Coach, Inc. (COH) Q3 2016 Earnings Conference Call April 26, 2016 8:30 AM ET
Andrea Shaw Resnick - Global Head, IR & Corporate Communications
Victor Luis - CEO
Jane Nielsen - CFO
Andre Cohen - President, North America
Bob Drbul - Nomura
Ike Boruchow - Wells Fargo
David Schick - Consumer Edge Research
Erinn Murphy - Piper Jaffray
Randy Konik - Jefferies
Oliver Chen - Cowen & Co
Michael Binetti - UBS
Anna Andreeva - Oppenheimer
Welcome to this 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 Global Head of Investor Relations and Corporate Communications at Coach, Andrea Shaw Resnick.
Andrea Shaw Resnick
Good morning and thank you for joining us. With me today to discuss our quarterly results are Victor Luis, Coach's Chief Executive Officer and Jane Nielsen Coach's CFO.
Before we begin we must point out that this conference call will involve certain forward-looking statements including projections for our business in the current or future quarters or fiscal years. These statements are based upon a number of continuing assumptions. Feature results may differ materially from our current expectations based upon a number of important factors including risks and uncertainties such as expected economic trends or our ability to anticipate consumer preferences, control costs, successfully execute our transformation and operational efficiency initiatives and growth strategies or our ability to achieve intended benefits, cost savings and synergies from the Stuart Weitzman acquisition.
Please refer to our latest annual report on Form 10K and our other filings with the Securities and Exchange Commission for a complete list of risks and important factors. Please note that historical trends may not be indicative of future performs. Also certain financial information and metrics that will be discussed today will be presented on a non-GAAP basis which you may identify by the terms non-GAAP, constant currency, excluding the negative impact of foreign currency or excluding charges associated with financing short-term, purchase accounting adjustments, contingent payments and integration costs.
You may find the corresponding GAAP financial information or metric as well as the related reconciliation on our website www.coach.com/investors and then viewing the earnings release posted today.
Now let me outline the speakers and topics for this conference call. Victor Luis will provide an overall summary of our third fiscal quarter 2016 results and will also discuss our progress on global initiatives across markets.
Jane Nielsen will continue with details on financial and operational results for the quarter and our outlook for the business for the balance of the year. Following that we will hold a question-and-answer session where we will be joined by Andre Cohen, President, North America. This Q&A session will end shortly before 9:30 AM, we will then conclude with some brief summary marks.
I would now like to introduce Victor Luis, Coach's, CEO.
Good morning, thank you Andrea and welcome everyone. As noted in our press release we are very pleased with our third-quarter performance which was consistent with our expectations and reflects the return to growth for Coach across the key financial metrics of sales, operating profit and bps. We drove further sequential improvement in North America direct business with both channels strengthening similarly while the Internet also contributed to results this quarter. Our international businesses posted strong growth on a constant currency basis highlighted by double-digit increases in Mainland China and Europe as well as sales gains in Japan and other Asian countries.
We were especially gratified by our ability to drive this inflection for the brand against the backdrop of macroeconomic and promotional headwinds and amid volatile tourist flows globally. Overall, our results continue to give us confidence that the cumulative impact of our actions will continue to drive topline growth this fiscal year and positive North American comps in the fourth fiscal quarter.
Importantly, during the third quarter we delivered on our plan across businesses and geographies while continuing to successfully execute our brand transformation across the key consumer touch points of product, stores and marketing.
Our elevated Coach 1941assortment resonated in our retail stores globally as well as in key new specialty retail accounts having debuted in Nordstrom Saks Opening Ceremony, Fred Segal and Jeffrey New York as well as Colette in Paris, LUISAVIAROMA, Umeda Hankyu in Japan, Galleria West in Seoul and Lane Crawford in Greater China. In outlet our snoopy fashion vignette was particularly well-received and we will continue to surprise and delight the consumer in this channel with increased levels of innovation. We continue to transition the fleet into our modern luxury concept driving comp improvement.
Finally, our new heritage marketing campaign focused on originality and authenticity highlights Coach's key competitive differences separating us from the landscape of both legacy European luxury and American accessible brands. We are also pleased by Stuart Weitzman's results this quarter. As noted in our press release we expect to close on the acquisition of the brands Canadian distributor in the fourth quarter. Longer-term, we continue to believe that Stuart Weitzman has significant potential in the integration to-date reflects our ability to operate as a multi-brand company.
And as Jane will discuss in more detail we also announced an operational efficiency plan today focusing on creating a more agile streamlined corporate structure enabling us to be more responsive to rapidly changing business conditions. The plan includes the elimination of over 300 positions worldwide representing about a 10% decrease in global corporate staff or about a 2% reduction in our total workforce.
These actions will allow us to emerge as a global brand led company with fewer layers, larger spans of responsibilities and a consistent global voice across merchandising and marketing. To this end, we are promoting two seasoned Coach executives Andre Cohen and Todd Kahn. Andre is being promoted to President, North America and Global Marketing adding North America wholesale as well as global marketing customer experience and digital to his responsibilities.
Todd is being promoted to President, Chief Administrative Officer & Secretary and will expand his scope to include IT, supply-chain, global environment and procurement. They are both proven leaders with experience across many aspects of Coach's global business and a well-prepared to address the opportunities ahead of us as we continue to transform.
