Coach's CEO Discusses F3Q13 Results - Earnings Call Transcript

Apr.23.13 | About: Coach, Inc. (COH)

Coach (NYSE:COH)

F3Q13 Results Earnings Call

April 23, 2013 8:30 a.m. ET


Andrea Shaw Resnick – Senior Vice President of Investor Relations and Corporate Communications

Lew Frankfort – Chairman and Chief Executive Officer

Victor Luis – President and Chief Commercial Officer

Jane Nielsen –Chief Financial Officer

Michael Tucci – President, North American Group

Jerry Strizske - President and COO


Bob Drbul - Barclays

Kimberly Greenberger - Morgan Stanley

Ike Boruchow - Sterne Agee

Oliver Chen - Citigroup

Brian Tunick - JPMorgan

[Maureen Hutchinson] - Bank of America

Liz Dunn - Macquarie

Barbara Wyckoff - CLSA

Jennifer Davis - Lazard Capital Markets

Dana Telsey - Telsey Advisory Group

Antoine Belge - HSBC


Welcome to the Coach Conference Call. Today’s call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Senior Vice President of Investor Relations and Corporate Communications at Coach, Ms. Andrea Shaw Resnick. You may begin.

Andrea Shaw Resnick

Good morning and thank you for joining us. With me today to discuss our quarterly results are Lew Frankfort, Coach’s Chairman and CEO; Victor Luis, President and Chief Commercial Officer; Jane Nielsen, CFO. Mike Tucci, North American Group President.

Before we begin, we must point out that this conference call will involve certain forward-looking statements, including projections for our business in the current or future quarters or fiscal years. These statements are based upon a number of continuing assumptions.

Future results may differ materially from our current expectations based upon risks and uncertainties such as expected economic trends, or our ability to anticipate consumer preferences. Please refer to our latest Annual Report on Form 10-K for a complete list of these risk factors. Also, please note that historical growth trends may not be indicative of future growth.

Now, let me outline the speakers and topics for this conference call. Lew Frankfort will provide an overall summary of our third fiscal quarter 2013 results. Mike Tucci will review North America, including some early reads on new programs in retail and wholesale. Victor Luis will discuss our progress on global growth initiatives, and Jane Nielsen will conclude with details on financial and operational highlights for the quarter. Following that, we will hold a question and answer session where we will be joined by Jerry Strizske, our president and chief operating officer. The Q&A session will end shortly before 9:30 a.m. Lew will then conclude with some brief summary comments.

I’d now like to introduce Lew Frankfort, Coach’s chairman and CEO.

Lew Frankfort

Good morning. Thank you, Andrea, and welcome everyone. As noted in our press release, we were pleased with our solid third quarter results and the overall progress we made against our initiatives, including growing our international business, becoming a market leader in the men’s accessories category globally, and harnessing the power of the digital world.

We also moved forward with our grand transformation, as we added to our creative leadership, building upon our strong team, and began to create a more robust lifestyle offering with the relaunch of footwear. Further, the announcement today of the increased dividend reflects our financial strength and our confidence in Coach’s future.

Separately, we also noted that Reed Krakoff does not intend to renew his contract, which expires in June 2014, to focus exclusively on his namesake brand. We are exploring strategic alternatives for the RK brand.

Reed has been my creative partner for 16 years, and has been instrumental in the brand’s remarkable evolution and growth and we have great admiration and respect for Reed’s significant accomplishments.

We’re also excited about the next chapter of our growth story, now underway as we transform Coach into a global lifestyle brand anchored in accessories. We have built a very strong creative team, and are now looking for a successor to lead it.

While we will get into further detail about current conditions and the [outputs of] business shortly, as always, I did want to take the time to review our quarter first. Some key financial highlights were, first, net sales totaled $1.19 billion versus $1.11 billion a year ago, an increase of 7%. On a constant currency basis, sales rose nearly 10%. Second, earnings per share totaled $0.84, up 10% from prior year.

Third, North American sales increased 7% to $792 million from $738 million last year, with direct sales up 8% on a 1% comparable store sales gain. And, fourth, international sales increased 6% to $382 million from $359 million last year, driven in part by a 40% gain in sales in China, with a continuation of double digit comps. On a constant currency basis, international sales were up 14%.

Looking first at global distribution, during the quarter in North America we opened one retail location, closed five others, and opened two new factory men’s stores. This brought the total to 352 retail stores and 191 factory stores in North America at the end of the period.

