Tapestry, Inc.
Q3 2015 Earnings Call Transcript

Published: 28 Apr 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 the Global Head of Investor Relations and Corporate Communications at Coach, Andrea Shaw Resnick.

[Andrea Shaw Resnick:]

Good morning and thank you for joining us. With me today to discuss our quarterly results are Victor Luis, Coach’s Chief Executive Officer; and Jane Nielsen, Coach’s CFO. Before we begin, we must point out that this conference call will involve certain forward-looking statements including projections for our business in the current and future quarter 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, our quarterly report on Form 10-Q for the period ended December 27, 2014, and our other filings with the Securities and Exchange Commission for a complete list of risks and important factors. Also [indiscernible] future performance. Now, let me hand over to Victor Luis to this conference call. Victor Luis will provide an overall summary of our third fiscal quarter 2015 results and will also discuss our progress on global initiatives across markets. Jane Nielsen will continue with a detailed analysis on financial and operational results for the quarter and our outlook for the balance of the fiscal year. Following that we will hold for question-and-answer session. The Q&A session will ensure that [indiscernible]. We will then conclude with some brief closing comments. I would now like to introduce Victor Luis, President and CEO.

[Victor Luis:]

Good morning. Thanks, Andrea, and welcome, everyone. As noted in our press release, our third quarter results were in line with our expectations and annual guidance, adjusted for the stronger-than-expected dollar. We continue to see steady progress in our results with sequential improvement in our bricks-and-mortar stores in North America as we continue to make strides against our brand transformation agenda including greatly reduced promotional impressions. International growth rates remain fairly stable, up mid single digits in local currency, with China and Europe driving overall performance and offsetting the difficult compares in Japan this quarter as we were up against the pull-forward in advance of the tax hike effected on April 1st, 2014. Overall, we are pleased with our team’s execution as we continue to gain traction on this strategic plan to reinvigorate growth and drive the Coach brand’s relevance. In the weeks ahead, we look forward to completing the acquisition of Stuart-Weitzman, which we announced last quarter, a luxury footwear brand that we believe has significant domestic and international growth potential. As noted previously, we will develop each brand separately. Over the longer term, we will learn from each other, driving synergies across our respective businesses. Specifically, we will leverage Coach’s international infrastructure and expertise in handbags and accessories to develop Stuart-Weitzman handbag and accessories business. And in turn Coach will benefit from the Stuart-Weitzman’s teams accessories and footwear developments, where they’re proven leaders in fashion and fit. As we prepare for the integration of Stuart-Weitzman, we have renewed Coach’s women’s footwear license with Jimlar for the next two years. This will allow us to develop the multi-brand infrastructure and systems necessary to bring the category in-house. We are very excited about our first acquisition and look forward to welcoming the Stuart-Weitzman brand and organization into the Coach, Inc. family. Separately, we also just announced the new multi-year fragrance agreement with [indiscernible], upon expiration of our license agreement with Estée Lauder and expect to launch our first scent with our new partner in the fall of 2016. Before we get into a discussion of the quarter and our progress on Coach’s transformation, I wanted to briefly touch on our global pricing strategy since the topic had become a focus for our peer group given the volatility in global currencies. Our pricing strategy has always been to provide exceptional value in local currencies to our global customers. We aim to be approximately 40% to 60% below our traditional luxury competitors, and at this time we do not have plans to change our strategy. Coach will continue to deliver on its modern luxury proposition, offering superb handcrafted products and superior customer service and image-enhancing locations. Given our high level of fashion innovation, we price our products each season and always consider exchange rates at product launches while taking into account the pricing structure of both domestic and international brands in each market. Now as we have been doing since we unveiled our playbook last June, I thought we would share some of the actions that we have taken in keeping with our plan as well as our updated learning’s and results across the three brand pillars. Starting with product, Stuart-Weitzman’s design represented virtually all of our retail stores women’s offerings during the third quarter led by our key silhouette, Swagger available in a number of sizes, colors, and novelty, including patch work. In our outlet stores globally, Stuart’s impact was also noticeable for the first time, with new group set collections including Mickey, Ruby, and Morgan complementing CV, Christy, and Kelsey, previous retail favorites. Margo, its first outlet design introduced for fall continued to be strong. Stuart’s products represented about a third of our outlet store’s women’s assortment during the third quarter. Most generally, our approach of providing value from product elevation has continued. Putting more makes and quality in the products has been very well received by outlet customers globally, giving us confidence in our long-term direction to drive relevance across all channels. In addition, we held our third New York Fashion Week presentation in February, showing our fall 2015 collection and once again garnered overwhelmingly positive reviews from both the editorial and retail communities. Following the fall 2015 presentation, we generated about 193 million lifetime impressions in the market, up approximately 50% from our presentation of spring 2015 in September. And as the editorial community and fashion prep has continued to react positively to our brands, we are also seeing continued progress with consumers. Our quarterly North America brand tracking survey delivered in March showed further improvement among category drivers that Coach has perceived as less promotional, while our brand affinities remain strong overall. In our third quarter, we continued to reaffirm that fashion, which was supported by marketing, drives high sell-throughs as has been indicated with the great success we have experienced with Swagger. On stores

