ITEM
2.
Management’s
Discussion and Analysis of Financial Condition and Results of Operations
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 American marketer of fine accessories and gifts for men and women.
Our
product offerings include handbags, women’s and men’s accessories, footwear,
outerwear, business cases, sunwear, watches, travel bags, jewelry and fragrance.
Coach operates in two segments: Direct-to-Consumer and Indirect. The
Direct-to-Consumer segment includes sales to consumers through Company-operated
stores in North America and Japan, the Internet and Coach catalogs. The Indirect
segment includes sales to wholesale customers in the U.S. and Asia as well
as
licensing revenue. As Coach’s business model is based on multi-channel
international distribution, our success does not depend solely on the
performance of a single channel or geographic area.
In
order
to sustain growth within our global framework, we continue to focus on two
key
growth strategies: increased global distribution, with an emphasis on our
direct
retail distribution in North America, Japan, and Greater China, and improved
productivity. To that end we are focused on four key initiatives:
|
·
|
Build
market share in the growing North American women’s accessories market by
leveraging our leadership position as a preferred brand for both
self
purchase and gifts. As part of this initiative, we continue to
emphasize
new usage occasions, such as weekend casual and evening. We also
continue
to introduce more sophisticated product to heighten our cachet,
especially
with our higher-end customers. Lastly, we continue to enhance the
level of
customer service in our stores by focusing on additional opportunities
to
deliver excellent customer service.
|
|
·
|
Rapidly
grow our North American retail store base by adding stores within
existing
markets, opening in new markets in the U.S. and by accelerating
store
openings in Canada. We plan to add about 40 retail stores in North
America
in each of the next several years and believe that North America
can
support about 500 retail stores in total, including up to 20 in
Canada. In
addition, we will continue to expand select, highly productive
retail and
factory locations.
|
|
·
|
Expand
market share with the Japanese consumer, driving growth in Japan
primarily
by opening new retail locations and expanding existing ones. We
plan to
add about 10 to 15 net new locations in fiscal 2008 and believe
that Japan
can support about 180 locations in total. We will also continue
to expand
key locations.
|
|
·
|
Raise
brand awareness in emerging markets to build the foundation for
substantial sales in the future. Specifically, Greater China, Korea
and
other emerging geographies are increasing in importance as the
handbag and
accessories category grows in these areas. In fiscal 2008, we intend
to
open approximately 30 net new locations, through distributors,
in Greater
China, Southeast Asia and the Middle East. This includes at least
five
more locations in major cities in mainland China, bringing the
total
number of locations in mainland China to at least
16.
|
In
addition, the growth strategies outlined above will allow us to continue
to
deliver superior returns on our investments and drive increased cash flows
from
operating activities.
SECOND
QUARTER OF FISCAL 2008 HIGHLIGHTS
In
the
second quarter of fiscal 2008, an increase in sales, slightly offset by a
decline in operating margin, led to an increase in net income and earnings
per
share growth. The highlights of the second quarter of fiscal 2008
were:
|
·
|
Earnings
per diluted share from continuing operations increased 21.0% to
$0.69 per
diluted share.
|
|
·
|
Net
income from continuing operations increased 17.6% to $252.3 million.
|
|
·
|
Net
sales increased 21.4% to $978.0
million.
|
|
·
|
Direct-to-consumer
sales rose 18.3% to $799.0 million.
|
|
·
|
Comparable
store sales in North America increased 7.0%, with retail stores
down 1.1%
and factory stores up 17.7%.
|
|
·
|
Coach
Japan sales, when translated into U.S. dollars, rose 21.4% driven
by
expanded distribution and mid-single-digit comparable store sales.
This
21.4% increase includes a 4.3% positive impact from currency translation.
|
|
·
|
In
North America, Coach opened 10 new retail stores and three new
factory
stores, bringing the total number of retail and factory stores
to 282 and
99, respectively, at the end of the second quarter of fiscal 2008.
