Coach, Inc. (COH) F4Q 2013 Earnings Conference Call July 30, 2013 8:30 AM ET

Andrea Shaw Resnick – SVP, Investor Relations and Corporate Communications

Good day, and welcome to the Coach Conference Call. Todays 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.

Thanks you. Good morning and thank you for joining us. With me today to discuss our quarterly and fiscal year end results are Lew Frankfort, Coachs Chairman and CEO, Victor Luis, Coachs President and Chief Commercial Officer and Jane Nielsen, –Coachs 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 year. These statements are based upon a number of continuing assumptions. Future results may differ materially from our current expectations based upon risks and uncertainties, such as expected economic trends or our ability to anticipate consumer preferences. Please refer to our latest Annual Report on Form 10-K for a complete list of these risk factors. Also, please note that historical growth trends may not be indicative of future growth.

Now, let me outline the speakers and topics for this conference call. Lew Frankfort and Victor Luis will provide C results and will also discuss our overarching strategy. Jane Nielsen will continue with details on financial and operational results for the quarter and in the year along with our outlook for FY 14. Following that, we will hold a question-and-answer session. This Q&A session will end shortly before 09.30 am. Lew will then conclude with some brief summary of comments. Id now like to introduce Lew Frankfort, Coachs Chairman and CEO.

Thanks Andrea and welcome everyone. We shared a lot of news in our press release this morning and we understand that it will take some time to digest. This year has obviously been unique and we have recognized all that is — thats not been business as usual. Most importantly, we have taken significant steps to help reposition the company to return to superior growth rates while maintaining outstanding profitability levels. Our focus and priority is on the brand and driving its relevance to reinforce our customers emotional connection to Coach notably in North America. We have a proven group of Coach Leaders to execute our transformation strategy. This is a multiyear journey and were excited about the future, building upon our strong brand and business equities with an exceptional team at the helm. I also want to take this opportunity to thank Mike and Jerry for their important contributions in building Coach into a leading international accessories brand. The entire Coach team has great admiration and respect for their significant accomplishments and we wish them the best. And now to our results and outlook.

During the fourth quarter we approached double digit growth in constant currency and continued to gain overall traction on our key strategies supporting our transformation. We generated strong international results, leveraged the mens opportunity globally, strengthened our digital capabilities and drove excellent results in the re-launch of footwear. While we maintained our outstanding profitability levels, we were not satisfied with our performance in the womens handbag and accessories category in North America.

Moving on to some key highlights of our quarter and fiscal year. Our performance in FY13 was highlighted by increases of 7% in revenues, a 2% rise in operating income and 6% in earnings per share. It was a year of many milestones. First, we continued to leverage the international opportunities for Coach, growing organically through distribution and productivity while accelerating the acquisition of international retail businesses to our direct control. In China, Coach sales exceeded $430 million, up 40% ending the year with about a 125 locations including over 100 on the Mainland.

Second, our mens business grew almost 50% in FY13 to about $600 million as we continued to open dedicated standalone and dual gender locations globally while also rolling out a broader expression of mens through additional North American retail stores. Third, we successfully expanded our digital initiatives, driving double digit online sales growth while also exploring new ways to engage with our consumer and grow our database reflecting, shifting, shopping preferences. Fourth, we increased our quarterly dividend by 13%, demonstrating our financial strength, cash flow generation and our commitment to shareholder return and confidence in the future. And fifth and most importantly we embarked on our journey to transform Coach into a global luxury lifestyle brand building upon our leadership position in accessories.

Some key fourth quarter metrics were. First, net sales totaled $1.22 billion, an increase of 6%. On the constant currency basis, sales rose 9% for the quarter. Second, earnings per share totaled $0.89, up 3% from $0.86 in the prior year.

Third, North American sales increased 6% to $825 million from $781 million last year with direct sales up 5% and comparable store sales down 1.7%.

And fourth, international sales increased 7% to $386 million from $362 million last year, driven in part by a 35% gain in sales in China with a continuation of double digit comps. On the constant currency basis, international sales rose 17%. Most broadly we were also very pleased with profitability levels in both the quarter and year.

Turning to global distribution, during the fourth quarter we opened three new North American retail stores and closed four others. We also opened two factory stores including one dedicated men store. At the end of FY 13, there were 351 full price and 193 factory stores in operation in North America. Total square footage grew 11% for the year.

Moving to China, during the quarter we added eight new locations on the Mainland, bringing the total to a 126 Coach locations in China including 108 locations on the Mainland and 47 cities. In aggregate, there was an increase of 30 net new locations for the fiscal year or square footage increase of 33%.

