Coach, Inc. COH
Q3 2010 Earnings Call Transcript
Operator: Good day, and welcome to the Coach Conference Call. Today’s call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Senior Vice President of Investor Relations and Corporate Communications at Coach, Ms. Andrea Shaw Resnick. You may begin.
Andrea Shaw Resnick - SVP and IR Officer: Thank you. Good morning everyone, and thank you for joining us. With me today to discuss our quarterly results are Lew Frankfort, Coach’s Chairman and CEO and Mike Devine, Coach’s CFO. Ian Bickley, President of Coach International is also joining us.
Before we begin, I must note that this call will include certain forward-looking statements, including projections for our business in the current and future periods. Future results may differ materially from our current expectations and historical growth trends may not be indicative of future growth based upon a variety of risks and uncertainties. Please refer to our latest Form 10-K for a complete list of these risk factors.
Now, let me outline the speakers and topics for this conference call. Lew Frankfort will provide an overall summary of our third fiscal quarter 2010 results and will also discuss our strategies. Ian Bickley will then discuss the increasing globalization of the Coach brand. Mike Devine will continue with details on financial and operational results of the quarter. Following that, we will hold a Q&A session that will end just shortly before 9.30 am. Lew will then conclude with some brief summary comments.
I’d now like to introduce Lew Frankfort, Coach’s Chairman and CEO.
Lew Frankfort - Chairman and CEO: Thanks Andrea, and welcome everyone. As noted in our release this morning, we were very pleased with third quarter results, including excellent sales and earnings growth and a further strengthening of our full-priced businesses across all geographies. Our performance reflects the continued traction of the product and growth strategies we put into place this fiscal year and bodes well for the future.
Beyond our recent performance, we’re also very pleased to announce the doubling of our dividend at the one-year anniversary of its initiation signaling our confidence in our outlets. We’ve also authorized a new $1 billion stock repurchase program. Finally, we’re encouraged with the progress we are making in transforming Coach into a global brand. As Andrea just mentioned, we’ve asked Ian Bickley to join today’s call to talk about our initiatives notably in Asia and our development strategy for Europe initially focusing on the U.K., France, and Spain.
While I’ll get into further detail about current conditions and the outlook for the category and our business shortly, I did want to take the time to review our quarter first. Some key highlights of our third fiscal quarter were. First, earnings per share rose 40% to $0.50 compared with $0.36 in the prior year. Second, quarterly net sales totaled $831 million versus $740 million a year ago, an increase of 12%. Third, direct-to-consumer sales rose 15% to $726 million from $634 million. Fourth, North American same-store sales for the quarter accelerated rising 5% from prior year, while total North American store sales rose 16%. Sales in Japan declined 1% in constant currency and rose 2% in dollars. And finally, we continued to generate very strong sales growth and significant double-digit comps in China.
During the quarter, we opened two North American retail stores, both in new markets for Coach, Burlington, Ontario and Brownsville, Texas, and closed two others. We also opened one factory store. Thus, at the end of the period, there were 343 full-priced and 119 factory stores in operation in North America.
Moving to Japan, we opened our first men's location as well as the factory store and the wholesale location. At quarter end, there were 166 total locations in Japan with 20 full-priced stores, including eight flagships, 116 shop-in-shops, 24 factory stores, and six wholesale duty-free locations.
Indirect sales decreased 1% to $105 million from $106 million in the same period last year. This decline was due to slightly reduced shipments into U.S. department stores. We continue to manage inventories into this channel carefully, although we’ve seen significant improvement at retail as sales at POS rose 11%, the firstly quarterly sales gain in two years. International POS sales also rose in the period driven primarily by distribution.
We estimate that the addressable U.S. handbag and accessory category rose at least 5% in the first calendar quarter continuing the improving trends noted over the back half of calendar 2009. Coach’s bag and accessory sales rose about 15% across all channels in North America over the most recent quarter. In our own stores, handbag and accessory sales rose 18%.
Our total revenues in North America rose at similar pace as our overall top line, up 13%, with our directly operated stores up 16% driven by both distribution growth and positive comp performance.
