligned with our overall theme. And we're bringing the story to life with partners too, including following up on the success of our 2014 Printemps partnership in Paris with a festive takeover of Harrods, here in London, which launched just last week.
This collaboration, over a year in the making, includes exclusive products, a dedicated pop-up store, and the iconic Christmas windows all along the whole of Knightsbridge, all of which are touch-responsive enabling visitors to interact directly with the sound, the lighting and the mood of each scene in each window.
And across all of this activity, we have our richest and most creative content ever, ensuring the customer sees one coherent message, Burberry message, wherever they are. Just a few reasons why we're feeling well-prepared for the coming weeks.
With that, I'd like to end by sharing the campaign film, that I hope you've all seen, The Tale of Thomas Burberry. This is the most ambitious piece of filmmaking we've done as a brand commensurate with its importance to us as an idea. And we're proud to have worked with some incredible, creative talent to bring that idea to life: Oscar-winning director, Asif Kapadia; Oscar-nominated screenwriter, Matt Charman; and an amazing cast featuring Domhnall Gleeson, Dominic West, Sienna Miller, and Lily James.
The result is a film inspired by the pioneering discoveries of our founder, and which re-imagines some of the key events that have shaped our history and our values, which are as relevant to us today as they ever were, and which sit right at the heart of the enduring magic of our brand. I hope you enjoy it and we will look forward to taking your questions afterwards, the film.
(Film showing)
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Christopher Bailey, Burberry Group plc - Chief Creative & CEO [5]
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Okay, I think we're ready for questions.
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Questions and Answers
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John Guy, MainFirst Bank AG - Analyst [1]
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John Guy, MainFirst. Three questions, please. After that it's going to sound quite boring, but maybe we'll start with costs. A pretty good job in terms of costs down 100 basis points on a constant currency basis; where do you see cost moving over the course of the next couple of years? We're still up as a percentage of sales in the mid 50%s; how much more is there to go? I appreciate that you've given us some updates around the FY19 plans, but I just wanted to get a greater sense of where you could maybe take a little bit more out.
In terms of the pricing architecture, the Banner bag you highlighted at GBP995 seems to be a strong price point and driving significant volume, yet within scarves, we see some of your prices are higher than that of Loro Piana. So there still seems to be an inconsistency around some of the product areas, so maybe you could give us a couple of points, Christopher, in terms of how you see, I guess, narrowing or, effectively, maximizing or optimizing the price mix architecture across different categories?
And then, finally, scotch the rumors, did you talk with Coach at all? Is there anything in that? It seems to go on and on and on. I guess you're probably not going to comment, but I might as well ask it anyway. Thanks.
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Christopher Bailey, Burberry Group plc - Chief Creative & CEO [2]
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Shall we start with the last one first? There's no comment to the speculation and rumors. As you just said, they keep on coming. We've never commented on those rumors so nothing more to share today. Sorry. Over to you, Carol.
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Carol Fairweather, Burberry Group plc - CFO [3]
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In terms of cost, John, as you say, in this half we've done a really good job; on an underlying basis, costs are actually down 1% year on year. We had guided to mid single-digit cost pressures going into this year. What we've done as we've gone through the half, as Christopher just spoke about, is we've really dynamically managed all discretionary costs. So no different than what we did last year.
As we went into this year, clearly, the markets are still challenging, so we've been very thoughtful about discretionary spend. And we've been able to offset some of our underlying cost inflation by just really being very thoughtful about how we're spending costs. We're not necessarily replacing people as soon as they leave, deferring costs into the second half. So a great job in terms of discretionary spend and importantly also, alongside that, in delivering the first GBP6 million out of our GBP20 million target for this year, on what I would call the more strategic cost savings.
As we look forward for the balance of the year, I would imagine now that -- and the other thing to mention again, Christopher referenced it, was the good job we've done in Asia on rent renegotiations, which has also helped offset some of that cost pressure.