In Japan, seven locations were added during the quarter, bringing the total to 198 with 24 standalone full price stores including nine flagships, 124 shop-in-shops, 43 factory stores and seven distributor-operated wholesale locations. In total, a net of 11 locations were added in Japan during FY 13 yielding total square footage growth of about 9%. We also directly operate 92 locations in Asia comprised of 48 in Korea, 27 in Taiwan, 10 in Malaysia and seven in Singapore.

Moving on to sales and productivity, starting in North America, our total revenues rose 6% for the quarter with our directly operated businesses up 5% on a 1.7% comparable store sales decrease, due in part to the Easter shift which we called out as a benefit to last quarter. While mens and our newly relaunched footwear categories performed well. As I mentioned, we were disappointed by our overall performance in womens bags.

More generally, internet sales and traffic continued up double-digit consistent with consumers shifting shopping preferences, while in-store trends notably traffic were weak. On these lower traffic levels in-store conversion was up and transaction side fell.

In department stores, sales trends at POS were slightly above last year, while shipments into this channel also rose. Overall, we estimate that growth in the addressable womens North American handbag and accessory category remained strong rising low double digits in fiscal 2013 to about $12 billion as bags and accessories continue to represent a growing portion of our wardrobe spend.

The combined North American premium womens and mens market rose about 15% in FY 13 to about $11 billion. Coach continued to participate in a market growth with our own direct channels posting solid gains for the year up 6% as mentioned with the combined market share of about 30%.

As weve discussed, were also continuing to drive our mens business globally to new standalone and dual gender of side-by-side stores and by dedicating more space for broader mens assortment in existing retail stores. In FY 13, Coachs sales of mens bags and accessories increased 50% in North America, driving the overall mens premium category which grew 25% to about $1 billion.

Looking ahead, we remain excited about the prospects to our global mens business where we believe we can reach $1 million in sales in three years from the $600 million achieved last year.

Id now like to turn it over to Victor to discuss international sales, product performance this quarter, as well as to give you an update on our progress, on transformation and what you can expect in FY 14. Victor?

Thanks, Lew. Starting with international, which today represents about a third of Coachs business, sales rose 7% in the fourth quarter or 17% on the constant currency basis, consistent with prior quarter and full year trends.

During the quarter, China sales rose about 35% from prior year, fueled by distribution and double-digit same-store sales. As Lew noted upfront, this took our full year sales to over $430 million, up 40%.

Clearly, the Chinese consumer continues to embrace Coach, as repurchase intent has remained high at over 80% among existing consumers. This is also evident by the increasing contribution of the Chinese tourist to our global sales.

Our other Asia direct businesses outside of Japan and China, Korea, Taiwan Malaysia and Singapore also posted strong aggregate growth in the quarter and the year. In total, they benefited from the retail step up from the prior year from Malaysia and Korea, which were acquired in early FY 13. Its important to note that their combined POS sales also rose at a high single-digit rate for the quarter and a double-digit rate for the year. As noted, for the quarter, we posted a 4% increase in local currency in Japan despite the top compare, while dollar sales declined 15% reflecting the weaker Yen.

Similarly, for the year, sales were essentially even with prior year on a constant currency basis and down 9% in dollars. Moving on to product, Legacy and Madison remained our key collections in the fourth quarter with new silhouettes and on trend colors introduced throughout the period. The Madison Phoebe Shoulder Bag launched at the end of the March in North America and later globally was particularly successful. We also featured a new group of Satchels and Totes across multiple collections in June.

Looking forward, were excited about the re-launch of Madison this quarter, which follows the same design aesthetic as Phoebe with clean sophisticated lines, feminine details, Rich leathers, and understated branding.

More generally, we saw a continuation of trends favoring leather hand bags across all price segments. In particular, we enjoyed healthy year-over-year sales increases in small bags and the above 400 segments continued to perform well at about 16% of handbags. Our overall handbag penetration was even for last year. And Id be remiss not to mention that this distinct newness in our factory channel where new designs are beginning to arrive in stores and online. Metro a great Tote group was a winner of late this spring and Park a fashionable leather based collection has just hit the stores and has been very well received. In fact, by the end of Q1, about 80% to 85% of our factory handbags will be new, innovative factory exclusives.

Turning to North Americas department stores, we are committed to growing this business and positioning Coach to win. Were focused on improving performance with an emphasis in growing our leather handbag and accessories business taking advantage of our auto replenishment program and executing our new shop renovation and case line transformation with significant roll out this year. Were also looking at incremental new door distribution opportunities with current partners.

