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Coach, Inc. (NYSE:COH)

F1Q 2014 Earnings Conference Call

October 22, 2013 08:30 ET

Executives

Andrea Shaw Resnick - Senior Vice President, Investor Relations and Corporate Communications

Lew Frankfort - Chairman and Chief Executive Officer

Victor Luis - President and Chief Commercial Officer

Jane Nielsen - Chief Financial Officer

Francine Della Badia - President, North America Retail

Analysts

Ike Boruchow - Sterne Agee

Nancy Hilliker – Citigroup

Brian Tunick - JPMorgan

Lorraine Hutchinson - Bank of America

John Morris - BMO Capital

Edward Yruma - Keybanc

Liz Dunn - Macquarie

Barbara Wyckoff - CLSA

Dana Telsey - Telsey Advisory Group

Kimberly Greenberger - Morgan Stanley

Michael Binetti – UBS

Tracy Kogan - Wells Fargo

Operator

Good day, and 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

Thanks you. Good morning and thank you all for joining us. With me today to discuss our quarterly results are Lew Frankfort, Coach’s Chairman and CEO; Victor Luis, Coach’s President and Chief Commercial Officer and Jane Nielsen, Coach’s CFO. Francine Della Badia, President, North America Retail is also joining us.

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 year. 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 first fiscal quarter 2014 results and will also discuss our progress on global initiatives. Francine Della Badia will speak to our North America business, product performance and review our key programs for the holiday season. Jane Nielsen will conclude with details on financial and operational highlights for the quarter and outlook. Following that we will hold the question and answer session where we will be joined by Stephanie Stahl, Coach’s Executive Vice-President of marketing and strategy. This Q&A session will end shortly before 9:30 A.M we will then conclude with some free summary remarks.

Of course Victor Luis will also be discussing our international growth and our strategies for the future. Now I would like to turn it over to Lew Frankfort, Coach’s Chairman and CEO.

Lew Frankfort

Thank you Andrea. Good morning everyone and I like to welcome everyone to my last call as Coach’s CEO. As you all know I will be moving on to Executive Chairman in January and I could not be more pleased with the choice of my successor Victor Luis who has demonstrated the passion, strategic vision, focus, superb execution and strong values that makes an outstanding leader. And Victor will have a stronger partner in our new Executive Creative Director, Stuart Vevers who officially joins us in September and is recognized as one of the world’s leading accessories designer. Stuart’s broad luxury experience focused on leather goods and his creative expertise grounded in accessories will enable him to draw upon Coach’s rich history to create innovative product and brand imaginary elevating the customer experience and creating a full expression of the brand. I’m confident that Victor together with Stuart will forge the ideal partnership or as I like to say the balance of logic and magic to advance Coach’s transformation.

Turning back to our quarterly results. As noted in our press release we achieved slight overall sales gains in constant currency benefitting from our geographic diversity. We continue to drive excellent growth in emerging markets in Europe as well in the men’s business and in developing lifestyle categories such as footwear. Importantly we moved forward with our transformation initiatives across all consumer touch-points, product, store environments and marketing focused on the competitive handbag and accessories category in North America. While we will get into further detail about current conditions and the outlook for our business shortly I did want to take the time to review our quarter first.

Some key financials were first net sales totaled $1.15 billion versus $1.16 billion a year ago, a decrease of 1%. On a constant currency basis sales rose 2% for the quarter. Second, earnings per share totaled $0.77 even the prior year. Third North American sales decreased 1% the $778 million from 784 million last year with direct sales also declining 1% on the 6.8% comparable store sales decrease and fourth international sales decreased 1% to $365 million from $367 million last year. On a constant currency basis international sales rose 9%. Sales in China remained strong increasing over 35% with a continuation of double digit comps while sales in our directly operated locations in Asia, ex-Japan and Europe rose sharply as well.

Looking first at global distribution, during the quarter the company closed one full price location and opened five North American factory stores, including one men’s freestanding store. At the end of the period, there were 350 full price and 198 factory stores in about 150 outlet malls in North America.

Moving on to China. During the quarter, we opened six net new locations all on the Mainland bringing the total number to 132 locations, including 114 on the Mainland and 49 cities. In Japan, we opened one net new men’s location during the quarter and we classified four doors from temporary to permanent bringing the total to 196 directly operated locations which included 149 full price and 47 factory locations in about 30 outlet malls. During the first quarter, we opened two locations in Singapore and now directly operate a total of 94 locations in the balance of Asia, including 48 in Korea, 27 in Taiwan, 10 in Malaysia and 9 in Singapore.

