|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:
As expressed in The Group’s Interim Report for the six months ended 31 December 2012, the combination of external and internal challenges has had considerable impact on the Group’s performance this year. For the financial year ended 30 June 2013, Group turnover amounted to HK$25,902 million (2012: HK$30,165 million).
Gross profit amounted to HK$12,837 million (2012: HK$15,206 million) with a gross profit margin of 49.6% over net sales (2012: 50.4%). Adjusted gross profit was HK$12,649 million(2012: HK$14,491 million) with an adjusted gross profit margin of 49.6% (2012: 50.9%).
Excluding the impact from currency exchange rates, the Divestment of NA and the Store Closures, turnover from the core businesses of the Group declined by -7.7% year-on year. This percentage decline in turnover was -6.4% in the second half of the financial year (“Second Half”) versus the -8.8% decline in the first half of the financial year (“First Half”).
Analysis of Group Turnover
The Group markets its products under two brands, namely the Esprit brand and the edc brand. In FY12/13, turnover from Esprit and edc branded products represented 76.0% (2012: 75.1%) and 24.0% (2012: 24.9%) of Group turnover respectively.
Turnover from Esprit branded products reported a -10.5% year-on-year decline in local currency. The results among the twelve product divisions of the Esprit branded portfolio were mixed. In general, The Group observed a more favourable development of the Collection divisions (more dressed up than the Casual lines). In fact, on a positive note, Women Collection, the third largest product division under the Esprit brand, contributed 11.1% (2012: 9.5%) of Group turnover and recorded a year-on-year turnover growth of +3.3% in local currency.
Also worth mentioning is the introduction of The Group’s Denim division as an opportunity to grow in the under penetrated denim segment. Since the delivery of its first collection during the First Half, the reporting of Denim products sales was carved out from Women Casual, Men Casual, Women Collection and Men Collection. The Trend division was also launched during the financial year with its first collection delivered to selected retail stores in Europe in July 2012. These two new divisions represented 2.5% and 0.9% of Group turnover in the current financial year respectively.
Due to the carving out of Denim’s turnover from existing divisions (Women Casual, Men Casual, Women Collection and Men Collection), and the effect of the Trend division against Women Casual and Women Collection, it is more meaningful to interpret their performances together with Denim and Trend as a whole. In FY12/13, the total turnover from Women Casual, Men Casual, Women Collection, Men Collection, Trend and Denim amounted to HK$14,433 million as compared to HK$16,539 million in FY11/12, representing a year-on-year decline of -10.3% in local currency.
As for the rest of the Esprit brand divisions, Kids’ 18.2% turnover growth in local currency is due to an internal change in the classification of product lines. Excluding the impact of this change, the division had a sales decline mostly caused by the reduction of selling space. Shoes and Body wear presented quite stable figures relative to the overall performance. Finally, Sports and de. corp presented the largest decline as a result of the internal decision to reduce these lines.
The turnover from edc branded products reported a decline of -14.6% year-on-year in local currency. This underperformance is partly attributable to the slightly higher mix of wholesale turnover (40.9%) as compared to the Esprit brand (38.2%) and to the larger impact of the reduction of selling space in the Retail stores of the Group.
Turnover by Distribution Channels
The Group adopts a multi-channel distribution strategy with three distribution channels, i.e. retail, wholesale and licensing. For the year ended 30 June 2013, retail and wholesale contributed 60.4% (2012: 59.0%) and 38.9% (2012: 40.2%) of Group turnover respectively. The remaining 0.7% (2012: 0.8%) of Group turnover was mainly licensing royalties from third-party licensees.
Retail Performance Scorecard
Retail turnover amounted to HK$15,652 million (2012: HK$17,806 million) and decreased by -12.1% year-on-year. Excluding impact from currency exchange rates, the Divestment of NA and the Store Closures, retail turnover declined by -3.5% year on year. This decline is mainly attributable to a comparable store sales decline of -3.3% as a result of a significant decline of footfalls in The Group’s stores. Comparable stores represented approximately 40% of total retail space.
Tactical sales activation initiatives were more ambitious since the middle of the financial year to improve store traffic and conversion rate. These initiatives contributed to the narrowing of the rate of retail turnover decline to -1.6% in the Second Half in local currency (First Half: -5.1%).
The Group are encouraged with this development that was observed in both Europe and the Asia Pacific regions. Excluding impact from the Store Closures, the retail turnover decline in Europe and the Asia Pacific both narrowed in the Second Half to -1.4% (First Half: -4.9%) and -2.2% (First Half: -5.5%) in local currency respectively. This improving trend is even more apparent in China, The Group’s third largest retail market, where The Group saw a positive retail turnover growth of +4.4% in the Second Half (First Half: -0.2%).