As noted, Q3 same-store sales rose 5% reflecting a further strengthening of our full-priced business. Fueling this total retail comp gain was significant gains in conversion from prior year, while in aggregate traffic was equal to last year’s level. We were particularly pleased with the conversion improvement as it is the driver that we have the most control over through product and service.
In full-priced stores, average transaction size was slightly lower compared to prior year as increased handbag penetration offset most of the impact of lower handbag and accessory prices. Traffic trends improved from the second quarter and were only slightly down from the prior year.
In factory, where we continued to leverage the flexibility inherent in our business model to drive sales through pricing, we saw increases in both traffic and conversion, while ticket declined slightly.
While most of the quarter remains ahead of us, we are tracking well and are excited about Mother’s Day and the rest of the spring season. It’s also important to note that we manage our North American store business in aggregate. As such, we will continue to fine tune our marketing and promotional levels to maximize the long-term returns of both channels, while maintaining the integrity of our full-priced proposition in retail stores. As you know, we have resale price maintenance 365 days a year, a full price proposition.
As noted in Japan, we posted a 2% increase in dollars on a 1% decline in constant currency. Our market share further expanded against a continued very weak category backdrop and reflects the relevance of our accessible luxury positioning with the Japanese consumer, who is becoming much more value-oriented.
We were also very pleased with our performance in China, where our proposition of New York fashion and accessible luxury is clearly resonating with both domestic consumers and with tourists in our Hong Kong and Macau stores. Clearly, our double-digit comp store sales growth further demonstrates Coach’s great potential with this emerging consumer group.
Finally, as mentioned in our press release, our sales are trending about a year ahead of our original plan unveiled two years ago when we announced our intention to take control of this business.
Moving on to products, during the third quarter, we maintained a high level of product innovation and distinctive units. Beginning on December 26, we transitioned to spring with the introduction of a Peyton collection offered across multiple fabrications and silhouette anchored by both our carryall and shoulder bag styles.
This was followed by the re-launch of Poppy in February and the new Kristin collection in March. With its new and distinctive hardware and soft feminine styling, Kristin represents another significant design evolution for Coach and was supported by our spring ad campaign.
Just this month, we introduced a collection of Charm Tote along with new floral, graffiti prints, and Poppy. And yesterday, we launched Julia, a modern tote and hobo story featuring new branding and leather op art and print concepts along with fresh colors and patterns in Madison, which are the key statements for Mother’s Day.
In addition, this July on its anniversary, we will re-launch Poppy in new and updated style, new materials, patterns, and prints with a comprehensive and integrated marketing campaign.
Our strong product offering and rebalanced assortment strategy continues to resonate with consumers as the handbag prices were down about 12% this quarter similar to the first half of the year. These factors were the primary drivers of our conversion improvement in full price as handbag unit sales rose 22% on a comp store basis. Handbags represented 59% of sales in our North American retail stores in the third quarter, up about 10% or five points from the 54% handbags represented in the same period last year.
Moving to factory, our business remained strong. Here, we are focused on maintaining very high level of productivity through the introduction of innovative factory exclusive products combined with in-store and direct marketing initiatives targeted at our best factory customers.
Of particular note in our factory business was a significantly higher penetration of factory exclusive product at 80% compared to last year’s 60% levels. This improvement in mix favoring made-for-factory products as well as improved manufacturing cost resulted in significantly higher profitability in this channel.
More broadly, our strategies remain largely unchanged focusing on expansion opportunities both here in North America and increasingly in international markets. In addition, as always, we are focused on improving performance in existing stores by increasing Coach’s share of our consumers’ accessories wardrobe, while continuing to attract new customers into the franchise.
Starting in North America, we plan to open an additional five stores this quarter bringing the total to 20 new American retail stores for the year. In addition, we will open two factory stores. In total, we expect North American square footage growth of about 8% this year, down from about 13%.
I’d now like to introduce Ian Bickley, President, Coach International to talk about our abundant opportunities outside of North America. As many of you know, Ian has been with Coach since 1993 and has been a key architect of our international growth strategies.
Ian?
Ian Bickley - President of Coach International: Thanks, Lew, and good morning. I am very pleased to be able to talk about the globalization of the Coach brand. We now expect the global luxury handbag and accessories markets to reach about $29 billion during 2013.
