Tapestry, Inc.
Q1 2016 Earnings Call Transcript

Published: 27 Oct 2015

[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 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. Andre Cohen, President, North America is also joining us. 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. Future 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, controlled costs, successfully execute our transformation 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 10-K, 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 performance. 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, or excluding charges associated with financing, short-term purchase accounting adjustments, and 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 first fiscal quarter of 2016 milestones and learnings and will also discuss our progress on global initiatives. Andre Cohen will speak to our North America business product performance and review our key programs for the holiday season. Jane Nielsen will follow with details on financial and operational results for the quarter, along with our outlook for FY 2016. After that, we will hold a Q&A session. This Q&A session will end shortly before 9

[Victor Luis:]

Good morning. Thank you, Andrea, and welcome, everyone. As noted in our press release, we're pleased with our first quarter performance, which was consistent with our plan and reflected continued progress on our transformation journey. We drove further sequential improvement in our North America bricks and mortar business – led, as expected, by our retail stores – with this momentum continuing into the second quarter. Our international businesses posted moderate growth on a constant currency basis, highlighted by double-digit increases in Europe and Mainland China, as well as sales gains in Japan. Overall, our results underscore our confidence that the cumulative impact of our actions will result in a return to topline growth in FY16 and positive North American comps by the end of the year. Importantly, we continued to successfully execute our brand transformation strategies in the quarter across our three key brand pillars

[Andre Cohen:]

Thanks, Victor. As you read in our release, for the quarter, our total Coach brand sales in North America were down 11% as reported and 10% in constant currency. Our direct business excluding wholesale was down 12% as reported and 11% in constant currency. For the quarter in aggregate and as planned, our total store comp improved sequentially led by retail. It was down 8% with high ticket offset by a decline in traffic which was hurt in part by the overall weak mall trends as well as lower conversion. Our total comp was pressured an additional 1.5 points by eOS as we pulled back from about one flash sale event a week in last year's first quarter or 13 in total to about two events a month or seven in total, two in July, three in August and two in September, in line with the second half of FY 2015 and our plan. Looking at results sequentially, both conversion and traffic comp improved from fourth quarter levels driving the comp uptick in our bricks and mortar stores as elevated fashion and compelling novelty styles drove improved handbag performance. And even as we've anniversaried the arrival of Stuart's elevated product in retail, we continued to see strength in the channel through October. This further underscores our confidence in building to a positive North American comp by the fourth quarter, again led by the improvement in our retail stores with the most significant driver being conversion. Now turning to our retail performance and the metrics we traditionally share on product. The above-$400 price bracket held in penetration, saw another positive comp on a unit basis and represented nearly 30% of handbag sales matching last year. The below-$300 price bracket also grew in penetration and posted a positive comp benefiting from our focus on essentials and achieving balance in the assortment, which bodes particularly well for holiday. As has been the case for quite a while, leather continued to outpace logo across all channels. In the first quarter, logo across all categories, represented less than 5% of North America retail sales. And in outlets, it was roughly 30%, down year-over-year in both channels. Now in stores, as Victor mentioned, we've been very pleased with the performance of our Modern Luxury stores, particularly in the North America retail channel, where comps remain positive. And in the outlet channel to date, we've also seen an improvement in trend post-renovation and relative outperformance versus the balance of outlet stores. We remain on target to renovate about 60 stores this year with approximately half expected to be completed prior to Black Friday. In addition to the physical changes to our stores, we've also changed our labor and staffing model notably in retail with a heightened focus on full-time store associates to create stronger relationships with our customers. Over the next year, we'll be adding craftsmanship bars to select flagship stores globally, providing customization options and leather services such as monogramming, harkening back to our roots as a leather goods manufacturer. We're also in the process of introducing a tier of leather services to all of our retail stores globally. Also in support of the customer experience, we continue to refine our modern luxury hosting ceremony and we've also just introduced a new store associate uniform globally. Turning to event marketing, as you know, over the last 15 months, we've changed our approach to customer events in the retail channel, resulting in a significant reduction in promotional activity on a year-over-year basis in FY 2015. In terms of learnings, as noted in the last call, we found that our semi-annual open sales, which will be known as the winter sale and the summer sale going forward, have served as recruitment vehicles for new customers. As a result, this year we will hold two shorter duration open sale events over key traffic periods including Black Friday with the intent of attracting new retail customers. As in the case of our original semi-annual open sale, we'll kick off the event with a VIP preview with a tiered offer and then open it up to the public. At the same time, we have adjusted the cadence and further reduced our closed targeted customer events to two a year, the first of which was held as planned in September with the next expected in the second half of FY 2016. Importantly, we continue to evolve and optimize the timing and type of events. Our goal is to further reduce the number of days on promotion in our retail channel in FY 2016. Looking ahead to holiday and applying our learnings from last year, our goal is to be a bolder destination for gifting with a balanced assortment and broader offering at opening price points. We'll incorporate seasonal fashion elements such as shearling, metallic and glitter across all categories for both men's and women's creating an emotional and compelling offering for the season. Specifically in retail, we will first continue our focus on brand elevation and fashion with Nomad, a sophisticated shoulder bag in glovetanned leather at $495 that's performed incredibly well. Second, animate essentials and build in our craftsmanship message through platforms such as patchwork and color block exotics in key silhouettes including Edie, Prairie and Crosby. And with new silhouettes, such as the Turnlock Tote, a very versatile bag with broad appeal at $350, which features refined pebbled leather and superb functionality. Third, become the holiday gifting destination with a variety of gifts at key price points, including some compelling gift boxes across women's and men's. Finally, we'll also be a bolder destination for men's with key new silhouettes focused on backpacks and incorporating seasonal fashion elements such as prints, color blocks and varsity stripes. As we move into holiday for North America outlets, we're excited about our continued product innovation in this channel. At the end of the first quarter, we introduced the Blake collection and have seen great early success notably with a carryall and shoulder bag silhouettes. Blake was launched as a premium price in outlets and we continue to see that our customer will pay higher prices for great fashion items that are proprietary to Coach. Building on the success of our Phoebe and Christie collections, we're introducing updates to these best-selling items with additional hardware details and a broader range of sizes as we expand these collections across a broad range of colors in leather and logo options. For holiday outlet, we'll offer compelling and emotional novelty items featuring three key stories that are aligned with our global message