Retail Turnover by Countries
The Group’s store network was comprised of 1,024 directly managed retail stores as at 30 June 2013, representing a net decrease of 42 points of sales (“POS”) from the beginning of the financial year. The decline is partly the result of the Store Closures involving 25 POS closures in the financial year.
The store portfolio (excluding the Store Closures) comprises 930 stores or concession counters, and 79 outlets. As part of The Group’s initiatives to build a platform for better inventory management, the Group strategically expanded its outlet channel with a net addition of 12 outlets (including The Group’s largest outlet in Ratingen, Germany with selling space of 3,500 m2) or 24.5% net increase in outlet space. Most of this growth happened in Europe resulting in a net increase of selling space (3.0%) while the Asia Pacific region showed a net decline (-2.9%) mainly because of the closures in the Australia and New Zealand markets.
Wholesale turnover amounted to HK$10,062 million (2012: HK$12,116 million) representing a -17.0% year-on-year decrease (-13.7% in local currency terms). The decrease was primarily attributable to a -13.4% year-on-year reduction in controlled wholesale space reflecting both the difficult trading conditions and the Group’s strategic initiative to rationalise the wholesale channel.
In view of the challenging operating environment for wholesale customers, relevant efforts were made to support and retain the Group’s key customers who account for a majority of the Group’s wholesale turnover and operating profit. During the financial year, HK$336 million (2012: HK$340 million) was spent in wholesale support measures, including HK$114 million in discounts and HK$141 million in subsidies for the refurbishment of 49,900 m2 of controlled wholesale space.
These wholesale support measures are yielding positive results. In FY12/13, wholesale turnover from the top ten customers in Europe, achieved positive growth of +3.3% in local currency. Unfortunately, these results were not enough to compensate for the loss of sales and space from the smaller wholesale customers.
In the financial year under review, total controlled wholesale space decreased by approximately 87,300 m2 to 566,176 m2 (30 June 2012: 653,493 m2). The largest reduction of controlled wholesale space was from franchise stores (-49,494 m2). In terms of space loss in percentage as compared with the previous year, the largest space loss happened in identity corners (-24.9%).
With regard to licensing operation, the Group continued to optimise its licence portfolio by terminating brand-dilutive licences, such as flooring, kitchen furniture, baby furniture and stationery, and is focusing on licences that add value to the core value and business of the Esprit brand. As a consequence, licensing turnover decreased by -15.2% (-14.5% in local currency) year-on-year to HK$172 million (2012: HK$203 million).
The Group’s licensing team continues to work closely with more than 30 licensing partners in developing products that complement the lifestyle of The Group’s targeted customers.
Europe remained the largest region, with its turnover as a proportion of the Group’s total turnover increased from 75.9% (excluding the Store Closures) last year to 78.4% (excluding the Store Closures) this year, mainly due to the Divestment of NA. In absolute terms, turnover in Europe (excluding the Store Closures) declined by -7.9% in local currency to HK$20,301 million (2012: HK$22,900 million) mostly due to the abovementioned trading difficulties in the wholesale channel.
On a half-on-half year basis, however, the rate of turnover decline (excluding the Store Closures) narrowed from -8.8% in the First Half to -6.4% in the Second Half, due to management efforts on sales activation initiatives. Within the region, Germany continued to be the largest market of the Group, accounting for 44.2% (excluding the Store Closures ) of Group turnover (2012: 42.2%), and reported a relatively lower rate of turnover decline of -6.5% (excluding the Store Closures) in local currency. Benelux was the second largest market of the Group, contributing 12.5% (excluding the Store Closures ) of Group turnover and reported a turnover decline of -11.0% (excluding the Store Closures) in local currency.
The Asia Pacific region reported a -6.7% turnover (excluding the Store Closures) decline in local currency to HK$5,079 million (2012: HK$5,423 million). China was the biggest market in the region in terms of turnover and the third largest market of the Group. In FY12/13, turnover from China represented 9.3% of Group turnover (2012: 8.6%) and recorded a turnover decline of -8.0% in local currency. Much effort has been put into growing the retail business in China, resulting in a +2.0% growth in turnover in local currency. Unfortunately, the positive growth in the China retail business was dragged down by a -22.9% decline in wholesale turnover in local currency, mainly due to a -19.1% loss of controlled wholesale space.
Regarding North America, following the closure of the retail operation in the second half of last financial year, its wholesale operation also ceased to operate. As a result of the Divestment of NA, turnover declined substantially to HK$201 million (2012: HK$928 million), the majority of which was third-party licensing royalties amounting to HK$143 million (2012: HK$175 million).
