Burberry Group PLC

LSE:BRBY

Earnings Call Transcript 2021-Q1

[Operator]

Ladies and gentlemen, welcome to the Burberry First Quarter Trading Update Call. My name is Stuart, and I will be the operator for your call this morning. [Operator Instructions] I will now hand you over to Julie Brown, Chief Operating and Financial Officer. Please go ahead.

[Julie Brown, CFO, COO & Director]

Good morning, everyone. I hope you're keeping well, and welcome to Burberry's First Quarter Conference Call. Slides are available to accompany this presentation on the IR section of our website. In today's presentation, I'd like to run through 3 areas: first, our retail sales and brand performance; second, some further information on organizational changes as we enter the second phase of our strategy; and third, our views on outlook. With me this morning is Annabel Gleeson, our Head of IR. And we will be happy to take your questions at the end. Finally, I would like to say that, when I refer to comparable store sales growth, no adjustments have been made for disclosures relating to the Hong Kong disruptions or COVID. Turning to Slide 3. I wanted to start with a summary of our strategic progress this quarter. Firstly, we saw an excellent response to new product launches in recovering economies as well as online. Demand for leather goods was strong in Mainland China and Korea, bringing new, younger luxury customers to the brand. Secondly, we focused on rebounding economies, tailoring initiatives to optimize our sales growth. We innovated in digital to inspire customers and drive sales both on- and off-line. And finally, as we enter the second phase of our strategy, we're making organizational changes to sharpen our focus on products and increase agility and generate structural savings that we will be able to reinvest in consumer-facing activities. Turning to Slide 4. I'd like to provide some context for the financial performance this quarter. We started the quarter with 60% of our stores closed, and this reduced to around 15% by the end of the period, albeit 45% of our retail network remains on reduced trading hours. Gradual store openings, together with strength in Asia and our digital business, caused our monthly comp performance to improve from minus 60% to minus 20% over the quarter. Turning to Slide 5 and looking at the major components of retail sales. Group retail sales comp was heavily impacted by COVID, delivering a decline of 45% in Q1. Space was a 4% headwind. This reflected the closure of 4 stores related to our rationalization program, together with the timing of store closures and openings. For the full year, we anticipate this to reverse in half 2 with space being broadly neutral for the year. In terms of openings this year, we're excited that our social retail store, developed in partnership with Tencent, will be opening in Shenzhen this summer. This experimental store will offer unique experiences that connects luxury customers' social and online lives to their physical environments using technology powered by Tencent. And we look forward to sharing more details with you shortly. In total, retail revenue declined 49% at constant exchange rates with a small benefit from currency. Turning to Slide 6. These charts show our retail comp performance globally and by region from January onwards and highlight the improvement in trading through the first quarter. Starting with Asia Pac, this region showed the earliest recovery and delivered minus 10% in the quarter as a whole. Performance was led by Mainland China, which grew mid-teens in the quarter. Korea was also strong with double-digit sales growth in Q1. In total, sales trends in Asia Pac returned to a plus 9% growth in the month of June. The Americas declined 70% in Q1, starting the period with all stores closed but began to reopen in May. The Americas has shown a dramatic improvement since reopening with comp sales in June down 27%, driven by local customers, which normally account for over 90% of the region's spend. This is a strong indicator of brand heat and perception in America, which, as you'll recall, was the region which required the greatest change to achieve luxury positioning. Finally, EMEIA declined 74% in the quarter. This region was impacted by the most prolonged period of store closures with the minority of stores reopening at the end of May and the U.K. only reopening on the 15th of June. EMEIA is also the region most dependent on the traveling consumer. And this business was significantly disrupted in Q1, particularly impacting performance in tourist cities like London, Paris and Milan. Domestic trends show a marked improvement through the month with Continental European domestic spend growing double digits in June. And this underpinned an improving trend in EMEIA, which declined 55% in June. Turning to China on Slide 7. I wanted to give a bit more color on the trends we're seeing in the Mainland. China grew mid-teens in the quarter, including an exceptional performance in digital and delivering an improving sales trajectory through the period. Sales in June already exceeded pre-COVID trading levels in January. We've also experienced an exciting rise in customers new to the brand, growing double digits year-on-year in Q1. The growth in China has been supported by the localized approach we've been taking market-by-market and