Most importantly, they have consistently delivered results for our brand and company in their respected 8 year tenures. In addition, Diane Mahady has assumed the role of Global Head of Merchandising for the Coach brand. In this Diane will oversee merchandising for the entire Coach portfolio including women's, men's and licensed categories.
With these changes Gebhard Rainer, President and Chief Operating Officer and David Duplantis, President, Global Marketing, Digital and Customer Experience will be leaving Coach. I want to take this opportunity to thank both Gebhard and David for their important contributions to the company. Gebhard notably for his work on the successful integration of Stuart Weitzman over the last year and most recently for his leadership in our restructuring and efficiency initiatives.
And David who has made significant contributions to Coach over his 18 year tenure and role spanning North America merchandising, e-commerce and digital and global marketing. He was a key player in building Coach into a leading global lifestyle brand establishing our digital footprint in most recently in our brand transformation. The entire Coach team has great admiration and respect for Gebhard and David significant accomplishments and we wish them the best.
Now, it has been our recent practice I would like to share some of the actions we've taken to build momentum across the three Coach brand pillars of product, stores and marketing. Starting with product, where Coach is clearly emerging as the house of modern fashion design.
During the third quarter as in the first half of the year, essentially all of our retail channel assortment both men's and women's were Stuart Weaver's [ph] designs. It was however the first quarter that included Coach 1941 and emphasized our elevation strategy. This was a pivot from holiday where we distorted the under $300 price point in our gifting assortment. The rouge, saddle and dinky [ph] have all performed well with price points up to $800 and above. The Swagger family which anniversary it's original launch in February 2015, comp to comp with the new Mercer Satchel also contributing to results.
Essentials while deemphasized were highlighted by the introductions of the Turnlock Edie, Edie 31 and Prairie. In outlet the offering of Stuart's designs in updates represented over 90% of the assortment with key new styles in women such as the Sierra Satchel, the City Zip Tote and the Mini Bennett performing well along with the Phoebe and Christie groups [ph].
On the men's side a strong group of bags and backpacks drove our business. We also had an exceptional response to the snoopy fashion vignette as mentioned proving that this customer will respond to innovation and novelty. After the success of our first complete runway show in September and the Coach 1941 launch we followed up in February at New York Fashion Week introducing our 1941 fall collection. Once again, it received significant attention from the fashion press as well as top-tier specialty retailers and luxury department stores.
On stores, we are continuing to establish our new modern luxury concept stores globally, renovating and opening 40 during the quarter including six renovations and two new modern luxury stores in our directly operated North American business taking us to about 290 across all channels worldwide. We remain on target to end the year at over 400 of our doors including wholesale in the new format. Consistent with plans these renovations have been driving significant inflections from previous trends and comps which exceed the balance of fleet in the vast majority of stores around the world.
We are especially excited about the ongoing positive comps we are driving in our renovated North America retail stores including those stores that have now anniversaried there remodels. In North American department stores we renovated eight shop-in-shop locations to modern luxury in the third quarter. Finally, we have about 35 shop managers in place today and have seen a significant impact versus the balance of doors and expect to hire another 15 by the end of the year.
On the marketing front, we remain focused on creating desire for our brand amplifying our fashion positioning and our 75 year legacy of design innovation, craftsmanship and quality, building emotional connections with consumers globally. In February we debuted our heritage campaign featuring Coach icons and starting with the saddle bag followed by the dinky bag in March.
This global brand campaign is a key vehicle to communicate our authentic history as America's original house of leather with taglines such as, We Got Our Heritage The Old-Fashioned Way, We Inherited It, setting us apart from the direct competitors who are often inspired by our archives. Also position to amplify our brand heritage we are very pleased with the response to our Coach vintage initiative. A collection of highly covered bags for the 1970s and 80s that we've reclaimed masterfully restored and hand embellished by Coach Artisans modernizing them for today in making each a one-of-a-kind. The collection was a big hit during its debut launch at Colette in Paris in December and later saw success at Barneys New York.
Our next installations will be available in premium locations in Beijing, Tokyo and Hong Kong with a global online auction completing the initiative later this fall further amplifying our storied heritage and fashion credibility to a cool audience. Our fashion advertising campaign supported the launch of Coach 1941. Focused on the saddlebag and shot by photographers Steven Meisel, it has captured the attention of consumers worldwide through our bold positioning in social, out of home and prints [ph].
And resonating with our broad audience and primarily position through the digital channels, Chloë Grace Moretz and Kid Cudi continue to be the faces of our celebrity campaign. Once again our runway shows we’re highly engaged and amplified through social media with our London Men's Show in January garnering over 150 million impressions and our February New York fashion week show driving over 700 million impressions and ranked number three of the top mentioned hashtags by WWD during New York Fashion Week reflecting the increasing vibrancy of our brand.
And our online instashop runway initiative featuring the rouge bag sold out within an hour. On Coach.com, we’re further enhancing our emotional bonds with our visitors through a series of personalization initiatives including the recent introduction of our customizable store repatch. We've also evolved our suite of monogramming initiatives and introduced a feature that allows for adding a charm to bags to making them even more personal.