We also
expanded five retail stores and three factory stores in North America.
|
|
·
|
In
Japan, Coach opened one net new location, bringing the total number
of
Coach Japan-operated locations at the end of the second quarter
of fiscal
2008 to 142. In addition, we expanded four locations.
|
|
·
|
In
Greater China, together with our distributors, Coach opened three
new
stores.
|
RESULTS
OF OPERATIONS
SECOND
QUARTER FISCAL 2008 COMPARED TO SECOND QUARTER FISCAL
2007
The
following table summarizes results of operations for the second quarter of
fiscal 2008 compared to the second quarter of fiscal 2007:
|
|
Quarter
Ended
|
|
|
|
December
29, 2007
|
|
December
30, 2006
|
|
Variance
|
|
|
|
(dollars
in millions, except per share data)
|
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
%
of
|
|
|
|
%
of
|
|
|
|
|
|
|
|
Amount
|
|
net
sales
|
|
Amount
|
|
net
sales
|
|
Amount
|
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
net sales
|
|
$
|
978.0
|
|
|
100.0
|
%
|
$
|
805.6
|
|
|
100.0
|
%
|
$
|
172.4
|
|
|
21.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
737.3
|
|
|
75.4
|
|
|
621.3
|
|
|
77.1
|
|
|
116.0
|
|
|
18.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
administrative
expenses
|
|
|
334.2
|
|
|
34.2
|
|
|
280.6
|
|
|
34.8
|
|
|
53.6
|
|
|
19.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
|
403.1
|
|
|
41.2
|
|
|
340.7
|
|
|
42.3
|
|
|
62.4
|
|
|
18.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income, net
|
|
|
10.6
|
|
|
1.1
|
|
|
7.9
|
|
|
1.0
|
|
|
2.7
|
|
|
34.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for income taxes
|
|
|
161.3
|
|
|
16.5
|
|
|
134.1
|
|
|
16.6
|
|
|
27.2
|
|
|
20.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from
continuing
operations
|
|
|
252.3
|
|
|
25.8
|
|
|
214.5
|
|
|
26.6
|
|
|
37.8
|
|
|
17.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from discontinued
operations, net of taxes
|
|
|
-
|
|
|
0.0
|
|
|
13.0
|
|
|
1.6
|
|
|
(13.0
|
)
|
|
(100.0
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
252.3
|
|
|
25.8
|
%
|
$
|
227.5
|
|
|
28.2
|
%
|
$
|
24.8
|
|
|
10.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income per
share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Continuing
operations
|
|
$
|
0.70
|
|
|
|
|
$
|
0.58
|
|
|
|
|
$
|
0.12
|
|
|
20.7
|
%
|
Discontinued
operations
|
|
|
-
|
|
|
|
|
|
0.04
|
|
|
|
|
|
(0.04
|
)
|
|
(100.0
|
)
|
Net
income
|
|
$
|
0.70
|
|
|
|
|
$
|
0.62
|
|
|
|
|
$
|
0.08
|
|
|
12.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Continuing
operations
|
|
$
|
0.69
|
|
|
|
|
$
|
0.57
|
|
|
|
|
$
|
0.12
|
|
|
21.0
|
%
|
Discontinued
operations
|
|
|
-
|
|
|
|
|
|
0.03
|
|
|
|
|
|
(0.03
|
)
|
|
(100.0
|
)
|
Net
income
|
|
$
|
0.69
|
|
|
|
|
$
|
0.61
|
|
|
|
|
$
|
0.08
|
|
|
13.1
|
%
|
Net
Sales
Net
sales
by business segment in the second quarter of fiscal 2008 compared to the
second
quarter of fiscal 2007 are as follows:
|
|
Quarter
Ended
|
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
|
|
Percentage
of
|
|
|
|
Net
Sales
|
|
Total
Net Sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December
29,
|
|
December
30,
|
|
Rate
of
|
|
December
29,
|
|
December
30,
|
|
|
|
2007
|
|
2006
|
|
Increase
|
|
2007
|
|
2006
|
|
|
|
(dollars
in millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct-to-Consumer
|
|
$
|
799.0
|
|
$
|
675.4
|
|
|
18.3
|
%
|
|
81.7
|
%
|
|
83.8
|
%
|
Indirect
|
|
|
179.0
|
|
|
130.2
|
|
|
37.5
|
|
|
18.3
|
|
|
16.2
|
|
Total
net sales
|
|
$
|
978.0
|
|
$
|
805.6
|
|
|
21.4
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
Direct-to-Consumer
Net
sales
increased 18.3% to $799.0 million during the second quarter of fiscal 2008
from
$675.4 million during the same period in fiscal 2007, driven by increased
new
store sales, comparable store sales, and expanded store sales.