Ill now give you an update on our footwear business, which as you know, we re-launched this spring in over 170 retail stores in North America with the objective of elevating our products proposition. Supporting Coach as a lifestyle brand and reinforcing our fashion credibility. The collection featuring great ballet flats, driving moccasins, fashion wedges, heels and on-trend casual style has been very well received by consumers. In fact, footwear in these locations went to almost 12% of the business immediately and stayed up the level for the fourth quarter versus about 7% in the year ago quarter positively impacting productivity in these stores.

Were focused in building our market share within this fragmented $20 billion global category. This fall well include more dominant fashion footwear assortments in our international and wholesale locations and continue to focus in building our key items. Were evolving our mix and growing both AURs and overall penetration levels across all of our businesses. Over the next few quarters the level of innovation across all products categories will continue to increase, adding emotion while strengthening fashion credibility and relevance for the brand.

This will be most notable in the holiday quarter with the arrival what were calling Capsule a curetted product assortments across categories focused on key items in bags, foot wear and outerwear. This Capsule collection will support our lifestyle imagery and to be available in select locations globally. At the same time, were enhancing our store environment across all channels and developing innovative marketing campaigns to communicate a more aspirational and consistent brand story reinforcing the bond with our existing consumers while driving new customer engagement globally. Our intent is to drive brand relevance, building on our leadership position in accessories.

Moving on to e-commerce as mentioned our North American online business was strong again this quarter with sales and traffic growing at a double digit pace with an increasing penetration coming from mobile and tablet. Additionally, we have been extremely pleased with our website evolution earlier this month as we improved the functionality and upgraded the look and feel of across all devices.

Earlier this year, we talked about our brand transformation into a global lifestyle brand anchored in accessories. As we have built out our strategic plan, we have focused on three key elements: product, stores and marketing.

To this end, weve made several important hires to strengthen our team and enhance the Coach experience. Importantly and most recently, we announced that Stuart Vevers will be joining Coach as Executive Creative Director in September and will be responsible for leading all creative aspects of the Coach brand, including womens and mens design, brand imagery and store environments.

Stuarts appointment marks an important milestone in our transformation and were extremely pleased that he will be leading our strong creative team already in place. His depth and breadth of experience will be an invaluable asset to the business in general and the design team in particular as we continue to evolve.

Im confident that his creative expertise with some of the worlds leading leather goods brands will enable him to draw upon Coachs rich heritage to create innovative product and brand imagery, elevating the customer experience and creating a fuller expression of the brand. And today we announced the reorganization primarily within the North America leadership team to enhance focus and drive execution in the companys largest market.

Most of you know, Coach Veteran, Francine Della Badia, who is currently the EVP, responsible for all North America Retail Merchandising, Planning and Allocation as well as Coachs Global Mens and Factory merchandising. She is succeeding Mike as President, North America Retail.

Longtime Coach leader, David Duplantis, EVP, Digital Marketing, is taking on the new role as President of Global Digital and Customer Experience. Javan Bunch, SVP Of Licensing, who has spearheaded our footwear relaunch, will assume the expanded role of SVP and President, North America Wholesale and Licensed Categories, reporting into Todd Kahn, our General Counsel in his expanded role as Executive Vice President, Corporate Affairs.

In addition, Ian Bickley, President, Coach International, is expanding his role to take on responsibility to include all international direct retail businesses as President, International Group. Finally, Stephanie Stahl, currently Senior Vice President, Strategy and Consumer Insights, is taking on an expanded role as Executive Vice President, Marketing and Strategy. Fran, David, Todd, Ian and Stephanie will report to me in their expanded roles.

As Lew mentioned, during the fourth quarter, we took significant steps to set the foundation for return to strong growth by streamlining the business, committing to additional brand investments and forging the next group of Coach leaders to drive our transformation.

As we enter FY 14, our strategic focus remains on the four pillars of growth we have previously shared. First and most broadly, growing our business in North America and globally by transforming into a global lifestyle brand; second, leveraging the global opportunity by aggressively growing our international businesses; third, tapping into the large and growing mens accessory category which Ive already touched on; and fourth, harnessing the growing power of the digital world.

Starting with distribution, we expect that our square footage globally and across all channels will increase about 9% in FY 14 compared to 11% in FY 13. Beginning in North America, as noted we are primarily focused on elevating our retail environment and replatforming our stores to showcase the full breadth of Coachs lifestyle categories.