So then, flipping to the full year, I would imagine that the underlying cost pressure now is probably more like low to mid single-digit. We will expect to bank some of those savings we made in the first half. We may not get the same run rate in the second half, but we will deliver the GBP20 million worth of cost savings in the full year.
And then, just thinking about the future, as we said, we're committed to delivering at least the GBP100 million by 2018/2019, and we'll update you on that progress as we go. But good initial early progress, and I think setting up the TMO gives us the confidence that we'll be on track to do that, if not better.
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Christopher Bailey, Burberry Group plc - Chief Creative & CEO [4]
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And then, your second question on pricing architecture, I'm going to hand over to [Donald] to give a little bit more detail. But just to put a bit of context around it, we did talk in May about looking at both ends of our pricing architecture. That's absolutely a part of our strategy, not only across different categories but also within, and you mentioned the Banner bag. But even in the Banner bag, we've got a stretch from an opening price point all the way through to the most expensive, beautiful alligator bridle bag.
So looking then at the other extreme, you'll see in festive, for example, as we're going into that season, that we've got the broadest range of opening price points that we've ever had. But we talked about adding fashion, innovation, newness, and that's been a very big part of what we're doing downstairs, also now linking things back to the shows which is, again, something that we've never done before, and any color?
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Donald Kohler, Burberry Group plc - President Burberry Americas [5]
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Yes, I would just add, I think there is a natural question that will come up about our general pricing architecture. We are moving, within the next week or so, to move prices. As we've spoken about before as a Group, we typically move pricing twice a year, October/November, May/June, those are our two times that we address that, based on our seasonal shift, so that pricing you'll see come into effect across a broad range of categories for the UK.
Your specific example, and tying back to what Christopher was saying around scarves, that's a perfect example of a place where we are absolutely confident in the pricing of our core cashmere; that is our heritage. But the opportunity does exist to develop creative, innovative product at the opening price point, and that's what you'll begin to see as we move forward.
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Christopher Bailey, Burberry Group plc - Chief Creative & CEO [6]
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By the way have you seen our beautiful scarves?
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Helen Brand, UBS - Analyst [7]
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Helen Brand, UBS. Three questions from me. Christopher, one for you first; how do you envisage the president role evolving for you and your relationship with Marco? So in terms of your day to day role how do you see that changing?
Secondly, maybe a question for Carol, just in terms of that beauty hit to the gross margin in H1. Was that a low double-digit millions impact on the gross margin, can you confirm that? And is that done now, or should we expect more in H2 in terms of the writeoffs? You've resized the UK market, is there more to do elsewhere?
And then finally, just to follow up on this pricing distribution; impressive performance in handbags in the second quarter, up double digit. Can you split that out between the volume and the AUR in terms of the handbags? And obviously, talking about that price range from the entry level to the high end, but in terms of the price distribution of your handbag architecture are you now happy with that, relative to your competition, or is there more to do on the handbag side?
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Christopher Bailey, Burberry Group plc - Chief Creative & CEO [8]
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Okay, so the first question, me, my role, Marco; first of all, I can't wait for Marco to join at some point next year. Marco and I will dovetail into each other very well. We both have very specific areas of responsibilities within our roles. I, as you'd expect, will be covering all of design, all of the creative aspects, everything to do with the brand of the Company.
Marco, again, as you'd expect, will be overseeing all of the commercial aspects of the Company. We will have joint responsibility for the strategic approach to our global business, and we will also be working together and have joint responsibility on our culture and the people side of our business. Again, as you can imagine, Marco and I have got to know each other very well over the months and I'm just very much looking forward to him coming in and to having a real partner.
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Helen Brand, UBS - Analyst [9]
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Just to follow up, have we got any final confirmation of his join/start date yet?
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Christopher Bailey, Burberry Group plc - Chief Creative & CEO [10]
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Nothing's changed to what we said, whenever it was, in July. It's at some point next year; we will tell you the second we have a proper date.
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Helen Brand, UBS - Analyst [11]
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Thank you.
