|Corporate Profile||Business Summary:|
The Group is principally engaged in wholesale and retail distribution and licensing of quality fashion and lifestyle products designed under its own internationally-known Esprit brand name.
Performance for the year:
Returned to profitability with positive EBIT of HK$361 million (2013: EBIT loss of HK$4,170 million) and net profit of HK$210 million (2013: net loss of HK$4,388 million) on the basis of improved performance in key business levers
Following the Group’s strategic decision to close unprofitable retail stores and rationalize the Group’s wholesale customer base, the Group’s total controlled space (retail and wholesale combined) declined by -10.7% to over 818,000 m2 as at 30 June 2014. This decline in controlled space led to a corresponding decline in Group turnover of -9.9% in local currency to HK$24,227 million (2013: HK$25,902 million). Benefiting from a favorable currency impact, the decline in the Group’s turnover narrowed to -6.5% in Hong Kong dollar terms. The close correlation between the development of the Group’s top line with its total controlled space is largely in line with the Group’s guidance.
Turnover by product division
The Group markets its products under two brands, namely the Esprit brand and the edc brand. In FY13/14, the share of turnover from Esprit and edc branded products represented 76.8% (2013: 76.0%) and 23.2% (2013: 24.0%) of Group turnover respectively. Both brands and all the Group’s product divisions have obviously been affected by the downsizing of the Group’s controlled space.
Turnover of Esprit branded products recorded a decline of -5.5% in Hong Kong dollar terms and of -9.0% in local currency but the Group would highlight that the turnover decline in Hong Kong dollar terms and local currency were-1.3% and -4.9% respectively for the Group’s Esprit women divisions. This is specially relevant for us because most of the new measures introduced in FY13/14 were only implemented in those divisions. During the financial year, the Group put in place a series of initiatives aimed at improving the value-for-money proposition of the Group’s products. As an example, product quality has been enhanced in many aspects including fabric, fitting and manufacturing; products were re-priced to a more competitive level in the market; and “Hero” products were introduced to driving additional traffic and sales. The men’s divisions, which did not benefit from such initiatives, had a turnover decline of -12.3% in Hong Kong dollar terms and- 15.3% year-on-year decline in local currency.
Turnover of other product divisions under the Esprit brand, including bodywear, accessories, shoes, kids and sports, recorded an aggregate decline of -8.4% in Hong Kong dollar terms and -12.0% in local currency. As mentioned in the Group’s interim results FY13/14, there are divisions that the Group is deliberately scaling back, such as kids, sports and de. corp and this explains for the larger decline of these product divisions.
The Group’s edc branded products recorded a -9.5% decline in turnover in Hong Kong dollar terms (-13.0% year-on-year in local currency). The decline is relatively higher than that of Esprit branded products, due to a greater reduction in controlled space that was the outcome of the Group’s previous decision to separate the two brands. Such decision has been revised in light of the actual impact on stores performance and the Group no longer intend to position edc as a separate brand operating independently from Esprit. That being said, the plan to diversify the Group’s brand portfolio in the long term is intact and this will be accomplished through the potential introduction of new brands.
In relation to the Group’s product divisions, an important milestone achieved by the Group during the financial year was the implementation of the high performance product engine (“the New Engine”), which establishes faster and more efficient product development and supply chain processes. This is fundamental to a successful turnaround and regaining long-term competitiveness for Esprit. After months of focused efforts across the Group, the New Engine was activated effective July 2014. The implementation was executed according to the Group’s expectations and whilst there are initial findings of the first execution, which is normal in the implementation of such major changes, overall, feedback from wholesale partners have been positive, both in relation to the products and to the new way of working (i.e. new calendar and flow of collections).
Turnover by distribution channel
The Group’s operating activities are primarily retail, wholesale and licensing businesses. As a result of the different development of the Group’s retail and the Group’s wholesale businesses over the last few years, the retail channel is gaining relative weight over the total revenue of the Group. In FY13/14, turnover from the Group’s retail, wholesale and licensing businesses contributed 62.8% (2013: 60.4%), 36.5% (2013: 38.9%) and 0.7% (2013: 0.7%) of Group turnover respectively.