Moving on to China, during the quarter we opened one new location on the mainland, bringing the total number to 118 locations, including 100 on the mainland in 41 cities. Following our Asian distributor acquisitions over the last 21 months, we now directly operate 93 locations in Asia comprised of 49 in Korea, including one location we opened in the quarter, 27 in Taiwan, 10 in Malaysia, and 7 in Singapore.

And in Japan, we closed two locations, taking the total to 191 at the end of the quarter with 23 standalone full-price stores including 8 flagships, 121 shop and shops, 40 factory stores, and 7 distributor-operator wholesale locations.

Moving on to sales and productivity, starting in North America, our total revenues rose 7% for the quarter with our directly operated businesses up 8% on a 1% comparable store sales increase. In department stores, sales trends at POS were slightly above prior year, while shipments into this channel also rose slightly. Overall, we estimate that growth in the addressable women’s North American handbag and accessory category remained strong in the latest quarter, rising high single digits.

Moving on, international sales, which today represent about a third of Coach’s total sales, rose 6% in the third quarter or 14% on a constant currency basis, consistent with prior quarter. China sales rose about 40% from prior year, fueled by distribution and double digit same-store sales. Clearly, the Chinese consumer continues to embrace Coach as evidenced by these results as well as the increasing contribution of the Chinese tourist to our global sales and the extremely high repurchase intent among existing customers.

Our other Asia direct businesses outside of China and Japan - Korea, Taiwan, Malaysia, and Singapore - also posted strong aggregate growth in the quarter. In total, they benefitted from the retail step up from the prior year from Malaysia and Korea. In addition, their combined POS sales also rose at a double digit rate. In Japan, sales were even with prior year, on a constant currency basis, while dollar sales declined 14%, reflecting the weaker yen.

Finally, I would like to touch on our international wholesale business where we experienced a modest decline in shipments while retail sales gains remained strong, driven primarily by distribution expansion. While Jane will get into more detail on our financials, I wanted to give you this recap.

As Andrea said, Mike Tucci has joined us today to discuss our North American business and some of our initiatives going forward. Mike?

Michael Tucci

Thanks, Lew, and good morning. Lew has just given you a recap of the quarter. Let me provide some detail on North American performance, along with progress on our key initiatives. Most generally, we’re pleased with our business as our revenue in North America grew at 7% overall and 8% in direct channels.

Our in-store traffic trends improved from the holiday quarter, while conversion was similar to prior year and ticket was up. Our internet business remains strong, driven by significant traffic gains continuing to contribute to overall comps. In aggregate, our comp stores sales increase was driven by an increase in transactions, fueled by our online businesses while ticket was even with prior year.

Looking at North America full price, and starting with handbags, Legacy and Madison remained our key collections in the March quarter, with new silhouettes introduced throughout the period. Two notable introductions were the Saffiano tote group and the limited launch of the Phoebe shoulder bag, both in March, and both well-received.

We saw a continuation of trends favoring leather, where we were well-positioned, and the above $400 segment continued to perform well, at about 18% of handbags. Small bags also trended particularly well, which impacted mix, resulting in slightly lower average handbag retails.

Looking ahead, we’re excited about our fourth quarter product initiatives featuring the new Phoebe shoulder bag, which, as noted, launched at the end of March, and will be our featured style for Mother’s Day. Phoebe represents our latest innovative design direction, and has been a huge hit with consumers, immediately becoming a best-seller. For spring, Phoebe is offered in a beautiful new leather quality, which is soft and drapey, with sleek hardware details and sophisticated subtle branding.

Throughout the quarter, we have new on-trend colors coming into existing collections, and in June we’re looking forward to a new satchel and tote product launch targeted to our fashion-conscious consumers who appreciate pretty styling and feminine details.

One product opportunity that we’re particularly excited about is footwear. In March, we relaunched shoes in over 170 retail stores in North America, featuring great ballet flats, fashion wedges and heels, and on-trend sneakers. In a select number of flagship stores, we began to install shoe salons to showcase the new world of Coach, and made shoes a feature of our windows in over 75 locations.

The response from consumers has been extremely positive as the business in these footwear locations went from about 3% to almost 12% of the business in five weeks, and has positively impacted productivity. Important to note is that we converted our past sneaker-focused business into a fashion business of key styles such as the Nadia loafer, the Nala heel, and the Dalia ballet slipper.

Not only have we gotten great traction on these anchor styles, but almost every fashion style, whether it’s a wedge, a woven heel, or a strappy sandal, is selling well. Shoes have been featured in our print marketing campaigns online and in many editorial credits this season.