some repatriation of spend. In April, we launched a leather goods campaign exclusively in Mainland China. This featured travel components, a bespoke bags experience on burberry.com featuring enhanced landing pages and product exclusives; a series of pop-up stores deliberately designed to be more sustainable and reconfigurable, incorporating an augmented reality experience, where animals come to life through mobile technology; and a limited edition pocket bag for influential fashion blogger, Mr. Bank's WeChat followers. The reaction was exceptional with the limited edition bag selling out within a minute of becoming available, and pocket bag styles overall selling out within 3 weeks of the campaign going live. It also helped to support a strong Q1 full price bag sales growth in Mainland China. In terms of the Chinese consumer globally, we've seen a decline in the Chinese cluster in the mid-20% range for the quarter and mid-teens in June, indicating some level of repatriation. Turning to Slide 8 and looking at our brand and product momentum. During Q1, we inspired customers with a number of product launches, including our new Autumn collection, Pride and Summer Monogram capsules and leather goods exclusives. The consumer response in recovering economies as well as online was excellent, including recruiting new, younger consumers to the brand. Our Autumn/Winter 2020 precollection campaign generated a reach 4x higher than last year's campaign. Our Summer Monogram campaign included a video set in a CGI geometric world featuring Kendall Jenner, a curated Spotify list and a new multiplayer media game called B-Surf. This has already been our best-performing Instagram TV video ever with an Instagram reach more than 60% higher than our previous monogram capsule. Turning to Slide 9. I wanted to explain more about the changes to products that we announced last week and some further organizational changes we're proposing to make. As we enter the second phase of our strategy, we are evolving our approach to product. Under the new structure, we will create 3 new business units, covering Ready-to-Wear, Accessories and Shoes, allowing us to embed product specialism resulting in a pooling of category expertise and enhanced product focus and elevated quality. Elsewhere in our organization, we are proposing to further streamline our enabling functions and improve retail efficiency. These changes also include office space rationalization following further development of ways of working. Turning to Slide 11. This shows the financial implications of our proposed changes. Subject to consultation, we expect the changes to deliver savings of around GBP 35 million in full year 2021 or GBP 55 million annualized with an associated one-off restructuring charge of GBP 45 million. These savings and costs are incremental to the previously announced GBP 140 million cumulative restructuring program. Conditional on the macroeconomic recovery of COVID-19 and the luxury industry growth, we will be able to reinvest these organizational savings into consumer-facing activities, including popup stores, visual merchandising, digital activations, events, as well as marketing. Turning to Slide 13. I wanted to recap on the diagram we shared in May. As you know, we've modeled a range of planning scenarios to ensure we're well prepared for a number of macro and regional situations. Looking forward, the course of the pandemic from here will largely depend on the actions governments pursue to control the spread of the virus as economies restart. In addition, our performance will depend on the phasing of store openings and closings, the easing of travel restrictions and overall consumer confidence. Our objective is to protect the long-term value of the brand and ensure we have the headroom to fuel growth. Given this backdrop, we're therefore unable to provide our usual annual guidance. But in order to aid your modeling, we'd like to provide some additional color on the quarter ahead. Turning to Slide 14. We expect our sales in the second quarter to continue to be materially impacted by the pandemic. In retail, tourist flows are likely to remain negligible and traffic is likely to remain weak. Based on our comp retail sales performance in June 2020 of minus 20%, we expect Q2 comp to decline by 15% to 20%. In wholesale, we anticipate half 1 sales declining by 40% to 50% as we collaborate with our partners to protect the brand and control inventory in the market. Based on these trading assumptions, we expect half 1 gross margin to decline by around 200 to 300 bps year-on-year and half 1 operating expenses to reduce by a mid-teens percentage compared to last year. Turning to the summary on Page 15. To conclude, our first quarter results have been heavily impacted by the global pandemic, and we expect a material impact on our Q2 performance. In line with our strategy, we believe it is crucially important to invest in strengthening the Burberry brand and continuing to excite the consumer with new products and innovative campaigns. We are planning organizational changes to increase product focus and deliver improved efficiency. And this, coupled with the embedded flexibility in our plans, will allow us further capacity to invest in growth-enhancing, consumer-facing activities as opportunities present. And now we would like to turn to the Q&A.