The Group’s retail operation delivered a turnover of HK$15,220 million (2013: HK$15,652 million), which represents a -2.8% decline in Hong Kong dollar terms. Excluding foreign currency impact, retail turnover declined by -6.0%, broadly in line with the -5.7% reduction in retail net sales area. Excluding store closures and stores with onerous leases (“Core Retail”), the turnover decline narrowed to -1.6% in Hong Kong dollar terms and -4.8% in local currency.
From a regional perspective, the Group is particularly encouraged by the stabilization of Core Retail in Europe, which was the result of improved sales and inventory management, and strategic expansion of the outlet channel. As a consequence, turnover of Core Retail in Europe grew +3.2% in Hong Kong dollar terms and dropped moderately by -1.5% in local currency, which was largely in line with the corresponding -0.9% reduction in retail net sales area. In general, the Group saw stable development across the Group’s European retail markets. It is also worth noting that in Sweden, Spain, Italy, Ireland and Portugal, where the Group no longer has a physical store presence, the Group managed to maintain and even grow retail turnover by leveraging the Group’s well-established e-commerce platform.
In contrast, Core Retail in Asia Pacific continued to be under pressure. In addition to the rationalization of unprofitable retail space, which affected mostly China (-13.3% year-on-year decrease in sqm) and Australia and New Zealand (-26.2% year-on-year decrease in sqm), performances of Core Retail in Asia Pacific including Hong Kong, Singapore, Malaysia and Taiwan, were further weighed down by lower traffic, stock availability issues and the unfavorable shift in product mix towards more basic items of lower average selling price. Consequently, Core Retail in Asia Pacific recorded a turnover decline of -15.6% in Hong Kong dollar terms and -14.4% in local currency, larger than the corresponding decrease in retail net sales area of -11.0%.
During the financial year, the Group made good headway in closing stores under previously announced “store closures and stores with onerous leases”, with 11 such stores closed. As mentioned in the Group’s interim results FY13/14, the Group is looking at package deals which may result in giving up some stores not previously earmarked for closures in order to resolve issues arising from closing those stores with serious loss-making situations.
As at 30 June 2014, Core Retail had 855 point-of-sales (“POS”) with total retail net sales area of 301,041 m2 . During the financial year, as a result of the rationalization of unprofitable retail space, store and concession counter space decreased by -6.2%, with the decline coming mostly from China and Australia. On the other hand, the Group strategically expanded the outlet channel with a net addition of 4 POS, representing a +8.2% increase in net retail sales area, as part of the Group’s initiative to establish a sustainable channel for the clearance of aged inventory.
The Group’s wholesale operation delivered a turnover of HK$8,835 million (2013: HK$10,062 million), representing a -12.2% decline in Hong Kong dollar terms. Excluding foreign currency impact, wholesale turnover declined by -16.1%, mainly attributable to a -13.8% year-on-year reduction in controlled wholesale space as well as the continued weakness in the business performance of the wholesale channel in general.
In the financial year under review, the Group’s efforts in the wholesale channel focused on rationalizing the Group’s customer base and actively clearing aged inventory for the Group’s wholesale partners. While these initiatives aggravated the decline in wholesale turnover, the Group believe that both were necessary to re-establish a healthier platform for the channel in the future.
For Europe as a whole, the Group’s wholesale business recorded a turnover decline of -7.9% in Hong Kong dollar terms and -12.0% in local currency, in line with a controlled space decline of -10.9%. On a positive note, the Group was particularly pleased by the stabilization of wholesale space productivity in Germany, where the wholesale turnover decline in local currency of -4.7% was less than the corresponding -5.6% year-on-year reduction in controlled space. This positive result, however, was offset by weaker wholesale performance in Rest of Europe, where wholesale turnover declined by -18.3% in local currency, larger than the corresponding -15.8% decline in controlled space, primarily due to lower demand from customers in Benelux and Scandinavia regions.
For Asia Pacific, the Group’s wholesale business remained under pressure and reported turnover decline of -46.5% in Hong Kong dollar terms and -48.0% in local currency, considerably greater than the corresponding -30.0% reduction in controlled space. The region’s weak performance was mainly due to China, the Group’s largest wholesale market in Asia Pacific, where the Group saw wholesale turnover decline by -52.7% in local currency, which was significantly higher than the -33.7% reduction in controlled space. The larger decline in turnover as compared to controlled space is due to the special return agreements to solve the Group’s long time problems with aged inventory in the country’s wholesale channel. This special return initiative is now completed with the last return taken place in July 2014. Additionally, the Group’s strategic decision to close the wholesale operation in Australia, leading to closure of all wholesale POS, also adversely impacted the region’s wholesale turnover.