Our emphasis on growing this category will continue to build as we head into fall and include more dominant fashion footwear assortments in our wholesale locations as well. We will continue to focus on building our key items, evolving our mix, and growing both AURs and overall penetration levels.

Shifting to ecommerce, online business was strong again this quarter, with sales and traffic growing at a double digit pace through and EFS, our factory site. In addition, we’re seeing an increasing percentage of sales and traffic coming from mobile. Clearly this trend is representative of our consumers’ shopping behaviors in this growing, digitally enabled environment, and is consistent with our increased emphasis on digital, through our own website, digital advertising, and social media. Our strategic intent is to rapidly drive further innovation in this channel.

We also remain really excited about the results we’re achieving in our men’s business, which is on track to grow about 50% globally this year to over $600 million. We’re experiencing success in men’s across all concepts and store types, and across all geographies and channels. In North America, men’s is driving productivity in existing stores, and also represents a substantial new distribution opportunity.

I’d also like to provide a brief update on our wholesale business. We are focused on improving our performance here, with an emphasis on growing our leather handbag and accessories business, taking advantage of our auto-replenishment program, and we’ll begin execution of our shop renovation and [case line] transformation during this quarter, with significant rollout in fiscal year ’14.

In summary, we’ll continue to drive our women’s business through fashion innovation and broadening the expression of the brand through lifestyle categories. We will leverage the opportunity in men’s and evolve our store individual concepts to provide a brand-right shopping experience for our consumer, wherever she chooses to shop.

With that, I’ll turn it over to Victor for a discussion of our strategies and further opportunities for growth.

Victor Luis

Thanks, Mike. Last quarter we talked about our brand transformation into a global lifestyle brand anchored in accessories. As we build out our strategic plan, we’re focusing on three key elements: product, stores, and marketing.

To this end, over the last quarter, we made several important hires to strengthen our team and enhance the Coach experience, including Sandra Hill, EVP of women’s design, with responsibility over all women’s products; Zach Augustine, as EVP, global environments, who is leading initiatives across visual merchandising, architecture, and all in-store creative development; Erin Thompson, as VP, artistic director of global environments, reporting to Zach and overseeing all creative developments for windows, in-store merchandising, showrooms, and events.

Sandra, Zach, and Erin joined a strong creative team in place, including Jeffrey Uhl, our SVP of men’s design, who has been leading the creative direction for all of men’s categories for both full price and factory: Javan Bunch, SVP of licensing, who is spearheading the relaunch of our footwear, and Maria Turgeon, who was recently promoted to a newly created role of SVP, women’s factory, and whose new designs will be arriving in stores later this spring and summer.

The creative team now in place is focused on developing and presenting a full head to toe expression of the Coach woman and man, including a focused ready to wear presentation to inspire our customers with a complete Coach point of view that is relevant to how she lives her life. Over the next few quarters, the level of innovation across product categories will increase as we continue to add emotion to our offering and greater fashion credibility and relevance to the brand.

Moving on to our distribution update, as our plans haven’t changed materially, I’ll be brief. Our square footage globally and across all channels will increase about 10-11% in FY13. In North America, we expect to open a few stores in the fourth quarter in addition to the 20 net openings in the first half, taking us to about 22 net stores for the year. In total, square footage will increase about 10%.

Turning to international, and starting with China, as you know we expect to open about 30 new stores this year, or at least another seven in the fourth quarter, bringing the total to about 125 locations at the end of the year. All of these openings are planned to be dual-gender stores, due to the size of the men’s opportunity. In total, square footage in China is expected to grow about 35%, and we now expect sales to total about $425 million, up from our previous guidance of at least $400 million, an increase of nearly 40% driven both by distribution and comparable location sales.

In terms of our other Asian direct markets, our primary focus continues to be driving improved productivity, rather than new distribution, as we continue to invest in training, merchandising, store environments, and systems, creating a brand-right experience.

In Japan, we will open seven additional locations in the fourth quarter, taking the total to 11 net new locations in FY13, most of them dedicated men’s stores. Earlier this month, we opened our ninth Japan flagship on Omotesando, which is, after Ginza, the second most important tourist shopping destination in Tokyo.

In total, we expect that net square footage growth will increase by about 10% this year, compared to about 5% in FY12. And, consistent with our strategy of directly operating select international markets, we are pleased to announce the purchase of our partner’s 50% interest in our European JV, with the transaction expected to close in July. Today, through the JV, we are operating 18 locations in the U.K. and Continental Europe.

