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COACH INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion of Coach's financial condition and results of operations should be read together with Coach's condensed consolidated financial statements and notes to those statements, included elsewhere in this document. When used herein, the terms "Coach," "Company," "we," "us" and "our" refer to Coach, Inc., including consolidated subsidiaries. EXECUTIVE OVERVIEW Coach is a leading New York design house of modern luxury accessories and lifestyle collections. Our product offerings include fine accessories, gifts and certain seasonal lifestyle apparel collections for women and men. Coach operates in two segments: North America and International. The North America segment includes sales to North American customers through Coach-operated stores (including the Internet) and sales to North American wholesale customers. The International segment includes sales to customers through Coach-operated stores (including the Internet) and concession shop-in-shops in Japan and mainland China, Coach-operated stores and concession shop-in-shops in Hong Kong, Macau, Singapore, Taiwan, Malaysia, South Korea, the United Kingdom, France, Ireland, Spain, Portugal, Germany and Italy, as well as sales to wholesale customers and distributors in approximately 35 countries. As Coach's business model is based on multi-channel global distribution, our success does not depend solely on the performance of a single channel or geographic area. In order to drive growth within our global business, we are focused on four key initiatives, which directly align with the Company's Transformation Plan, described below: • Grow our business in North America and worldwide, by transforming from a leading international accessories Company into a global lifestyle brand, anchored in luxury accessories. • Leverage the global opportunity for Coach by raising brand awareness and building market share in markets where Coach is under-penetrated, most notably in Asia and Europe. We are also developing the brand opportunity as we expand into South America and Central America. • Focus on the Men's opportunity for the brand, by drawing on our long heritage in the category. We are capitalizing on this opportunity by opening new standalone and dual gender stores and broadening the men's assortment in existing stores. • Harness the growing power of the digital world, accelerating the development of our digital programs and capabilities in North America and worldwide, reflecting the change in consumer shopping behavior globally. Our intent is to rapidly drive further innovation to engage with customers in this channel. Key elements include www.coach.com, our invitation-only outlet Internet site, our global e-commerce sites, marketing sites and social media. During the fourth quarter of fiscal 2014, Coach announced a multi-year strategic plan with the objective of transforming the brand and reinvigorating growth, which will enable the Company to return to 'best-in-class' profitability. This multi-faceted, multi-year transformation plan (the "Transformation Plan") builds on the core brand equities of quality and craftsmanship with the aim of evolving our competitive value proposition. We believe our strategy offers significant growth opportunities in handbags and accessories, as well as in the broader set of lifestyle categories that we have operated in for some time but are less developed, including footwear and outerwear. This strategy has required an integrated holistic approach, across product, stores and marketing and promotional activities, and entails the roll-outs of carefully crafted aspirational marketing campaigns to define our brand to deliver a fuller and more consistent brand expression. Key operational and cost measures needed in order to fund and execute this plan include: (i) the investment of approximately $570 million in capital improvements in our stores and wholesale locations during fiscal 2015 and through fiscal 2017; (ii) the optimization and streamlining of our organizational model as well as the closure of approximately 70 underperforming stores in North America in fiscal 2015; (iii) the realignment of inventory levels to reflect our elevated product strategy in fiscal 2014; (iv) the investment of approximately $50 million in incremental advertising costs to further promote our new strategy, starting in fiscal 2015; and (v) the significant scale-back of promotional events, particularly within our outlet Internet sales site which started in fiscal 2014. The Company believes that long-term growth can be realized through its transformational efforts over time. The Company's execution of these key operational and cost measures continues to be on plan through the first quarter of fiscal 2015. For further discussion of charges incurred in connection with the Transformation Plan, see "Items Affecting Comparability," herein. Current Trends and Outlook In addition to the risks surrounding the successful execution of our Transformation Plan initiatives, our outlook reflects a certain level of uncertainty surrounding the global economy. The global economic environment continues to have an impact on consumer confidence, which in turn influences the level of spending on discretionary items. Consumer retail traffic remained