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Coach Inc. (NYSE:COH)

Morgan Stanley 2013 Global Consumer & Retail Conference

November 20, 2013 9:45 am ET

Executives

Jane Nielsen – Chief Financial Officer

Francine Della Badia – President, North America Retail

Andrea Shaw Resnick – Senior Vice President, Investor Relations

Analysts

Kimberly Greenberger – Morgan Stanley

Kimberly Greenberger

Okay, we’re about one minute past the start time, so if everybody wants to take a seat that would be great, we’ll go ahead and get started with Coach management. My name is Kimberly Greenberger. I’m Morgan Stanley’s soft lines analysts, and thanks so much for joining us here at Day Two of the Morgan Stanley Global Consumer Conference.

Our next session here is a fireside chat session with Coach’s management. Victor Luis, Coach’s CEO could not be with us today. He’s actually in Madrid, Spain opening Coach’s 1,000th – 1,000th? – store and its first flagship in Spain, so that’s a super-exciting event this week. Obviously he sent very, very capable people in his stead. We’re pleased to be joined today by Fran Della Badia, President of Coach’s North American Retail division, and Jane Nielsen, Coach’s Chief Financial Officer, in addition to Andrea Shaw Resnick, who almost all of you in the room probably know, Senior VP of Investor Relations.

So Fran is going to kick it off with a couple of opening remarks, and then we’ll move into the fireside chat portion of the session today. Thanks so much, Fran.

Francine Della Badia

Thanks. Hi, good morning everybody. Is my mic on? Am I on? Okay. So I just wanted to say a few opening remarks because I’m new to my role in North America, but I’m not new to Coach. At Coach, we’ve been talking a lot about the brand transformation, and I started at Coach in 1999. We kind of think about that—for me, I think about that as our first chapter. I started in 1999, and we had unlined glove-tanned handbags. When I started, the big news was that we had just introduced nickel hardware on the glove-tanned unlined handbags, and it did really well. So I started at a point in the history of the company where the company was owned by Sara Lee and we needed to really reinvent the brand. The business was about $500 million. We had kind of stalled out at that level, and we had hired Reid a couple of years before to really infuse some new energy into the product assortments.

So I participated in the first steps of reinventing Coach, and what we were focused on at that time were really five things: one, reinvigorating the product assortment and creating this casual lifestyle, casual handbag company and house of leather goods into a fashion company. When I started, we didn’t have a logo developed. There was no logo product, so we worked on developing that, so really focusing on product strategy, product assortments to grow our business was key. The second thing was stores and our retail environments, creating much more dynamic retail environments and a much stronger presence in the North American landscape in our stores. The third was marking and really creating integrated marketing campaigns that would tell the new story of the Coach brand.

And when I started, as I mentioned, the glove-tanned handbags, we didn’t have a well-developed supply chain. We had a factory in Florida that was making product, and we really needed to innovate our supply chain processes and focus on our fifth segment of our strategy, which was product development and what did the product development process look like vis-à-vis all of our supply chain efforts and really starting to outsource and become much more innovative around product development and sourcing raw materials and driving better cost and margins.

So that was sort of the first chapter, and that was from 1999 to about 2002, so then as you guys know the story, we went public and then we really grew the business. The second chapter was growing our distribution and our presence and really creating the accessible luxury segment. We created it, and as our business grew, the market grew and we were becoming international, so we were focused on expanding our business internationally.

Now we’re at the third phase of our brand transformation, and it really started about three years ago. So three years ago, we started really ramping up our efforts as becoming a global brand, and what did that mean to be a truly global brand? As Kimberly just said, Victor’s opening our 1,000th store in Spain, so really having that global reach.

The second piece was men’s. We had spent so much time on our women’s effort, we hadn’t focused enough on our men’s business; and we actually started out as a men’s company in 1941. We brought a new consumer into the brand – men – and grew that very, very quickly over the past three years. Then the third piece was really digital and capitalizing on the momentum in the digital space.

So today we have those three kind of segments that we’ve been focused on, and today we’re facing increasing competition. I think that’s pretty obvious. In the face of that, we are entering the next chapter of our transformation as a brand. We’ve done it before, we’re going to do it again, and it’s really about changing brand perception and creating high emotional content and telling a more compelling story about the Coach man and the Coach woman.