Moving on to sales and productivity. Our total revenues in North America declined 1% for the quarter with our directly operated businesses also down 1%. As noted, total Q1 same-store sales declined 6.8% while digital men’s and our newly re-launched footwear categories performed well. We were disappointed by our overall performance in women’s handbags and accessories. More generally, we continue to achieve sales gains on the internet while in-store trends notably traffic remained weak. On these lower traffic levels, in-store conversion was up and transaction size held. In department stores, sales trends at POS were modestly prior year, while shipments into department stores declined slightly. Overall, we estimate that the North American premium women’s handbag and accessories market rose at a high single-digit rates in the first quarter. This was a modest deceleration from recent trends impacted by core consumer categories by the cautious spending environment.

As we have discussed, we are also continuing to drive our men’s business globally through new standalone and dual-gender stores and by dedicating more space for a broader men’s assortment in existing retail stores. In the first quarter, Coach’s sales of men’s bags and accessories increased over 25% globally. Looking ahead, we remained bullish about the prospects of our global men’s business where we are targeting about $700 million in sales in FY ‘14, up about 20% and $1 billion in sales in three years. Before we discuss international sales and progress on transformation, Francine Della Badia has joined us today to discuss our product performance for the first quarter and our holiday sales initiatives. Fran?

Francine Della Badia

Thanks Lew. Starting with product, as Lew mentioned, we continue to feel pressure in our North America business in traffic in our retail stores impacting women’s handbags and accessories. I am going to give some underlying texture to the comp performance both in our successful and strong product initiatives, which are resonating with consumers and where we see the opportunities to strengthen our product positioning in North America.

We were peaked with the re-launch of Madison this quarter. Madison was completely redesigned with the sophisticated and elevated attitude featuring well-defined and timeless elements, feminine details, rich leathers and beautiful texture and understated branding. The new silhouette accessory to smaller version of our popular Phoebe Shoulder Bag, the new Madeline Satchel in two sizes and Kimberly Carryall are best sellers. Customers responding to the prettier and more emotional sensibility with properly integrated functions to support our customer’s busy lifestyle and therefore the overall effortlessness of these products. For more capital Legacy [ph] handbag choices we also introduced new shapes in Legacy such as the drawstring shoulder bag and the turnout coat. As expected trends continue to favor leather handbags across all price segments. In particular the above $100 segment continued to perform well at over 20% of handbag sales. Our overall handbag penetration to our woman’s business was about even till last year. We see opportunities in woman’s handbags and accessories and continuing to infuse more emotion into our product leveraging our distinctive brand. Stuart Vevers luxury experiment and his passion to make the Coach’s [indiscernible] relevant for today where it needs creativity and superior functionality are crafted into beautiful Coach leather bags will allow us to speak to more aspirational consumer and continue to inspire our customers globally. We continue to see strength in our lifestyle categories in Q1. For three months this spring about a 170 price locations, double in penetration from about 4% to over 8%, as higher AUR reflective of the compelling assortment. This category performs highlights our consumer desire for more emotional trend right fashion product.

We’re seeing strong performance across heels, flats and booties. We’re focused on building our market share within the fragmented nearly $25 billion global premium footwear category. This fall we have introduced more dominant fashion footwear assortments in our international and wholesale locations and continue to focus on building our key items.

We are evolving our mix and growing both AURs and overall penetration levels across all of our businesses. At the end of Q1 over a 100 Coach international retail locations offer the elevated collection and response from customers is an excellent. I also know [indiscernible] watches we’re advancing [ph] and expanding our collection, repositioning into a fashion assortment and focusing our sweet spot in an average $225 price point.

In our factory channel as planned new designs represented the majority of our handbag assortment last quarter. First a stylist collection came in July and sold extremely well. Campbell and more sophisticated group of iconic Coach turnout hardware [ph] offered a multiple fabrications including exotic performed strongly. During August we launched an assortment of made for factory footwear in 20 store and we are very pleased with customer response. We will be significantly expanding the distribution and offering starting in the spring. More broadly we’re expanding the role that lifestyle categories play in factory including outerwear, watches, jewelry and sunwear. In addition we have remodeled a majority of our factory stores in for our new factory design concepts, including an enhanced visual merchandising and marketing elements.

Moving to digital, as mentioned our North America online business continues to be strong with traffic growing at a double digit pace driven by engagement from tablet and mobile devices which represent for the 50% of our site visits. Optimization of these devices has been a key focus for us creating more compelling customer experiences. Turning to holidays, we continue to focus on increasing the level of innovation across all product categories adding emotion while strengthening fashion credibility and relevance to the brands. This will be most notable with the arrival of Capsule, a curated product assortment across categories focused on key items in bags, footwear and outwear which started arriving in stores last week.

