Full Transcript of Coach’s 1Q06 Conference Call - Prepared Remarks (COH)

| About: Coach, Inc. (COH)

Here’s the entire text of the prepared remarks from Coach’s (ticker: COH) Q1 2006 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.

Executives:

Andrea Shaw Resnick, VP of Investor Relations

Lew Frankfort, Chairman and Chief Executive Officer

Mike Tucci, President of North America Retail

Mike Devine, Chief Financial Officer

Analysts:

Bob Drbul, Lehman Brothers, Analyst

Dana Telsey, Bear Stearns, Analyst

Margaret Mager, Goldman Sachs, Analyst

Neely Tamminga, Piper Jaffray, Analyst

Jeff Edelman, UBS Securities, Analyst

Pauline Reader, Thomas Weisel Partners, Analyst

Elizabeth Montgomery, SG Cowen, Analyst

Christine Chen, Pacific Growth Equities, Analyst

Operator

Good day, ladies and gentlemen, 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 Vice President of Investor Relations and Corporate Communications at Coach, Ms. Andrea Shaw Resnick. You may begin.

Andrea Shaw Resnick, VP of Investor Relations

Good morning, and thank you for joining us. With me today to discuss our quarterly results are Lew Frankfort, Coach's Chairman and CEO; Mike Devine, Coach's CFO; and Mike Tucci, President of North America Retail, will also be joining us.

Before we begin, we must point out 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 or control costs. 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.

We presently expect to update our estimates each quarter only; however, the failure to update this information should not be taken as Coach's acceptance of these estimates on a continuing basis. Coach may also choose to discontinue presenting future estimates at any time.

Now let me outline the order of speakers and topics for this conference call. Lew Frankfort will provide an overall summary of our first fiscal 2006 results, and we'll also discuss our strategies, going forward. Mike Tucci will review our key initiatives for the holiday season, Mike Devine will conclude with details on financial and operational highlights for the quarter as well as our outlook for the second quarter and full fiscal year 2006. Following that, we will hold a question-and-answer session that will end by 9:30 a.m.

I would now like to introduce Lew Frankfort, Coach's Chairman and CEO.

Lew Frankfort, Chairman and Chief Executive Officer

Thanks, Andrea, and good morning, everyone. As you know, we have once again announced excellent top-line growth and even stronger bottom-line results of 30% and about 50%, respectively, for the quarter just completed.

Our quarterly results are especially impressive when you consider that we have achieved exceptional double-digit sales growth in the first quarter of each of the last four years, up 28% in '03, up 34% in '04, up 33% last year, and now up 30% in '06 for a four-year CAGR of over 31%, as sales have tripled.

As most of you know, during the last several years, we have established a lane between the moderate segment and the old luxury accessory brands, which we termed "accessible luxury." This positioning coupled with our brand and business equities is Coach's competitive advantage yielding staying power, more predictable results, and increasing productivity.

Some highlights of our first fiscal quarter were, first, net income rose 48% to $100 million, or $0.26 per share compared with $68 million, or $0.17 per share in the prior year. Including the impact of stock option expense, net income rose 53% to $94 million, or $0.24 per share compared with $61 million, or $0.16 per share in the prior year.

Second, net sales totaled $449 million versus $344 million a year ago, a gain of 30%.

Third, direct-to-consumer sales, which now include sales generated by Coach Japan rose 29% to $315 million from $244 million in the prior year.

Fourth, U.S. same-store sales for the quarter rose 25.1% with retail stores up 14.4% and factory stores up 35.8%.

It is worth mentioning that in U.S. retail, we have achieved a double-digit comp in the first quarter in each of the last four fiscal years, 21% in '03, 29% in '04, 17% in '05, and now 14% in '06. On average, our retail stores are twice as productive than they were just four years ago.

Finally, sales in Japan rose 24% in constant currency driven by new stores, expansions, and mid-single-digit retail comps as we continue to rapidly grow our market share.

During the quarter,we opened 6 U.S. retail stores including 2 in new markets for Coach, Wilmington, Delaware, and Memphis, Tennessee, as well as three factory stores. In addition, we expanded 3 U.S. full-price stores, Copley Place in Boston, White Plains in Westchester, and a store in Scottsdale, Arizona. Thus, at the end of the period, there were 199 full-price and 85 factory stores in operation.