Today, about 50% of global category sales and 90% of Coach sales are generated in North America and Japan pointing to a very large opportunity outside of our core markets. The most rapid growth is coming from the emerging markets, notably in Asia with China, clearly, our largest opportunity as it is expected to double from about 10% of the global market today to nearly 20% by 2013, contributing the lion’s share of category growth.
The Chinese consumer loves Coach as evidenced by the significant double-digit comps we are consistently generating and the extremely high repurchasing (tent) among existing customers. Coach’s potential in the China market is reflected in our very low unaided brand awareness of 8% compared with 72% in the U.S. and 63% in Japan among target consumers.
As mentioned, our business is trending about a year ahead of the plan we originally articulated back in the spring of 2008. We’re now targeting to achieve about $250 million in sales during FY ’12. And as a result of this growth, we are now profitable in China, also ahead of schedule as strong unit economics have allowed us to leverage the considerable infrastructure investment.
In China, we expect to open five new locations during the remaining few months of the year. This will bring our net FY ‘10 openings to 13, resulting in approximately 50% growth in square footage.
As mentioned, this week, we’re officially opening our first flagship location on the mainland in Shanghai, just ahead of the World Expo, which is expected to attract 70 million visitors to the city over six months. This 7,000 square foot store reflects Coach’s latest flagship design. We believe this important store will further elevate the brand’s image and is consistent with our strategy of raising awareness and aggressively growing market share with the Chinese luxury consumer.
Next year, we will accelerate new store openings with at least 20 new locations planned. To support our growth in China and the region, we have just started up an Asia distribution centre in Shanghai, allowing us to better manage the logistics in this region while reducing costs.
It’s important to note, that our growth in China is not constrained by finding the right locations, but rather our emphasis on excellent customer service which requires recruiting and training the right retail teams to run our stores, a much greater challenge than finding stores sites.
In Japan, the overall consumer market is very challenging and the category continues to see declines. Our focus remains on growing market share and we have done this quite well in our core women’s business. We’re now exploiting new categories such as men’s, where we’ve already seen early successes. For context, the men’s imported leather goods market is nearly $1 billion in size and has been less impacted by the macroeconomic environments than women’s.
With only a 3% share of the men’s market today, Coach is very underpenetrated. And over the next few years, we believe it has an opportunity to match our total market share of 14%. We will open two more locations in FY ‘10 or seven net new locations for the year, including the first two men’s shops. In total, we expect that net square footage growth in Japan will increase about 5% this year compared to about 8% in FY ’09.
Finally, beyond our directly owned international businesses in China and Japan, we do have significant and growing distributor run businesses in other Asian countries. For example, in Korea, Singapore, Taiwan and Malaysia, there are about 90 total Coach locations generating nearly $200 million of sales at retail. Coach is already among the top five imported brands in these markets with significant potential for further strong growth.
During this quarter, we plan to open about six net new international wholesale locations. This would take us to about 25 net new international distributor operated locations this year. At fiscal year end, there will be about 180 Coach international wholesale locations in over 20 countries around the world, generating sales at retail of nearly $350 million.
We’re also pleased to announce our expansion plans into Western Europe. As you know, Europe is a large market for women’s and men’s luxury accessories representing about 25% of the global category sales. Our experience with European tourists in combination with recent consumer research has given us confidence that our current design direction resonates with Europeans and that our price points will offer a compelling value proposition.
Further, Coach's heritage linked to New York fashion is appealing for most Europeans and creates a differentiated positioning compared to the traditional luxury brands. As discussed in our press release, we are starting with a two-pronged approach with strong local partners. Initially, we will focus on France through a distribution agreement with the prestigious Printemps department store group. Through Printemps, we expect to open at least 14 shop-in-shops in their stores over the next three years. The first will be 1,700 square foot shop which will open in June in their flagship boulevard Haussmann location in Paris followed by five additional locations by the end of the calendar year.
We have also agreed in principle to establish a joint venture with Hackett Limited, the iconic British retailer, to open in the U.K., Spain, Portugal, and Ireland creating a multi-channel distribution model in these markets. We expect the first locations in the U.K., Spain, and Portugal to open during the next 12 months.
With that, I will turn it over to Mike Devine.