As you know, Europe is a large market for women’s and men’s luxury accessories, representing about 25% of the global category sales. Coach’s heritage, linked to New York fashion, is appealing for many Europeans, and creates a differentiated positioning compared to the traditional luxury brands. In addition, we believe the region has significant long term potential, attracting both domestic shoppers and the international tourists.

Finally, beyond our directly owned international businesses, we have significant and growing distributor-run businesses in other countries. We are focusing on expanding through partners in three other regions. First, Latin America, including Mexico, Brazil, Venezuela, Colombia, Panama, Chile, and Peru. Second, other Asia-Pacific markets such as Australia, Thailand, and Indonesia, and third, in the Middle East.

These are an addition to the significant global travel retail opportunity that continues to exist for Coach as the brand’s recognition continues to grow globally. We’ve just reviewed our strategies, built upon our strong brand and business equities. Over the long term, we have significant runway ahead of us. At this time, I will turn it over to Jane Nielsen, our CFO, for further detail on our financials and investment plans. Jane?

Jane Nielsen

Thanks, Victor. Lew, Mike, and Victor have just taken you through the highlights and strategies. Let me now take you through some of the important financial details of our third quarter results.

Our quarterly revenues increased 7%, with North America up 7% and international up 6%. As noted, the weakening yen reduced sales growth, so in constant currency, revenues rose 10% overall, with international sales up 14%. Net income for the quarter totaled $239 million, up 6%, with earnings per diluted share of $0.84, up 10%. This compared to net income of $225 million and earnings per diluted share of $0.77 in the prior year’s third quarter.

For the first nine months, net sales were $3.85 billion, up 7% from the $3.61 billion reported in the first nine months of fiscal 2012. Net income totaled $813 million, up 3% from the $787 million reported a year ago, while earnings per share rose 6% to $2.84 from $2.67.

Our tax rate for the quarter was 31.3%, taking our year to date rate to the current run rate of 32.4%. The lower than expected tax rate for FY13 is a function of the favorable mix in our countries.

For the third quarter, our operating income totaled $348 million, 3% above the $337 million reported last year on a GAAP basis, while operating margin was 29.3% versus 30.4%. During this quarter, gross profit totaled $880 million versus $818 million a year ago, an increase of 8%.

The gross margin rate was 74.1%, up 35 basis points from last year. As expected, our expense ratio in Q3 totaled 44.8%, compared to the 43.3% reported in the year ago quarter, reflecting the acquisition of distributors made earlier this fiscal year. Even including these investments, we were able to gain leverage to EPS.

Moving on to the balance sheet, inventory levels at the end of the quarter were $560 million, 9% above the $475 million reported at the end of last year’s Q3 and more in line with sales growth.

Before turning to the cash flow statement, I’d like to provide some details about our new corporate headquarters, originally announced in November of 2011. We entered into a joint venture agreement with [Related] to develop our new worldwide corporate headquarters in Manhattan in the Hudson Yards district. Our new headquarters will allow our business units to operate under one roof, reflecting the collaborative way in which we work today.

As detailed in our 8-K filing earlier this month, we expect to invest approximately $750 million over the next three years, or $620 million net of the proceeds from the sale of our current building. This year, our cash outlay will be between $130 million and $160 million, depending on the progress in construction. Of this, $30 million of capex was already included in the company’s guidance. The balance is treated as an investment in our joint venture with related.

Moving back to the third quarter financials, cash and short-term investments stood at $928 million, as compared with $930 million a year ago. During the first nine months, we repurchased and retired just over 7 million shares of common stock at an average price of $56.63, spending a total of $400 million. We did not repurchase any shares in the third quarter, and therefore, at the end of the quarter, about 1.4 billion still remained on our current repurchase authorization.

As noted, we increased our cash dividends by 13%, raising it to an annual rate of $1.35 per share, reflecting our commitment to return capital to shareholders balanced with our investment in the growth of the business.

Net cash from operating activities in the third quarter was $209 million compared to $103 million last year during Q3. Free cash flow in the third quarter was an inflow of $167 million versus $61 million in the same period last year.

Our capex spending was $43 million versus $41 million in the same quarter a year ago. We continue to expect that capex this year will be in the area of $250 million, primarily due to new store openings and expansions across all geographies, elevating our store environment, and investments in the technology and infrastructure necessary to enable global expansion. As noted, this included the $30 million of capex associated with the new headquarters.

Looking ahead, we’re mindful of balancing the impact of the still-muted global consumer environment and challenging market dynamics in North America with our continued optimism around men’s and the strong international expansion opportunities for Coach. We also recognize the yen will be an accelerating headwind. Therefore, the second half operating outlook provided on the January call remains the same.