That’s it.

Question and Answer Session

Kimberly Greenberger

Okay, fantastic. Thanks so much, Fran. I’d like to start with you in terms of the fireside chat portion. I’m wondering if you can share with us your key priorities as President of North America and any early learnings that you’ve had in your first, you know, not quite year on the job.

Francine Della Badia

Sure, yes. I had this job in July. So my priorities are very, very clear. One is product, focusing on product. The second is stores, and the third is really focusing on marketing. I would say starting with stores, really thinking about every consumer touch point, everything that the consumer sees in our stores, so whether it’s a window presentation, whether it’s what our sales associates are wearing, do our sales associates have fashion credibility with the customer when he or she walks into the store. Thinking about the product assortments in the store, how they’re merchandised, the store environment itself, the music that’s playing, so every consumer touch point related to the stores, and then really thinking about what’s a next generation store for Coach, what does that look like. On Friday, we’re opening our first flagship store, next generation store for Coach on Lower Fifth Avenue. It was a space that we had on Lower Fifth and 16th that we fully gutted, and it will be a very new concept store for us, so on the store side.

In terms of product, we really need to create more relevant product and get more compelling handbag and accessory product out into the marketplace. We’ve also been focused on developing our lifestyle categories, so those ancillary categories like footwear, like outerwear, jewelry; and again, creating more lifestyle categories for the brand.

And then the third piece is marketing, which is all about getting the brand story and the messaging out. We have been over the past few years too quiet on the marketing front, and this past fall we just launched our New York Stories marketing campaign using the top three models in the world, more diversity in the campaign, and then leveraging all of the social channels and digital that we can to get the story out. I think in terms of my biggest learning since assuming this role in July is I would say how unbelievably committed and dedicated our store field associates are to transform the brand and to get behind this, so that was a big piece of the business that I picked up, and I’ve been really impressed by their level of energy and commitment to moving the brand forward.

Kimberly Greenberger

Fantastic. Speaking of that store on Lower Fifth, you’ve been talking about these two new lab stores – I think the other one is in South Coast Plaza. What is it that makes these stores different, and if you find some degree of success as you’re reopening these stores or re-launching in this new format, how quickly could you roll out some of the most successful elements to rest of chain?

Francine Della Badia

Yes, okay. So we know that the experience—we have to be thinking, very forward-thinking about the customer experience in the store environment. I think obviously digital has become much more of a normal way of doing business, and in terms of customers coming into the stores, it’s really important to give them a very unique and different experience in the stores. What Lower Fifth really represents is much more residential feeling, and it is the first time where we’ve taken all of our lifestyle categories and really integrated them into the design of the store. So when you walk in, the residential piece that you’ll feel is warmth, vintage furniture so it will be more unique in terms of looking less like a retail store and more like a home, and there are rooms so there is an element of discovery for the customer who wants to come in and have that in-store experience.

In terms of our selling and service model, really evolving that also, testing things like digitally enabling our selling staff to be as digitally enabled as our consumer is. So a consumer walks into a store today and she or he has an iPhone, maybe an iPad with them. Are our sales associates as digitally enabled as our customer, and what does that mean and how does that change the selling and service experience? Using capsule, which is our first real apparel collection, how do we sell to a lifestyle collection, how do we sell apparel, putting fitting rooms into the stores, all of those things.

So we’re going to use Lower Fifth and we’re going to use South Coast Plaza as labs, as you mentioned, and really work the model, understand consumers’ perceptions and reactions to it, understand how we can continue to be thoughtful and innovative around the experience, and then think about how would we roll that out to more stores. And I would think about it as looking at the key markets across North America and having real distortion in those markets and having a flagship presence around do we have the right flagship presence in Boston, do we have the right flagship presence in L.A., and starting there. And then I think it’s multi-dimensional in terms of a rollout because we do have 350 stores. What can we do with paint and rugs that’s more cost effective, that can change kind of the environment immediately, sooner, faster.