Looking forward to the balance of calendar 2016, we will continue to amplify our fashion positioning while celebrating our 75th anniversary focusing on our distinctive brand proposition. No other American brand in our space can claim the unique combination of heritage and craftsmanship that is our DNA fused with the modern fashion sensibility of Stuart's vision. As a result of these efforts we are seeing continued progress with consumers. Importantly, in our quarterly North America brand tracking survey fielded in March we saw an increase in category drivers as a percentage of Coach consumers and strength in our overall brand affinities.
So as our plans unfold and the momentum builds we are delighted with our progress and proud of all that our team has accomplished to drive Coach's transformation. The Coach brand is very much on its way to evolving from a specialty retailer and accessories brand to a true house of fashion design defining modern luxury. We are excited to see our creative vision and direction gain traction and will continue to update you on these initiatives as we move forward.
Turning now, to a discussion of category trends. Overall, we estimate that the North America premium women's handbag and accessories market grew at a low single-digit rate in the March quarter. Our quarterly survey also showed a higher handbag purchase intent among the broad premium purchases versus six months ago. Importantly, Coach's sales of women's bags and accessories once again improved sequentially in North America. And of course, as a lifestyle and multi-brand company we also participate in categories outside of women's bags and accessories. Men's which represents about 17% of global net sales on an annual basis posted strong results in the quarter.
We continue to believe it is a growth opportunity for the brand and is still forecasting mid-single-digit growth during FY ‘16. Over our planning horizon, we believe men's remains a $1 billion opportunity. In North America, we have tested and intensified men's focus in key stores which entailed increased marketing support and enhanced assortment in a more prominent location in-store.
With a strong response from consumers we will be expanding our men's presence in the fourth quarter and specifically we will be rolling out men's to over 25 more retail and 40 more outlet doors. And of course, we also remain focused on building Coach, Inc. market share within the fragmented men's and women's $27 billion global premium footwear category which we estimate will grow at a mid-single-digit pace over our planning horizon.
Looking ahead, we see significant growth opportunities for the Stuart Weitzman and Coach brands in this category. While Jane will provide additional details on sales and distribution by geography we wanted to touch on some current trends and strategies by market starting with North America. As you read in our release for the quarter our total Coach brand sales and direct business in North America were up both 1% as reported in 2% in constant currency.
In aggregate, we drove another significant improvement in our direct businesses in the third quarter. Comp trends in both retail and outlet stores accelerated while the Internet contributed to aggregate comp as well. Overall, our comp was flat lead as expected by retail including a slightly positive impact of our e-commerce business which contributed less than one percentage point. Higher ticket and higher conversion were offset by a decline in traffic which was hurt in part by the overall weak mall trends.
As a reminder, we have now fully anniversaried the pullback in eOS and in preferred customer events which impacted both our coach.com and retail businesses. Therefore, going forward we would expect our online business to move at least in-line with our store trends. Now looking at results sequentially, as planned improvements in both conversion and traffic from the second quarter drove results with tickets still positive. While Easter contributor to our comp, this was offset by a shorter winter sale period which ended about 10 days earlier than last year. Importantly, our performance underscores our confidence in delivering positive North America comp by the fourth quarter.
Now turning to our retail performance and the metrics we traditionally share on product. The above $400 price bracket rose in penetration saw another positive comp on a sales and unit basis and reported about 40% of handbag sales up from about 30% last year. The increases showed continued progress of our elevation strategy driving our handbag AUR to over $300 in the quarter for the first time since FY '09. As planned we deemphasize the entry price point gifting assortment coming out of holiday and therefore saw a decline in the 300 and below handbag price segment.
And after several years of decline in logo penetration and gains in leather our North America logo business has stabilized at less than 5% in retail and about 25% in our outlet channel similar to the prior year. We will continue to monitor consumer preferences and fine tune this balance as needed.
Now on stores, as mentioned, we have been very pleased with the performance of our modern luxury stores particularly in the North America retail channel where comps remain positive with now 67 stores renovated including 15 added in the last nine months. As noted, we are especially excited about the ongoing positive comps we are driving in those stores that have now anniversaried there remodels. In the outlet channel as noted previously, our results have been more mixed and we have not seen the same level of inflection given the newer store base notably in men's standalones.
To-date, we have completed 31 outlet renovations including 17 in FY ‘16 and opened a total of seven outlet stores in the new format three in FY ‘15 and four year-to-date. We remain on target to resonate about 60 North American stores this year. In terms of elevating our customer experience this quarter we made significant progress in leveraging our leather services to differentiate the Coach experience and to drive conversion while opening three new craftsmanship bars globally [indiscernible] and Sendai, Japan and King of Prussia in Philadelphia.
Turning to event marketing. In FY ‘16 we've continued to evolve and optimize our events with the goal of further reducing the number of days on promotion and as previously mentioned, our plan included two closed or targeted events this fiscal year, the first of which was held in September and the second of which occurred in March consistent with prior years timing. We will also run two shorter duration open sales events over key traffic periods, Black Friday and Mother's Day. We've been encouraged by the behavior of new customers acquired during sales events who subsequently engage in full price purchasing at the same rate as new customers acquired during the non-promotional periods.