In
North
America, sales from new stores, comparable store sales growth, and sales
from
expanded stores accounted for approximately $56 million, $34 million and
$8
million, respectively, of the net sales increase. Since the end of the second
quarter of fiscal 2007, Coach has opened 45 new retail stores and nine new
factory stores, and expanded 20 retail stores and 12 factory stores in North
America. In Japan, sales from new stores, comparable store sales growth,
and
sales from expanded stores accounted for approximately $12 million, $4 million
and $2 million, respectively, of the net sales increase. Since the end of
the
second quarter of fiscal 2007, Coach has opened 15 net new locations and
expanded 10 locations in Japan. Coach Japan’s reported net sales were positively
impacted by approximately $5.9 million as a result of foreign currency exchange.
Sales growth in the Internet business accounted for the remaining sales
increase. These sales increases were slightly offset by store closures.
Indirect
Net
sales
increased 37.5% to $179.0 million in the second quarter of fiscal 2008 from
$130.2 million during the same period of fiscal 2007, driven by growth primarily
in the U.S. wholesale and international wholesale divisions, which contributed
increased sales of approximately $28 million and $14 million, respectively.
Licensing revenue of approximately $7 million and $3 million in the second
quarter of fiscal 2008 and fiscal 2007, respectively, is included in indirect
sales.
Operating
Income
Operating
income increased 18.3% to $403.1 million in the second quarter of fiscal
2008 as
compared to $340.7 million in the second quarter of fiscal 2007, driven by
increases in net sales and gross profit, partially offset by an increase
in
selling, general and administrative expenses. Operating margin decreased
to
41.2% as compared to the 42.3% operating margin in the same period of the
prior
year as gains from increased net sales and the leveraging of selling, general,
and administrative expenses were offset by a decrease in gross
margin.
Gross
profit increased 18.7% to $737.3 million in the second quarter of fiscal
2008
from $621.3 million during the same period of fiscal 2007. Gross margin was
75.4% in the second quarter of fiscal 2008 as compared to 77.1% during the
same
period of fiscal 2007. The change in gross margin was driven by promotional
activities in Coach-operated North American stores and the fluctuation in
currency translation rates.
Selling,
general and administrative expenses were $334.2 million in the second quarter
of
fiscal 2008 as compared to $280.6 million in the second quarter of fiscal
2007.
As a percentage of net sales, selling, general and administrative expenses
decreased to 34.2% during the second quarter of fiscal 2008 as compared to
34.8%
during the second quarter of fiscal 2007, as we continue to leverage our
expense
base on higher sales.
Selling
expenses were $234.1 million, or 24.0% of net sales, in the second quarter
of
fiscal 2008 compared to $196.5 million, or 24.4% of net sales, in the second
quarter of fiscal 2007. The dollar increase in selling expenses was primarily
due to an increase in operating expenses of North American stores and Coach
Japan. The increase in North American store expenses is attributable to
increased variable expenses related to higher sales as well as expenses from
new
and expanded stores opened since the end of the second quarter of fiscal
2007.
The increase in Coach Japan operating expenses was primarily driven by increased
variable expenses related to higher sales and new store operating expenses.
In
addition, the impact of foreign currency exchange rates increased reported
expenses by approximately $2.5 million. The remaining increase in selling
expenses was due to increased variable expenses to support sales growth in
other
channels.