First, and most generally, we expect to achieve high single-digit second half sales growth, with North America fourth quarter comps about even with prior year, impacted by the Easter shift into March.

Second, our second half gross margin is planned to improve modestly on a year over year basis, as channel mix and our sourcing initiatives continue to contribute to profitability. On balance, we continue to expect gross margin to remain high at about 73% for the year.

Third, on SG&A, as we’ve noted previously, international acquisitions alone will cause our expenses to rise about 150 basis points for the year. Fourth, therefore, taken together, we still expect an annual operating margin of about 31%, with compression from the prior year as a result of our investments.

Notably, we expect our core businesses to continue to deliver leverage to EPS. At the same time, given our international mix, we are changing our guidance and now project our tax rate is likely to be in the area of 32.5% for the year.

As is our practice, we look forward to providing you with initial FY14 guidance when we report our fourth quarter results in late July. At that time, we will also share our expectations for growth over our planning horizon as we continue to refine the roadmap for our brand transformation. Importantly, we have the financial strength and the brand vibrancy to capitalize on the opportunities ahead.

I’d now like to open it up to Q&A.

Question-and-Answer Session


[Operator instructions.] Our first question today is from Bob Drbul with Barclays.

Bob Drbul - Barclays

I have two questions, actually. The first one is Lew, can you talk about how you are feeling around the creative team in place, and the ability to implement the brand transformation? And the second question I have is you mentioned some details around the innovation in handbags. Can you just elaborate a little bit more exactly how the team is positioned to expand and create more innovation in the category over the coming quarters?

Lew Frankfort

Sure. First, as I mentioned earlier, we do have a very strong creative team in place, where we expect it to transition will be seamless. One of the excellent aspects of where we are today is that our entire creative and business team is aligned on the transformational strategies that are underway. We are also very focused on what we need to do from a focus and pacing perspective. And we’re confident that we’re going to be able to continue to move forward as we have. Victor and I have been working very closely with Reed to spearhead the transition and everyone is up to speed.

In terms of our focus, as we said earlier, we began with men’s. We relaunched footwear. And the initial results are extremely satisfying. We are moving forward to launch a head-to-toe capsule group that will be anchored in accessories, which bridges to innovation in handbags. One of the opportunities for Coach is to offer a more sophisticated, tailored look that will appeal to consumers who are both in our franchise as well as to our new consumers, and we will begin to see some of these styles during our holiday quarter.


Our next question is from Kimberly Greenberger of Morgan Stanley.

Kimberly Greenberger - Morgan Stanley

I’m wondering, can you talk to us about your assessment of the store opportunities over the medium term in both the North American and Japanese markets? And specifically, regarding Japan, can you talk to us about any hedging activities that you may or may not engage in with the yen falling, or if there’s any expectations of price adjustments in that market, just given what we’re seeing with the weakening yen?

Lew Frankfort

Jane, why don’t you take the second part first?

Jane Nielsen

Sure, why don’t I take the hedge aspect of the question? We actively hedge, overall, for transactions, so that we minimize the impact to cost of goods sold by hedging in a layered fashion every quarter so that we are protected about three quarters out to a substantial degree. We’ll continue that practice. Really, our objective is to smooth the impact of the yen on our costs over time. And we’ve been able to successfully do that this year and we’ll continue to practice layered hedging as we move forward.

Michael Tucci

Kimberly, just to clarify, are you curious in North America about, when you say store activity, is that a distribution-related question?

Kimberly Greenberger - Morgan Stanley

Mike, just in terms of store count, are you getting to the point where you’re ready to slow down the new store growth? Or are there still pockets like, for example, men’s factory outlet stores, that you’re looking to continue growing, both in the mature U.S. market and the mature Japanese market?

Michael Tucci

Thank you, that’s helpful. Let me take full price first, where there’s an interesting inflection happening in full price today, where we have a significant amount of leasing activity happening around leases that are coming due, which provides us an opportunity for repositioning, looking at market penetration, and potential downsizing of stores in select markets. In addition, we have significant lease rights built in, which allow us to take action, and on a select basis, underperforming stores.

On the opposite end of that is an intense focus around our top 100 locations in North America, including wholesale, for repositioning, replatforming, supporting our business from a transformation standpoint. So in full price, it’s a combination of some pruning and what I would call market analysis, and then really focusing on top stores for maximum positioning and competitive positioning to support the transformation.