In Japan ,4 locations were added while 1 was expanded. At quarter-end there were 110 total locations in Japan. Indirect sales, which now exclude sales generated by Coach Japan increased 34% to $134 million from $100 million in the same period last year. Results were primarily driven by strong gains in U.S. department store and international wholesale sales. In fact, U.S. department store results at PoS continued to be excellent despite continued sluggish overall channel sales, running up about 30% at PoS last quarter.

Most broadly, we once again effectively executed our growth plans and realized company-wide performance that outpaced our stated goals. Not surprisingly, we remain confident in our ability to sustain our growth and deliver excellent results over our planning horizon.

We were particularly delighted with the continued momentum of Coach U.S. retail stores, which enjoyed increases in average ticket and traffic. Results are now full-price businesses, both Coach retail stores and U.S. department stores continued to be driven by the monthly flow of fresh and relevant product, notably handbags and women's small leather goods. Our U.S. factory store business remained remarkably strong this quarter, even in the wake of higher gasoline prices given the vibrancy of the Coach brand, the appeal of the Coach product, our exceptional value, and the continued relative strength of premium factory centers.

We were also very pleased with the performance of Coach Japan this quarter, it’s first as a wholly owned subsidiary where sales rose 23% in dollars and 24% in yen as our market share continued to grow rapidly. Clearly, this emphasis on distribution growth is working given the sales gains we are continuing to achieve while rapidly growing our footprint. Last quarter our growth in Japan was fueled primarily by distribution through both new stores and expansions augmented by mid-single-digit, same-retail location sales gains.

Finally, as always, we were particularly pleased with the significant improvement in operating margins. While Mike Devine will get into more detail on our financials, I wanted to give you this recap and tell you how pleased we are with Coach's first quarter performance.

As you know, I've asked Mike Tucci to also join us today to discuss our product performance for Q1 and our holiday sales initiatives. Mike.

Mike Tucci, President of North America Retail

Thanks, Lew. As mentioned in our release, our transitional and fall offerings were remarkably successful across all categories and collections. We began the quarter with Hampton's Weekend offered in a new fall palette, which also featured a great signature scarf print version for the first time. Also in July we brought back an updated Soho collection in leather, suede, and mini signature, which included novelty studded and ocelot styles.

In August, the Chelsea handbag group, offered in leather, Nubuc, and Optic signature was very well received.

In September, our popular Hamptons collection returned for a sixth season and performed strongly across all fabrications, leather, suede, and signature as well as a stripe application on our classic signature fabric. This fall, the collection also included a stylish update on the carryall, which was particularly successful, actually selling out in certain sizes and colors.

Throughout the quarter, we were extremely pleased with consumers' response to our more sophisticated Silhouette and luxurious materials, as Limited Edition styles sold extremely well at higher price points. Examples of Limited Edition styles, which blew out and speaks to the ongoing opportunity to selectively trade up our average retail in handbags include the Optic signature chenille tote at $598, the signature python striped satchel, and the Soho studded flap satchel, both at $498. More broadly, a key driver of our success in Q1 was a planned shift in color selling from brights; that is, pinks and greens, to more neutral shades such as warm browns and khakis.

For holiday, building on this shift in the marketplace, you will see a broad range of neutrals complemented by pops of reds as well as a stronger patchwork statement. In addition, many of our items will offer stylish embellishments such as metallics, fur, and beading, which are particularly suitable for holiday gift-giving.

We are excited about the 10 key concepts and items that we will have in place for holiday. Collectively, we estimate that they will represent over 60% of our business in the second fiscal quarter. They are, one, duffels, launched on 10/1. Leading the list, these great new takes on the duffel were inspired by iconic Coach styles and reinterpreted into modern, sophisticated Silhouettes. They are offered across multiple core fabrications with new hardware detailing and include a Special Edition patchwork and Limited Edition shearling version.

Two, gallery totes, also launched on 10/1, already a success, this group also includes stylish beaded series in classic signature and suede, which have new details, colors, and treatments, including fur trim.

Three, holiday patchwork, which is launching later this week, a perennial favorite, this year's sophisticated take on patchwork will include touches of metallic and ocelot, will be available across a range of handbag silhouettes, including totes, duffels, demis, and in a wristlet as well.

Four, Madison, also launching this week, Coach's lifestyle evening collection will return after its successful debut last year. It includes handbags, accessories, hats, scarves, gloves, shoes, and outerwear. This collection will be fabricated in satin, chenille, Lurex, and mink with some styles accented with crystal and velvet details.

Five, ski, coming later this week as well, made of a quilted satin fabric with a subtle interpretation of the iconic C, these bags will be available in select hobo silhouettes and wristlets and have a soft, relaxed feeling with fur trim that adds an element of luxury.