All stores in North America have now received new Capsule handbags silhouette to [indiscernible] in two sizes and three colors. A tiered offering of more fashion handbags and additional colors and material are offered in select flagship locations with the full assortment including ready to wear available in 25 global flagships including 11 in North America. This Capsule collection supports our lifestyle imagery, featured in our new fully integrated marketing campaign Coach New York Stories showcasing top fashion models wearing Coach set against recognizable New York backdrop.

This campaign communicates a more aspirational and consistent brand story reinforcing the bond with our existing consumer while driving new consumer engagement globally. The campaign is already generated significant buzz in the fashion press and in social media channels around the world. At the same time, we are enhancing our store environments unveiling a new store concept in two key flagship locations in New York and Southern California during the holiday quarter. In department stores, we are also elevating our presence with new shop-in-shops and converting our case line presentations to open sell. In fact, we have seen a significant lift in sales in about a dozen locations where we have transitioned from case line to open sell format.

In summary, we will continue to drive our women’s business through fashion innovation across lifestyle categories supported by dynamic integrated marketing. We will also leverage the opportunity in men’s and evolve our store and digital concept to provide a brand-right shopping experience for our consumer wherever she chooses to shop.

With that, I will turn it over to Victor for a discussion of our international business, strategies and further opportunities for growth. Victor?

Victor Luis

Thanks Fran. Starting with our international segment, which represents about a third of Coach’s business sales rose 9% on a constant currency basis in the first quarter, but declined 1% on a reported basis due to the weak yen. China sales rose over 35% from prior year fueled by distribution and double-digit same-store sales. We are very pleased by the continuing strength in this market, which bodes well for our global travel retail business with the Mainland Chinese tourist plays an increasingly important role. You may remember that our e-commerce site in China launched a year ago and while still in early stages, the internet customer within Mainland China is shopping us from over 200 cities, including more than 150 where we have no bricks and mortar presence. This is another sign of the substantial distribution opportunity for the brands beyond the top tier markets.

Further as Coach’s is relatively young brand in China, we are already recognized as a dual-gender and lifestyle as men’s products and women’s lifestyle categories taken together represented a third of sales in the first quarter. Our other Asia direct businesses outside of China and Japan, Korea, Taiwan, Malaysia and Singapore also posted strong aggregate growth increasing at a double-digit rate for the quarter with robust comparable store sales as we anniversary-ed the purchase of our retail operations in Malaysia and Korea during the quarter. In Japan, we posted a 2% increase in constant currency as the market growth slowed while sales in dollars were down 22% reflecting the weaker yen. As discussed in our release in early July, we completed the purchase of our partner’s 50% interest in our European joint venture. In addition also in July, we transitioned the two Printemps’ Boulevard Haussmann locations to our direct control. Today, we operate 20 locations across the UK, France, Ireland, Spain, Portugal and Germany.

During the first quarter under our direct control, we saw significant sales growth at POS and strong comps in these locations. Also we just opened our first location in Galeries Lafayette yesterday and look forward to opening our first flagship location in Spain in mid-November along with a men’s shop in Galeries Lafayette. We continue to believe that Europe represents a significant long-term opportunity for Coach both with domestic shoppers and the international tourist notably in key European cities with the accessible luxury segment is outperforming traditional luxury.

Looking forward to the balance of FY ‘14, our strategic focus remains on the four pillars of growth we have previously shared. First and most broadly growing our business in North America and throughout the world by transforming into a global lifestyle brand; second, leveraging the global opportunity by aggressively growing our international businesses; third, tapping into the large and growing men’s accessories category which we have already touched on; and fourth, harnessing the growing power of the digital world. While focusing in productivity, we will selectively continue to expand our distribution. As our plans haven’t changed materially from what we outlined on the July earnings call [indiscernible]. We continue to expect that our square footage globally and across all channels will increase about 9% in FY ’14. In North America, our square footage will be up about 7% driven by 20 new store openings focused on factory, 15 to 20 previously announced full price closures and about 20 total expansions across both channels within the context of our transformation. In China we expect to grow square footage about 25% in FY ’14 was about 30 net new dual gender stores. We expect sales to total about 530 million driven by both distribution and double digit comparable location sales.