On the factory side, frankly there’s a lot of development happening. There’s an enormous amount of new development and there we’re focused on select new market entries and new store entry, as well as maximizing the men’s opportunity with some repositioning in smaller stores. I think we’ll give you a lot of detail on that when we talk about our longer term strategy in the fourth quarter call.

Lew Frankfort

And Kimberly, just on Japan, quite a similar story in the sense that there is very little development taking place in full price. Indeed, most of luxury full price distribution is through the department store channel, which is not growing, and has in fact been contracting for over a decade. Our focus there is on men’s distribution. Given the department store distribution, our handbag distribution tends to be in women’s spaces, so we have been selectively adding men’s location in buildings where we already exist, leveraging the management talent and infrastructure in place.

In terms of factory distribution, the market is pretty much saturated and mature. There will be some select closings and openings as we evolve, but we see our focus really being on current distribution, remodeling, and continuing to drive the brand transformation through innovation in the space that we’re in.


Our next question is from Ike Boruchow with Sterne Agee.

Ike Boruchow - Sterne Agee


I wanted to ask about your thought process on the current pricing architecture at both full price and factory in North America. There was a lot of buzz going around the past month or two as it looked like your factory couponing was much deeper than it was last year. Yet your gross margins in the quarter were very healthy. So are you price engineering for these discounts? Or is there something else there? How should we kind of think about that?

Michael Tucci

That’s a good question. There was a lot of chatter about that. There’s a lot to it. One, it’s critical to note that we have to separate some of the tactical things we do in stores and in our marketing to drive engagement, and to drive conversion with the net margin impact.

And all of our promotional strategies are built with the assortment when we set our assortments almost a year in advance, with a number of options against how we want to play it. And so we’ve gone from some discounting activity on total transactions, to a targeted promotional campaign on handbags, which had an incredible impact on mix and ticket within the factory channel. And we’ll continue to work it.

What we’ve found is that the factory channel expects promotional value, and we are working to nuance that and play that in the most effective way that we can. The most important thing we can do is continue to focus on innovation there and in full price, and to deliver compelling products. And that offers us the most pricing flexibility going forward.


Our next question is from Oliver Chen with Citigroup. And as a reminder, one question, one follow up question, please.

Oliver Chen - Citigroup

Could you update us on the competitive environment, what you’re seeing in the marketplace with respect to the heightening or the latest [spots] there? Also, we’re pretty excited about the transition of watches to the fashion category. Do you expect that your floor space commitment will increase for that category? It feels like your press release speaks a lot to the evolution of how you think about head to toe in store. So if you could just preview for us how we should think about the engineering of the floor space in regard to the transition, that would be helpful.

Lew Frankfort

First, in terms of competition, we’d rather focus on the category dynamics in terms of size. And as I indicated earlier, the category grew high single-digits. It’s extremely vibrant, and we’re participating in that growth. And of course we need to look at our business globally and we also need to look at our men’s business. And I think the results speak for themselves.

Relative to watches, you’re correct. We did make a strategic decision to shift watches to the much more dynamic fashion area within department stores. And as part of that change, we are also evolving our assortment holistically so that we can offer more compelling, relevant fashion at good price points.

Oliver Chen - Citigroup

And a follow up on Europe, that sounds quite constructive. It’s been not the easiest market for U.S. luxury and accessible luxury brands to penetrate. Are there product strategies and marketing strategies that you’re undertaking in order to maximize your opportunity for success in that market?

Victor Luis

Sure, let me touch on that. We believe that the transformation that is going underway, and that we’re executing at the moment plays right into the European consumer needs in providing a head to toe look that is relevant in today’s fashion.

I would just remind us that the European market is a large one, approximately 20% of the global premium market at $6.5 billion or so. As I mentioned, today we have these 18 locations that were taken back from the JV, and we’re very excited to bring them in house. And as we have shown in the past with all of our buybacks, we’ve executed effectively and are looking forward to bringing those businesses under our leadership.


As a reminder, please limit yourself to one question. Our next question is from Brian Tunick with JPMorgan.

Brian Tunick - JPMorgan

First, for Jane, maybe if you could just help us out on thinking about the SG&A dilution from the distributors this year. I think you’ve continued to say 150 basis points. So I was just wondering how should we be thinking about that dilution as you lap it? And does the U.K. acquisition you guys talked about now impact the timing? How much should we potentially expect to see next year?

And then the second question, maybe if Lew wants to talk about it, we’ve had a lot of questions from investors on the balance sheet, and we’re just wondering, you know, as you talk about your capex needs, can you maybe talk about your thoughts on the minimum cash position? And as you move the company into more of a lifestyle brand, does that open up your thoughts to potentially buying versus building any skill sets the company currently doesn’t have?