Looking ahead to spring and summer, in retail we are excited about introducing our first ever pre fall collection rounded [ph] in handbags and ready to wear with new animations and sizes of the best-selling rogue and new novelty platforms and the iconic Coach Dinky and saddlebags. We will continue to implement our elevation in fashion strategy in all doors with additions to the popular swagger family in a rainbow of fun fashion colors and unique colorful exotics.
Additionally, we had SKU adds in the Mercer Satchel and market [ph] tote coming in May. Men's trend strength continues into the fourth quarter driven by ongoing traction in leather goods ready-to-wear and footwear with enhanced store placement and marketing distortions. And in June, we will be celebrating our 75th anniversary with a special collaboration with another storied American brand to be announced later this spring.
In outlet we are heading into Mother's Day which will feature elevated floral novelty via leather [indiscernible] details and print. Our gift offering is robust including boxed sets, color print in small bags and small leather goods and newness into jewelry. In May, we have launched a rainbow color story aligned with our retail stores featuring some of our strongest new styles that launched in the third quarter including the Sierra Satchel. Just in time for Memorial Day we will reintroduce our reversible toast which was the bestseller during the holiday season.
In June, we tell an Americana story featuring an update to our best-selling [indiscernible] print in totes and small bags which are important key drivers for the summer season and we're also excited to roll out men's to all outlet locations anchored by leather backpacks, messenger bags and an assortment of wallets and belts.
And now moving on to international, in greater China our third-quarter sales rose 2% in constant currency driven by double-digit growth and positive comps on a the Mainland, Hong Kong and Macau -- on the Mainland, excuse me. Hong Kong and Macau remained weak and continues to be impacted by a dramatic slowdown in inbound tourist traffic notably from the Mainland. At this juncture, with very limited visibility to an evolving macroeconomic environment and tourist spending flows we’re updating our annual forecast to be in the area of $600 million to reflect continued softness in Hong Kong and Macau.
Importantly, and despite near-term volatility, we remain optimistic on the prospects for this market over the long term as the drivers we have consistently mentioned are more relevant than ever. It's important to note that we see the Chinese consumers and increasing part of our total business. During the third quarter, our global business with the Chinese continued to grow. Declines in travel flows into North America and Europe notably France, along with continued softness in Hong Kong and Macau were more than offset by strong domestic spending and growth in Chinese tourist spend in other key travel destinations including Japan, Korea and Southeast Asia.
To that end, sales in Japan were up 7% on a constant currency basis and 8% on a dollar basis reflecting the strong yen despite a decrease in square footage. Sales again benefited from increased PRC tourist flows and the positive response to our new modern luxury stores from Japanese consumers and tourists alike seemed most notably in conversion in these locations. We would expect some slowdown in the constant currency growth of our Japan business in the fourth quarter as we anniversary the dramatic increase in Chinese tourist last spring. In Europe our brand is continuing to grow rapidly through new directly operated stores, wholesale locations, and comps. Our overarching focus continues to be building the brand awareness with both local domestic consumers as well as tourists.
In the third quarter, our business grew at a double-digit pace driven by both distribution and comparable store sales. As many brands have referenced, we did experience relative softness in France in the quarter due to weaker tourist traffic following the tragic terrorist attacks.
Overall, and despite these headwinds we are maintaining our FY ‘16 sales outlook of about $125 million. Over our planning horizon our goal is to achieve over a $0.5 billion in sales at retail representing a mid-single-digit share of the premium men's and women's bag and accessory market. In our other directly operated Asian markets outside of China and Japan, namely South Korea, Taiwan, Singapore and Malaysia, sales growth was solid across the entire region and local currency but declined in dollars. Here to we are focused on driving productivity through our transformation initiatives.
Finally, I would like to point out that we are seeing disparate results in our international wholesale businesses which while small are important to growing brand awareness. In the third quarter our overall sales at POS increased moderately driven by strong growth in those distributor operated locations focused on the domestic consumer while travel retail blowup [ph] was relatively weaker due to volatility of tourist spending flows globally. On a net sales basis revenue grew modestly in the quarter driven by shipment timing with the second quarter.
In closing, we are encouraged with the momentum of our business across all of our regions and the return to growth for the company. Most importantly we are proud of the progress we have made along our transformation journey in the evolving perception of the Coach brand and Coach, Inc. as we move from the specialty retailer to a house of modern luxury brands.
Now I'll turn it over to Jane for details of our financial results and guidance for fiscal 2016. Jane?
Thanks, Victor, and good morning. Victor has just taken you through the highlights and strategies. Let me now take you through some of the important financial details. Please note, the comments I'm about to make are based on non-GAAP results corresponding GAAP results as well as the related reconciliation can be found in the earnings release posted on our website today.
Overall, we are very pleased with our performance in the third quarter which marks a return to growth for the company. With an inflection across the key metrics of sales, operating profit and earnings. These results clearly reflect the positive impact of our transformation strategy augmented by the Stuart Weitzman business. Consolidated net sales totaled 1.03 billion for the third fiscal, an increase of 11% versus prior year. On a constant currency basis total sales increased 13% for the period.