[Jane Hamilton Nielsen:]

Thanks, Victor. Victor has just taken you through the highlights and strategies. Let me now take you through some of the important financial details of our third fiscal quarter results as well as our outlook for the fourth quarter. Our quarterly revenues declined 15%, with North America down 24% and International down 3%. As noted, total sales would have been 3% higher excluding the impact of currency, with international sales up 4% on a constant currency basis. Excluding transformation and other related charges, net income for the quarter totaled $100 million, with earnings per diluted share of $0.36. This compares to net income of $191 million and earnings per diluted share of $0.68 in the prior year’s third quarter. For the quarter, operating income totaled $146 million on a non-GAAP basis versus $253 million last year while operating margin was 15.8% versus 23.9%. During the quarter, gross profit totaled 665 million as compared to $781 million a year ago, while gross margin was 71.6% versus 71.1%. As expected, gross margin benefited from the reduction in North America promotional activity and was helped by out-performance in Japan relative to our expectations. SG&A expenses as a percentage of net sales totaled 55.8% on a non-GAAP basis compared to 47.2% in the year-ago quarter. Absolute SG&A dollars were essentially flat to prior year and well below our expectations despite a $10 million increase in marketing spend. There were three primary drivers in the variance to our forecast. First, our fleet had lower-than-expected depreciation and occupancy expense given the shift in timing of renovations and new store openings, notably flagships into FY 2015. This will also impact our fourth quarter which I’ll speak to shortly. The second is currency as SG&A costs in the quarter benefited from the impact of the stronger dollar. Third, restructuring savings – as we continue to capture savings related to our restructuring sooner than originally anticipated and now expect savings of closer to $100 million in FY 2015. As I turn to GAAP metrics, let me recap key transformation and other related charges. With the realization of our restructuring savings, we now expect to incur pre-tax charges in the $300 million range associated with our transformation plan. $210 million of this charge has been taken over the last four quarters. As previously announced, these charges, which will be largely completed by the end of FY 2015, are related to inventory and fleet-related costs including impairments, accelerated depreciation, and severance associated with store closure. In total, we now expect to capture about $100 million in savings related to our transformation initiatives in fiscal 2015 and approximately 150 million in ongoing annual savings in fiscal year 2016. During the third quarter of FY 2015, the company recorded charges of 23 million under the company’s multi-year transformation plan. These charges consisted primarily of accelerated depreciation for renovations, lease termination costs related to store closures, and organizational efficiency costs. These actions increased the company’s SG&A expenses by $23 million, negatively impacting net income by $12 million after tax or $0.04 per diluted share in the third quarter. Therefore, during the first five months of fiscal 2015, the company’s recorded transformation related charges of $80 million and acquisition related costs of approximately 44 million. These charges increased SG&A expenses by approximately 479 million in total and costs of sales by $5 million, reducing net income by $56 million after tax or $0.20 cents per diluted share for the current nine-month period. Moving on to the balance sheet

[Operator:]

Thank you. [Operator Instructions] The first question today is from Bob Drbul with Nomura.

[Bob Scott Drbul:]

Hi. Good morning.

[Victor Luis:]

Good morning, Bob

[Jane Hamilton Nielsen:]

Morning, Bob.

[Bob Scott Drbul:]

I guess the question that I have is, you know, this was I think the first quarter with some of the newer product in the Outlet business in North America. So can you just elaborate a little bit more what’s going on in the Outlet business? Did it in fact show sequential improvement from the second quarter?

[Victor Luis:]

Sure, Bob. The short answer is yes, it did. And as we have been very consistent in communicating, we really believe that transformation is about touching all of the consumer touch points

[Bob Scott Drbul:]

Great. Thank you very much.