relatively weak and inconsistent, which has led to a more promotional environment due to increased competition and a desire to 21 -------------------------------------------------------------------------------- offset traffic declines with increased levels of conversion. Furthermore, recent macro and geopolitical events in China and southeast Asia have contributed to volatility in consumer spending within the region. If the global macroeconomic environment remains volatile or worsens, the constrained level of worldwide consumer spending and modified consumption behavior may continue to have a negative effect on our trends in fiscal 2015. We will continue to monitor these risks and evaluate and adjust our operating strategies and cost management opportunities to mitigate the related impact on our results of operations, while remaining focused on the long-term growth of our business and protecting the value of our brand. For a detailed discussion of significant risk factors that have the potential to cause our actual results to differ materially from our expectations, see Part I, Item 1A - "Risk Factors" disclosed in our Annual Report on Form 10-K for the fiscal year ended June 28, 2014. 22 -------------------------------------------------------------------------------- SUMMARY - FIRST QUARTER OF FISCAL 2015 In the first quarter of fiscal 2015, we reported net sales of $1.04 billion, net income of $119.1 million and net income per diluted share of $0.43. This compares to net sales of $1.15 billion, net income of $217.9 million, and net income per diluted share of $0.77 in the first quarter of fiscal 2014. In the first quarter of fiscal 2015, the comparability of our operating results has been affected by $37.1 million of pretax charges ($26.7 million after tax or $0.10 per diluted share) related to our Transformation Plan. There were no items affecting comparability in the first quarter of fiscal 2014. Our operating performance in the first quarter of fiscal 2015 reflected a decline in net sales of 9.7%, primarily due to decreased revenues from our North America business partially offset by gains in our International businesses. Excluding the effects of foreign currency, net sales decreased 9.1%. Our gross profit decreased by 13.4% to $715.4 million during the first quarter of fiscal 2015 which included the negative impact of charges under our Transformation Plan of $4.0 million. Selling, general and administrative ("SG&A") expenses increased by $30.6 million to $535.6 million in the first quarter of fiscal 2015 and SG&A expenses as a percentage of net sales increased by 770 basis points, primarily due to the impact of our Transformation Plan on our fiscal 2015 first quarter results. Excluding charges under our Transformation Plan of $33.1 million in the first quarter of fiscal 2015, SG&A expenses declined slightly. Net income decreased in the first quarter of fiscal 2015 as compared to the first quarter of fiscal 2014, primarily due to a decrease in operating income of $141.8 million, partially offset by a $44.0 million decrease in our provision for income taxes. Net income per diluted share decreased due to lower net income. Excluding charges under our Transformation Plan in the first quarter of fiscal 2015, net income decreased 33.1% and net income per diluted share decreased 31.1%. FIRST QUARTER FISCAL 2015 COMPARED TO FIRST QUARTER OF FISCAL 2014 The following table summarizes results of operations for the first quarter of fiscal 2015 compared to the first quarter of fiscal 2014. All percentages shown in the table below and the discussion that follows have been calculated using unrounded numbers. Quarter Ended September 27, 2014 September 28, 2013 Variance (dollars in millions, except per share data) (unaudited) % of % of Amount net sales Amount net sales Amount % Net sales $ 1,038.8 100.0 % $ 1,150.8 100.0 % $ (112.0 ) (9.7 )% Gross profit 715.4 68.9 826.6 71.8 (111.2 ) (13.4 ) Selling, general and administrative expenses 535.6 51.6 505.0 43.9 30.6 6.1 Operating income 179.8 17.3 321.6 27.9 (141.8 ) (44.1 ) Interest income, net 0.7 0.1 1.7 0.1 (1.0 ) (56.7 ) Provision for income taxes 61.4 5.9 105.4 9.2 (44.0 ) (41.7 ) Net income 119.1 11.5 217.9 18.9 (98.8 ) (45.3 ) Net income per share: Basic $ 0.43 $ 0.77 $ (0.34 ) (44.0 )% Diluted 0.43 0.77 (0.34 ) (43.7 ) 23-------------------------------------------------------------------------------- Items Affecting Comparability The Company's reported results are presented in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The reported gross profit, SG&A expenses, operating income, income before provision for income taxes, provision for income taxes, net income and earnings per diluted share during the first quarter of fiscal 2015 reflect certain items which affect the comparability of our results, as noted in the following table. Refer to page 29 for a discussion on the Non-GAAP Measures. September 27, 2014 (dollars in millions, except per share data) (unaudited) GAAP Basis Non-GAAP Basis (As Reported) Transformation Actions (Excluding Items) Gross profit $ 715.4 $ (4.0 ) $ 719.4 Selling, general and administrative expenses 535.6 33.1 502.5 Operating income 179.8 (37.1 ) 216.9 Income before provision for income taxes 180.5 (37.1 ) 217.6 Provision for income taxes 61.4 (10.4 ) 71.8 Net income 119.1 (26.7 ) 145.8 Diluted net