Six, Soho small hobo and small-flap hobo, these consumer favorites are among our best-selling bags and will be offered in a range of fabrications and colors from mini signature to metallic.

And on the accessory front, seven wristlets offered in core and novelty fabrications at a wide range of price points.

Eight, wallets ,offered in multiple colors and fabrications including metallic. A great item for gift or self purchase.

Nine, watches, which feature the popular gallery interchangeable bezel model, along with new watches, which offer diamond accents or alligator and lizard straps.

And, 10, cold weather, including scarves offered in a range of colors and great novelties and gloves in neutrals and brights featuring proprietary hardware such as the Soho buckle and grommets, the perfect cold-weather gift.

A great group of novelty accessories will complement our key items for holiday including letter charms and iPod cases. Already introduced, these were instant successes. Beyond our key 10 holiday statements, we are capitalizing on seasonal and niche opportunities through our Resort and Coach Baby offerings, which will launch in December, and which will also be featured in our gift guide.

First, Resort will feature appliquéd signature carryalls and suede-trimmed duffels, a new edited tote and accessory group featuring a whimsical bubble print and learning from last year's assortment, which identified an opportunity for leather within Resort will offer a leather and suede group of soft hobos offered in metallic and soft pastels.

And, second, Coach Baby is a niche offering, which includes baby bags, photo frames, a brag book, and a capsule group of baby accessories, and we have an adorable Coach teddy bear, which will round out the assortment.

As always, our holiday floor set will be installed on the Monday before Thanksgiving with special attention given to clean and bold presentations of the key item holiday statements and items. A front table change in all stores will take place in early December to coincide with the launch of Resort.

On the marketing front, our expanded holiday catalog featuring the World of Coach, will be in home in early November and will include our Resort collection. We are also very excited about our expanded gift guide, which goes from 16 pages last year to 24 pages this holiday. It will be in-store before Thanksgiving and will include mail distribution as well, a change from the prior year. This piece is an important selling tool for our store teams and also will be put in each consumer's shopping bag with her purchase. As always, it will highlight the key concepts and items we have in place for holiday.

And, finally, on the in-store experience, as you know, Coach services and initiative we began implementing last year, it is intended to enhance our consumers' in-store experience and ultimately drive conversion. This comprehensive training program teaches interactive selling and engagement techniques to our sales associates. For FY06 the program has evolved focusing on new opportunities to deliver consistent customer service.

In Q1, we introduced Client Track, essentially the next phase of Coach service. This automated online journal keeps track of customers and their profiles including contact information, bag style and color preferences as well as special requests. Client Track also helps the store manager facilitate the timely follow-up of customer request, such as new items in store, arrival of out-of-stock items, in-store events, and gift-giving occasions, enabling the store manager to monitor customer requests and reach out to her beyond the four walls of the store.

This fall we introduced Smart Scheduling to aid store managers in identifying key traffic opportunities we call "peak days" and "power hours," and effectively scheduling the right sales associates on the selling floor at these peak selling times. Essentially, this means that our store managers will be getting more detailed sales and labor forecasts as well as projected traffic patterns earlier in the season than in prior years, allowing them to hire for each store's holiday staffing requirements up front, and for the first time using our new Shopper Track system during the holiday season, store managers can access real-time hourly sales, traffic, and conversion data to better impact labor allocation during shifts.

For holiday, we'll take key Coach service learnings and operational best practices from last year to improve upon our customer-centered and operationally efficient in-store experience. These include, one, an enhanced service leader role and use of daily coverage tools to support Smart Scheduling; two, the use of Client Track to support gift-giving through customer follow-up and in-store wish listing; and, finally, three, the introduction of our multiple gifting initiative as part of our Coach By Special Request program to better service our customer purchasing multiple quantities.

Simply put, our objective this holiday is to leverage our PoS transaction speed with improved service and operating standards to move the lines through the store faster. Naturally, many of these initiatives introduced for holiday will continue afterwards.

With that, I will return the discussion to Lew with our over-arching strategies. Lew.

Lew Frankfort, Chairman and Chief Executive Officer

Thank you, Mike. Within an ever-changing environment, Coach remains true to our proven formula for success. We continue to stand apart from the competition based upon our five touchstones, distinctive brand, leadership position, loyal consumer base, multi-channel international distribution, and our focus on innovation and the consumer. Our strong and seasoned management team, relevant and exciting product supported by our dynamic global supply chain continues to sustain our unique position in the marketplace.