[Operator:]

Thank you. The next question is from Matthew boss with JPMorgan.

[Matthew Robert Boss:]

Hi. Good morning. So can you just help walk us through the bridge in your store comp between today and then your expectation for the return to growth at some point next year? And with that, when will we be fully apples-to-apples on a promotional basis?

[Victor Luis:]

From a promotional basis in terms of being apples-to-apples, it’s really looking toward July. Once we get beyond, of course, our seasonal clearance, which we will have comps this past year as well as of course getting beyond the event. From a third quarter of 2016, we will be apples-to-apples on EOS, which of course we have reduced from what was in essence three a week now to as I mentioned on my call two per month on average.

[Matthew Robert Boss:]

Okay. And then on the margin recovery, what type of sales recovery is needed to move EBIT margin, you know, say back to mid 20s which we saw only a few years back? And do we need to think about any kind of expense build next year given some of the – it sounds like some of the store builds potentially shift into next year?

[Jane Hamilton Nielsen:]

Yeah, Matthew, as we talked about in June when we laid out our long-term transformation plan. We will – right now in FY 2017, we’ll return to growth in line with the category. And our guidance suggests that that’s the point we’ll be back in the higher 20% margin range. As you look at FY 2016, what we have called out is that some of our store renovations and flagships have shifted into FY 2016. So that will put some SG&A pressure into FY 2016. Again, we’re executing the plan as laid out. There’s just a shift in timing here.

[Matthew Robert Boss:]

Okay. Great. Best of luck

[Operator:]

Thank you. The next question is from Barbara Wyckoff with CLSA.

[Victor Luis:]

Morning, Barbara.

[Barbara Wyckoff:]

Hi, everybody. Can you talk about the dynamic of the U.S. full-price stores versus outlet traffic conversions? You talked about ADT being up in outlets. What about the full-priced stores? And then maybe touch on the mix a little bit. How has it changed?

[Victor Luis:]

Sure. Pretty much consistent with what we have been experiencing last quarter, Barbara, and what we shared, which is performance has really been driven by ADT across both channels. Even if we have seen a sequential improvement in the traffic from the second quarter to the third quarter, it still remains a drag. Of course in full price, that’s very much also driven by the broader pressure that we have seen across malls. In terms of other news in the full-price channel, very pleased still with the performance that we’re seeing in the above $400 price bucket, which I mentioned in my notes is now still hanging at above 30% penetration compared to the 23% last year. Good performance in our footwear business across all channels, full price included, and of course beyond that driven by a reduction in conversion, which as we have consistently communicated is impacted by of course the promotional cadence year-on-year. In the full-price channel, once we get beyond semiannual sales, so into July, we’ll be on a like-for-like comparison with promotions. So there we should see of course a change in those trends.

[Barbara Wyckoff:]

All right. Thank you. Are you going to still be not participating in doing Coach Days in department stores? Or was that just a test for the spring season?

[Victor Luis:]

No. That has been our strategy for the whole year, and that is our strategy goes forward.

[Barbara Wyckoff:]

Thank you.

[Victor Luis:]

Thank you.

[Operator:]

Thank you. [Operator Instructions] The next question will be Joan Payson with Barclays.

[Joan Payson:]

Hi. Good morning.

[Jane Hamilton Nielsen:]

Morning, Joan.

[Joan Payson:]

So just in terms of some of the dynamics we’ve been seeing with tourist traffic in the U.S., could you just quickly touch on if that affected comps at all in North America? And then also just in terms of the overall category growth comments you had in terms of mid-single digit growth, it looks like Coach has now been more focused on basically product over $200. So are you seeing any differences in category trends in the over $200 versus under $200 segment?

[Victor Luis:]

Sure. In the tourist flows we have not seen dramatic changes in our North American business. As I did mention our notes, the major change in flows of what we’re seeing, especially in terms of the PRC consumer are really within Asia, with especially Tokyo, Seoul, Taipei picking up increased tourist flows at the expense of a reduction in Hong Kong and Macau for all of the reasons that most of you know of course with the geopolitical conditions there. In terms of the North American category, we have not seen necessarily a slowdown in the below 200 and increase in above 200. We have been speaking very much to our own strategies and two of course our own individual performance. In general, the slight slowdown that we talked about in the category has really been at the expense of the larger brands in the space, which of course is driven in part by our own pull-down in our promotional activities that we have mentioned very consistently.

[Joan Payson:]

Great. Thank you.

[Victor Luis:]

Thank you.