[Operator]

[Operator Instructions] The first telephone question today is from Louise Singlehurst from Goldman Sachs.

[Louise Susan Singlehurst, Managing Director]

Can you hear me okay?

[Julie Brown, CFO, COO & Director]

Yes.

[Louise Susan Singlehurst, Managing Director]

Just three questions from me, please. I suppose when we look at the exit rate in going into the current quarter, the minus kind of 15% to 20% can seem a little bit cautious in terms of remarks. But I know it's obviously an environment which is very difficult to read. Can you just help us think about the impact of the delaying of the Autumn/Winter product into stores and the impact that's having? And what's the appetite for customers coming in and wanting full price product? Obviously, we're in a very much a markdown activity at the moment, but is there a reason for extra caution just on that sales momentum because of the absence or the shifting out of the full price Autumn/Winter new products coming through? And then secondly, Julie, I wonder if you can just help us think a little bit more about the savings that you've announced, the GBP 55 million. How is that going to be allocated? You obviously talked a lot about the customer engagement, and I'm sure the team is trying to work out the projects. But what's really driving the number? Is it more about what savings can be delivered? Obviously, you're working the team very hard to get and deliver the savings. Or is it more about what's required for the projects that are in place?

[Julie Brown, CFO, COO & Director]

Okay. Thanks, Louise. So you're spot on. We're dealing with a very uncertain macro environment at the moment with the coronavirus. We were pleased with the June exit rate, around minus 20%. But we've taken into consideration, we expect tourist flows to remain under pressure, particularly long haul, which affects our EMEIA business considerably, which is a sizable chunk of our business. We also see America's facing some uncertainties with second waves breaking out and obviously high infection rates in some states, and as we saw yesterday, California having to make tough decisions around lockdowns. We've also seen that in other countries. I mean we saw the issues in Beijing relating to a second lockdown together with recently Australia. So we're kind of very cognizant of the fact that the virus lives with us. It stays with us until we've got a vaccine. And therefore, infection rates are going to be volatile and therefore sales. So I don't think in this world that we can really safely extrapolate a result that we had in June. You're absolutely right as well. There are a number of moving parts within this. We've got Autumn/Winter has gone into the stores. There was a slight delay in it going into the stores because of the distribution chain. And we've got -- obviously, we're now in the markdown period, the classical markdown period across the world that goes in phases across the world, as you know. But now most luxury brands are in that period of clearing the Spring/Summer period. So there are a number of moving parts. But net-net, we believe we can't give guidance for the full year because of the impact of second waves in the winter period, when we think it might be more significant. But we're trying to give some line of sight to the second quarter basically as best we can. In terms of the savings program, we're definitely feared of -- we're entering the second stage of the strategy, the focus is very much on the product, product specialism, quality and putting more specialism behind Ready-to-Wear, Accessories, and Shoes, which are technically very different areas of the business. So this allows our planning, product development, merchandising teams to focus on those areas. The second part of it is all really about the enabling areas of the business and increasing the efficiency of running those enabling areas of the business. And it's all been about streamlining decision-making and ways of working to allow us to create these savings, which we then -- the first port of call would be reinvestment. Now we haven't got a firm view of how exactly they will be allocated. But what we're doing is we're taking a 360-degree view. So in the case of China recently, for example, and the bag campaign, we had a number of areas of engagement with the consumer to inspire the consumer. So we had the collaboration with influential fashion blogger, Mr. Bags. We've also had pop-ups. We've also had dedicated product line to China with the Pocket Bag and a limited edition Pocket Bag in collaboration with Mr. Bags. So it's really a 360 approach to the consumer, to inspiring the consumer around different campaigns. You've also seen the beginnings of that with the Summer Monogram with Kendall Jenner. So it's going to depend on the quality of the projects and the campaigns that we believe we can support and approaching them very much in a holistic way as a company. Final thing to say on this. We are very much putting our focus when it comes to reinvestment into rebounding economies. So this does mean that Asia is rebounding very quickly, China, in particular. Korea is also very, very strong at the moment. So these are the areas that we're very much focused on. It's very much recovering and rebounding economies.