The Coach brand has never been stronger nor has our proposition ever been more vibrant, thus positioning us to capitalize on the abundant growth opportunities ahead of us and to achieve continued excellent financial results in the years ahead.

To this point, as most of you know, we have been implementing four key strategies that focus on sustaining growth. First, most generally, we are building market share in the growing North American women's accessories market by leveraging our unique position as an accessible luxury lifestyle brand. As part of this strategy, we've been emphasizing new usage occasions such as weekend or evening, and offering novelty and Limited Edition products to heighten our cachet, especially with our top-tier customers.

Our second strategy is the continued rapid growth in U.S. retail. We plan to add 100 U.S. retail stores over the next four to five years, bringing the retail store base to at least 300. During FY06 we intend to open about 25 new retail stores, which will include 8 new full-priced markets for Coach, Wilmington, Delaware, and Memphis, Tennessee, two stores we opened already in the first quarter. The other six will be stores in Oklahoma City; Naples, Florida; Albany, New York; Reno, Nevada; Fresno, California; and Omaha, Nebraska. In keeping with our strategy to expand our most productive locations, we will be expanding at least six U.S. retail stores in FY06. These expansions will add a total of about 9,000 additional square feet, or about 2% to our total full-price retail space.

In addition, we are also planning on opening three more factory stores in FY06 and expanding five outlets given the tremendous success we have experienced through our Woodbury Commons store expansion, which we discussed during our last conference call.

Separately, I wanted to mention how excited we are about the two flagship openings coming up in November, Rodeo Drive in Beverly Hills and the new 595 Madison Avenue store here in New York. As you know, we view our flagships as grand statements or beacons for the brand conveying the essence of Coach in the lifestyle environment. We appreciate that flagships actually advance consumers thinking about the brand by allowing us to showcase the entire world of Coach.

These two high-profile flagships convey a strong sense of American luxury. We've used a combination of natural and raw materials to create a sophisticated yet inviting and unique environment. And, third, outside the U.S., we are continuing to rapidly grow market share with the Japanese consumer from about 8% this past year to a goal of 15% during the next four to five years. We are driving growth in Japan primarily by opening new retail locations and by expanding existing ones.

Overall, we expect that we could eventually have a total of at least 140 Coach locations in Japan across the same multi-channel distribution model that we have established in the U.S. During this fiscal year, we now expect to open about 12 new locations in Japan, including one flagship located in Kobe, which we currently plan to open late in the fourth quarter. Also, we plan to expand about 10 of our most productive shop-in-shops adding nearly 7,000 square feet, or about 4%, to our retail base. Overall, in FY06, we expect CJI constant currency sales to increase at least 20% from FY05 as we continue to gain share.

Our increases will primarily come from distribution growth with mid-single-digit comps expected for the year.

And, lastly, of course, we continue to have an overall focus on improving the rate of profitability so that our bottom line results continue to outpace top-line performance. These strategies and actions are designed to enable us to achieve excellent financial results through our planning horizon.

I will now turn it over to Mike Devine, our CFO, for further detail on our financials. Mike.

Mike Devine, Chief Financial Officer

Thank you, Lou. Lou and Mike 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.

As mentioned, our quarterly revenues increased by 30%, direct-to-consumer, which now includes CJI and represents about three-quarters of our business was up 29%, and our indirect segment was up 34%. Net income for the quarter before option expense increased 48% to $100 million, or $0.26 per share as compared to $68 million, or $0.17 per share in the year-ago period. Results for the first quarter were ahead of the consensus estimate of $0.25 per share. Including after-tax option expense of about $7 million in both periods, net income for the quarter increased 53% to $94 million from $61 million a year ago.

It should be noted that option expense on a per-share basis in both quarters was flat at just under $0.02.

Our operating income before option expense rose 40% to $156 million in the first quarter versus the same period last year. Operating margin on this basis in the quarter was 34.8% of sales compared to 32.5% in the year-ago quarter. Including option expense in both periods, operating income rose 44% year-over-year, and the operating margin expanded 310 basis points from 29.2% of sales to 32.3%.

In the first quarter our gross profit margin expanded by 100 basis points over the comparable period of the prior year, from 75.0% to 76.0% of sales. There are two primary contributors to this quarterly improvement. First, the positive impact of product mix driven by increased penetration of higher margin, Limited Edition, and mixed material collections and, second, our sourcing cost initiatives.

Selling, general, and administrative expense ratio before option expense declined 130 basis points in the quarter and represented 41.3% of sales versus 42.6% for the year-earlier period.