Michael F. Devine, III - EVP and CFO: Thank you, Ian. Lew and Ian have just taken you through highlights and strategies. Let me now take you through some of the important financial details of our third quarter results.
As mentioned, our quarterly revenues rose 12% with direct-to-consumer, which represents over three quarters of our business up 15% and indirect down 1% due to slightly lower shipments to U.S. department stores.
Earnings per share for the quarter increased 40% to $0.50 as compared to $0.36 a year ago, while net income rose 37% to $158 million from $115 million. Excluding the one-time charge from last year’s third quarter, EPS rose 31% and net income increased 28%.
Operating income totaled $249 million, up 34% from the $185 million reported in the comparable year ago period, while operating margin was 30% versus 25.1% reported for the prior year. Excluding the one-time charge last year, operating income rose 25% from prior year or double the rate of sales growth as the year ago operating margin was 26.9% on the same basis.
In the third quarter, gross profit rose 17% to $616 million from $525 million a year ago and gross margin rate increased to 74.1% versus 71% flat in the prior year. The primary driver of our substantial gross margin expansion was lower manufacturing costs. Product mix, notably the increased sell-through of handbags in our full-priced stores and increases of higher margin made-for-factory product and factory stores was also a contributor to the year-over-year improvement.
SG&A expenses as a percentage of net sales at 44.1% compared to 45.9% in the year ago quarter. Excluding the one-time charge in the year ago comparison, the expense ratio was equal year-over-year at 44.1%. Once again, our two primary direct businesses here in North America and in Japan, both provided leverage not only to their own P&Ls, but to the corporate consolidated P&L as well.
Inventory levels at quarter end were $307 million, down about 14% from prior year on a comparable basis. On a unit basis, inventory was up 3% reflecting our lower average unit cost.
Cash and short-term investments stood at $908 million as compared with $551 million a year ago despite new purchases of $700 million worth of Coach common stock over the last 12 months. During the third quarter, we continued our repurchase activity buying nearly 11.3 million shares of common stock at an average cost of $35.52.
As of the end of the period, approximately $10 million remained under the Company’s previous repurchase authorization. As noted in the press release and by Lew earlier on this call, the Board has authorized a new $1 billion repurchase program.
As you know, we’ve also announced the doubling of our dividend rate from $0.30 to $0.60 annually effective with our July payment. It’s important to note that it will still represent only a fraction of our cash flow at about $180 million a year, leaving us more than ample cash to fund our growth and continue our buyback program.
Net cash from operating activities in the third quarter was $205 million compared to $207 million last year during Q2. Free cash flow in the third quarter was an inflow of $190 million versus $180 million in the same period last year due to lower CapEx and a higher net income. Our CapEx spending was $15 million versus $27 million in the same quarter a year ago. Naturally, we are very pleased to report third quarter earnings that demonstrated our ability to achieve strong top line and accelerated income and earnings growth.
Looking ahead, I think it would be helpful for you modelers out there to keep a few things in mind when projecting our fourth quarter. First, we would reiterate that our gross margin is expected to expand significantly in Q4 versus last year, although it will likely be somewhat lower than our Q3 rate due to channel mix as factory will be distorted in the 14-week quarter.
Second, as a result of our sales productivity gains and our ongoing operating efficiencies, we continue to expect that our SG&A dollar growth will be quite close to our top line growth for the fourth quarter. We are targeting these levels in spite of more difficult compares from last year’s fourth quarter due to our higher investment spending and increased incentive compensation accruals.
Third, we do expect to see some inventory growth as we planned to build inventories for the fall season and we begin to anniversary our average unit cost improvements. Separately based on some changes in project timing, we now expect that this year’s CapEx will be in the area of 90 to $100 million, down from our previous guidance of $110 million.
In summary, our double-digit growth demonstrates our ability to manage our business nimbly, while investing prudently in longer term opportunities for the brand. We’re accelerating our distribution plans to leverage the emerging market opportunity with a particular focus on China, while also exploring new geographies capitalizing on the increasing popularity and recognition of the brand with discerning consumers globally.
And with the business model that generates significant cash flow and with virtually no debt, we are in a position to take advantage of profitable growth opportunities globally while continuing to return capital to the shareholders.
Thank you all for listening this morning. And we’d be happy to open that up to Q&A.
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