Net sales for the Coach brand rose 3% in dollars and 4% on a constant currency basis with both the North America and international segment up on a year-over-year basis. Stuart Weitzman brand sales were 79 million in the quarter, total gross profit was 713 million, an increase of 7% compared to the year ago period while gross margin was 69% versus 71.6% last year negatively impacted by foreign currency and the inclusion of Stuart Weitzman in this year's margin.
Coach brand gross margin was 69.9% and included approximately 110 basis points of pressure from currency. In terms of trends by segment, North America gross margin declined on a year-over-year basis but to a lesser extent than in the first half of the year as planned. Margin continued to be negatively impacted by increased promotions in the outlet and wholesale channels in response to heightened discounting activity. These decreases were partially offset by the impact of an improved mix of elevated product sales and higher initial markups primarily in our outlet stores. International segment gross margin increased from prior year excluding the negative impact of foreign currency.
Stuart Weitzman brand gross margin was 58.2% in the first quarter and pressured overall consolidated gross margin by 90 basis points as expected. Consolidated SG&A expenses were 561 million, an increase of 8% versus prior year. As the percentage of net sales SG&A totaled 54.3% compared to 55.8% in the year ago quarter. Coach brand SG&A expenses increased 1% consistent with expectations and totaled 54.8% as a percentage of sales.
Stuart Weitzman SG&A expenses were 39 million or 48.9% of sales. Total operating income for the quarter increased 4% from last year to a 152 million while operating margin was 14.7% versus 15.8%.
Operating margin for the Coach brand was 15.1% in the quarter, importantly we were pleased with our margin results in Q3 and are confident in our path to operating margin expansion beginning in the fourth quarter of FY ‘16. Operating margin for the Stuart Weitzman brand was 9.3% and pressured Coach, Inc. consolidated operating margin by 40 basis points in the quarter. Net interest expense was $7 million in the quarter as compared to 1 million in the year ago period.
Net income for the quarter totaled a 124 million with earnings per diluted share $0.44, up 24% and 23% versus prior year respectively. This included a contribution of $5 million or $0.02 per share from Stuart Weitzman. The charges under our previously announced transformation plan have totaled 313 million to-date including 9 million in the third quarter as outlined in detail in this morning's press release.
We continue to expect to incur the balance of these charges by the end of FY ‘16 primarily related to global store closures and organizational effectiveness bringing the total multiyear charge to about 325 million.
Now moving to global distribution, as you know, our overarching focus continues to be re-platforming our stores, elevating brand perception, optimizing our store fleet and opening new locations selectively in key markets. In total, we closed nine net Coach brand locations globally primarily related to store closures in North America as planned. In addition, we opened one Stuart Weitzman directly operated location in the quarter.
Looking to the full-year, in FY ‘16 we continue to expect our Coach brand directly operated square footage to be up low single digits globally. This guidance continues to assume that Coach brand square footage in North America will be essentially unchanged. Internationally, distribution growth will be led by Europe and China where we continue to project double-digit increases in square footage.
In Japan, we continue to estimate a mid-single-digit decline in square footage as we take a portfolio approach to optimizing our fleet. And in our directly operated businesses in Asia outside of China and Japan we continue to focus on developing our current store base and expect only modest square footage growth this fiscal year. Closing with Stuart Weitzman distribution we continue to expect to open approximately 10 new directly operated locations in FY ‘16.
Moving to the balance sheet, inventory levels at quarter end were $464 million including 27 million of inventory associated with Stuart Weitzman. This compared to ending inventory of 457 million for the Coach brand in the year ago period. Therefore, inventory rose 2% on a Coach, Inc. consolidated basis but was down 4% for the Coach brand. Cash and short-term investments stood at 1.3 billion as compared to 2.0 billion a year ago. Given our debt issuance in the third quarter FY ‘15 and the subsequent closure of the Stuart Weitzman acquisition, our total borrowings outstanding were approximately 900 million at the end of the fiscal quarter.
As previously shared, we expect to use these proceeds to cover our working capital needs in light of investments in our business and the new corporate headquarters. Net cash from operating activities in the third quarter was 199 million compared to 167 million last year. Free cash flow in the quarter was an inflow of $98 million versus 122 million in the same period last year. Our CapEx spending was $101 million versus 45 million in the same quarter a year ago.
Now turning to our outlook, as noted in our press release, we are maintaining our overall FY ‘16 guidance for both the Coach and Stuart Weitzman brands. Starting with our outlook for the Coach brand on a standalone 52-week non-GAAP basis for FY ‘16. Coach brand sales are still expected to increase at a low single-digit rate in constant currency in fiscal year 2016. Based on current exchange rates currency headwinds are expected to negatively impact annual revenue growth by 225 to 250 basis points.
We are still projecting a low single-digit aggregate comp decline in North America in FY ‘16 while reaching positive comps in the fourth quarter. Gross margin for the Coach brand is still projected to be in the range of last year's margin of about 69.5% on a constant currency basis with negative foreign currency effects expected to impact gross margin by 90 to a 100 basis points.
SG&A expenses net of savings are still expected to grow at a low single-digit rate in constant currency while growth is expected to be roughly flat in dollars. We continue to expect at least 50 million in incremental cost savings from our previously announced transformation initiatives. This guidance also includes the expected small positive impact from savings related to the operational efficiency initiatives as outlined in today's press release.