[Victor Luis:]

Thanks, Andre. Moving on to international. Most generally and similar to North America, we're distorting our focus in developed markets towards maximizing productivity. We're taking a portfolio approach to our store base investing in our best locations where we'll see the biggest return and culling where appropriate, while in developing markets we're continuing to open stores taking advantage of real estate opportunities. In all markets, we are increasing marketing and investing in the Modern Luxury store experience using elements such as the craftsmanship bars to underscore our heritage and history of authenticity. In Greater China, our first quarter sales rose 3% in constant currency, in line with annual target with double-digit growth on the Mainland and with positive comps offsetting weak results in Hong Kong and Macau. Hong Kong and Macau continue to be impacted by a dramatic slowdown in inbound tourist traffic, notably from the Mainland. Despite some macro slowdown and stock market gyrations in China, we remain confident in our $625 million forecast for FY 2016 even at current exchange rates and optimistic on the prospects for this market over the long-term as the drivers we've consistently mentioned are more relevant than ever. It's important to note that we do see the Chinese tourist as an increasingly large part of our business globally, and we have experienced the strengthening in Chinese tourist spending, notably in Japan and Europe. We are staffing into this trend increasing the number of Mandarin-speaking store associates in these geographies. To that end and as expected, Japan sales were up 6% on a constant currency basis, benefiting from increased tourist flows from Mainland Chinese. On a dollar basis, sales declined 10% reflecting the weaker yen. While Japan is a mature market where we are distorting investment to our high profile Tokyo stores and flagships while optimizing our fleet, we are continually assessing and leveraging the opportunity with the tourists. In addition, the response to our new Modern Luxury stores from Japanese consumers has been quite positive, seen most notably in conversion in these locations. In Europe our brand is continuing to grow rapidly through new directly operated stores, wholesale locations and comps. I mentioned the importance of our Paris flagship in raising awareness with both domestic consumers and tourists and we will continue to look for other flagship opportunities with a focus on other major European cities. Overall, we continue to believe that FY 2016 will be another year of very strong growth with sales growing to 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 were up slightly in local currency and declined in dollars. Here too, we are focused on driving productivity through our transformation initiatives. Finally, I would point out that we're seeing disparate results in our international wholesale businesses, which while small are important to growing brand awareness. In the first quarter, we saw strong growth in those distributor operated locations focused on the domestic consumer, while travel retail has been impacted by MERS in South Korea and the volatility of tourist flows globally notably in Hong Kong and Macau. Generally, across geographies we are on track to meet our guidance, while we continue to execute our brand transformation. Now I will turn it over to Jane for details on our financial results and guidance for the year ahead. Jane?