And then the last thing I’ll say is as leases expire, we’ll be very opportunistic around that. A lot of times when we renew a lease, we will do that in conjunction with a renovation, and at that point we’ll be able to incorporate the elements from our learning into those stores, too.

Kimberly Greenberger

Great, excellent. I think as of June 30 this year, Coach still had number one market share position in North American U.S. handbags, about 25%. Obviously if you include men’s and women’s, I think the number is more like 30%. But if you could just talk about the women’s market share and how you’re—what are your targets in terms of market share and some of the strategies around that.

Francine Della Badia

Sure. I think overall as we think about market share, we are looking over time with this transformation to participate in the growth of the category. So we would look to grow with the category in North America, and we expect to accelerate growth in areas like Europe where our presence is very small, market share is small. We expect to accelerate growth in China and grow with the market, in a mature market, more mature market like Japan. So we see markets like China, Europe men’s as being market growth, market share accelerants, and we expect to get back to participating in the healthy growth of the category in North America.

Kimberly Greenberger

Okay, wonderful. Maybe you can just step back for a second and share with us your view of the North American consumer. Any observations that you have about consumer behavior would be great.

Jane Nielsen

What we’ve seen is a very fragile and, I would say, volatile consumer environment. You saw the latest November consumer sentiment number came out, unexpectedly fell. I think it was the lowest level in two years, so this is after the government shutdown. We’ve continued to see traffic into North America full price malls – this is not into our stores specifically, but into malls in general – be extremely weak coming out of the recession. We saw it fall off a cliff in the first two weeks of October. The next two weeks showed a pop back – probably some pent-up demand. But surprisingly again in November, we’ve seen very sharp declines in the NRTI, the National Retail Traffic Index.

So there is a lot of concern out there. When we piloted our own survey with Coach customers in October, and we do this every October to understand anticipated holiday spending behavior, our customers said they expected to spend 4% less on gifts across all categories for this holiday season, so obviously a lot of concern out there. We’ve seen some positive news obviously out of the stock market as well as net worth in terms of home values, but at the end of the day it seems to be a very fragile and volatile consumer environment.

Kimberly Greenberger

Great. Here’s a question I get from investors all the time. What do you think the right balance is between full price and factory stores in terms of sales, square footage, et cetera here in North America, and do you think that the growth in factory has hurt the Coach brand?

Francine Della Badia

So I think about it like this. No, I don’t think that the growth in factory stores has hurt the Coach brand. Factory is an incredible business for us. We’re very proud of our factory business and our factory consumer, and if you think about economics alone, there is more scale available to us to participate in an handbag category that’s under $300 than at our full-price average unit retail of $300. So I love our factory business, I’m very proud of our factory business.

I think the issue for us has been that we have not had enough brand impressions in the marketplace on the full price side, and what is very clear is that full price has to lead in everything we do. Full price has to lead, and so now we’re really shifting our emphasis and putting balance back into the mix on the full-price side of our business. Full price offers a halo for the brand, and so in terms of energy and effort, Stuart is on board now and focuses most of his time today on handbag and accessory development for full price.

We’re thinking about, as we mentioned earlier, full price stores – what does next generation full price stores look like? The full price marketing campaign that we launched, New York Stories, we’re actually using those full price marketing assets in our outlet stores, so you may not see a heroic shot of product on Carly cloth, but you are going to see Carly cloth and the same brand imagery in an outlet store that you are going to see in a full price store.

So it’s one brand with two different levels of distribution, and that’s how we’re thinking about it. It is as important today as we look at the outlet and factory development in North America. Our co-tenants many times are European luxury brands. The whole landscape of the factory business has really changed quite dramatically. The consumer that’s shopping in outlet stores is evolving, and it’s as important for us to show up in a very fashion-relevant modern way in our outlet division as it is in full price.

Jane Nielsen

We’re also viewing wholesale department stores as an opportunity to accelerate those full price impressions and the fashion-forward elements of our product. We see a distribution opportunity in wholesale and we’re also investing to make sure that our store environments or our shop environments are consistent with what they see when they walk into a Coach store.

Kimberly Greenberger

Great, thanks so much. As a management team, you’ve all been talking about the lifestyle transformation for the brand. Can you share with us when you expect some of this transformation to start impacting the business, and what are the sort of signposts that we should look for along the way that would suggest to us that this strategy is gaining traction?