Taken together, operating margin is still projected to be in the mid to high teens. Interest expense for the year is estimated to be in the area of 30 million and finally our tax rate is still expected to be in the area of 28% for the year. The expected rate reduction on a year-over-year basis is primarily attributable to the geographical mix of earnings, the ongoing benefit of available foreign tax credits, the anticipated closure of certain audits and the expiration of statutes in 2016.
In addition, we are continuing to forecast Stuart Weitzman brand sales to be in the area of 340 million on a dollar basis for fiscal 2016, an increase of about 10% from FY ‘15 driving Coach, Inc. consolidated revenue growth to high single digits on a constant currency basis and adding about $0.12 to earnings per diluted share excluding charges associated with financing, short-term purchase accounting adjustments, contingent payments and integration costs.
Keep in mind, we continue to project a negative impact of about 70 basis points and 20 basis points on a consolidated gross margin and operating margin respectively from the inclusion of Stuart Weitzman given the margin profile of the business. As mentioned, we are also excited to announce the purchase of Stuart Weitzman's Canadian distributor which is expected to close in Q4 and have an immaterial impact on this year's results.
As a reminder, fiscal 2016 will include a 53rd week in our fiscal fourth quarter which is expected to contribute approximately 75 million to 80 million incremental revenue and $0.06 in earnings per diluted share on a non-GAAP basis.
We expect CapEx for FY ‘16 for Coach, Inc, to be the area of $250 million excluding the capital cost associated with the new headquarters which are expected to be approximately 175 million in FY ‘16.
Before concluding, I did want to provide you with an update on the status of our investment and our new headquarters building at Hudson Yard. As you know, together with our partner related companies we are exploring options to sell our interest in the Hudson Yard's joint venture while securing our future need for space by entering into a long-term lease there.
It remains unlikely that any sale of our interest or other transaction would close prior to our fiscal year end. Importantly, our capital allocation policy remains unchanged and over the next few years our first priority is to continue to invest in our business as we have a compelling opportunity to drive sustainable growth and value creation and we are putting our capital against this opportunity.
Our second priority, strategic acquisitions is also about growth, while we have nothing planned imminently, we want to have the flexibility to act if and when it's in the best interest of Coach, Inc. and our shareholders.
And third, capital returns. As I’ve stated before, we are committed to our dividend and expect our dividends to grow at least in-line with net income growth as our transformation takes hold. Underpinning all three of these priorities, our guardrails for allocating capital effectively, maintaining strategic sensibility, strong liquidity and access to the capital markets.
In closing, we are very pleased with our progress to-date. Our third-quarter results mark the return to topline operating profit and earnings growth and underscore our ability to drive sustainable growth for the Coach brand and Coach, Inc. To this end, we continue to expect FY ‘17 to be the year when Coach brand returns to growth across all financial metrics leveraging topline growth that is expected to be in-line with the category.
We remain committed to driving process improvements to be a more agile, focused and effective organization while also creating the flexibility to pursue our creative vision and drive growth across our brand. In support of this goal and as Victor mentioned, today we announced a series of operational efficiency initiatives focused on creating an agile and scalable business model. In aggregate, we expect to incur pretax charges associated with these actions of approximately $65 million to $80 million which will be reflected beginning in the fourth quarter of fiscal 2016. It will be substantially complete by the end of fiscal 2017. The significant majority of these charges will be recorded in SG&A expenses.
Importantly, combined with other key measures previously implemented under our transformation plan, these initiatives are expected to enable us to reach our previously stated goal of about a 20% operating margin for the Coach brand in fiscal year 2017 despite increased category and macroeconomic uncertainty and while continuing to invest in our growth strategies.
With that, I would now like to open it up to Q&A.
[Operator Instructions]. Our first question comes from the line of Bob Drbul. Sir, you may ask your question.
I’ve a two-part question on sales really. Given that you mentioned January was impacted by the shorter winter sale and your accomplish [indiscernible] for the quarter, wouldn’t that suggest that you are already running a positive comp for the last two months February and March? And the second part of it is, taking it one step further when you think about your guidance for the positive North American comp in the fourth quarter, would that suggest you’re running a positive comp right now as well?
Thanks for the question, Bob, it's certainly hard to argue with the math and I think that you can certainly safely assume that we did indeed have positive comps in February and March as you suggest.
In terms of the fourth quarter, look we still have a couple of months ahead of us but certainly is a team we remain confident in our guidance of positive North America comps for the quarter?
[Operator Instructions]. Our next question comes from the line of Ike Boruchow of Wells Fargo. Your line is now open.
So I guess Bob took sales I'll take margin. So I just wanted to dig into the fiscal '17 margin comment about 20% for the Coach brand so that's pretty impressive step up from what looks like will be something around 17% to 18% this year. Can you just kind of walk us through the drivers there? Maybe bucket the biggest opportunities as you see it and conversely what you think are the biggest headwinds you face on the margin front as you get into next fiscal year?