[Jane Hamilton Nielsen:]

Thanks, Victor. Victor and Andre have just taken you through the highlights and strategies. Let me now take you through some of the important financial details of our first fiscal quarter results for the consolidated business of Coach, Inc., as well as the Coach brand and Stuart Weitzman ending with our outlook for FY 2016. 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, our first quarter performance was consistent with our expectations. Starting with Coach, Inc., on a consolidated basis, net sales totaled $1.03 billion for the first fiscal quarter compared with $1.04 billion reported in the same period of the prior year, a decrease of 1%. On a constant currency basis, total sales increased 3% for the period. Gross profit totaled $697 million versus $719 million a year ago, while gross margin was 67.7% versus 69.3%. SG&A expenses of $532 million compared to $503 million in the prior year, an increase of 6%. As a percentage of net sales, SG&A totaled 51.7% compared to 48.4% in the year ago quarter. Operating income for the quarter totaled $165 million compared to $217 million in the prior year, while operating margin was 16% versus 20.9%. Net interest expense was $7 million in the quarter as compared to net interest income of $1 million in the year ago period. Net income for the quarter totaled $113 million with earnings per diluted share of $0.41. This included a contribution of $11 million or $0.04 per share from Stuart Weitzman. This compared to net income in the first quarter of FY 2015 of $146 million with earnings per diluted share of $0.53. Now drilling down to performance by brand and starting with the Coach brand. As a reminder, all the comments I'm about to make are on a non-GAAP basis. Net sales for the Coach brand totaled $943 million for the first fiscal quarter compared to $1.04 billion reported in the same period of the prior year, a decrease of 9%. On a constant currency basis, total sales decreased 5% for the period. Gross profit totaled $647 million, while gross margin was 68.6% pressured by about 60 basis points from currency. SG&A expense totaled $497 million, a decrease of 1%. SG&A expenses in the first quarter were somewhat lower than our expectations and reflected a reversal of prior-year accruals, as well as a shift in marketing timing. The stronger dollar also was a benefit to expenses. As a percentage of net sales, SG&A expenses totaled 52.7%. Operating income was $150 million, while operating margin was 15.9%. Turning now to Stuart Weitzman. Stuart Weitzman brand net sales totaled $87.5 million for the first fiscal quarter. Gross profit for the Stuart Weitzman brand totaled $50.6 million resulting in a gross margin of 57.8%. SG&A expenses were $35.5 million or 40.6% of sales. Operating income was $15.1 million representing an operating margin of 17.2%. During the first quarter of FY 2016, the company recorded charges of $13 million under its multiyear transformation plan. These charges consisted primarily of organizational efficiency costs and accelerated depreciation for store renovations. In addition, the company recorded costs of approximately $11 million associated with the acquisition of Stuart Weitzman. These actions taken together increased the company's SG&A expenses by about $23 million and a cost of sales by about $1 million, negatively impacting net income by $17 million after tax or about $0.06 per diluted share in the first fiscal quarter. As a reminder, we have taken the majority of our total expected transformation related charges over the last six quarters, totaling about $290 million, including rightsizing of our inventory levels. We continue to expect to incur the balance of these charges by the end of FY 2016 primarily related to global store closures and organizational effectiveness, bringing the total multi-year 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. During the quarter and consistent with our annual guidance, there was little change in our global directly operated door count. As we are now including a table detailing our openings and closures by geography and brand in our press release, I'll just touch on the highlights. In total, we added eight net Coach brand locations worldwide, all outside North America. We also opened two Stuart Weitzman locations in the quarter, one in the U.S. and one in Europe. Looking to the full year and starting with North America, in FY 2016 we continue to expect to close a total of approximately 20 retail stores and close a few outlet stores on a net basis. Taken together with a number of relocations and expansions, we expect our directly operated Coach brand square footage in North America to be essentially unchanged for the year. On the North American department store front, we ended the quarter with about 975 locations, no change from the previous quarter. And in FY 2016, we still expect to open about 10 doors. Moving to China, we still expect to open about 25 new locations for the year, closing about 5 to 10 with square footage growth of about 12% to 15% in FY 2016. In Japan, as previously announced, we will focus on our modern luxury renovations notably in stores in and around Tokyo. We'll continue to take a portfolio approach to optimizing our store base and expect about five closures and a 5% to 10% decline in our square footage for the year. In Europe, in FY 2016, we expect to open 5 to 10 directly operated stores for a square footage growth of 40%. In addition, we ended the first quarter with over 225 wholesale and multibrand locations and will continue to leverage the wholesale opportunity moving forward. In our directly operated businesses in Asia, outside of China and Japan, we are focused on developing our current store base and don't expect additional net openings or meaningful square footage growth this year. Taken together in FY 2016, we continue to expect our global Coach brand