Jane Nielsen

Sure. We’ve been very clearly as a management team with ourselves and we hope with our investor community that this is a multi-year journey. We know that as we step back, next year in the fall and next holiday season, that Stuart will have his first fashion—his first collection in our full price stores. We will have marketing that you see today. We’ll continue marketing so that our consumers will be aware, and elements of what Fran talked about in terms of store environments will be in across our fleet in different ways. So we’re really looking at that as a moment in terms of what we have in the store.

As you look for signposts along the way, I think I’d have to call out footwear in 170 locations in North America. In terms of what we’re seeing, we’re seeing higher AURs in our footwear, so the redesigned collection, higher AURs; and we’ve seen penetration double. We’ve also been able to do that with an enhanced gross margin on footwear because we’ve been able—the demand is strong enough that we’ve been able to delay footwear markdowns that are a normal course of business. So we’re very encouraged by what we’ve seen in terms of footwear.

We’re also encouraged with what we’ve see in terms of capsule collections, most notably the Borough bag that’s in the market right now – no discounts on the Borough bag, no resistance to a $548 price point for that medium sized Borough bag. In capsule collection, we’re getting great editorial pick-up on some of the ready-to-wear that we have in a very limited selection of stores – 11 flagship stores today. But we’re getting great editorial pick-up, and that’s really what ready-to-wear is about, presenting that head-to-toe Coach woman, and fashion credibility will be picked up in editorial by the press.

Andrea Shaw Resnick

And you know, Kimberly, I’d add just two things to that. Fran already talked a little bit about our success with men. Most of you know that we took men’s from a $100 million business in FY10 to $600 million last year. It will be over $700 million this year, on it’s way to a billion. We took a lifestyle strategy approach to men’s right from the beginning. I would also point to the success of our lifestyle dual gender presentation in places like China where there wasn’t necessarily a preconceived notion of Coach as a pure handbag brand where illustratively just last quarter one-third of our sales in mainland Chinese stores came from men’s and other lifestyle categories. So that would be another proof point, if you will, along the road to transformation.

Kimberly Greenberger

Okay, excellent. Part of this process is really transforming the business from being an international handbag resource to a global lifestyle brand, and I often get asked what gives management confidence that they can navigate the transition, and are there any other companies or brands who have gone through this kind of transformation that you’re embarking on?

Francine Della Badia

So as I said and started out, I’d been a part of our first reinvention. We have done this before. This isn’t new to us. What’s different is that then we were $500 million and today we’re $5 billion. Some of the things I pointed out around supply chain underdevelopment is now highly developed, so we’re in a position today to as we start to get some of these proof points in place and, incredibly importantly, we need to allow time for the creative process to take hold. Our business is product. Product needs to be emotional, and we needed to bring Stuart in to really inspire a new way of thinking about Coach product, particularly in the handbags and accessory category, and that is going to allow us to really have a big re-launch when we get there in September. His fall collection really hits September, and then a big push for holiday next year.

We do today have 350 points of distribution in full price. As Jane talked about, footwear I think today—footwear is the best category that’s demonstrative of the consumer appetite and acceptance of fashion from Coach at a higher AUR, at better full price sell-throughs. So thinking about that and what that means just as a model to where we can get to in handbags and accessories, and because of the infrastructure and our operating model, we can get there very, very quickly once we get the product designed and developed to where we want it to be.

Andrea Shaw Resnick

And I’d just add onto that, the second part of your question on are there brands that have done this before, I think if you look at the vast majority of European luxury brands, and I won’t call them out by name, but may have started as, for example, luggage companies or shoe companies or, for example, trench coat companies – I know none of you can guess who I’m talking about – who have successfully transformed taking their sort of brand equity, because all of them grew organically from the product rather than a person and have transformed into lifestyle brands very successfully. So I think there is significant proof points out there in the marketplace.