Sure, you know, as we've stated our operating margin guidance for fiscal FY ‘17 is really premised on the return to growth in-line with the category of the Coach brand. We now expect the category to be in the low to mid-single-digit range, a very stable growth margin on a constant currency basis of 69% to 70%. So stable gross margin, top line growth and then we will leverage SG&A to get to the operating margin expansion that leverage SG&A fully incorporates what we called out in our original transformation plan which was the restructuring actions that we will conclude with this fiscal year and a small benefit from the operational efficiency initiatives that we announced today.
Our next question comes from the line of David Schick of Consumer Edge Research. Your line is now open.
So I'll go back to sales on a longer-term basis. You talked about e-commerce impacting the comp positively and also you talked about the net effects of the Chinese consumer in different markets.
Could you talk about how to think about e-commerce impacting your, over the long-term you know going forward and again, sort of on a net basis what's the right way to think about the longer-term trend in the Chinese tourist impacting all these different markets?
Sure, in terms of e-comp we have now of course anniversaried all of this eOS pullback so we would expect it to grow at least in-line with what is happening in our store network. Of course look, the consumers are continuing to shift online so I will not be surprised if it is growing at a slightly faster pace than the store network from here on out now that we have comped all of the pullback.
In terms of the Chinese consumer and the excitement, look, first and foremost, the long-term opportunity with the Chinese consumers is as present as ever. I could not be more excited about what we're seeing in terms of even government policies still focused on domestic consumption, the infrastructure continued to develop in the mainland which is obviously helping domestic consumption as well, as well as the continued traction that our team is driving for the brand there and it's absolutely vital of course because relevance on the Mainland will mean relevance wherever the Chinese consumer chooses to shop as they travel globally.
Today what we are seeing most recently as I mentioned earlier is of course the impact of the terrorist attacks in France and specifically in Paris having a direct negative impact on Chinese tourists flows there, we’re seeing slightly negative flows here into the U.S. as well of course as continued negative flows into Hong Kong and Macau. That is one area where we thought in the fourth quarter we would have seen ourselves comping the fall from last year and we have not.
But that's more than being offset by the very strong growth that we have continued to see in Japan, Korea and increasingly in Southeast Asia and although many of those markets are distributor run, we’re very excited by what we’re seeing in Thailand and in Australia as well.
Our next question comes from the line of Erinn Murphy of Piper Jaffray. Your line is now open.
I wanted to focus on the outlets actually. I realized that they are lagging the full price in part on plan but maybe speak a little bit more about some of the initiatives you're working on to close the gap in performance between full pricing whether you can expound upon the upcoming [indiscernible] that you have in this channel and any tweaks that you're making now to the remodel strategies you’ve gone deeper into that? Thank you.
Well first let me start by saying both channels actually improved on a similar rate sequentially so we are pleased with the performance both in retail and in outlet. We had always said that retail was going to lead so the retail performance in absolute terms is slightly ahead of outlets. Basically a couple of main areas we've been working on in outlets specifically one is design and innovation. We've realized through the vignette I think Victor mentioned in his prepared remarks on snoopy that when you have got real innovation and emotion it trumps price. It was successful and it's something that we are planning to replicate over the next few quarters both in terms of these one-off sort of we call them play concepts and more generally in terms of putting more design and innovation in the outlet channel.
In terms of the modern luxury renovations, they have not been as successful as in retail. We've not moved the needle that much, that said we have got a number of learnings that we are currently addressing. We have used our Woodburry common store as a pilot where we have done things such as moving more product to the floor. We’ve realized that when there is too much product on the wall, not enough on the floor it effects impedes conversion. We've fragmented the store a bit too much so you don't get a sort of 360 view when you enter the store etcetera. So loads of small operational improvements. The positive news is that in Woodburry when we started these tweaks about two or three months ago we have seen an improvement in the control of the metrics conversion in ADT, so good learnings and we're going to keep implementing them throughout the chain.
Our next question comes from the line of Randy Konik of Jefferies. Your line is now open.
I guess just back on the outlets. You’ve done a great job on the full price channel getting rid of those promotions and moving to a more full price higher average ticket business. You talked a little bit about, just a little bit about the increased promotions and outlet wholesale. Can you give us some perspective on what inning we are in their where you can potentially maybe walk a little away from those promotions? And just a little more flavor there will be very helpful. Thank you.
I will let Andre start with outlets and then I'll take the wholesale channel.
Sure, so we have certainly seen the environment become more competitive in outlet generally over the past couple of quarters. Traffic has continued to drop and competitive intensity has increased. So we have been pragmatic in dealing with that. We have been promotional where we had to be, we have pulled up where we could.
Going forward again the plan is to innovate more to just have a high content of newness, innovation and more emotional play concepts to offset the price pressures we have seen over the last couple of quarters.
In terms of the wholesale channel, look, I think all of you who traveled to the department store world where we are present in North America obviously very aware of the environment. You may also follow a lot of the brand trackers that are out there in terms of sales to understand what is happening with promotions and AUR in that channel and I would say that we are in the very early inning there of our transformation. As many of you know, we've invested now and I just mentioned in my prepared remarks in 12 locations in the new concept, that's out of a thousand that we have across North America. We are investing in the shop manager program for the Top 50 locations by the end of this fiscal year and in both of those cases we are seeing a inflection versus the rest of the fleet.