footprint across channels and geographies to be up low single digits in square footage. Closing with Stuart Weitzman distribution, we expect to open approximately 10 new directly operated locations in FY 2016. Moving to the balance sheet, inventory levels at quarter end were $575 million, including $32 million of inventory associated with Stuart Weitzman. This compared to ending inventory of $597 million for the Coach brand in the year ago period. Therefore, inventory declined 4% on a Coach, Inc. consolidated basis and 9% for the Coach brand, in line with net sales. Cash and short-term investments stood at $1.3 billion as compared to $908 million a year ago. Given our debt issuance in the third quarter of FY 2015 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 first quarter was $8 million compared to $139 million last year in Q1. Free cash flow in the quarter was an outflow of $61 million versus an inflow of $99 million in the same period last year. Working capital changes contributed to the majority of the decline in cash driven by two factors. First, higher bonus payments in the first quarter of FY 2016 versus last year as we met the performance goals laid out a year ago. Second, accelerated timing of payments. These primarily related to inventory as we prepared for the upcoming holiday season, store fixture prepayments for bulk procurement and transformation related activities. Finally, our CapEx spending was $69 million versus $40 million in the same quarter a year ago. Turning now to our financial outlook for the Coach brand on a standalone 52-week non-GAAP basis in FY 2016. As our annual plans have not changed from those shared on our fourth quarter FY 2015 earnings call, I'll be brief. First, on Coach brand sales, we expect to deliver a low single-digit increase in constant currency in fiscal year 2016. Based on current exchange rates, currency headwinds are expected to have an approximate 200 basis point negative impact on an annual revenue growth disproportionately impacting the first half. We are projecting a low single-digit aggregate comp decline in North America with eOS pressuring comp again in the second quarter, as we continue to run about two events per month versus about 10 events in last year's second quarter. As previously noted, we would expect comp to improve throughout the year with the most significant inflection occurring into – in the second quarter, the holiday quarter, driven by product innovation, renovated modern luxury stores, and our 75th anniversary marketing initiative. We expect to reach positive comps in the fourth quarter. Gross margin for the Coach brand is projected to be in the area of 70% on a constant currency basis with negative foreign currency effects expected to impact gross margin by 80 basis points to 100 basis points. SG&A expenses net of savings are still expected to grow at mid-single digit rate in constant currency and somewhat less in dollars. Expense growth ahead of sales is reflected at increased marketing spend, transformation initiatives and higher occupancy and depreciation expenses related to store renovation and flagship project timing shifts from FY 2015 to FY 2016 as discussed previously. However, given the favorability realized in Q1, which was also driven in part by the reversal of prior-year accruals, we now expect SG&A expenses to come in at the lower end of this mid-single-digit constant currency range. We continue to expect at least $50 million in incremental cost savings from our transformation and restructuring initiatives. Taken together, we expect operating margin to be in the mid to high teens. Interest expense for the year is estimated to be in the range of $30 million to $35 million. Finally, our tax rate is 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 geographic mix of earnings, the ongoing benefit of available foreign tax credits, the anticipated closure of certain audits and the expiration of statutes in 2016, which will significantly impact our tax rate in the third quarter. In addition, we are forecasting Stuart Weitzman brand sales to be in the area of $335 million on a dollar basis for fiscal 2016, an increase of about 10% from FY 2015 driving Coach, Inc. consolidated revenue growth to high-single digits and adding about $0.09 to earnings per diluted share excluding charges associated with financing, short-term purchase accounting adjustments, contingent payments and integration costs. As previously noted given the lower gross margin and operating margin profile of the Stuart Weitzman business relative to the Coach brand, it will be a negative impact to consolidated gross margin rate. We expect this impact to be about 80 basis points to 90 basis points to Coach, Inc. gross margin and pressure operating margins by roughly 50 basis points in FY 2016. 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 in incremental revenue and $0.06 in earnings per diluted share on a non-GAAP basis. We still expect CapEx for FY 2016 for Coach, Inc. to be in the area of $300 million, excluding the capital cost associated with the new headquarters, which are expected to be approximately $185 million in FY 2016. There has been no change in our capital allocation policy 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're 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 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 are our guard rails for allocating capital effectively, maintaining strategic flexibility, strong liquidity, and access to the capital markets. In closing, we have a clear strategy and a well-articulated implementation plan for FY 2016 and we're pleased with our progress to-date. Building on this momentum we remain confident in our long-term targets. Importantly, we believe that we have the resources to fund our plan, while maintaining our dividend during our heavy investment period. I'd now like to open it up to Q&A.