[Operator]

Next question is from the line of Thomas Chauvet from Citi.

[Thomas Vincent Chauvet, Research Analyst]

A couple of questions, please. The first one on the LFL pattern. If you take January and June, so both months where you had a substantial amount of stores that were opened around the world, did you see a change in patterns between full-price stores, outlets and online? And in markets where you had double-digit growth in June, like China and Korea, can you comment on the level of discounting you may have had to implement to drive traffic, conversion, whether that's in full-price stores or outlets? And secondly, in your product division reorganization, you created a specific unit distinct from Accessories and Ready-to-Wear, which is Shoes. I thought that was quite interesting, a category that Burberry may not have always been very, very successful. Can you comment on where you see the opportunity and maybe provide a few numbers? What was the weight of shoes in full year '20 sales, the split between sneakers and more formal footwear, men, women? And where does Shoes now sit in terms of margin hierarchy between Ready-to-Wear and leathergoods? And how you're going to push that category? Is it going to be wholesale, online-driven in particular?

[Julie Brown, CFO, COO & Director]

Okay. Thank you very much, Thomas. So taking your first question, like-for-likes, June compared with January, as you say, is a good comparison. Most of the stores were open. We've actually seen the strongest area of the business as being full price, so a very good-performing -- in terms of our comp in the quarter of minus 45%, the full price was outperforming that comp. Online was a very impressive performance. So online in full price again was up double digits in the quarter, a very strong performance in June from our online full-price business. So overall, the 2 clear strengths in there were full price and online. In terms of the outlet business, it's been more challenged. I think in the outlet business, we've got more traveling consumers. And also, of course, the outlet business has got more of a presence in the Western markets, which has been the most badly hit, much less of a presence in the Asian markets, which have returned to growth quite quickly. So those are the reasons, I think, the outlet business has been under pressure. No major change at this stage to levels of discounting to quote in the quarter. Clearly, we're now coming into the major sale periods. It varies by region. But the major sale periods, we'll have a better view when we get through the first half on that. In terms of the project reorganization, Shoes, you mentioned about the Shoes. Shoes, just to give you a stat on this, they're around 3% of our business at the moment. This is pre-COVID, obviously. We do see a significant opportunity. We also believe it's a technical area that we need to put more emphasis on. So it's more about appreciating the technical complexity of Shoes. Very similar to the work we did almost 2 years ago now, when we purchased the leathergoods center of excellence in Italy. It's recognizing where the technical expertise lies and making sure that we capitalize on the opportunity. It's all about driving the quality of the product and the craftmanship associated with the product. Now just to point out as well, because Shoes are relatively small compared with the rest of our business, the head of the Shoe unit will report into the head of Accessories. And -- but obviously, the Ready-to-Wear expert, who's just joined us, Adrian, and the Head of Accessories, will report to Marco.

[Thomas Vincent Chauvet, Research Analyst]

And has it become really a sneakers business now like for some of your peers? Or do you still believe in formal footwear?

[Julie Brown, CFO, COO & Director]

We believe in both. I mean the sneakers business is going extremely well. But we do believe in both. Because, as you know, we're very focused on an outlooking -- an outfitting initiative, where we've actually very much focused on the look of the woman or the man. And of course, in formal wear with females, often, it will be a heeled shoe. So we actually believe in both because we want to maintain that silhouette with the woman in the way that Riccardo has imaged in terms of the way that he's designed product, which is holistic. So we believe in both.

[Thomas Vincent Chauvet, Research Analyst]

Okay. And for the profitability, I guess, it's a bit like leathergoods. You don't have scale and the AUR is not at full potential, given the perception maybe on the category is not super luxury yet, so lower gross margin and profitability than Ready-to-Wear?