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Christopher Bailey, Burberry Group plc - Chief Creative & CEO [12]
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And gross margins?
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Carol Fairweather, Burberry Group plc - CFO [13]
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Gross margins, so beauty gross margins, as you said, the impact in the half on gross margin on a constant basis is purely to do with beauty, fashion, and fashion margins were flat. Beauty was about just over GBP10 million, so as you calculated, a combination of incremental stock provisions and a little bit to do with product mix in the half. We expect that to go back to more normalized margins in H2; this really reflects the review that we've done of the business and very much looking to reduce that secondary distribution as we move forward. So just a little bit more stock provisioning on the older lines.
The pillar fragrances that we have launched continue to do incredibly well, and we're gaining market share in those. So your question about what does it look like, going forward, I would expect to see nice growth in those pillar fragrances, which is exactly what we intended to do when we bought the license back; well positioned now alongside the rest of our categories. And then, over time, I would expect to see the secondary distribution pull right back and we'll be managing that closely over the coming couple of years.
And then, yes. Thank you, Donald.
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Donald Kohler, Burberry Group plc - President Burberry Americas [14]
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As it relates to the pricing conversation on bags, it's very consistent with what I said earlier. So the way that I see it is we're looking at the year ahead, knowing the introductions that we'll be having, it's focusing on the upper end and on the opening. So I would say that our sweet spot I think we feel we have covered quite nicely. We're going to be pushing to the upper end in the first half of next year and, in the second half of next year, pushing to opening price point aligned with festive. And I think I would suggest that the AUR might grow ever so slightly but, again, that's just an estimate at this point because it's all in the mix.
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Helen Brand, UBS - Analyst [15]
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And in terms of the Q2 number, [obviously the AUR had double-digit growth, was it the same in volumes]?
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Donald Kohler, Burberry Group plc - President Burberry Americas [16]
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It was a combination of both AUR and volumes.
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Julian Easthope, Barclays - Analyst [17]
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Julian Easthope, Barclays. First of all, I think, Carol, this is your last presentation so I guess the first question I have is regards to wholesale. I think, every year for the last few, there's been a cleansing of the wholesale operation. So if you take a long-term theoretical view, if you started with a complete blank sheet of paper, how big would your wholesale business actually be? And is that where you expect to get, say, in five-year time horizon?
And second question actually comes back to Carol. It's a really dull question I know, but you've probably taken a look now at the lease adjustments from the new reporting standards that come into place, is it below 5 times because I think you've got quite a few leases that are below five years and I'd just be interested to know what you think you'll actually have to bring back on balance sheet? Thank you.
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Christopher Bailey, Burberry Group plc - Chief Creative & CEO [18]
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Okay, so just the first one in terms of wholesale; we have been talking, for several years, about cleaning up wholesale, we still have much to do. I think it's important to just go back and look at the single-label strategy that we've just introduced. That was designed as a wholesale strategy; I think we talked in May about the flip of our business over the past years from a predominantly wholesale to a retail.
We do have a lot of work there to do; it continues to be a work in progress. We talked also about the beauty wholesale; we have got a lot of work to do there. It's something that we're taking some short-term gains. We're being probably more aggressive at the moment than we may have been in the past, I think, specifically talking about beauty, but we know that the opportunity is there to make sure that we've got a strong qualitative and sustainable business with our wholesale partners.
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Carol Fairweather, Burberry Group plc - CFO [19]
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I think as we look forward, Julian, I think the other thing to call out is around third-party digital, because I think that's another way in which we will grow our wholesale revenue. So I think, to Christopher's point, it will be about continuing to elevate the brand. I think wholesale is a part of the business we want to be in, but we want to be in it in the brand-appropriate way and, therefore, I think you will see, going forward, more cleaning up. But absolutely growth in those key accounts, like some of the third-party digital wholesale players, [ahead] of fragrances and beauty, and some of the other areas in EMEA, and travel retail is another one I'd probably call out.