[Operator:]

Thank you. We will now begin the question-and-answer session. And our first question comes from Bob Drbul with Nomura Securities. You may ask your question.

[Bob S. Drbul:]

Hi. Good morning.

[Jane Hamilton Nielsen:]

Good morning, Bob.

[Victor Luis:]

Good morning, Bob.

[Bob S. Drbul:]

I just have a couple quick question. The first one is when you look at the Chinese sales globally, it appears that many luxury brands are seeing declines in their business to the Chinese globally. However, you noted yours was up. What do you think is driving that? And second quick question if I could is within the outlet business, can you just talk about – are you driving the outlet business with a higher discount rate or what's the trend in full price product in there, and just maybe talk a little bit more about the success you're having there?

[Victor Luis:]

Good morning, Bob. I'll take the first one, and then pass on to Andre for the second one on outlet. In terms of China, as you mentioned, we're really pleased to be bucking the trends that many of our traditional competitors are reporting. I have just had the pleasure of spending a week with our teams in Shanghai, in Hong Kong, visited our renovated flagship stores first on Canton Road and then at Hong Kong Plaza in Shanghai, as well as IFC in Hong Kong, and was really pleased and proud of the work that the team is doing on the ground. All of those locations are being incredibly well received and our team is managing our brand incredibly well in what is of course a very turbulent environment, not only with the exchange rate fluctuations and the impact on traffic into Hong Kong and Macau, but also the domestic stock market gyrations which are now very well-publicized. As to the mainland itself, as we noted, our revenue has held at double-digit growth with positive comps and this is very much similar levels to what we saw in the fourth quarter. We continue to see the slowdown in Hong Kong and Macau with the Chinese as well, of course, as in South Korea with the impact of MERS and some slowdown here in North America due to currency fluctuations, but we have seen PRC growth in the mainland, of course, and in Japan and Europe more than make up for those drops in the specific locations mentioned. In the medium-term, I think we can expect the MERS impact to lessen in South Korea. In fact, we are already, as we head into this quarter, beginning to see that which is great news. And over the medium term we also expect a better Hong Kong, Macau trend, especially in Q4, as we anniversary the slowdown there. I just think it really speaks to the great work of our teams and increasingly our transformation taking hold. I'll now pass on to Andre for your question on outlet.

[Andre Cohen:]

Hello, Bob. For outlet, well, first in general, we've been pleased with the sequential improvements of the business there from the last quarter to this one. Discount rates are actually slightly lower than they were last quarter, so we're making progress there with more elevated product and a high share of Stuart Vevers designed product. And in terms of your question on full-price product in outlet, actually the proportions remained similar to what it's been historically, actually slightly lower, so there's slightly more made-for-outlet product selling through at the moment.

[Bob S. Drbul:]

Great. Thank you very much.

[Operator:]

Thank you. Our next question comes from Joan Payson with Barclays. You may ask your question.

[Joan Payson:]

Hi. Good morning, everyone.