In addition of course, we have made very significant progress in our penetration with the Tier 1 department stores with 1941 while also pulling back on those Coach specific promotional days. Irrespective of all of that, the absolute number of chain wide sale days continues to be an issue in that channel and we continue as a team to have discussions with our partners about a couple of areas.
One, first and foremost is the potential for the pull back on all our promotions which would include our exclusion and cooperation with our partners from the bulk of storewide event and quite frankly we are also looking at potentially exiting lower volume doors going forward. So these are considerations we are taking right now.
Our next question comes from the line of Oliver Chen of Cowen & Co. Your line is now open.
Regarding inventories, our question is regarding inventories and what are the thoughts regarding the next few quarters in holiday in terms of the context of the handbag sector and the promotional environment? And also in context of how you are thinking about how you will bucket prices with the 300 below versus the above 400 mix? Thanks.
I'll let Andre start with first and foremost the bucketing strategy and dealing with seasonality in that area and then Jane will take total inventories.
Yes, so as you know for Q2 our holiday quarter we had beefed up our gifting assortment to be able to just offer a wide range of prices and that strategy worked well. Coming out of Q2, we focused on our elevation strategy with 1941 launching across the bulk of the chain. We have seen a significant improvement in our $400 and above price point. It's now 40% of the business.
Overall our AUR handbags have actually record high of $300, that’s the highest we have been in handbags since fiscal '09. So the elevation strategy is working. Obviously as we get into the more holiday periods we will flex with again with a wider gifting assortment at a wide range of price points.
Oliver, if you look at inventory, as it's been our case, we always look to match inventory roughly in-line with our sales growth outlet. So I think you'll start to see inventories and very modest growth in the fourth quarter and moving into FY ‘17 is very much in line with our sales outlook and expectations.
Our next question comes from the line of Michael Binetti of UBS. Your line is now open.
I know there been a few questions on the outlets. If I could just -- I guess I was just thinking a little bit more broadly about North America brand sales. As we think about your guidance next year Jane for low to mid-single digits North America comp growth roughly in line with category, I guess by channel you sound clearly more comfortable with the sustainability of what you are seeing in full price.
Do the outlets in your mind need to be positive to deliver that kind of low to mid -singles on a sustainable basis for the blended comp? And if so maybe just a few comments on what you're seeing that gives you confidence that the outlet channel contributes you know at the positive level in the next year.
So I just want to clarify that our guidance just to be specific is for North America would be our growth and globally in line with the category which we now see to be low to mid-single digits as is our custom will come back with more specific guidance in Q4, but what we've seen is a sequential improvement in both channels they improved this quarter similarly and we would expect to see continued improvement as we move into FY ‘17.
Our next question comes from the line of Anna Andreeva of Oppenheimer. Your line is now open.
We are hoping to talk about the initial CapEx expectations in '17. As the headquarter investment rolls off, how should we think about the free cash flow generation in the business and as we think about priorities for cash could we I guess expect a dividend increase as net income is inflicting now? And just quickly follow up on what sounds like positive quarter to-date comp are you seeing improvement in the outlet channel as well? Thanks so much.
So why don’t I take the cash flow and dividend and then I will turn it over to Andre on the outlet channel. So as our net income growth and we complete the buildout of our headquarter building you will see a corresponding cash flow growth as we move into FY ‘17 as expected. Our dividends is really a part of our priorities for cash and our priorities for cash are really unchanged.
First and foremost, investing in the organic growth of our business. Second priority being M&A value creating acquisitions. As I said, nothing eminent but we want to remain open and flexible should we find something that we believe will create long-term value for Coach, Inc. in our shareholders and then finally is the return of capital to shareholders with our commitment to the dividend. We look at our dividend annually with our Board in August as we talked about in April 2014. We will look at the dividend in August that coincides with our year-end results and outlook for the following year and make a determination at that time.
In terms of just the fourth quarter, we’re left unplanned with -- we're still working towards a positive comp for the quarter. We've seen all the indicators that we saw at the end of the third quarter, still maintaining the momentum and we’re on plan, I'm not sure what -- all I can say at this point.
Andrea Shaw Resnick
Thank you. That will conclude our Q&A as we are now past 9:30 and the market has opened. I will now turn it over to Victor for some concluding remarks. Victor?
Thank you Andrea. Let me just thank everybody for joining us. A very important quarter for us this past third quarter as it marks a return to growth for the Coach brand. I could not be more excited with the momentum in our business and as a team, we are obviously very proud of the evolving perception not only of the Coach brand but up Coach, Inc. and our impact in the marketplace.
The positive impact of our brand transformation augmented by of course Stuart Weitzman is clearly reflected in the overall financial performance with terrific inflection across all of our key metrics with sales, profit and earnings growth for the first time since the fourth quarter of '13.
The turnaround of course that we've achieved to-date underscores our confidence in driving sustainable and profitable growth for Coach, Inc. over the long term and I could not be prouder of our entire team for the work and commitment that they have put in to driving our brand and the passion that they are showing to win in the marketplace. Thank you, all.
This does conclude today's Coach, Inc earnings conference. We thank you for your participation.
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