In terms of our other direct Asia markets of Korea, Taiwan, Malaysia and Singapore while we expect to open a few stores our primary focus remains productivity. We have begun to see the results of Coach’s direct management as well as the successful expansion of lifestyle categories in these markets.

In Japan we expect that next square footage growth will increase slightly and expect to open about 5 to 10 net new locations, most of them dedicated men stores. And in Europe including the UK, we expect to open 10 retail location focused on key European capitals and about 50 wholesale locations in Fiscal Year ’14.

As you know, we also have significant and growing distributor run business in other countries. Our primary areas of focus are first Latin America, including Mexico, Brazil, Venezuela, Colombia, Panama, Chile, Peru and Argentina. Second other Asia-Pacific market such as Australia, Thailand, Indonesia and Vietnam, and third in the Middle East. These are in addition to the significant global travel retail opportunity that continues to exist for Coach as the brands recognition continues to grow globally. I've just reviewed our strategies to drive growth, while taking to improve productivity in North America. At this time I will turn it over to J Nielsen, our CFO for further detail on our financials. Jane?

Jane Nielsen

Thanks Victor. Lew, Fran 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 first quarter results. Our quarterly revenues decreased 1% in both North America and international declining 1% in dollar. As noted on a constant currency basis revenues rose 2% overall with international sales up 9%. Net income from the quarter totaled 218 million was earnings per diluted share of $0.77. This compares to net income of 221 million and earnings per share of $0.77 in the prior year’s first quarter. Our operating income totaled $322 million 3% below the 332 million reported last year while operating margins was 27.9% versus 28.6%.

During this quarter growth profit totaled $827 million versus the 845 million a year ago, a decrease of 2%. Growth margin was 71.8% versus 72.8% for the prior year. Our expense ratio n Q1 totaled 43.9% improving from the 44.2% reported in the year ago quarter.

Inventories at the end of the quarter were $637 million, a 6.5% increase over the 598 million reported at the end of last year’s Q1. Cash and short term investments sit at $855 million as compared with 761 million a year ago. During the first quarter we repurchased and retired nearly 3.3 million shares of common stock at an average cost of $53.17 spending a total of $175 million. At the end of the period about 1.2 billion remained in the company’s current repurchase authorization.

Net cash from operating activities in the first quarter was a $164 million compared to $202 million last year during Q1. Free cash flow in the first quarter was an inflow of $118 million versus $146 million in the same period last year. Our CapEx spending was $46 million versus $56 million in the same quarter a year ago.

Looking forward at the balance sheet, we are deploying international cash into high-quality investments with higher yields and with some durations over a year and expect to shift between cash and short-term investments into other’s non-current assets. Consistent with our guidance last quarter, we expect that CapEx will be in the area of $280 million primarily due to new store openings and expansions across all geographies, elevating our store environments within our existing stores and investments in the technology and infrastructure necessary to enable our global expansion and transformation.

While we are encouraged by the initial iterations of our transition to a lifestyle brand, we have recognized that the full reflection of this positioning is part of a multi-year journey. In addition, the retail environment remains challenging with soft mall traffic and volatility in consumer sentiment. Therefore, as you think about the remainder of 2014, our updated outlook is as follows. We expect to deliver flat to low single-digit sales growth in constant currency. Assuming the yen remains close to 100, this would equate to sales growth about even with last year in dollars with currency more of a factor in the first half.

Also we are forecasting our North America comp run rate to be down high single-digits for the balance of FY ‘14. Gross margin is projected at about 70% to 71% for the year. The primary impact compared to last year will be increased factory clearance levels, the weaker yen, rising sourcing costs as well as inventory amortization from the JV acquisition in Coach Europe. We expect modest SG&A dollar growth with increased investments in Europe marketing and other brand transformation initiatives generally funded by the restructuring actions taken in Q4 with some de-leverage on a lower sales forecast. Taken together, we would expect operating margins to be about 28%. Finally, our tax rate is expected to be around 32% for the year.

Regarding our balance sheet, cash flow and capital allocation we continued to have a strong balance sheet and substantial operating free cash flow of over $1 billion annually. As always, we will prudently invest in the growth of our business while also returning cash to shareholders through dividends coupled with share repurchases. Our current FY ‘14 outlook continues to reflect about $700 million in share repurchases approximately equivalent to our prior three-year average. Most importantly, our long-term commitment to growth and shareholder value are unchanged. We have a business model that generates significant cash flow and we are in a position to invest in our brand while continuing to return capital to shareholder. I’d now like to open it up to Q&A.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) The first question today is from Ike Boruchow with Sterne Agee.