Advertising,
marketing, and design costs were $41.0 million, or 4.2% of net sales, in
the
second quarter of fiscal 2008, compared to $31.5 million, or 3.9% of net
sales,
during the same period of fiscal 2007. The increase in advertising, marketing
and design costs was primarily due to increased expenses related to direct-mail
marketing programs and increased staffing costs.
Distribution
and consumer service expenses were $12.9 million in the second quarter of
fiscal
2008, compared to $15.3 million during the same period of fiscal 2007. The
dollar decrease was primarily due to efficiency gains, partially offset by
higher sales volume. In addition, efficiency gains led to an improvement
in
distribution and consumer service expenses as a percentage of net sales from
1.9% in the second quarter of fiscal 2007 to 1.3% in the second quarter of
fiscal 2008.
Administrative
expenses were $46.2 million, or 4.7% of net sales, in the second quarter
of
fiscal 2008 compared to $37.3 million, or 4.6% of net sales, during the same
period of fiscal 2007. The increase in administrative expenses was driven
by the
following: a $2.8 million charge related to a potential legal settlement
incident to the ordinary course of business; an increase in employee staffing
costs, including share-based compensation expense; and an increase in consulting
and depreciation expenses as a result of investments in technology systems.
Interest
Income, Net
Net
interest income was $10.6 million in the second quarter of fiscal 2008 as
compared to $7.9 million in the second quarter of fiscal 2007. This increase
was
primarily due to higher average cash balances.
Provision
for Income Taxes
The
effective tax rate was 39.0% in the second quarter of fiscal 2008 as compared
to
38.5% in the second quarter of fiscal 2007. The increase in the effective
tax
rate is attributable to incremental income being taxed at higher rates.
Income
from Continuing Operations
Net
income from continuing operations was $252.3 million in the second quarter
of
fiscal 2008 as compared to $214.5 million in the second quarter of fiscal
2007.
This increase is attributable to an increase in net sales and operating income,
as discussed above.
Income
from Discontinued Operations
In
March
2007, the Company exited its corporate accounts business in order to better
control the location and image of the brand where Coach product is sold.
Through
the corporate accounts business, Coach sold products primarily to distributors
for gift-giving and incentive programs. The results of the corporate accounts
business, previously included in the Indirect segment, have been segregated
from
continuing operations and reported as discontinued operations in the Condensed
Consolidated Statements of Income for all periods presented.
In
the
second quarter of fiscal 2007, net sales and net income from discontinued
operations were $30.8 million and $13.0 million, respectively. In the second
quarter of fiscal 2008, there was no activity in the corporate accounts
business.
FIRST
SIX MONTHS FISCAL 2008 COMPARED TO FIRST SIX MONTHS FISCAL
2007
Results
of operations for the first six months of fiscal 2008 compared to the first
six
months of fiscal 2007 are as follows:
|
|
Six
Months Ended
|
|
|
|
December
29, 2007
|
|
December
30, 2006
|
|
Variance
|
|
|
|
(dollars
in millions, except per share data)
|
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
%
of
|
|
|
|
%
of
|
|
|
|
|
|
|
|
Amount
|
|
net
sales
|
|
Amount
|
|
net
sales
|
|
Amount
|
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
net sales
|
|
$
|
1,654.7
|
|
|
100.0
|
%
|
$
|
1,335.0
|
|
|
100.0
|
%
|
$
|
319.7
|
|
|
23.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