FY12/13 was an extraordinarily challenging year for the Group. On the one hand, overall business performance was dragged by the Group’s negative top line development (as seen before). On the other hand, the bottom line results The Groupre impacted by the following items:
i) The Divestment of NA effective April 2012;
ii) Store Closures announced in prior years;
iii) Non-recurring provisions and impairments amounting to HK$2,722 million as high lighted in the profit warning announcement in May 2013 (the “Non-recurring Provisions and Impairments”) majority of which are non-cash items including:
a) HK$1,996 million non-cash impairment of goodwill arising from the acquisition of the remaining interests of associated companies in China.
b) HK$274 million provision and impairment for 16 additional store closures, includingHK$78 million impairment of fixed assets. In FY12/13, these stores had turnover ofHK$295 million.
c) HK$224 million provision and impairment for onerous contracts for 43 store leases, including HK$24 million impairment of fixed assets. In FY12/13, these stores had turnover of HK$477 million.
d) HK$228 million additional provision for inventory arising from a change in the estimation methodology to reflect more appropriately the net realizable value of aged inventory.
iv) Higher than expected levels of impairment of fixed assets for loss-making stores (HK$244million), provision for doubtful debts (HK$312 million) and provisions for aged inventory(HK$299 million) primarily caused by the negative top line development (the “Special Items”). These items amounted to HK$855 million (2012: HK$322 million) and increased year-on-year by HK$533 million.
Looking ahead, the management team expects the next financial year to be a period of transition where The Group aim to stabilize The Group’s business performance and build the basis for a sustainable turnaround. In the short term, The Group do not foresee a visible improvement of the top line given the The Groupak macroeconomic environment, The Group’s reduced selling space and the fact that most of the structural measures The Group are putting in place are still work-in-progress. Consequently, management priorities will focus on returning the Group to profitability through cost reduction, inventory normalization and overhauling The Group’s operations.
Continued efforts in reducing operational expenses
Reducing the costs of operating The Group’s business is a critical goal for Esprit. The continued decline in turnover over the past years requires an adjustment of The Group’s expenses in order to recover profitability. Moreover, stabilizing cash consumption is vital to maintain sufficient resources necessary to complete The Group’s transformation. To achieve this, The Group are implementing opportunistic as The Groupll as structural measures, including:
i) Minimizing operational expenses by continuing to evaluate and address every single line item of the Group’s cost structure. Although The Group are beginning to see some good progress, The Group believe there is additional room for improvement in many areas and therefore The Group will continue to seek opportunities to further reduce consumption of resources.
ii) Enhancing overall efficiencies by reducing unnecessary complexities and streamlining the Group’s processes and organizational structure. These are ambitious measures that will require more time to implement, but once they are completed, The Group will have a more solid platform for the business.
iii) Rationalizing The Group’s business units and The Group’s distribution network to help us focus the Group’s resources on those areas of the business that are both profitable and core to the Group. While this rationalization will reduce the scale of the business (e.g. because of store closures), The Group is unavoidable in order to ease some of the pressure on The Group’s profitability.
The Group anticipate that the above measures will help generate significant operating leverage when sales recover.
Proactive and preventive actions to normalize inventory
The Group will continue to implement specific measures to stimulate inventory sales, avoid further increases in inventory levels and clear out aged inventory on a timely basis. In the short term, this involves opportunistically clearing out excessive levels of out-of-season stock. The Group also aim to establish the infrastructure (i.e. network of outlets) and practices necessary for more efficiently managing of inventories in the near term.
Leveraging The Group’s new infrastructure to optimize operations
In FY12/13, the Group completed the two most important infrastructure projects in The Group recent history: 1) the migration of The Group’s THE GROUP systems to a new platform and 2) the launch of a highly automated distribution center to manage deliveries to all of The Group’s European markets. Both of these are high potential assets that The Group can leverage to create maximum value by increasing productivity, improving service to customers and enabling higher efficiency across the whole organization.
Restoring sustainable and profitable growth
In parallel with the above short term priorities, The Group will continue to implement medium-term initiatives to turn around the business and ensure sustainable growth. The key initiatives that The Group are focusing on include:
i) Building a “High Performance Product Engine” that is capable of consistently delivering an outstanding value for money product. Adoption of a more vertically integrated business model will play a key role in this process and will enable us to enhance The Group’s speed to market and cost efficiency.
ii) Enhancing the appeal and productivity of The Group’s stores, firstly by introducing and extending best practices in The Group’s store management model and secondly by continuing the development of The Group’s new Lighthouse store concept. The new concept has had an increasingly positive impact on business performance since The Group inception and therefore The Group believe The Group has significant high potential going forward. The Group expect The Group to become a pillar of The Group’s brand enhancement strategy in the near future.