Ike Boruchow - Sterne Agee

Hi. Good morning everyone. Thanks for taking my question and Lew congratulations on a great run and best of luck in your new role.

Lew Frankfort

Thank you.

Ike Boruchow - Sterne Agee

So it sounds like conversion in the U.S. has actually been pretty good the past six months which is a good sign but people just aren’t coming in the doors, is there anything you think you can do to pull them back inside cum [ph] holiday? And then I guess Jane is in regards to the new outlook, I guess maybe when would you anticipate some improvement in North America and in your outlook why don’t you assume any improve in the North America comps over the nine months. Thank you.

Lew Frankfort

Let me begin by saying that, we have a broad and comprehensive program across product marketing and environments which is kicking in. So if you visit our stores today you will see as Francine mentioned the arrival of the Borrow Bag Capsule. You will see a complete head to toe look in our marketing, enhanced environments. Traffic is a lagging indicator what we expect to see which is occurring and has been occurring is higher conversion and steady of somewhat higher ADT with an intensified need of 12 gram [ph] across both digital and traditional we’re hopeful that we will see an increase in our traffic levels. Having said that until this occurs we are not going to forecast and improvements in your trend rates within North America so we’re actually waiting for it to occur and when it occurs you will know about it.

Operator

Thank you. The next question is from Oliver Chen with Citigroup.

Nancy Hilliker – Citigroup

Hi everyone this Nancy Hilliker filling in for Oliver Chen. I wanted to follow-up on just what I was talking about also can you give us any information in terms of why maybe the new lifestyle program and new capital collection et cetera wouldn’t maybe help comp guidance going into holiday and also if you could talk a little bit about skew rationalization just if you’re planning to sort of focus more on certain products et cetera that will be great. Thank you.

Lew Frankfort

In terms of Capsule as we have communicated in the past it is a very small collection, there are five handbag skews that go across all stores and this is the collection that only launched 3 – 4 days ago and the initial results are very promising that we can share but obviously given the size of the launch we do not expect it to be providing a major inflection alone to the business. In terms of skew rationalization that will certainly be something that we look at moving forward especially as we look at bringing other categories into our fleet as you have heard Fran report earlier our shoe relaunch continues to take hold where we have seen footwear move from the 4% penetration to 8% of the business. Most of that has come in the expansion within the 70 locations where we have added fashion assortments and as you also heard Fran referred we’re very pleased with the fact that it is the fashion assortment that is checking with consumers and not just the typical snicker and flip-flop business of the past.

Operator

The next question is from Brian Tunick with JPMorgan.

Brian Tunick - JPMorgan

First question on SG&A came in better than what we would have expected given the sales. So I’m wondering if there were any timing shifts maybe from marketing perspective or anything we should think about coming into big holiday period [ph]. And then on inventory at the channel, it would be very helpful if you could provide some more color on how do you feel about inventory levels at department stores or wholesale accounts like Zappos given that you mentioned U.S. sales were down modestly and selling was down slightly. Thanks.

Jane Nielsen

Sure just let me comment on the 30 bips of SG&A leverage that you saw, it's largely timing. As you think about legacy last year the marketing was more predominately in the first quarter. New York Stories is going to hit in the second quarter and that accounts for all the difference in SG&A leverage. So it's simply timing. We’re calling for as you heard in the guidance SG&A, modest SG&A dollar growth and so that’s very consistent so it's an element of timing. In turns of overall inventory, if you think about inventory, we don’t guide to inventory, you saw our inventory is up about 6.5%. If you think about inventory, think about the increased overall AUCs or average unit cost is driving overall inventory and obviously our sales was – were below our expectations. Those are two primary drivers.

Brian Tunick – JPMorgan

Thanks. Best of luck.

Operator

Thank you. The next question is from Lorraine Hutchinson with Bank of America.

Lorraine Hutchinson - Bank of America

Thank you. Good morning.

Lew Frankfort

Good morning.

Lorraine Hutchinson - Bank of America

Following up on the factory question, can you talk about some of the promotions that you have tested within factory? And then how much excess inventory you expect to manage to clear over the coming quarters?

Jane Nielsen

Hi. So as you know, we – factory is our promotional channel and there are number of different levers that we used during the year to manage our factory business and drive revenue. This quarter, we did take additional promotion of on our clearance business in factory and that was mostly to offset higher AURs that we experienced with the new products that we have been launching to balance the business for the quarter.

Operator

Thank you. The next question is from John Morris with BMO Capital.