[Operator:]

Thank you. Our next question is from Ike Boruchow with Sterne Agee.

[Ike Boruchow:]

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

[Victor Luis:]

Good morning.

[Ike Boruchow:]

Victor, I just wanted to ask a higher-level question regarding your traffic and profitability within the full-price channel. So excluding EOS. So, you’re doing a great job holding back from discounts and markdowns within your stores, but some of your bigger competitors are building larger clearance sections and going deeper on their sale merchandise. Is there a point where you need to evaluate your thought process around how you balance sales and margins? I guess basically does your customer need more value to come back into the store to get the traffic positive again is what I’m asking?

[Victor Luis:]

Yeah, of course in many ways that is job description for us, and we have to obviously continue to evaluate what is happening across all channels. EOS does not really impact the full price business. It has been a flash sales model focused on our outlet consumer database only. And in the case of the full-price channel and what we’re seeing with the competitors and how promotional they may be, either seasonally or openly, for us it’s really about continuing to improve our own product assortment and looking to balance price points across all of the price buckets. So rather than producing and introducing a product that’s, say, $300 or $400 and having it on sale constantly in the full price channel for $30 or $40 off, our preference is to give the consumer value by giving them and creating consumer trust by giving them a great product at a suggested retail price. And then at the end of the season, that product which doesn’t perform is the case with most fashion brands will go on sale, and then eventually if it doesn’t sell there of course into our outlet channel. So our focus is really on getting the balance at full price within all of those buckets. We have seen that over the last quarter and communicated it specifically at gifting periods. And that is something that we are developing into.

[Jane Hamilton Nielsen:]

I would just add, Ike, that as we move to semiannual sale, one of the benefits that we saw is that it did pull new consumers into the store as we switched from PCs which went to our loyal consumers to semiannual sale, we saw new consumers enter the store during that period which was a benefit.

[Ike Boruchow:]

Got it. Thanks so much

[Operator:]

Thank you. The next question is from Anna Andreeva with Oppenheimer.

[Anna Andreeva:]

Great. Thanks so much. Good morning.

[Victor Luis:]

Good morning, Anna.

[Anna Andreeva:]

A question on inventories

[Jane Hamilton Nielsen:]

Sure, Anna. Just as we said today, we’re very pleased with our inventories. I think we’re well-positioned. We feel that we’re well-positioned to support our sales plan as we move forward and as we move forward and as we move into the fourth quarter, our inventory is fresh and in great shape. So we feel good about where we’re at. We made a commitment to manage our inventory tightly as we came out of our transformation, and that’s what we did. On your question on gross margin in the fourth quarter, we’re really executing against our strategy, and that is to keep making our product, valuing our product, pull back on promotion, and balance the headwinds that we’re seeing in rising sourcing costs and FX. And that’s what you’ll see play out in the fourth quarter as it’s played out all year. There will be pushes and pulls. We expect a little bit more pressure from FX, and we’ll see our production variances move more in line with what we had in the first half, which is about 50 basis points of pressure. Even though it’s after 9

[Operator:]

Thank you. The next question is from Oliver Chen from Cowen & Company.

[Oliver Chen:]

Thanks. Congrats on the progress of the brand management. Regarding Stuart and the outlet opportunity ahead, could you give us a yardstick from which you’ll reach a half or three quarters and then as we think about the metrics, is this main impact as he illustrates more progress on this assortment ticket or traffic or a combination of both? And then, Victor, I just had a question on the inventory composition with respect to the pricing spectrum. Are you happy with the freshness across your different price points including, you know, the access?

[Victor Luis:]

Sure. Let me first touch on the inventory one, and then I’ll talk a little bit ability outlet products from Stuart and how that flows in. On inventory, we’re very happy both with the freshness of the inventory and with the sell-throughs that we’re seeing. We are really pleased with the product that we continue to launch in the full price channel, and as I mentioned in my prepared notes, especially what we’re seeing with our new macro style in swagger and some of those styles in certain fabrications. We’re very much in chase mode, and that is a collection that we will continue to develop into and have a lot of excitement and innovation that we’re working into that line over the course of the next 12 months or so. In addition, we have been, as I mentioned in my reference to Ike’s question, continually developing into the key price buckets and functionalities. We have some key tote silhouette coming out from June, another key carryall silhouette coming out in August, and other smaller cross-body especially at shopper price points but for the full price channel coming out throughout later in the fall and into spring into holiday and spring of next year. So very, very actively developing for balance across all price points. In terms of outlets and the continued rollout of Stuart’s product, by fall and into holiday, the vast majority of outlet product will be new designs and even current designs that are there will get a certain freshening up facelift if you will so that all products will have Stuart’s influence in it. We’re very pleased. And there again our strategy continues to be to provide great value to the consumer at great price points, but certainly to continue to invest in giving the make and to continue to elevate the product.