In Full Price, where we have a significant number of leases coming due, were taking the opportunity to streamline our store base and reposition while at the same time reviewing expansion and relocation opportunities and capture mens footwear and outerwear businesses.

In the North America factory channel, where there is an enormous amounts of new real estate development, were focused on select new market entry as well as capitalizing mens opportunity with some repositioning in smaller stores. Balancing these factors, we will open about 20 new stores in FY 14, including two new full priced locations and at least 15 factory outlets most of which will be dual gender stores with one free standing mens store planned as well.

In addition, weve planned to close 16 full price locations as we streamline our store base by closing less productive units. Importantly, we are also expanding about 20 locations, seven full price and about 13 factory to accommodate the full build out of our dual gender presentation by adding mens to our existing stores. In total, we expect North American square footage growth of about 7% this year driven by the net of these activities versus about 10% in FY13.

Turning to China, in FY 14, we again expect to open about 30 new stores, all dual genders bringing the total to about 155 at the end of the year. In total, square footage in China is expected to grow about 25% in FY14. We expect sales to total about $530 million driven by both distribution and double digit comparable location sales. In terms of our other direct Asia markets of Korea, Taiwan, Malaysia and Singapore our primary focus remains productivity as weve invested in training, merchandising, store environments and systems creating a brand right experience. In Japan, during FY14 we expect to open about five to ten net new locations most of them dedicated mens stores. In total, we expect net square footage growth in Japan will increase by about 3% this year.

As discussed in our release, in early July we completed the repurchase of our partners50% interest in our European JV. In addition, also in July, we transitioned the two (inaudible) locations to our direct control. Therefore today, we operate 20 locations across the U.K, France, Ireland, Spain, Portugal and Germany.

As a reminder, Coachs annual sales at retail in Europe are approximately $40 million with the vast majority represented by the stores that are now directly operated as retail businesses. As you know, Europe is a large market for womens and mens luxury accessories, representing about 20% of the global category sales. We believe the region have significant long-term potential for Coach, attracting both domestic shoppers and the international tourists. Its important to note that was in bags and accessories accessible luxury is growing rapidly and as we have proven with our other directly operated businesses, we plan to play a leadership role in the development of this market segment.

Further, Coachs heritage linked to New York fashion as appealing for many Europeans and creates a differentiated positioning compared to the traditional luxury brands. Moving forward, we expect to swiftly increase our distribution primarily to wholesale locations and key retail stores. All together, we expect to open approximately 70 wholesale and ten retail locations across the U.K and Europe in FY14.

Finally, beyond our directly owned international businesses, we have significant and growing distributor run businesses in other countries. Were focusing on expanding through partners in these other regions. First, Latin America including Mexico, Brazil, Venezuela, Colombia, Panama, Chile and Peru.

Second and other Asia-Pacific market such as Australia, Thailand and Indonesia and third in the Middle East. These are in addition to the significant global travel retail opportunity that Lew mentioned earlier and continues to exist for Coach as the brands recognitions continues to grow globally.

I have just reviewed our strategies to drive growth while taking steps to streamline our fleet and maximize productivity in North America. At this time, I will turn it over to Jane Niel, our CFO for further details on our financials. Jane?

Thanks, Victor. Lew and Victor have just taken you through the highlights and strategies. Let me now take you through some of the important financial details of our fourth quarter and fiscal year results.

Our quarterly revenues increased 6% with North America up 6% and International up 7%. As noted, on a constant currency basis, revenues rose 9% overall, international sales up 17%. For the fiscal year, sales rose 7% totaling $5.08 billion with North America up 5% and International up 10%. On a constant currency basis, total sales rose 8% for the year with International sales up 15%.

Excluding unusual items, net income for the quarter totaled $254 million, up 1% with earnings per diluted share of $0.89, up 3%. This compared to net income of $251 million and earnings per diluted share of $0.86 in the prior years fourth quarter.

For the quarter, operating income totaled $371 million essentially even with the year ago period on a non-GAAP basis while operating margin was 30.3% versus 32.1%. During the quarter, gross profit rose 6% to $892 million from $838 million reported a year ago, while gross margin was 73%, an increase of 40 basis points versus year ago primarily due to sourcing cost improvements.

SG&A expenses, as a percentage of net sales, totaled 42.6% compared to the 40.5% reported in the year-ago quarter. For the full year FY 13, operating income totaled $1.58 billion on a non-GAAP basis, 2% above the $1.55 billion reported in the year-ago period. Also on a non-GAAP basis, operating margin was 31.1% versus 32.6% last year.