Jane Nielsen

Why don’t I start, just in terms of the dilution in SG&A. We’ve called out the 150 basis point impact to our SG&A margin. So as you think about, we took on our acquisitions. We had them evenly spaced throughout the quarter.

So it’s been about $100 million over the four quarters, evenly paced through the four quarters. It was more or less dilutive, depending on the size of the quarter, but the actual dollars paced out about the same, as we moved through the quarter. So as we come out of fiscal year ’13, that SG&A that was a pick up from the Asian distributor acquisition will be in our base, and you should start to see a normalization of growth rates into SG&A.

The transaction in Europe, we’ll get back to you in the fourth quarter with more specific announcements as to impact, in conjunction with our FY14 guidance. It’s at $40 million in POS. It’s smaller than our Asia distributor acquisitions, but we will take on SG&A as we take on the European JV.

Lew Frankfort

With regard to your question around volume versus building skill sets, first, we do have a very seasoned and strong team. Our bench, both on the creative side, as well as on the retail and operating side, has experience across all of the categories that we’re in today. And in fact, we have experienced, even at POS, in most of everything that we plan to launch in holiday, our focus, it’s really on augmenting our leadership team with key significant hires, which Victor mentioned earlier in the call.


Our next question is from [Maureen Hutchinson] with Bank of America.

[Maureen Hutchinson] - Bank of America

Can you comment on traffic and ticket trends in full line and factory? And also, have you gotten the mix of logo to where you wanted it?

Michael Tucci

The logo opportunity for us continues to evolve. We had a tremendous quarter in leather. The logo trends were probably at their lowest level, and we think that’s a good thing longer term, as we begin to lap that, particularly as we go into next season. I feel very good from a positioning standpoint about our balance between logo and leather. And I think going forward the opportunity is to [distort] leather further.

In terms of traffic, what we said was, and please be mindful that we don’t disaggregate metrics in detail, we did see some sequential improvement from the holiday quarter. And one thing I want to note, and I feel good about this, we’re seeing a very strong performance in our stores, both full price and factory, around key holidays.

So we saw it coming out of the Christmas period, the holidays that fell into January. We saw a very strong performance around Chinese New Year and President’s Day, Easter as well. I think that bodes well for us for Mother’s Day, which is the single biggest holiday period in our stores other than Christmas. And it’s just a few weeks away. So we want to continue to focus on maximizing opportunities around our biggest traffic periods, and hopefully that will continue to help drive productivity.


Our next question is from Liz Dunn with Macquarie.

Liz Dunn - Macquarie

My question is regarding the footwear business. Can you just talk about how that business will build in your direct channel over the next couple of quarters? And how that should impact the margin structure, both in the near term and longer term? And then as a follow up to I think it was Brian’s question, would you ever consider specifically buying the footwear business back in?

Michael Tucci

In terms of of positioning, footwear, we’re just getting started on it. To get some scope on this, I believe that footwear represents the single largest opportunity that we have in front of us in women’s. It reminds me a little bit of the early days when we started with our men’s strategy.

We’re focused today on setting the assortments, positioning the assortments properly in terms of size of assortment and offer and pricing. We feel good about our store count in North America at about 175 stores. We’re beginning to dabble with the idea of what footwear might look like in the factory channel, and you’ll see us play there in future.

And I actually believe that from an assortment and positioning standpoint, the fall assortment that we launch is truly stronger than what we have today. It’s an assortment that was built with more time, with Javan and our design team, and we will have the benefit of further in-store execution, [unintelligible] wrap removal, mobile POS, [seeding], presentation, and most importantly, more time with selling confidence and service as we launch that.

So early days. We’re committed to it. And we’ll continue to focus on it as a growth category.

Lew Frankfort

With regard to our margin structure, we don’t believe that our overall margin will change materially from growth in our footwear business. We do believe it will help grow the overall business, and grow overall profitability.

With regard to future plans, we have a great partnership with our licensing partner and our contract doesn’t expire for another two years.


The next question is from Barbara Wyckoff with CLSA.

Barbara Wyckoff - CLSA

Can you talk about the key drivers in men’s? I always think about wallets and belts, but can you talk about the balance with bags, briefcases, totes, outerwear? How much are those categories as a percentage to the total? And how big could this business be over the next, say, three to five years?