Your techy question on lease accounting; my team are very busy working through first stages of lease accounting. It's a hugely complex model and we'll update you when we've got visibility on that, because there's a lot of work going on at the moment in terms of what that might look like.
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Annabel Gleeson, Redburn Partners - Analyst [20]
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Annabel, Redburn. Just two questions; the first is I know your bags grew mid-single digit in the half, but your accessories number is obviously negative. So I was just wondering what's maybe not performing as well, and is there a cross-selling opportunity to maybe smaller leather goods now that your bags seem to be performing better.
The second question is on inventory, one for Carol; your inventory days seem to be up even though you're doing all this in backend processes, can you just comment on maybe why and what's the opportunity there maybe to pull that number down?
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Christopher Bailey, Burberry Group plc - Chief Creative & CEO [21]
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Just in terms of accessories, bags were up double-digit in the last quarter just gone. That is purely to do with all the work and the focus that we've put on this pillar and style strategy. It is a multifunctional approach and also a global approach. It starts with products, but also goes through to the supply chain, the way we merchandise, our selling techniques, the training that we've got in-store, so visual merchandising.
We are at the beginning; I just want to temper that a little bit. We talked about these strategies in May; we've started implementing it. We've become very rapid in certain areas and started to see results. We also talked about the small leather goods and the opportunities there, which is one of our focuses as well. But more to come there as we start to look at other categories.
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Carol Fairweather, Burberry Group plc - CFO [22]
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And then just in terms of inventory levels, we're about up 10% year on year at the half, pretty much where we were at the yearend. I anticipate that coming down as we get towards the end of this financial year; I think I've been talking about that during the period. It really reflects the buys that we did a couple of seasons ago before we saw the overall luxury market slow down. So it'll take us just a little bit of while to get through that.
We did significantly pull back on the buys in the main market, which is why I'm confident that, over time, we'll get back to more normalized levels. Important to say, both the aging and the quality of that inventory is good, so there's a lot of replenishment in there so we're not worried about the inventory levels, but I would expect it to come down.
Medium-term opportunity, I think as we continue to develop our operational processes, I think there will be an opportunity to do even better. Over the last few years, I think we've demonstrated great progress; this has been a little bit of a blip, reflecting really what's going on in the wider macro. But I think there's quite a lot more to go for as we become a lot more dynamic in how we manage inventory globally.
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Luca Solca, Exane BNP Paribas - Analyst [23]
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Luca Solca, Exane BNP Paribas. You talk about digital and you clearly have a leadership in that area; I was wondering about direct to consumer, and how much of your sales actually go to consumers that you know by name and you can potentially address individually. And how do you see CRM growing in the business, going forward?
A second point, improbable things seem to be happening more and more frequently, so--
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Christopher Bailey, Burberry Group plc - Chief Creative & CEO [24]
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What do you mean, Luca, do you have any examples?
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Luca Solca, Exane BNP Paribas - Analyst [25]
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I think we have a big example this morning. I was wondering how you think, and potentially anticipate, Brexit risk in the ongoing negotiations that you will have between the UK and the European Union, beyond currency, I mean? And if you are taking any action on that?
And on beauty, are we right to expect that, although there's a very significantly better alignment with the rest of the strategy in the Company, from a financial viewpoint this will continue to be dilutive in both operating profit and return on invested capital for a while? Thank you.
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Unidentified Company Representative [26]
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Thanks, Luca. I'll just deal with the digital question first. As you know, Luca, and thanks for saying it, we do see digital as a differentiator. And we've been calling out for a while now that of our growth in the future we expect about one-third to come from everything that we do digitally. It's not just about burberry.com, although that is, of course, the centerpiece of any digital strategy for any company. It is also about what we do on third parties, an area we've been embracing for a very long time.
I think we said in May that we saw maybe two-thirds of the overall growth coming from digital coming from our relationships with third parties, which we built a lot during the half. Traffic is up, conversion is up on both channels, and, of course, we're investing in omnichannel through things like [store stop, look up], being able to ship directly from stores, single pool of inventory, and all those things.