[Jane Hamilton Nielsen:]

Good morning, Joan.

[Andrea Shaw Resnick:]

Good morning, Joan.

[Joan Payson:]

I think you talked a little bit about the under $300 handbag comping positively now, and I was wondering if you could just give a little more detail in terms of what percentage of the business that segment is, when the last time it was that it comped positive? And then in hand with that, you also mentioned that Logo was still down year-over-year. So just when you expect that piece of the business to stabilize?

[Andre Cohen:]

Sure. So essentially our above $400 business, as I mentioned in my prepared remarks, was up in units. We've seen a very good growth between $400 and $600, a significant comp growth there, above $600 assortments being a little lighter than it was last year, so there we saw a drop actually, which resulted in a drop in AUR about $400 and that's an opportunity we see in the future for 1941 as we launch that label. Now below $300, we've actually filled gaps in the assortment, so there we've seen a significant increase and we think that bodes really well actually for the holidays where we had gaps as we know last year.

[Joan Payson:]

And just in terms of the Logo business as well?

[Andre Cohen:]

The Logo business has continued decline, as we focused on leather, capitalizing on a trend in the market that's moving more towards non-Logo products. So it's down this quarter. I don't see that trend changing significantly over the next couple of quarters.

[Joan Payson:]

Okay, great. Thank you.

[Operator:]

Thank you. Our next question comes from Anna Andreeva from Oppenheimer. You may ask your question.

[Anna Andreeva:]

Great. Thanks so much. Good morning, and congrats on seeing nice progress.

[Andre Cohen:]

Thank you.

[Jane Hamilton Nielsen:]

Thank you.

[Anna Andreeva:]

I guess a question on the comp improvement. Is that being driven more by outlet versus full-price or should we think both channels are performing about equally right now? And as we think to the positive comp inflection in the fourth quarter of 2016, should one channel lead the other? Thanks so much.

[Andre Cohen:]

Sure. So we've seen improvements in terms of comps sequentially in both channels. It has been led by retail where there we've seen good trends in both conversion and traffic improving sequentially. ADT average transactions have remained positive in retail. We've seen a similar trend in outlet but a bit more muted than in retail.

[Operator:]

Thank you. Our next question comes from Ike Boruchow with Wells Fargo. You may ask your question.

[Ike B. Boruchow:]

Hi. Good morning, everyone. Thanks for taking my question.

[Andre Cohen:]

Good morning, Ike.

[Ike B. Boruchow:]

I just wanted to quickly talk about the North America comp, specifically the eOS impact, just 1.5% this quarter, well below last quarter's impact. I would've thought there would've been a larger drag this quarter. Maybe, Victor, can you comment if anything changed during the quarter, meaning did you expect a greater negative impact before the quarter started and maybe pull back less for some reason? And any color would be helpful.

[Victor Luis:]

No. Very much per our plan, Ike. Last year this time we had 13 events. We've been very much planning about two per month and that's very much what we did this quarter as you heard in Andre's prepared remarks with seven events. So very much per our expectations, nothing different.

[Jane Hamilton Nielsen:]

And, Ike, for Q2 you'll recall we're overlapping ten events in the prior-year fiscal quarter, so we called out that we'd expect the impact to be slightly less in Q2.

[Ike B. Boruchow:]

Got it. Thank you.

[Operator:]

Thank you. Our next question comes from Michael Binetti with UBS. You may ask your question.

[Michael Binetti:]

Hey, guys. Good morning. You guys have a really heavy mix of your annual earnings that happen during the holiday. So obviously the stock takes a lot of cues from trends in the second quarter. You've obviously been very clear about guiding us to the biggest sequential improvement of the year happening in the second quarter in the comps for North America. Obviously, you've talked a few times about identifying a few gaps in the assortment with the bags under $300, but can you give us a little bit more of how you're thinking of – how you build up your plan to get to that bigger step-up, because I think it will be pretty meaningful for the path of the stock from here.