Licensing, although a small segment contributing 0.7% of Group turnover, continues to be an important part of the business, highlighting the strength of the Esprit brand. In FY13/14, licensing turnover amounted to HK$170 million (2013: HK$172 million), representing a slight decline of -1.3% in Hong Kong dollar terms (-2.1% in local currency). This slight decline was a result of the combined effect of the continued growth of existing licensed products and the Group’s decision to terminate certain brand-dilutive licenses, primarily those under Home World and Babies & Kids World, in favor of core licensed product categories to bring the licensed product portfolio in line with the Group’s brand positioning. As at 30 June 2014, the number of licensed product categories decreased to 18.
Turnover by geography
The majority of the Group’s businesses are located in Europe and Asia Pacific. As the Group’s top line performance continued to be impacted by store closures and stores with onerous leases announced in previous financial year(s), it is important that the Group assess the actual top line performance of both regions excluding store closures and stores with onerous leases and North America wholesale (“Core Operations”). Turnover from the Group’s Core Operations in Europe and Germany accounted for 81.3% (2013: 77.4%) and 45.5% (2013: 42.0%) of Group turnover respectively.
In Europe, the Group observed a continued stabilization of space productivity of Esprit’s Core Operations in the region, where the Group’s initiatives on sales activation (including improved promotional calendar, better management of markdowns, and enhanced value-for-money proposition of the Group’s products) effectively supported controlled space productivity. As a consequence, turnover from Core Operations in Europe declined by -1.8% in Hong Kong dollar terms, and the corresponding decline in local currency of -6.3% was lower than the decline in its total controlled space of -7.9%. Specifically, in Germany, turnover from Core Operations recorded growth of +1.4% in Hong Kong dollar terms, and a decline of -3.3% in local currency, which was lower than the corresponding decline in total controlled space of -4.4%. And in Rest of Europe, turnover of Core Operations registered a decline of -5.5% in Hong Kong dollar terms and -9.7% in local currency, also lower than the corresponding decline of -11.6% in total controlled space.
In Asia Pacific, turnover of Core Operations registered a decline of -22.2% in Hong Kong dollar terms and -21.6% in local currency, with a corresponding decline in controlled space of -19.2%, due to certain developments in both the retail and wholesale channels as explained in the previous sections. China remained the largest market for the Group in the region and the third largest market overall in terms of turnover. Performance of the Core Operations in China was far from satisfactory, recording turnover decline of -28.3% in local currency with a corresponding decline in controlled space of -24.3%. A number of factors, both external and internal, have led to this weak performance in China: i) softer domestic economic growth; ii) closure of unprofitable retail stores upon expiry of leases; iii) rationalization of wholesale customer base; iv) the special return agreements to solve the Group’s long time problems with aged inventory in the wholesale channel (completed with the last return taken place in July 2014); and v) a higher proportion of merchandise shifting to imports resulting in initial stock availability issues. Under the leadership of the new management team in China, the Group will refocus the Group’s strategy on improving operations and product performance as the Group develop a more sustainable expansion plan for the Group’s retail and wholesale in coming years.
Looking ahead to FY14/15, the Group expect to stabilize the controlled space development in the Group’s retail channel, while reducing the rate of decline of controlled space in the Group’s wholesale channel. In terms of stores’ space productivity (sales per sqm), the Group aim to maintain it at a stable level during the Transformation phase. As a consequence, the Group's top line is expected to decline in accordance with the decline in controlled space. Nonetheless, volatility is expected during the year due to the multiple changes in the Transformation phase.
Gross profit margin is expected to increase slightly as the Group will actively protect the profitability of its product lines by continually implementing improvements in the Group’s supply chain management.
While it will likely be necessary to increase spending in certain areas in order to secure the successful implementation of the changes associated with the Company's Transformation (e.g. IT), the Group aim to maintain total OPEX at a similar level to last year. In the longer run, the healthier cost base achieved in the past year will enable us to generate further leverage when the top line recovers.
Investment in capital expenditure will remain selective but will increase compared to last year as the Group accelerate the Group’s store refurbishing plans.