John Morris - BMO Capital

Thanks. Good morning. I wanted to talk a little – get a little bit more color from you guys on maybe comparing and contrasting the business between the retail stores and the factory specifically traffic trends and the like, maybe a little bit more color there beyond what you have already commented on? Thanks.

Lew Frankfort

Well first as reported, traffic trends in factory stores and retail stores have been tough and then – and indeed in the full price stores, our traffic slightly worsened in our – in the quarter, but overall conversion has remained strong and in fact it’s higher than our last year.

John Morris - BMO Capital

And between the two channels, Lew, was factory worse than retail in terms of traffic and/or in terms of conversion I am looking to start with [ph]?

Lew Frankfort

We don’t – just to aggregate that is a two channels, but what we can tell you is that the patterns that have existed – that existed in the prior quarter and in the prior 12 months remain consistent.

John Morris - BMO Capital

And just can Francine give us a little bit more color on where we see – where she sees the holiday opportunity this year versus last year maybe some of the specific initiatives that you might be doing around holiday to help drive the business? Thanks.

Francine Della Badia

So for holiday on the full price side and I think actually more broadly we have this fully marketing – this fully integrated marketing campaign across both marketing in our stores, in our windows and also across all of our digital channels who are very active in social media right now, those are efforts to continue to drive traffic into all of our stores during the holiday quarter. And I think specifically to Victor’s comment about the recent launch of capsule, where we are feeling good about the burrow [ph] bag and that’s a good indicator for our products initiatives as we go forward. And as we have spoken to we are excited to continue to drive our lifestyle categories, specifically footwear in men’s. On the factory side, I can tell you that we continue to see great consumer response with the new product that we have been launching so that product has performed well. We will continue to be promotional more around our clearance, but at any given point in time, we are continually testing and piloting our promotional levers in factory.

Lew Frankfort

And let me just – I would like to also add in terms of our advertising spends we are intensifying spending in the quarters that you will be seeing in both our traditional media and digital a much stronger presence of Coach communicating on the broader expression of the brand.

John Morris - BMO Capital

Thanks very much. Good luck.

Lew Frankfort

Thank you.

Operator

Thank you. At this time, please limit yourself to one question per request. The next question is from Edward Yruma with Keybanc.

Edward Yruma - Keybanc

Hi thanks and good morning. I was wondering if you could tell us about the customer that’s in the stores buying some of your lifestyle product, if it would be shoes or watches. Is it existing customer? Are you capturing new customers and are they also making a purchase of the bag at the same time? Thanks.

Jane Nielsen

We’re experiencing both, so it is an existing customer, would you find that consumer to buy handbags from us also participate in a significant way in other parts of the business and the other lifestyle categories and we’re also attracting new customers, especially with some of their repositioning, moving watches to a more fashioned assortment at a $225 average price point and also footwear with the new trend right fashion product assortment, we’re definitely seeing new customer engaging in the footwear category for us.

Operator

Thank you. The next question is from Liz Dunn with Macquarie.

Liz Dunn - Macquarie

I was just wondering on gross margin if you could give us a sense of where merchandised margin or mark downs shook out in the quarter relative to last year and as I look at the guidance sort of versus last time is the delta there just increased promotion at factory because off the other sort of items that you have mentioned had been pressures that we were expecting before or have any of those sort of intensified? Thank you.

Jane Nielsen

Yeah sure. Liz let me break it down for you that, to equate to our guidance now. So there will be heightened promotional levers in our North Americas factor channel as Brian mentioned largely related to clearance especially during the holiday season. So that’s one of the largest changes from our previous guidance as we have noted before we expect the Yen to be about 50 basis points of pressure on us and that is reflected in channel mix that we don’t get the benefit because of the Yen of the higher growth margin in Japan. Overall we have also seen some rising sourcing cost, called out labor in the fourth quarter, we’re also seeing some overall sourcing cost increases and then we have the inventory amortization from the acquisition of our JV and Coach Europe. If I break it into those four buckets that encompasses the margin pressures both versus prior year and versus previous guidance.

Operator

Thank you. The next question is from Barbara Wyckoff with CLSA.

Barbara Wyckoff - CLSA

Could you talk about the key differences between China and the North America in terms of conversion, men’s we know is stronger, you know in terms of just the big business buckets?