In terms of being able to address customers directly, we've got about 12 million people on our CRM database at the moment. We've had a program of capturing new data for new customers for quite a while. We have about an 85% success rate of any new customers coming in-store. 85% of them are likely to go into the database; they give us permission. Once we've got that data, we then use it in all sorts of ways. We can use it in a macro way to look at traveling patterns, behavior shifts, trends, and so on, what's happening to the Chinese customer, and things like that.
And we can do it on a micro basis, either by in-store, allowing sales associates to have the data on their iPads to be able to have a meaningful conversation with a customer, based on actual purchases that customer has made in the past. And once the sales associate has identified a customer, and typed the name in on to the iPad, all previous purchases, with a picture of what they bought, and when they bought them, come up. So you can have a meaningful conversation around that rather beautiful jacket you're wearing, Luca; would you like to have the latest trousers just come in off the runway?
And we can also use it in a micro way to target customers on the CRM database to stratify it and send out emails and other forms of communication, specifically tailored to the likely shopping habits of that individual customer, because we've got the data.
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Christopher Bailey, Burberry Group plc - Chief Creative & CEO [27]
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And just to add that we're launching an app that we just mentioned there in a couple of months. That will give us a whole load of more data on our customers. It's a very personalized app. It links directly to our store associates for storytelling of the brand, and it's a very, very personalized experience, which will allow us to have a much, much more intimate relationship with our customers.
You just asked about beauty; Carol's going to go into some of the detail. But just to give a little bit of context there, we bought back the license in April 2013. We had a very strong approach to creating a pillar strategy, to align it much more closely with where we were going with the rest of the fashion business. We did take, when we took over that license, a distribution, a very, very broad distribution, that was not the right one for where we were going with the brand.
We feel very proud of the pillars that we have created. We know that there's huge potential there; we know that there's huge opportunity. We feel very confident that it's a right thing for our brand, and now we're looking at how to make sure that we create a strong, sustainable and profitable business that is positioned in the right way to the rest of the business. Carol.
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Carol Fairweather, Burberry Group plc - CFO [28]
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In terms of a impact on margins, going forward, as Chris has said, we're taking a hit this year. And we will then, I believe, get back to margins that won't be substantially different from the overall retail wholesale margin for the Group. It may take a little bit of time to build, because we will be continuing very robustly in terms of the amount of distribution that will let into those secondary channels. But I'm confident, in the longer term, it should not be particularly dilutive to gross margin or return on invested capital.
In terms of Brexit, I don't know whether you're talking specifically about actions we might be taking to try and mitigate the impacts when they come. Clearly, we've got teams across the Company, across finance, supply chain, HR understanding, all the areas of the business where we may be impacted. I think it's still too early to say what those impacts will be. We will look to mitigate incremental customs costs where we can. That said, we're a British brand, and so I don't see it fundamentally affecting the way in which we operate here in the UK. But we will look where we can to mitigate, if appropriate.
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Melanie Flouquet, JPMorgan - Analyst [29]
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Melanie Flouquet, JPMorgan. I have a number of question, actually. The first one is a little bit dull, it's regarding ForEx. I think the impact on gross margin is certainly smaller than I would have anticipated. I'm not too sure whether we're getting the hedging on sourcing wrong, but could you help us understand what's going to be the ForEx impact next year, assuming spot rates? So that's the first question, because clearly, there is an impact of delayed impact on sourcing.
The second question is on the humpback strategy from a distribution standpoint. I was wondering whether there is a shift there; whether this has over-indexed retail and is shifting to wholesale, so therefore, we have a bit of an impact there potentially this year in the acceleration.
And my third question is on management. I was wondering whether you could share with us what was it exactly that attracted you to your new CEO. And you mention a hiring from a trust formation manager, so I was wondering whether you could help us understand what he is working on. What are, in other words, the one or two projects that could be transformational in luxury and at Burberry, in your view, in the next five years.