[Julie Brown, CFO, COO & Director]

I mean, obviously, we will -- when we're talking about initial margins, as we call it, looking at the profitability of lines as we're introducing them, we'll always be very cognizant of the gross margin when we're introducing new lines but nothing really to mention specifically because, at the moment, it's so small that it's unlikely to move the dial. Leathergoods was a much more significant part of our business, so it had a much more significant impact. But we'll certainly keep you posted as the category develops.

[Operator]

Next question is from the line of Zuzanna Pusz from UBS.

[Zuzanna Pusz, Head of European Luxury Equity Research]

Can you hear me well?

[Julie Brown, CFO, COO & Director]

[indiscernible] It's a little bit faint. Why don't you turn the volume up.

[Zuzanna Pusz, Head of European Luxury Equity Research]

Well, I hope that that's better. I try to speak loud. So I have two questions, please, if possible. So the first question is on China. Is there any chance you could comment on the sequential performance of China in Q1? I think you mentioned in the press release that the exit rate was above 30%. So just to clarify, I mean, did you turn positive in China already in April? Or was it in May? And if you could maybe comment sort of just on what was the performance sort of April, May, June, whether May was already double digits or April maybe was already double digits. Some sort of color would be very helpful because I think the problem we all have this quarter is that the numbers between the companies are not very comparable. So it would be just helpful, I think China is the only region where we can really compare things like-for-like.And then second question on the restructuring. So first of all, on the restructuring charge, just to clarify, unless I missed it, is it all cash? And also, what is the sort of split between FY '21, FY '22, just so that we know for the modeling purposes? And also the cost savings, so I understand there's the additional cost savings right now on top of the GBP 140 million cumulative. But can you just remind me, is this additional -- I remember the previous cost savings, they were net of annual reinvestments. So how should we think of these new cost savings? Are they net of reinvestments? Or should we assume that basically you're saving in one place, but it's going to be reinvested, so net-net, it's net that's sort of -- yes, reinvested? That would be very helpful.

[Julie Brown, CFO, COO & Director]

Okay. Thank you very much, Zuzanna, for the question. Just taking each one, so in China, we've tried to be super helpful in the sense of providing the chart to show the monthly trends in the deck. I don't know if you've had a chance to look at that yet. But China was already in growth, double-digit growth in May and obviously exceeded the January rate already in June. So we saw a very, very, very quick improvement. I mean Korea has been strong throughout as well. So yes, we're very encouraged by the monthly trends that we're seeing in China. And obviously, for the quarter, as we mentioned, it was mid-teens. So going back to your question on restructuring. In terms of the restructuring charge, it's going to be mostly cash. There is potentially an element but will not be cash relating to office space. But we're anticipating most of it being cash. And there's a -- I think -- I mean probably talking about a single-digit number that may not be cash. It's probably going to be that sort of split. And then in terms of the charge in full year '21 and full year '22, again, the majority will be in full year '21. So we anticipate most of the spend to go out this year with again probably single-digit number into next year. In terms of the cost saving, so you're absolutely right, this is incremental to the cost-saving program of GBP 140 million cumulatively. This has been really a secondary view of the ways of working in the business. It's been designed to gain further operational efficiency in the business, clarity of decision-making, clarity of roles between regions and center. And that's what's driven the savings that we've published this morning of GBP 55 million annualized. Now in terms of natural growth, this is the growth saving. We are -- because we're a growing business, we are focused on growth. We're also very focused on the opportunity that we've got in front of us now with a great product range, I think, a great marketing team, the ability to create activations across the world, the opportunity is there. And particularly in rebounding economies, there's a real desire to the product in rebounding economies. So we're intending to reinvest a large proportion of this, depending on the way the economies rebound and depending on the strength of the cases that we have in front of us. But I think the safe assumption is to assume it's reinvested.

[Zuzanna Pusz, Head of European Luxury Equity Research]

Perfect. So just to clarify on April in China because I'm not great at reading charts, I guess, but the April -- because it looks like -- so April probably still wasn't as a whole positive. It's not the wrong assumption, right, in China?

[Julie Brown, CFO, COO & Director]

Yes. As a whole, it was slightly negative but very marginally.

[Operator]

Next question is from the line of Melanie Flouquet from JPMorgan.