Lew Frankfort

Overall I would say that of course what we’re experiencing in China is a much lower conversion rates that is due to our lack of awareness and as awareness grows of course so will our conversion as consumers discover more fully the Coach story. Saying that our lack of history of course has the advantages as I addressed in the speaker’s notes of allowing us from the very early stages to position the brand as a lifestyle brand. As I mentioned this past quarter approximately in fact almost exactly 1/3rd of our sales in China came through other categories, men’s and other lifestyle categories including footwear and women’s outerwear and we expect that will continue to increase as we further develop in the quarters ahead our lifestyle categories through transformation and this really speaks to our previous comments that the impact of transformation on the brand of course is not only going to provide the context and relevance for Coach to achieve renewed growth in the North American market but also to help position us more fully to compete more successfully in emerging and international markets where we don’t have a history.

Barbara Wyckoff - CLSA

Can you also talk about the tests in the United States to add more footwear using a pool stock [ph] for shipment to customers what is going on with that? Fill footwear in more stores.

Jane Nielsen

So we do footwear in 175 locations right now and what we have been doing is testing footwear in having a smaller assortment in about 10 additional doors to see if we can service the customer with sizing in inventory in an order from Jack and we will continue to test and probe more around distribution opportunities in footwear. The other thing that I will say is as we continue to look at the fleet and have remodeled store opportunities, we will take advantage of mobile POS technology and remove cash wrap for the mobile POS technology and dedicate more square footage on the selling floor on two categories like footwear. In terms of Jacksonville, we have a very active program right now in our distribution center, where customers can order shoes from any store in the fleet.

Barbara Wyckoff - CLSA

So by the end of the year, you will have footwear you think in how many – the ability to buy footwear in how many locations?

Jane Nielsen

And you can buy footwear in any location today off of our program CBSR which is the Coach by special request, you can order from any store.

Operator

Thank you. (Operator Instructions) The next question is from Dana Telsey with Telsey Advisory Group.

Dana Telsey - Telsey Advisory Group

Good morning everyone. As you think about inventory planning if you go into the balance of the year, how you are planning inventories and if you think about the collections what should we be looking for in terms of updates to collections, new collections until Stuart comes out with his own collections? Thank you.

Francine Della Badia

Yes. So why don’t I address the inventory question. So I think as I said we don’t provide guidance on inventory, but we expect based on square footage growth that you will see continued inventory growth through FY ‘14. And we have a few factors that I outlined and you see cost increases, the acquisition of Coach Europe and also our expansion into lifestyle categories. So there are three things that are driving inventory growth. And you know that we have a proven track record of managing our inventory very profitable over time. So our inventory is current, its currency and we feel that we are in a reasonable position.

Lew Frankfort

In terms of your question on newness moving forward, we see in the second half as we go beyond holiday an increasing presence in capital that will be a further rollout of burrow [ph] and other capsule silhouettes across the entire fleet both in terms of new fabrications as well as a couple of new styles. In addition in the second half of the year, we will be bringing out new silhouettes including Domed Satchel and other collections from the spring that will lead into Stuart’s first collection, which will be in stores from fall of next year. We expect it to run across the entire fleet from September. Stuart of course is very busy currently in developing that collection and we will have more to share on that in the spring.

Operator

Thank you. The next question is from Kimberly Greenberger with Morgan Stanley.

Kimberly Greenberger - Morgan Stanley

Okay, thank you. Good morning.

Lew Frankfort

Good morning Kimberly.

Kimberly Greenberger - Morgan Stanley

My question is just about the one, two, three-year outlook, could you help us understand how you view Coach’s go-forward strategy in terms of either stabilizing market share in the U.S. and what do you think the drivers there might be and/or it’s rather you are just going to progress with the lifestyle conversion of the brand perhaps a little bit of that market share slide away in hopes of stabilizing the business potentially at a slightly smaller level. I am just looking for your big picture thinking on the kind of three-year outlook for the business?

Lew Frankfort

Our objective has been and will be to grow with the category. Handbags and accessories has been and will continue to be a key core category for Coach and the main driver of our business. Transformation is truly about providing context and emotion for the Coach brands. We do not see us evolving into a ready to wear resource first and foremost. And as we have stated previously, our focus will be in driving the other key categories around handbags and accessories that provide some context with footwear and outerwear being key drivers. We have talked about this being a multi-year strategy; we believe it's the right strategy and the right one to drive long term growth. We have a great team in place and certainly we don’t know of another brand in our core space that has the experience and the execution of transformations in their path as we do and we’re excited about writing this chapter and the journey ahead.

Operator

Thank you. The next question is from Michael Binetti with UBS.

Michael Binetti – UBS

I wanted to ask you about the U.S. store count and I guess the full price stores and you guys gave some update language [ph] on that, it sounds like it's still tracking to the plan you gave us 90 days ago. I wanted to think about that in the context of where the comps are and how you see the trajectory of the comps over the next few quarters Lew and perhaps why it makes sense to continue growing footage here, will we see more a stabilization in the U.S. same store sales numbers?