The decline in the quarterly rate was the result of achieving leverage in all aspects of our business. All selling units taken together saw their year-over-year spending rates decline as we continued to leverage the top line in our centralized functions. Including option expense of about $11 million pretax both this year and last year, the SG&A expense ratio declined 210 basis points to 43.7% of sales from 45.8% in the year-earlier period.

Inventory levels at October 1, 2005, were $215 million, up about $11 million from $204 million or about 5% above prior-year levels. As our supply chain improvements and inventory management program allowed us to support 24 net new North American stores, six net new CJI locations, and substantially increased sales levels with minimal additional inventory investment.

Accounts receivable balances rose approximately $19 million, or 23%, driven by the strength of our U.S. wholesale business. Our balances continued current and day sales outstanding remained very well controlled at 34 or about flat to last year.

At the end of the first quarter, our cash and marketable securities position stood at $539 million, about the same as prior-year levels as a result of free cash flow driven by significantly higher net income and option exercises. This was offset by substantial stock buybacks and the cash used to buy out Sumitomo's interest in Coach Japan, which, together totaled about $500 million.

Our balance sheet remains essentially debt-free at quarter's end.

As we mentioned in our press release, the company repurchased and retired 921,000 shares of common stock at an average cost of $32.54 during the first fiscal quarter. At this time, approximately $220 million remains available for future repurchases under the recently expanded program, which expires in May of 2007.

Net cash from operating activities in the first quarter was $54 million compared to $43 million last year during Q1. Free cash flow in the first quarter was an inflow of $32 million versus an inflow of $27 million in the same period last year, primarily due to higher net income. Capex spending, primarily for new stores and renovations, was $22 million versus $17 million in the same quarter a year ago.

Now I'd like to provide you with some of our goals for fiscal 2006. For the second fiscal quarter we are targeting net sales of at least $645 million, representing a year-on-year increase of at least 21% with comparable store sales gains of at least 10% in both the U.S. retail and factory channels and mid-single-digit comparable location sales growth in Japan. Operating income, both before and after option expense, up at least 24% year-over-year. Option expense in the second quarter is expected to total about $0.02 per share yielding earnings per share of at least $0.45 before option expense versus the analyst consensus of $0.44 a share and at least $0.43 after option expense, an increase of at least 32% both before and after option expense.

Our current goals for the full fiscal year 2006 are, net sales growth of about 23% to $2.1 billion with at least 10% comparable store sales gains in both the U.S. retail and factory channels in all quarters and a total sales increase in Japan of at least 20% in constant currency, which would translate to sales of at least 47.5 billion yen; Japan sales are expected to be driven primarily by distribution growth through new store openings and expansions augmented by mid-single-digit same-location sales growth; and operating margin of well over 37% before option expense or about 34.5% including option expense as compared to 33.5 on the same basis in fiscal year '05; operating income dollar growth of at least 26% from FY05 levels both before option expense and including it; interest income of about $28 million will add to EPS this year.

However, two factors will somewhat moderate that growth on the EPS line in 2006. First, a higher share count brought about by option exercises and, secondly, a higher tax rate rising to 38% due to the fact that incremental taxable income is being taxed at higher rates.

Including all of these factors, we expect to generate EPS growth of at least 28%, which will produce earnings per share, before option expense, of at least $1.28 compared with the analyst consensus estimate of $1.26. Including option expense of about a dime, similar to the percentage impact in FY05, we are projecting EPS of $1.18 per share, up at least 28% from the $0.92 per share reported on the same basis in fiscal year '05.

Separately, as mentioned on our August earnings call, we expect capex to rise to about $120 million in FY06 with the increase from the $95 million in '05 primarily due to our capitalizing on some outstanding new-store real estate opportunities. We will also be investing in our New York corporate facilities where we have a long-term lease as well as in our distribution center in Jacksonville, Florida.

We will be opening approximately 30 new U.S. retail and factory stores and continuing our North American expansion program. In Japan, we will be opening an estimated 12 new locations including a flagship location in Kobe.

While these are our current goals, our actual results may vary from these targets based upon a number of factors including those discussed under the business of Coach, Inc., and risk factors in our annual report on Form 10-K. Coach also does not assume any obligation to update these targets as the year progresses.

In summary, we are confident that our growth strategies will enable us to continue to gain share in the large and growing global market for fine accessories and gifts. Thank you, everyone, for your attention. And now Lew, Mike, Andrea, and I will be happy to take questions.

Question-and-Answer Session

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