[Andre Cohen:]

Sure. So it's really about the three pillars that we've been talking about for the past two quarters coming together, so products, marketing obviously and distribution. In terms of product, as I mentioned earlier, we have filled gaps in the below $300 bracket, which I think were an opportunity last holiday season. So a lot more in both channels, frankly, retail and outlets, a lot more of an offering in the below $300 bracket. We've also added I think a lot more emotion and elevation at the same time in our stores, a big focus on gifting, I mentioned shearling, metallics, glitter, et cetera, in full price and outlet. The other thing in outlet is we had a gap we know, an opportunity last year in gift sets below $100. We tripled our investment in that area. So I think we're positioned much better in terms of product, certainly, than we were a year ago. We're also building on the momentum of all the marketing activities that started with the runway show. That continues to gather momentum and obviously we're continuing to see strength in our modern luxury renovations. So we think the three pillars are going to be slowly coming together this quarter. Also I should note that the momentum that we saw in Q1 has continued into October, so that we think bodes well for the holiday.

[Michael Binetti:]

If I could follow up with one quickly. The comment that we still expect comps to go positive by fourth quarter, can you talk about, with the outlet driving so much of the North America comp, what do you need to happen between today and the fourth quarter at the outlets? You said they're still negative but improving sequentially at a slower pace than retail. What do you think – which of maybe the components' traffic conversion need to accelerate the most to get to the overall North America comp positive by fourth quarter?

[Andre Cohen:]

Sure. We think the conversion is the metric that's going to be improving the most. We've maintained positive ADTs. We see that continuing, but conversion is the metric that we're expecting to improve sequentially in both channels the most.

[Michael Binetti:]

Thank you.

[Operator:]

Thank you. Our next question comes from Oliver Chen with Cowen and Company. You may ask your question.

[Oliver Chen:]

Hi. Thanks for the comments and the product is looking really sequentially improved. Regarding...

[Victor Luis:]

Thank you, Oliver.

[Jane Hamilton Nielsen:]

Thank you.

[Oliver Chen:]

Sure. The outlet side, we're just curious about the progress on the renovations and learnings that you've had on your earlier renovations versus the ones you're doing going forward and any changes you're making kind of to the store experience there and how you assort Stuart's and lay out Stuart's new product.

[Andre Cohen:]

Yes. So we've seen on the outlet front first in product an increasing share of Stuart designed product and that's been impacting performance obviously. The modern luxury renovations that we've completed so far have been outperforming the rest of the chain, so that's given us confidence to continue to deploy that plan. The one learning I'd say is in the men's renovations, men's modern luxury renovations in outlet where we've seen less of an impact candidly and I think that comes from the fact that the men's doors are more recent doors. The modern luxury doesn't look as different as it does from the core doors, so our focus is going to be more on our core outlet doors in terms of renovations.

[Jane Hamilton Nielsen:]

Yes, Oliver, we talked about it last quarter, but one of the learnings that we did call out last quarter was just that our lighter touch renovations were not yielding the improvement that we had expected, and so we've moved away from essentially the paint and carpet, if you will, to actually doing a little heavier renovation, which gets us the lift as we replace fixturing. The good news is that our overall cost of renovations through bulk purchasing and procurement activities has gone down, so we're able to accommodate that shift, while lowering our total capital cost expectations for our fleet renovation.

[Oliver Chen:]

And on the outlet side, you're pleased with the renovations and kind of how the customer has been shopping the newer stores there.

[Andre Cohen:]

Very much so, Oliver, and I would say globally.

[Oliver Chen:]

Okay. Thank you. Best regards.

[Andre Cohen:]

Thank you.

[Jane Hamilton Nielsen:]

Thank you.

[Operator:]

Thank you. Your next question comes from Randy Konik with Jefferies. You may ask your question.

[Randal J. Konik:]

Yes. Thanks a lot. Quick question on the outlets again. So I think you talked about the Logo penetration in full-price down to about 5%, but I think you said 30% in outlets. So is that Logo penetration, is that still a headwind then in the outlet division? And strategically, how do you think about where you want the Logo penetration to be in outlets versus where they are in full-price? And if I could just add one more, are you seeing any differences in product trends in the wholesale channel from what you're seeing in the retail channel at current time? Thanks.

[Andre Cohen:]

So the Logo penetration has dropped in outlet. It's at about 30% now versus roughly 40% a year ago. It's an integral part of the business. It's obviously become smaller than it was a few years and quarters ago. We see that continuing to decline slowly, while leather has been comping positive in outlet, and that's something that I think is very consistent with Coach's core equities. We stand really for leather, so. The wholesale question I may let Victor on.