Francine Della Badia

And just to add one more thing, I think that we have really—as a brand, we have really strong emotional equity out there in the marketplace. We do, and so my experience is everybody has a Coach story. Everybody has their first Coach story, whether or not they are an existing consumer today or not. There is that positive emotional connection to Coach, and the idea is to leverage that and to take that emotional equity and really bring it forward into being competitive in the marketplace with highly emotional, great product today.

Kimberly Greenberger

Great, excellent. Oh my goodness – do we really only have three minutes left? I hope that’s not right. I think we’re running out of time. Very quickly I’ll ask one last finance question and then see if there are any questions in the audience. Jane, can you talk about some of the moving pieces in operating margin, you know, gross margin versus SG&A, and what are you doing to sort of maximize your operating margin? And then maybe if you could just mention your capital allocation policy and is there any sort of appetite for additional share repurchases, or how do you think about cash deployment?

Jane Nielsen

Sure. Why don’t I start with the first in terms of the moving pieces in terms of operating margin. So as we talked about versus last year, if I segmented it into the key drivers, what we called out was that the yen having a big impact in terms of gross margin, about 80 basis points. We also called out versus last year that product sourcing is a big impact, largely labor but broader than that. In China, everyone is aware of what is happening in terms of labor rates, minimum wage increasing 16% as it was called out. Now, we’ve been front-footed in combating that in terms of diversifying our manufacturing space out of China into lower labor markets, but the inflation is a factor that’s playing out there. Again, that’s about 80 basis points.

The other factor in terms of gross margin versus last year is the acquisition of our business in Europe and the acquisition of that inventory has an impact for the first couple of quarters in terms of gross margin. We also talked about in our first quarter call that our expectation is that we’ll be more promotional, especially in clearance in our factory stores, especially in the second quarter. So those are some of the factors.

As we think about getting down to operating margin, we have a number of factors that are playing in favorably. We have the mix shift into international – that’s a favorable. The mix shift into men’s is also favorable from a gross margin standpoint and therefore an operating margin standpoint as tailwinds into the marketplace.

We are spending more in terms of marketing, which we signaled. If you peel back against marketing, one of the factors that we called out is that we are going to spend all the marketing, about $25 million that was spent on (ph Reese Grakoff) brand on the Coach brand. So you may not see it in terms of percentage of sales, but we’re going to have more marketing overall against the Coach brand.

We’ll continue to leverage the infrastructure that we’ve put in place in China, and that will be accretive to operating margin as China builds in overall operating margin.

In terms of—now I see that I’m running out of time. In terms of capital, we called out that we continue to be committed to returning capital to shareholders, both in the form of dividends which we had a history of growing, we said that we’ll at least grow that with net income, and $700 million in terms of share repurchase that we’re forecasting for FY14, so about at our three-year average. So it’s a billion dollars returning capital to shareholders – great yield, great profile in terms of returning capital to shareholders while we continue, as I called out, to invest in the business.

Kimberly Greenberger

Excellent. Maybe we’ll just take one question from the audience, and I’m sorry we ran out of time here. Is there a question? We’ve got one up here.

Unidentified Analyst

Yes, I wonder if you could discuss demographics of the new Coach lifestyle purchaser. Can you compare and contrast it to the existing Coach customer, and what kind of a Coach customer in terms of age group, income you’re really targeting in this new look?

Francine Della Badia

We’re targeting both bringing in a younger consumer, the 18 to 24-year-old, as well as our existing consumer today. Our first metric to move will be conversion with our existing customers coming into the store and seeing more product that they like. Our average North America customer is in her mid-30s with an average household income of around $100,000. Interestingly in factory as well, although in factory she tends to be in her 40’s. She is college educated. If she’s buying us in our full price store, she tends to be in the white collar workforce right now. If she’s buying us in factory, she tends to be on sabbatical from the white collar workforce, and that’s basically here in North America.

In Japan, we would see the average household income closer to—excuse me, average age closer to 40 based on the demographics of Japan. Her average household income is about $80,000, and she also tends to be employed. If you’re looking in mainland China, shockingly the average household income is about $26,000 U.S. equivalent, so we’re clearly targeting that emerging middle class there, and the average age of the consumer is about 30.

Kimberly Greenberger

Excellent. Ladies, thank you so much. It was really a pleasure to have you today. Thanks everyone.

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