Victor Luis

The business, we believe, in the medium term, is a billion dollar global opportunity. And the shifts that we’re seeing globally is the growth in the bag business. It’s slightly different, of course, by market, in terms of attitude, but we are also seeing a very strong trend in certain key locations in our outerwear and our team is also today developing other categories more fully. Of course, there’s opportunity in tech, small gifts, the holiday season, but in the quarters ahead we will also be looking at the footwear opportunity, just as we are in the women’s space.


The next question is from Jennifer Davis with Lazard Capital Markets.

Jennifer Davis - Lazard Capital Markets

First question and then a follow up. How much time has Reed spent, I guess in the last year or so, on the Coach brand versus his own brand, or his own line? And then could you talk a little bit about the talent underneath him?

And then a follow up, I guess, on apparel. Just wondering, what should we expect in the holiday quarter? Should we expect about a rack out there in the stores? A couple of racks? Are you planning on putting dressing rooms in the stores that are going to be a relatively small piece of the total?

Lew Frankfort

Reed has been careful to balance his time, so that both Coach and RK can benefit from his considerable talents. A good part of Reed’s effort and my efforts, and more recently Victor’s, has been to forge a creative team that can work collaboratively and who are empowered, and we have been working very closely with that team and do believe, as I said earlier, that we’re in a very strong position to move forward without any disruption.

Relative to ready to wear, I think the context you really need to think about is that we’re not looking to sell tops and bottoms. This is not a full launch into ready to wear. This is a very careful, methodical approach to create a story of who the Coach woman is.

And our intention in all of our lead stores is to provide a capital group of ready to wear with our outerwear, and it’s going to be a tiered structure. There will be a small number of stores that will carry ready to wear, who have dressing rooms. We are contemplating adding a small number of dressing rooms.

A much larger number of stores will be carrying key iconic items, led by accessories, shoes, bags, outerwear. And in China, there’s an opportunity that’s much larger, where we already have outerwear representing over 20% of our sales in key stores.


The next question is from Dana Telsey with Telsey Advisory Group.

Dana Telsey - Telsey Advisory Group

Lew, as you think about the talent that remains to be added, characteristics that you’re seeking in the successor to Reed, given that it’s a different place and time now from what the business was 16 years ago? And then also, as you see the men’s opportunity, margin performance in the U.S. and China, is it where you wanted it to be now? And how do you see it moving forward?

Lew Frankfort

With regard to the second part of your question, did you say margin performance?

Dana Telsey - Telsey Advisory Group

Yes, exactly.

Lew Frankfort

On margin, it’s exactly where we would like it to be. Men’s is at parity with women’s. In terms of Reed’s successor, obviously, as you say, it’s a different point in time. We’re early in our search. We are looking for someone who will be able to oversee the global men’s and women’s design effort and help to spearhead our creative functions. But again, depending on the person that we find, we’ll adjust the organizational structure. We are, of course, looking for someone who is highly collaborative, who works across different channels, different geographies, who will be partnering with our very strong team.


The next question is from Antoine Belge with HSBC.

Antoine Belge - HSBC

Just one question on China. Can you maybe provide a little bit of color about the most recent trend there [unintelligible] some of your European competitors have been experiencing a slowdown there’s. Are you benefitting from that? And are you actually targeting a different customer base for the time being?

Michael Tucci

I would say that as you have heard, we’ve seen really no visible change in our trend. We continue to be focused on our distribution growth as well as driving efficiency in our stores. We have a very experienced and increasingly seasoned team on the ground. And we’re very, very pleased with the repurchase intent that we’re seeing with consumers.

Our strategy is obviously very different than the traditional European luxury brands who are much more focused on exclusivity. Coach is much more focused on being a selective brand and we believe the opportunity is tremendous, and being in only today 41 cities, out of what the Economic Intelligence Unit is telling us is 210 cities with a population of a million or more, in most recent data, gives us a tremendous confidence on the opportunity that lies ahead. We truly believe it is still very much boundless.

And of course, we’re seeing tremendous benefits from our investments in China, not only in China, but indeed in almost every single market where we have retail today. The impact of these Chinese consumers, and the Chinese tourist, is a growing one.


Thank you. I will now turn the call back over to Ms. Andrea Shaw Resnick.

Andrea Shaw Resnick

Thank you all for joining us today. Now I’d like to turn it back to Lew for some closing comments. Lew?

Lew Frankfort

Obviously there’s a lot going on here at Coach. I think you heard a lot of enthusiasm from myself and our team. We are at an exciting juncture. We’re galvanized towards what we need to do, and we’re very enthusiastic about our long term opportunities. So I wish you all a good day. Thank you.

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