income per share 0.43 (0.10 ) 0.53 Items Affecting Comparability First Quarter Fiscal 2015 Items Transformation Actions In the first quarter of fiscal 2015, the Company incurred restructuring and transformation-related charges of $37.1 million under its multi-year Transformation Plan as announced in the fourth quarter of fiscal 2014. The charges recorded in cost of sales and SG&A expenses were $4.0 million and $33.1 million, respectively. These charges, which are primarily associated with our North America business, relate to corporate severance costs and fleet-related costs. Refer to the "Executive Overview" herein and Note 4, "Transformation and Other Actions," for further information regarding the Transformation Plan. Additional actions will continue into the remainder of fiscal 2015. First Quarter Fiscal 2014 Items There were no items affecting comparability in the first quarter of fiscal 2014. Currency Fluctuation Effects The change in net sales for the first quarter of fiscal 2015 has been presented both including and excluding currency fluctuation effects (primarily attributable to Coach Japan). 24 -------------------------------------------------------------------------------- Net Sales Net sales decreased 9.7% or $112.0 million to $1.04 billion. Excluding the effects of foreign currency, net sales decreased 9.1% or $105.1 million. The decrease was driven by lower net sales in the North America business partially offset by gains in the International business and increased sales in other ancillary channels. The following table presents net sales by reportable segment for the first quarter of fiscal 2015 compared to the first quarter of fiscal 2014: Quarter Ended Total Net Sales Percentage of Total Net Sales September 27, September 28, Rate of September 27, September 28, 2014 2013 Change 2014 2013 (dollars in millions) (unaudited) North America $ 633.7 $ 778.3 (18.6 )% 61.0 % 67.6 % International 381.0 365.0 4.4 36.7 31.7 Other(1) 24.1 7.5 NM 2.3 0.7 Total net sales $ 1,038.8 $ 1,150.8 (9.7 )% 100.0 % 100.0 % (1) Net sales in the Other category, which is not a reportable segment, consists of sales generated in ancillary channels, including licensing and disposition. NM - Percentage change is not meaningful North America Net Sales decreased 18.6% or $144.6 million to $633.7 million. This decrease was primarily driven by lower comparable store sales of $170.4 million or 24% largely due to lower traffic. The Internet business had a negative impact, of approximately 5%, on comparable store sales which is attributable to the Company's decision to limit access to our outlet Internet sales site. This decrease was partially offset by an increase of $24.4 million related to net sales generated by new store openings which were partially offset by the absence of net sales for those stores that have closed since the first quarter of fiscal 2014. Since the end of the first quarter of fiscal 2014, Coach opened a net 13 outlet stores, including the closure of two Men's outlet stores, and closed a net 21 retail stores. International Net Sales increased 4.4% or $16.0 million to $381.0 million. Excluding the unfavorable impact of foreign currency, primarily due to the Japanese yen, net sales increased $21.7 million or 5.9%. The $21.7 million increase in net sales was primarily due to low double digit growth in China reflecting an increase of $12.1 million primarily due to net new stores, an increase of $10.2 million related to the expansion of our business in Europe and an increase of $6.9 million in our international wholesale business due to higher shipments. These increases were partially offset by a decrease in net sales in Japan of $10.0 million due to lower traffic. Since the end of the first quarter of fiscal 2014, we opened 29 net new stores, with 26 net new stores in mainland China, Hong Kong and Macau and Japan, and three net new stores in the other regions. Gross Profit Gross profit decreased 13.4% or $111.2 million to $715.4 million in the first quarter of fiscal 2015 from $826.6 million in the first quarter of fiscal 2014. Gross margin for the first quarter of fiscal 2015 was 68.9% as compared to 71.8% in the first quarter of fiscal 2014. Excluding items affecting comparability of $4.0 million, related to charges under our Transformation plan in the first quarter of fiscal 2015, gross profit decreased 13.0% or $107.2 million to $719.4 million; and gross margin was 69.3% in the first quarter of fiscal 2015. There were no items affecting comparability in the first quarter of fiscal 2014. Furthermore, our gross profit was negatively impacted by unfavorable effects of foreign currency of $3.2 million. North America Gross Profit decreased 20.1% or $102.4 million to $408.0 million in the first quarter of fiscal 2015. Gross margin decreased 120 basis points from 65.6% in the first quarter of fiscal 2014 to 64.4% in the first quarter of fiscal 2015. The decrease in gross margin is due to a 140 basis point decline as a result of increased discount rates in our outlet channel, partially offset by favorable product mix. International Gross Profit increased 1.0% or $2.8 million to $295.4 million in the first quarter of fiscal 2015. Gross margin decreased 270 basis points from 80.2% in the first quarter of fiscal 2014 to 77.5% in the first quarter of fiscal 2015. The decrease in gross margin