During the year, gross profit rose 7% to $3.7 billion from $3.47 billion a year ago. The gross margin rate was 73%, up 20 basis points versus a year ago and in line with our guidance. SG&A expense as a percentage of net sales totaled 41.9% compared to 40.2% reported in fiscal FY 12.

As I turn to GAAP metrics, let me recap the unusual items. In the second and fourth quarters of fiscal 2012, we recorded favorable tax settlements and made charitable contributions which precisely offset the benefit of the tax settlements to net income and earnings per share in both these periods. As noted in our press release, during the fourth quarter of FY 13 we recorded charges of $53 million for unusual items.

These consisted primarily of corporate restructuring, severance related expenses, impairment charges related to retail stores, as well as the write-down of a small amount of inventory. These steps include a reduction in corporate staffing levels with an elimination of over 200 jobs globally. And in aggregate, these actions increased our SG&A expense by $48 million and cost of sales by $5 million in the period negatively impacting earnings by $33 million after tax or $0.11 per diluted share.

Separately, as you saw in the press release this morning, we did announce that weve entered into a binding agreement to sell the Reed Krakoff to a group led by Reed. The sale was anticipated to close in the first quarter of FY 14 and Reed will depart the company upon the sale of the business.

Including charges, net income for the fourth quarter totaled, $221million with earnings per diluted share of $0.78 bringing total year net income to $1.03 billion and earnings per share of $3.61. Taken together, these restructuring actions will streamline our business, drive efficiencies and leverage our technology in global capabilities. In addition, these savings will fund key initiatives related to our European acquisition and our transformation. Notably, an increase in marketing spend around brand development. Importantly, we believe they will have a one-year payback and result in savings of over $50 million annually.

Moving to the balance sheet. Inventory levels at quarter end were $525 million, up 4% from FY 12 year end. Cash and short term investments stood at $1.1 billion, 24% above $917 million a year ago. During physical year 2013, we repurchased and retired over $7 million shares of common stock at an average cost of $56.61, spending a total of $400 million. At the end of the year, approximately $1.4 billion remained under the companys current repurchase authorization.

As noted last quarter, we increased our cash dividend by 13%, raising it to an annual rates of $1.35 per share, reflecting our commitment to return capital to shareholders, balance with our investment in growth of the business.

Net cash from operating activities in the fourth quarter was $375 million compared to $283 million compared last year during Q4. Free cash flow in the fourth quarter was an inflow of $293 million versus $210 million in the same period last year. Our CapEx spending was $81 million versus $73 million in the same quarter a year ago.

For the full physical 2013, net cash from operating activities was $1.4 billion, compared to $1.2 billion a year ago. Free cash flow in fiscal 13 was an inflow of $1.2 billion versus $1.0 billion in fiscal year 12. Capital spending totaled $241 million for the year compared to $184 million in the prior year. Its important to note that based on our current plans for FY 14, we expect CapEx for the next year to be up in the area of $280 million, primarily due to new store openings and expansions across all our geographies elevating our store environments within our existing store and investments in the technology and infrastructure necessary to enable global expansion.

Consistent with our practice, over the past several years, we will not be giving specific guidance for FY 14. As you know, we are focused on driving sustainable long term growth against the healthy and attractive brand propositions. The restructuring charges we reported today will allow us to align our resources for maximum impact, while effectively managing our expense ratio.

As you think about 2014, keep the following in mind. While we are enthusiastic about early iterations of our transition to a life style brand, which will begin to be seen during this holiday season, we recognize that a full reflection of this positioning is part of a multi-year journey. Therefore, we are not building in an improvement from the negative low single digit Q4 North American comp run rate into out FY 14 plans at this time.

We expect to deliver mid-single digit sales growth in constant currency. Assuming the Yen at close to 100, this would equate to low-to-mid-single digit in dollars with currency another factor in the first half.

Gross margin is projected at 71% to 72% for the year. The expected decline versus prior year primarily reflect currency notably the weaker yen, rising labor cost, especially in the second half, as well as inventory amortization from the JV acquisition in Coach Europe.

SG&A expenses are expected to grow in line with sales. Increased investments in Europe, marketing and other brand transformation initiatives are expected to be funded by the restructuring actions. Taken together, we would expect operating margin to remain high at about 30%.

And finally, our tax rate is expected to be in the area of 33% for the year. In terms of how the quarters layout, there will be puts and takes through the year. Looking at overall topline growth, the first half and especially the first quarter will be most impacted by the yen.

Regarding our balance sheet, cash flow and capital allocation, we continue