[Melanie Anne Flouquet, Head of European Luxury Goods and General Retail]

The first one is I wanted to come back on your impairments on right-of-use assets that you posted at the end of last year, and it's going to help D&A this year. I was wondering, when you face a big impairment like this linked to 4 years' assumption on this, does that not tell a story as to whether you should be more active in closing stores? And if that's not the case, why not? So that's my first question. The second question is on gross margin. You're guiding for 200 to 300 basis point negative impact on H1 for on gross margin. And I understand there are a number of pressure points going on. But I wondered whether you could help us understand a bit better how much is markdowns, how much is capacity -- production capacity underutilization, product investments. Because, of course, channel and geographic mix, I imagine, is positive on the other hand. So if you could help us a bit more understand where this pressure is coming from and how much is going to stay in the business, therefore, then on.The third point is actually a bit linked. Clearly, we've had a bit more than a year of product investments going on. When do you think this starts being an impact on the business? And notably, when do you think you'll be able to use your pricing power a bit more to compensate some of these product investments?

[Julie Brown, CFO, COO & Director]

Okay. Thank you very much, Melanie. So first of all, and you're absolutely right, with regard to the impairment charge that we took at the end of last year, so there is in terms of a benefit to depreciation and amortization. In terms of store portfolio, clearly, this is something that we keep under review. We did a very comprehensive review of the store portfolio. It must be about 2 years ago now. And we concluded that we needed to take 38 stores out of the network at that point. And we're just over halfway through that store closure program. We felt that, that was absolutely the right thing to do. When we looked at strategic reasons for the store, we looked at financial performance of those stores and we looked at the future of those stores in the network, we made that decision. I think in view of COVID, it would be too early, first, to form any permanent conclusions around the store footprint. But clearly, what we're doing is whenever a store comes up for renewal, we're reviewing that footprint in the context of what we're finding. But with COVID, it's a very uncertain situation as to whether the long-haul traveler, when they return. And I think that will be a big determinant of the future of the store footprint generally. So that's number one. The second question you raised was about the gross margin and the moving parts within the gross margin guidance. And you've summarized the main pressure points. But starting with the positives, there will be a positive mix effect because the business has moved closer towards Asia. And we've also got a retail performance outperforming compared with wholesale. So that is a positive mix effect. We are anticipating that level of the discounting potentially in the second quarter will be at a higher level than the previous year. In addition to that, we've got supply chain overcapacity at the moment relating to cost absorption increases while production levels are at a lower point. And then there are some other mechanical effects in gross margin due to the sales being lower, the percentage gets affected. The good news is we've looked at this in some depth. And we believe that the majority of these gross margin headwinds, the additional ones that we're seeing in the first half of this year, we anticipate they should be resolved in subsequent years because they're more related to overcapacity issues and particular issues relating to the COVID period than they are permanent structural changes. So we hope that's helpful to people for their modeling. The final part of your question was all about product investments. And we -- the area where we've probably made the most product investment is in leather. And this is part of our strategic move into leather to ensure that the value is perceptible to the consumer. So we've invested significantly into the design facility that we've got in Italy. We have not got the prices up commensurately to the quality of the leather and the design of the bags. But we anticipate being able to do that at some point in the future. But we'll clearly keep the situation under review as the luxury sector emerges from COVID.

[Operator]

[Operator Instructions] Next question is from Anne-Laure Bismuth from HSBC.

[Anne-Laure Bismuth]

So I have two questions, please. My first question is about the space contribution. So it had a negative impact in Q1. And I was just wondering what -- I know the visibility is quite limited. But what should we expect in H2 and for the full year? So if you can give us more details about store closure or any openings for this year. I know the visibility is limited but just about the impact from the contribution from space for H2 and the full year. And my second question is about the U.S. market. So with the second wave of COVID, the riots we see there, so I know again the visibility is limited, but how do you see this market evolving going forward?