is due to the negative translation effect of changes in foreign currency, primarily associated with fluctuations in the Japanese Yen, selling products with a higher average unit cost and increased penetration of our broadened lifestyle categories, a less favorable geographic mix of our net sales as well as increased promotional activity, all of which were partially offset by the lower step-up of inventory as part of the purchase accounting related to the acquisition of our Europe business in the prior year. 25 -------------------------------------------------------------------------------- Corporate Unallocated Gross Profit decreased $16.5 million from $17.1 million in the first quarter of fiscal 2014 to $0.6 million in the first quarter of fiscal 2015. Excluding items affecting comparability of $4.0 million in the first quarter of fiscal 2015, gross profit decreased by $12.5 million to $4.6 million in first quarter of fiscal 2015, due to less favorable production variances. Selling, General and Administrative Expenses SG&A expenses are comprised of four categories: (i) selling; (ii) advertising, marketing and design; (iii) distribution and customer service; and (iv) administrative. Selling expenses include store employee compensation, occupancy costs and supply costs, wholesale and retail account administration compensation globally and Coach international operating expenses. These expenses are affected by the number of Coach-operated stores open during any fiscal period and store performance, as compensation and rent expenses vary with sales. Advertising, marketing and design expenses include employee compensation, media space and production, advertising agency fees, new product design costs, public relations and market research expenses. Distribution and customer service expenses include warehousing, order fulfillment, shipping and handling, customer service and bag repair costs. Administrative expenses include compensation costs for "corporate" functions including: executive, finance, human resources, legal and information systems departments, as well as corporate headquarters occupancy costs, consulting and software expenses. Administrative expenses also include global equity compensation expense. Coach includes inbound product-related transportation costs from our service providers within cost of sales. Coach, similar to some companies, includes certain transportation-related costs related to our distribution network in selling, general and administrative expenses rather than in cost of sales; for this reason, our gross margins may not be comparable to that of entities that include all costs related to their distribution network in cost of sales. SG&A expenses increased 6.1% or $30.6 million to $535.6 million in the first quarter of fiscal 2015 as compared to $505.0 million in the first quarter of fiscal 2014, primarily driven by an increase in administrative expenses. As a percentage of net sales, SG&A expenses increased to 51.6% during the first quarter of fiscal 2015 as compared to 43.9% during the first quarter of fiscal 2014. Excluding items affecting comparability of $33.1 million in the first quarter of fiscal 2015, SG&A expenses decreased $2.5 million from the first quarter of fiscal 2014; and SG&A expenses as a percentage of net sales increased, primarily due to the de-leverage of selling expenses as net sales have declined. There were no items affecting comparability in the first quarter of fiscal 2014. Selling expenses were $361.2 million, or 34.8% of net sales, in the first quarter of fiscal 2015 compared to $365.1 million, or 31.7% of net sales, in the first quarter of fiscal 2014. The $3.9 million decrease represents lower selling expenses related to our North America stores and Internet business, which were mostly offset by increases to support growth in our International business. Advertising, marketing, and design costs were $53.9 million, or 5.2% of net sales, in the first quarter of fiscal 2015, compared to $57.6 million, or 5.0% of net sales, during the first quarter of fiscal 2014. The decrease was primarily due to the divestiture of the Reed Krakoff business and lower costs incurred as a result of fewer promotional events made by the Company, primarily as a result of the Company's decision to limit access to our outlet Internet sales site. These costs were partially offset by higher costs for marketing-related events. Distribution and consumer service expenses were $17.7 million, or 1.7% of net sales, in the first quarter of fiscal 2015, compared to $21.5 million, or 1.9% of net sales in the first quarter of fiscal 2014. The decrease was primarily due to lower variable costs as a result of lower sales associated with the Company's decision to limit access to our outlet Internet sales site. Administrative expenses were $102.8 million, or 9.9% of net sales, in the first quarter of fiscal 2015 compared to $60.8 million, or 5.3% of net sales, in the first quarter of fiscal 2014. Excluding items affecting comparability of $33.1 million in the first quarter of fiscal 2015, administrative expenses were $69.7 million, or 6.7% of net sales, in the first quarter of fiscal 2015. The increase is primarily due to additional costs incurred particularly related to information technology and higher equity compensation, which is due to the absence of forfeitures of certain share-based awards, recognized in the first quarter of fiscal 2014, as a result of the departure of certain key executives. Operating Income Operating income decreased 44.1% or $141.8 million to $179.8 million in the first quarter of fiscal 2015 as compared to $321.6 million in the first quarter of fiscal 2014. Operating margin decreased to 17.3% in the first quarter of fiscal 2015 as compared to 27.9% in the first quarter of fiscal 2014. Excluding items affecting comparability of $37.1 million in the first quarter of fiscal 2015, operating income decreased 32.6% or $104.7 million to $216.9 million; and operating margin was 20.9% in the first quarter of fiscal 2015. 