1,255.5
|
|
|
75.9
|
|
|
1,027.3
|
|
|
77.0
|
|
|
228.2
|
|
|
22.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
administrative
expenses
|
|
|
613.7
|
|
|
37.1
|
|
|
505.9
|
|
|
37.9
|
|
|
107.8
|
|
|
21.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
|
641.8
|
|
|
38.8
|
|
|
521.4
|
|
|
39.1
|
|
|
120.4
|
|
|
23.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income, net
|
|
|
25.6
|
|
|
1.5
|
|
|
14.5
|
|
|
1.1
|
|
|
11.1
|
|
|
76.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for income taxes
|
|
|
260.3
|
|
|
15.7
|
|
|
206.1
|
|
|
15.4
|
|
|
54.2
|
|
|
26.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from
continuing
operations
|
|
|
407.1
|
|
|
24.6
|
|
|
329.7
|
|
|
24.7
|
|
|
77.4
|
|
|
23.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from discontinued
operations,
net of taxes
|
|
|
0.0
|
|
|
0.0
|
|
|
23.4
|
|
|
1.8
|
|
|
(23.4
|
)
|
|
(100.0
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
407.1
|
|
|
24.6
|
%
|
$
|
353.1
|
|
|
26.4
|
%
|
$
|
54.0
|
|
|
15.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Continuing
operations
|
|
$
|
1.11
|
|
|
|
|
$
|
0.90
|
|
|
|
|
$
|
0.21
|
|
|
23.3
|
%
|
Discontinued
operations
|
|
|
0.00
|
|
|
|
|
|
0.06
|
|
|
|
|
|
(0.06
|
)
|
|
(100.0
|
)
|
Net
income
|
|
$
|
1.11
|
|
|
|
|
$
|
0.96
|
|
|
|
|
$
|
0.15
|
|
|
15.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Continuing
operations
|
|
$
|
1.09
|
|
|
|
|
$
|
0.88
|
|
|
|
|
$
|
0.21
|
|
|
23.9
|
%
|
Discontinued
operations
|
|
|
0.00
|
|
|
|
|
|
0.06
|
|
|
|
|
|
(0.06
|
)
|
|
(100.0
|
)
|
Net
income
|
|
$
|
1.09
|
|
|
|
|
$
|
0.94
|
|
|
|
|
$
|
0.15
|
|
|
16.0
|
%
|
Net
Sales
Net
sales
by business segment in the first six months of fiscal 2008 compared to the
first
six months of fiscal 2007 are as follows:
|
|
Six
Months Ended
|
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage
of
|
|
|
|
Net
Sales
|
|
Total
Net Sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December
29,
|
|
December
30,
|
|
Rate
of
|
|
December
29,
|
|
December
30,
|
|
|
|
2007
|
|
2006
|
|
Increase
|
|
2007
|
|
2006
|
|
|
|
(dollars
in millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct-to-Consumer
|
|
$
|
1,306.7
|
|
$
|
1,079.5
|
|
|
21.0
|
%
|
|
79.0
|
%
|
|
80.9
|
%
|
Indirect
|
|
|
348.0
|
|
|
255.5
|
|
|
36.2
|
|
|
21.0
|
|
|
19.1
|
|
Total
net sales
|
|
$
|
1,654.7
|
|
$
|
1,335.0
|
|
|
23.9
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
Direct-to-Consumer
Net
sales
increased 21.0% to $1.3 billion during the first six months of fiscal 2008
from
$1.1 billion during the same period in fiscal 2007, driven by increased
comparable store sales, new store sales and expanded store sales.
In
North
America, comparable store sales growth, sales from new stores and sales from
expanded stores accounted for approximately $88 million, $86 million and
$14
million, respectively, of the net sales increase. Since the end of the second
quarter of fiscal 2007, Coach has opened 45 new retail stores and nine new
factory stores, and expanded 20 retail stores and 12 factory stores in North
America. In Japan, sales from new store sales, comparable stores sales growth,
and sales from expanded stores accounted for approximately $24 million, $6
million and $4 million, respectively, of the net sales increase. Since the
end
of the second quarter of fiscal 2007, Coach has opened 15 net new locations
and
expanded 10 locations in Japan. Coach Japan’s reported net sales were positively
impacted by approximately $4.6 million as a result of foreign currency exchange.
Sales growth in the Internet business accounted for the remaining sales
increase. These sales increases were slightly offset by store
closures.