[Oliver Chen:]

Thank you. Best regards.

[Victor Luis:]

Thank you.

[Operator:]

Thank you. And as a reminder, we do ask for one question per caller. The next question is from Dana Telsey with Telsey Advisory Group.

[Dana Telsey:]

Good morning, everyone, and nice to see the improvement. I was in the Beverly Hills store last week, and I can tell you that it looked terrific.

[Victor Luis:]

Thank you, Dana.

[Dana Telsey:]

As you think about the gross margin impact of fewer promotions versus higher leather goods, how should we – because this is the first gross margin improvement we’ve seen in, like, six quarters. How should we see that gross margin continue to trend and will more of the improvement come from the fewer promotions, higher leather goods? How are you seeing it? And are you seeing this penetration or product globally? Thank you.

[Victor Luis:]

Thanks, Dana. So the way our strategy is to balance the pullback in promotions with the increased make that we’re putting into the product. So that’s sort of the strategy. We balance those two with a very high gross margin. As we have called out through our transformation, we expect that to be in the 69% to 70% range. There’ll be some pushes – pushes and takes in terms of sourcing costs and FX, but overall we’ll continue to have our tailwind benefit as international grows sets the growth pace and that will continue to be a tailwind for gross margin overall. But it’s really balancing those two and managing the headwinds and tailwinds.

[Dana Telsey:]

Thank you.

[Operator:]

Thank you. Our final question today is from Erinn Murphy with Piper Jaffray.

[Erinn Murphy:]

Thanks. Good morning. I just want to go back to kind of your comments in the prepared script on higher promotional activity in the category. Are you seeing that across the board from your competitors? Is there a specific channel that that’s showing up? And then in particular, and then if you take a step back, if the category remains increasingly promotional, are you worried about kind of the timeline as you kind of work on improving your own promotional cadence and kind of elevating the product in terms of the turnaround? Thank you.

[Victor Luis:]

Sure. Thanks, Erinn. We have seen of course the outlet channel by its very nature is a promotional channel. So there’s nothing new there. It’s always been promotional. And from our perspective there, the key is of course to engage and convert consumers coming in. We don’t outwardly advertise to that channel, and it’s about providing them with excitement. And I think that the step change that we’re making across all of the consumer touch points in that channel with our new store concept, of course most importantly the new product, which is now across stores as well as our new visual merchandising guidelines, are proving to be the winning recipe there rather than providing further increased discounts at the moment. So very pleased there. In terms of the other channels in our own full-price channel and the shopping mall, I think there was some reference to some competitive brands potentially always being on sale. That is not our strategy. We – both in our full price stores and in .com we have the seasonal sales. We believe that that is the best way to build relationships with our consumers. In the case of the wholesale channel, we are not participating in our own Coach days, and I believe that was a question asked earlier by Barbara in terms of Coach-only events. We have reduced those, and that was a reduction of 30 – by 30 days compared to last year. Of course there are other promotional days that are across the channel that we participate in to some extent. Wholesale is really 8% of our total business, and we’re really focused in driving the transformation plan per the strategy that we have laid out.

[Andrea Shaw Resnick:]

Thank you. That concludes our Q&A. I will now turn it over to Victor for some concluding remarks. Victor?

[Victor Luis:]

Thanks, Andrea. I want to once again thank you all for following us and continuing to be on this transformation journey. As a team, we’re incredibly encouraged by the positive signs that we’re seeing in the execution of our strategies as we continue to drive first and foremost fashion relevance for the Coach brand, as well as to differentiate it from the accessible luxury competition that has grown over the last 5 to 10 years. I want to recognize our entire Coach’s team for their commitment and most importantly for continuing have the courage and the discipline to stay the course with our strategies, which are very much in the long-term interest of our brand health and of our business. And I know that I speak for all of us at Coach as we prepare to welcome the Stuart-Weitzman team to the Coach, Inc. family and looking out with great excitement to having them join us. So with that, I thank you all, and look forward to seeing you over the course of the next few months. Thank you.

[Operator:]

Thank you. This does conclude the Coach Earnings Conference. We thank you for your participation.