26 --------------------------------------------------------------------------------The following table presents operating income by reportable segment for the first quarter of fiscal 2015 compared to the first quarter of fiscal 2014: Quarter Ended Operating Income Variance September 27, September 28, 2014 2013 Amount % (dollars in millions) (unaudited) North America $ 221.5 $ 299.6 $ (78.1 ) (26.1 )% International 118.0 130.1 (12.1 ) (9.3 ) Other(1) 9.3 5.6 3.7 68.5 Corporate unallocated (169.0 ) (113.7 ) (55.3 ) (48.7 ) Total operating income $ 179.8 $ 321.6 $ (141.8 ) (44.1 )% (1) Operating income in the Other category, which is not a reportable segment, consists of sales and expenses generated in ancillary channels, including licensing and disposition. North America Operating Income decreased 26.1% or $78.1 million to $221.5 million in the first quarter of fiscal 2015 reflecting the decrease in gross profit of $102.4 million which was partially offset by lower SG&A expenses of $24.3 million. The decrease in SG&A expenses was due to lower variable selling costs as a result of lower sales in our North America stores and Internet business. Operating margin decreased 360 basis points to 34.9% in the first quarter of fiscal 2015 from 38.5% during the same period in the prior year due to higher SG&A expense as a percentage of net sales of 240 basis points and lower gross margin of 120 basis points. International Operating Income decreased 9.3% or $12.1 million to $118.0 million in the first quarter of fiscal 2015 primarily reflecting higher SG&A expenses of $14.9 million partially offset by higher gross profit of $2.8 million. The increase in SG&A expenses is related to a $10.4 million increase in China and Asia, excluding Japan, related to new store openings and a $7.6 million increase in Europe to support growth in the business. The increase in SG&A costs were partially offset by foreign currency effects in Japan of $3.2 million. Operating margin decreased 460 basis points to 31.0% in fiscal 2014 from 35.6% during the same period in the prior year primarily due to lower gross margin of 270 basis points and higher overall selling expenses as a percentage of net sales which increased by 190 basis points. Corporate Unallocated Operating Expense increased $55.3 million to $169.0 million in the first quarter of fiscal 2015, an increase of 48.7% from $113.7 million in the first quarter of fiscal 2014. This increase was primarily attributable to charges incurred by the Company in the first quarter of fiscal 2015 as part its Transformation Plan. Excluding items affecting comparability, unallocated operating expenses increased by 16.1% or $18.2 million to $131.9 million in the first quarter of fiscal 2015. This increase is primarily related to higher information technology costs and higher equity compensation, which is due to the absence of forfeitures of certain share-based awards, recognized in the first quarter of fiscal 2014, as a result of the departure of certain key executives. Provision for Income Taxes The effective tax rate was 34.0% in the first quarter of fiscal 2015, as compared to 32.6% in the first quarter of fiscal 2014. Excluding the items affecting comparability, the effective tax rate was 33.0% in the first quarter of 2015. The slight increase in our effective tax rate was primarily attributable to the geographic mix of our earnings in first quarter fiscal 2015 as compared to the first quarter fiscal 2014. The loss of certain foreign tax benefits that expired at the end of fiscal 2014 also contributed to the increase in our effective tax rate. The Company anticipates a full year fiscal 2015 effective tax rate of approximately 32% including and excluding items affecting comparability. Net Income Net income decreased 45.3% or $98.8 million to $119.1 million in the first quarter of fiscal 2015 as compared to $217.9 million in the first quarter of fiscal 2014. Excluding items affecting comparability, net income decreased 33.1% or $72.1 million to $145.8 million in the first quarter of fiscal 2015. This decrease was primarily due to lower operating income partially offset by lower provision for income taxes. 27 -------------------------------------------------------------------------------- Earnings per Share Net income per diluted share decreased 43.7% to $0.43 in the first quarter of fiscal 2015 as compared to $0.77 in the first quarter of fiscal 2014. Excluding items affecting comparability, net income per diluted share decreased 31.1% or $0.24 to $0.53 in the first quarter of fiscal 2015, due to lower net income. 28-------------------------------------------------------------------------------- |