Lew Frankfort

I’m sorry, the last part you did a review of the comps?

Michael Binetti - UBS

Right why I guess the square footage growth rate in the U.S. is staying where it's at as far as the plan considering where comps are right now and the trajectory that Jane laid out for us over the next few quarters, does it make sense to continue the footage growth in the U.S. until we see more of a stabilization in the comps.

Lew Frankfort

The answer is that we’re very thoughtful about the way in which we look at distribution and we have that situation where we do have markets both on a factory side and extremely selectively on the full price side whether opportunities are to develop, a three standing dual gender stores as well men stores at the same time we’re focused on productivity measurements particularly being sensitive to our full price fleet which needs to lead. And what we’re not showing in comp of course, comps that not show is the benefit of the revenues that we’re achieving in the first 12 months of these new store openings and we might say when we look at these new store openings through a store they are very productive.

Jane Nielsen

But Michael just to build on what we called out in Q4 is that we do continue and what you saw still in Q4 as we continue to look at our overall real estate position as things come under lease renewal and expiration and we make a judgment based on each store and the trading area and we will continue to do that. It's in our practice and we will continue to do that across our fleet.

Michael Binetti - UBS

And maybe would you mind telling us a little bit about I’m a little bit interested to hear where some of the good SG&A control came from in the quarter particularly with the square footage growth being up. You know I will get some detail when the 10-Q comes up and maybe you can just talk about it qualitatively? Thank you.

Jane Nielsen

Well I think that what we called out in Q4 was that the actions we took in the restructuring, we’re going to fund investments that we’re making in the brand. You saw that play out in Q1 with the improvement in our SG&A ratio we will be coming from an issue of timing of marketing spend, so you will see that the about consistent through the year should be up through the year but Q1 was the low Q1 last year because of the difference of timing between Legacy and Coach New York Story.

Operator

Thank you. The next question is from Paul Lejuez with Wells Fargo.

Tracy Kogan - Wells Fargo

Thanks its Tracy Kogan filling in for Paul. I had a question about your launch of more lifestyle categories within the factory channels. If you could just help us what with when we might see these categories in the stores and how many stores will get them, how many skews et cetera and then if you could just tell us maybe I think you said 20 stores where you had footwear, how did the productivity of those stores compare to those without the footwear? Thanks.

Jane Nielsen

Right now we have outerwear in 140 factory stores, so the initiative in outerwear is rolled out and it's performing quite well so we’re seeing good improvement to last year in that category. We just recently launched women’s and men’s made for factory watches. That is the new launch this quarter. And so we are excited about the growth opportunity in the watch category in factory stores. In related to footwear in the 20 stores, we are going to be rolling out to an additional 70 stores later in the spring and in the 20 stores where we currently have footwear we are continuing – we are looking at optimizing the footwear presentation in these locations and adding additional assortment to these locations starting in the third quarter. In terms of productivity in these stores, the productivity is incremental and is – they are performing quite well. We are also seeing the same type of fashion appetite coming out of our factory division that we are seeing in full price.

Lew Frankfort

We invite you to visit factory and full price stores near you. And what you will see in the factory fleet, in particular, is our new design concept, which has been extremely well received and actually provides the environment for a much fuller expression of the brand.

Operator

Thank you. This does conclude the question-and-answer session. I would like to turn the call back over to Andrea Shaw Resnick for closing remarks.

Andrea Shaw Resnick

Thank you all for joining us today. As our practice, we like to close the call before the market opens. So I would like to turn it back to Lew and Victor for some closing comments. Gentlemen?

Victor Luis

Thank you, Andrea. I would first just like to thank everyone for joining us and want to congratulate Lew on his last call as CEO. And we on the management team of course are very much looking forward to partnering with him in his new role. This leadership team inherits a fantastic iconic brand that is grounded in authenticity and heritage with a proven history and success in reinventing itself. And we are all very excited about working together and partnering to write the next chapter of the Coach brand. As I mentioned earlier very few if any brands in our space indeed have the success of reinvention that this brand and this company has. And we are excited about resetting ourselves for a period of sustained growth.

Lew Frankfort

And well, I have said on previous calls from time-to-time just stay tuned everybody. Have a good day and enjoy the rest of the week. Thank you everybody.

Operator

Thank you. This does conclude the Coach Earnings Conference. We thank you for your participation.

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