[Julie Brown, CFO, COO & Director]

Thanks very much, Anne, for the two questions. So turning to the space, so starting with the first quarter, we've got a space of minus 4%. We've got basically a net movement in stores of minus 4 stores. It takes our store count down to 417. We've got closures of 7 in the period. The main -- one of the main factors here is that it's due to the timing and the low levels of sales from stores that opened over the last 12 months and came online. So due to the COVID impact, as the new store comes online, once it annualizes, the sales impact of the coming online is a lot lower than the sales impact of stores that closed previously. So there's a mathematical impact just because of COVID. In terms of expectations, we anticipate that space will probably be at about minus 3% for the half year. And then we're expecting this to unwind and turn neutral for the full year. So I think that all hopefully clarifies the position on space. And then coming back to the broader question of the U.S. market. Some encouraging news in terms of the U.S. market in terms of the speed of the recovery. So the U.S. market, unlike EMEIA, is a local -- heavily a local market. So it's about 90% local. So it's not a market that gets seriously impacted by tourist flows. And as you can see from the chart we presented, you know we've had a very steep recovery in the U.S. market, which is really encouraging. And because it was previously one of the markets, when we did the brand perception work, it was -- the area that we -- the area in the world that we needed to do the most work in terms of brand perception, it's actually a very encouraging result to see that the momentum in terms of the recovery. Now looking forward, having said this, clearly, there are significant uncertainties in the U.S. largely because of the infection rate in certain of the states and the decision those states then take as to whether they engage in a second series of lockdowns. And we've seen that just recently in the last 2 days in California. So I think that is really the level -- the area of concern and the thing that we've got to look out for now in the second and third quarters.

[Operator]

Next question is from Charmaine Yap from Redburn.

[Charmaine Yap, Analyst]

I have three questions, please. The first one on gross margin. I wanted to come back to this to clarify that if it's on a reported basis, the guidance that you've given. And given that you've already taken a big inventory markdown in the previous year, so I assume is there any mechanical impact whereby you expect sales to be sort above that level, to be recognized as revenues, but you don't get that on gross margins? So I'm trying to see if there's any mechanical impact from the write-downs already taken on the guidance. And in terms of the second question, I was going to ask about the organizational changes. As I understand in the past few years, you've already streamlined the team to increase accountability, more flexible ways of working. But so how does the new business units really differ from the existing team? And how does that relate to the creative teams and the merchandising teams? Are they part of this structure? Just to help us a little bit understand. And when you talked about the office space rationalization, is that in London? And the third question, which is just a clarification, did you mean that you haven't done any material price increases in the recent months? And in terms of your price architecture, thinking longer term, do you see the need to evolve it in any way, be it a bit more skewed on the lower end and upper end or any changes that you think is warranted, given the environment?

[Julie Brown, CFO, COO & Director]

Okay. Thank you very much, very comprehensive questions. So in terms of gross margin, the gross margin guidance is on an adjusted basis. So we're always reporting on that basis. In terms of inventory, it's -- what we do is we review the inventory provisioning position at the end of each balance sheet date. So the next big review point will be when we report the results in November. And the impact on that inventory provision will largely depend on the sell-through rates of the products that were provided for related to COVID, if you're talking about the exceptional item. As you know, we very unusually provided for 3 seasons, but with the more recent seasons that we thought will be impacted by COVID, which was the spring '20 and the prior 2 seasons. And the final verdict on the inventory provision, which will reverse below the line, also will depend on the sell-through rate when we get to the end of September. So I think we need to just wait and see with that one. In terms of the gross margin guidance, it's allowing -- it's before any reversal of the exceptional COVID inventory provision that we took last year. In terms of the second question you raised around the organization, under the new structure, we will have end-to-end management and accountability for each of the major areas: Ready-to-Wear, Accessories, and Shoes. And therefore, whereas, previously commercial planning, merchandising and product development went across all those categories, we're now reorganizing the teams to be business units focused on each of these 3 major areas. So Ready-to-Wear picks up men's, women's and children's, and then Accessories and Shoes. These being new heads, head of Ready-to-Wear and head of Accessories, will report to Marco, and Shoes will report into Accessories because of the scale of it at this point in time. Very importantly, Riccardo remains in charge of the design team, and he continues to report to Marco. So there's no change being proposed to design. I hope that gives you a bit more clarity on that. Offices in London, no proposal. We're making a change to the office footprint. It's outside the U.K., and it's based on ways of working that we've discovered. It's not in London. And then the final piece is about price increases. In terms of price increases, we haven't made any material changes to price increases in this period. We're aware that some of our competitors have, but we haven't done that. We will keep the pricing under review as we normally do, and we may make changes in the future. We've got a certain set of objectives in mind, where we're being guided at the moment by ensuring the product is a protectable value to the consumer. And that's our primary driving force. But at some point, we will look to recoup some of the gross margin investments we've made over the last number of years.