[Victor Luis:]

I didn't get the question.

[Randal J. Konik:]

I'm just curious if you're seeing any differences in product trends or product perception or what people are buying in your wholesale channel distribution relative to the retail channel distribution. Just curious there.

[Victor Luis:]

No, not dramatically. Of course, we're seeing a slightly higher promotional cadence within the wholesale channel in general, a little bit more price competition which is leading to the below $300 bucket having a higher penetration overall, but in general I would say no really dramatic differences.

[Randal J. Konik:]

Helpful. Thank you.

[Victor Luis:]

Thank you.

[Operator:]

Thanks. Your next question comes from Brian Tunick with Royal Bank of Canada. You may ask your question.

[Brian Jay Tunick:]

Thanks. Good morning, everyone.

[Victor Luis:]

Good morning, Brian.

[Brian Jay Tunick:]

I guess two questions. I know you guys do a lot of customer surveys out there. So with the category growing low-single digits, just curious, I mean, what are you hearing from your customers regarding where their spending is? Are their closets full of handbags already or they're just waiting for more newness? And then on the store closing side, can you talk about maybe what kind of transfer rate you're seeing or maybe the web shopper? What are you watching to see what the right footprint may be is for your full-price business? Thanks very much.

[Victor Luis:]

I'll take the first question and then pass on to Andre in terms of the store closings here specifically in North America, Brian. In terms of the consumer survey, it's very much as you mentioned, we see consumers a little bit on the sidelines. Obviously there's a lot of macro and currency and other issues that are impacting global trends today. But as we've mentioned over the last call and, again, I think are seeing in our most recent quarterly survey, consumers are looking to be inspired and they're looking for newness and innovation. Our transformation is very focused on that and we're incredibly excited, of course, by the progress that we're seeing, especially through our full-price channel. Andre, maybe on the...

[Andre Cohen:]

Sure. So we've seen very minimal transfer of sales from closed doors. The doors we closed were primarily smaller doors that had limited material impact on the rest of the chain. And look, we'll continue to evaluate and optimize our fleet. As leases come up, we'll make decisions on continuing on closures so that's an ongoing process. We are closing about 22 doors this year, as Jane mentioned, so that's in the plans.

[Operator:]

Thank you. Our final question comes from Erinn Murphy with Piper Jaffray. You may ask your questions.

[Erinn E. Murphy:]

Great. Thanks. Good morning and congrats on the progress.

[Victor Luis:]

Thank you, Erinn.

[Erinn E. Murphy:]

I was hoping you guys could clarify the October trends. I mean you mentioned in North America improving quarter-to-date. What have you seen in China just given that October encompassed Golden Week? And then I guess the follow up on the wholesale side of the business, I would just love to hear how department stores are managing their open-to-buy dollars in the handbag category overall. And then there's a lot of concern on traffic in department stores broadly, both apparel, footwear (1

[Andrea Shaw Resnick:]

Thanks, Erinn, for your 42 questions. I'll pass that over to Victor.

[Victor Luis:]

And I would say we haven't seen any change from the previous quarter to this quarter in any one of those areas. Very consistent really. PRC has continued along the same lines as we saw last quarter and I would say that in the department store it's very consistent as well.

[Erinn E. Murphy:]

Okay. Thank you, guys.

[Victor Luis:]

Thank you.

[Andrea Shaw Resnick:]

Thank you all. That concludes our Q&A. It is now 9

[Victor Luis:]

Thank you all for listening. I just want to close by thanking and congratulating our Coach teams globally. Thanks to their hard work, their perseverance and, of course, their excellence in execution, our transformation remains very much on plan. We're pleased with the progress that we're seeing here in North America, of course, with the sequential improvement in our business which has been led, as we have always expected, by our full-price channel where we have put the greatest investments and focus. In what is a rather turbulent global environment for the category, our balanced and strong franchise in Asia as well as our greenfield opportunity in Europe is serving us well. And lastly, I'm excited by the emerging trends that we've seen at the Stuart Weitzman brand, not only thanks to the very strong product foundation that they have but also thanks to the very strong and growing momentum that we're seeing with them in Asia. So all bodes well for us for the rest of the fiscal year. Thank you.

[Operator:]

This does conclude the Coach earnings conference. We thank you for your participation.