And again, thank you very much, Carol.
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Carol Fairweather, Burberry Group plc - CFO [30]
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Okay, I'll take the FX one first. Early days, Melanie. Clearly, we have hedged effectively the first season of next year at the moment, but as always, we find it easier to come back and actually update you on the overall impact when we know what rates are going to be.
Clearly, on procurement, given the way rates have moved, there will be some pressure from a procurement point of view. It will really depend where rates go over the course of this year and into next year from a translation point of view. And I think the easiest thing to do is to update you on that specifically. But clearly, on procurement per se, there will be some impact, and we've only hedged through the first half of next year at the moment.
Christopher, do you want to speak about Marco?
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Christopher Bailey, Burberry Group plc - Chief Creative & CEO [31]
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Perfect. About Marco, yes, he has a broad experience. I'm sure some of you may know him. He's had a very strong luxury experience; he's very commercially minded. He understands retail incredibly well, but he also understands how to get creativity, design and brand messages across a global retail network. He also has the right values for our Company in terms of understanding about heritage, but also about contemporizing heritage. And has a very strong understanding of the whole end-to-end process, from design all the way through to supply chain to shipping and get into our stores.
And then also, just on a very human level, we connected on a very personal level, and I think, when you spend time with someone and very quickly you can start to finish each other's sentences because you see things in a similar way, you know when something feels right. So that was an important part of that.
Just to go -- because the next thing was the transformation office, just to clarify the transformation office is really working with the business to ensure that we execute and implement all of the five strategies that we've just talked about. So it's not about the big transformational things that may happen; it's really ensuring that we're on track both in terms of critical paths, budgets and expectations, and what we've committed to. And as I said, John is leading that.
In terms of the bags distribution, obviously we're looking at the distribution constantly of our products. Within the category management, the 360 of looking at our bags, we know that we've got a huge opportunity there. We've talked already about pricing; that will influence distribution. We will, of course, want, and be seeking out with our partners, bigger corners as we further develop it. But again, we're early on in this work but it's something that we know the opportunity and the potential there is for us to grow that market. And the initial signs that we've started have been going incredibly well as well. That's both in our own stores, but also wholesale and third party.
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Rogerio Fujimori, RBC Capital Markets - Analyst [32]
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Rogerio Fujimori, RBC. With regards to the improvement in bags in Q2, was it driven by the Chinese customer base, or you also saw an improvement with the local customers in key cities in Europe and US?
Second question, perhaps related to that, how do you feel about the Chinese cluster as for the second half?
And the third is about outwear. It was a bit softer than usual in the first half; what kind of actions you are taking to win that growth back in the second half, especially in women's? Thanks.
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Christopher Bailey, Burberry Group plc - Chief Creative & CEO [33]
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So bags, yes, of course, it was also the Chinese but it was also our local customers, and very much as you said, linked. For example, here in the UK, we're enjoying, which is lovely, a foreign exchange positive for us which is bringing in tourists, many of them Chinese consumers. But important to say, here in the UK as well, as well as the increase in tourism, we saw also an increase in our local customer as well. Obviously, in China the business remains strong and the performance remains strong, but here particularly in the UK, we've had very strong Chinese consumers.
In terms of outerwear that you just mentioned, it has been a little bit subdued in the last half, but nothing that we're unduly concerned about. We're just coming into our key selling period for outerwear. We've got lots of initiatives, both marketing and product, and we expect to see that gaining strength again. But like I said, a little bit subdued but nothing that we're overly worried about at this point.
So that is the end, and just again to thank everybody for joining us. We're surprised by the turnout. I think we were all a little surprised when we put the news on at 3 o'clock this morning. Thank you for being with us today to allow us to share more detail around the strategies. We will see you all again in May.
I do just want to take this opportunity, as a few of you have, to say a huge thanks to Carol. She is a magnificent partner to every single one of us in this room, both inside the Company and outside. Thank you, Carol.
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