[Charmaine Yap, Analyst]

Okay. And just to clarify, the merchandising team, does that get split up into the business units now?

[Julie Brown, CFO, COO & Director]

Yes, it will. Yes, the merchandising team is also included in the split. The idea is that we get product development, merchandising, and commercial planning very closely linked by business unit.

[Operator]

Next question is from Marion Cohet Boucheron from MainFirst.

[Marion Cohet Boucheron, Research Analyst]

Three follows-up from me, please. The first one, you were flagging Europeans were up double digit in June, I think. Would you say that's more revenge spending or delayed after lockdown? Or is it more the brand gaining shares in Europe? I mean do you see this pace of growth sustainable or not? And just can you recall us what tourism was in Europe as a percentage of sales? Then on the wholesale, once we've passed H1, are you using the period to close doors? And so should we still expect a decline in the remainder of the year? Or could we see an inversion of the trends?

[Julie Brown, CFO, COO & Director]

Could I just clarify that final question relating to your stores at the end of the year? Was it about space?

[Marion Cohet Boucheron, Research Analyst]

No. It's more on the wholesale, wholesale picture...

[Julie Brown, CFO, COO & Director]

Oh, the wholesale.

[Marion Cohet Boucheron, Research Analyst]

Yes, exactly.

[Julie Brown, CFO, COO & Director]

Okay. Got you. Okay. Thank you very much for clarifying that. Yes, so in terms of -- we saw a strengthening in Continental Europe. It was not across the board in Europe in June in terms of domestic recovery. It was really concentrated in Continental Western Europe. But it is encouraging. We found with the regions that, when countries come out of lockdown, some countries have responded extremely well, particularly the Asian ones. Other countries, like the U.K., are very cautious. So it does depend. So it's difficult to call it at this stage as to whether it's an element of revenge spending. But generally speaking, what we're seeing in Europe is it's not attributable to that. It's more about, I think, there's a level of caution across Europe in terms of reopening and consumer behaviors. So in terms of tourism, the percentage of tourists in Europe has dropped considerably. So we tend to find about half of our EMEIA business is tourist, and less than that is long haul. But it's around about half of our business. We found significant drops in the tourist business in Europe in the order of 90% sort of drop. It's very, very significant. And then finally, with regard to wholesale, yes, we are working with our wholesale partners to continue to protect Burberry and enhance the image of Burberry. We've got reasonable visibility over the order book in half 1. And this is why we've decided to give guidance on half 1. Again, we've been driven by the fact that the most important thing is to protect the brand. In terms of half 2, we haven't provided any guidance on half 2 simply because probably the biggest single factor will be how the virus progresses, particularly in the winter months. So we've decided not to provide guidance. But of course, at the half year, we'll try and get some further line of sight as we've done today on the next quarter to half.

[Marion Cohet Boucheron, Research Analyst]

Okay. And just one more question. On the Q2 guidance for retail, how much would you think that it's affected also by the average price going down as a result from the significant markdowns there currently?

[Julie Brown, CFO, COO & Director]

No. It's largely a factor entirely -- in fact, entirely a factor of footfall in the stores. It's absolutely not to do with AUR or average price. It's all to do with footfall in the stores, all stores being closed for a period or reclosing as we've now experienced in Australia and in the U.S. state of California.

[Operator]

In the interest of time, we have to stop the Q&A session, and I will now hand back to Julie Brown for any closing comments. Please go ahead.

[Julie Brown, CFO, COO & Director]

So thank you for joining our call today, and we look forward to updating you on our interim results early in November. Thank you very much, everyone.

[Operator]

Ladies and gentlemen, this concludes today's conference. Thank you for joining. You may now disconnect. Goodbye.