Indirect
Net
sales
increased 36.2% to $348.0 million in the first six months of fiscal 2008
from
$255.5 million during the same period of fiscal 2007. This increase was driven
by growth primarily in the U.S. wholesale and international wholesale divisions,
which contributed increased sales of approximately $58 million and
$33
million, respectively, as compared to the same period in the prior year.
Licensing revenue of approximately $12 million and $5 million in the first
six
months of fiscal 2008 and fiscal 2007, respectively, is included in indirect
sales.
Operating
Income
Operating
income increased 23.1% to $641.8 million in the first six months of fiscal
2008
as compared to $521.4 million in the first six months of fiscal 2007, driven
by
increases in net sales and gross profit, partially offset by an increase
in
selling, general and administrative expenses. Operating margin decreased
to
38.8% as compared to the 39.1% operating margin in the same period of the
prior
year as gains from increased net sales and the leveraging of selling, general,
and administrative expenses were offset by a decrease in gross
margin.
Gross
profit increased 22.2% to $1.3 billion in the first six months of fiscal
2008
from $1.0 billion during the same period of fiscal 2007. Gross margin was
75.9%
in the first six months of fiscal 2008 as compared to 77.0% during the same
period of fiscal 2007. The change in gross margin was driven by promotional
activities in Coach-operated North American stores and the fluctuation in
currency translation rates.
Selling,
general and administrative expenses were $613.7 million in the first six
months
of fiscal 2008 as compared to $505.9 million in the first six months of fiscal
2007. As a percentage of net sales, selling, general and administrative expenses
decreased to 37.1% during the first six months of fiscal 2008 compared to
37.9%
during the same period of fiscal 2007, as we continue to leverage our expense
base on higher sales.
Selling
expenses were $426.0 million, or 25.8% of net sales, in the first six months
of
fiscal 2008 as compared to $353.6 million, or 26.5% of net sales, in the
first
six months of fiscal 2007. The dollar increase in these expenses was primarily
due to an increase in operating expenses of North American stores and Coach
Japan. The increase in North American store expenses is attributable to
increased variable expenses related to higher sales as well as operating
expenses associated with new and expanded stores. The increase in Coach Japan
operating expenses was primarily driven by increased variable expenses related
to higher sales and new store operating expenses. In addition, the impact
of
foreign currency exchange rates increased reported expenses by approximately
$1.9 million. The remaining increase in selling expenses was due to increased
variable expenses to support sales growth in other channels.
Advertising,
marketing, and design costs were $73.1 million, or 4.4% of net sales, in
the
first six months of fiscal 2008, compared to $59.4 million, or 4.4% of net
sales, during the same period of fiscal 2007. The increase in advertising,
marketing and design costs was primarily due to increased expenses related
to
direct-mail marketing programs and increased staffing costs.
Distribution
and customer service expenses were $24.5 million in the first six months
of
fiscal 2008 compared to $26.9 million during the same period of fiscal 2007.
The
dollar decrease was primarily due to efficiency gains, partially offset by
higher sales volume. In addition, efficiency gains led to an improvement
in
distribution and consumer service expenses as a percentage of net sales from
2.0% in the second quarter of fiscal 2007 to 1.5% in the second quarter of
fiscal 2008.
Administrative
expenses were $90.1 million, or 5.4% of net sales, in the first six months
of
fiscal 2008 compared to $66.0 million, or 5.0% of net sales, during the same
period in fiscal 2007. The increase in administrative expenses was driven
by the
following: a $3.5 million charge related to a potential legal settlement
incident to the ordinary course of business; an increase in employee staffing
costs, including share-based compensation expense; and an increase in consulting
and depreciation expenses as a result of investments in technology systems.
Interest
Income, Net
Net
interest income was $25.6 million in the first six months
of
fiscal
2008 as compared to $14.5 million in the first six months
of
fiscal
2007. This increase was primarily due to higher average cash
balances.
Provision
for Income Taxes
The
effective tax rate was 39.0% in the first six months of fiscal 2008 as compared
to 38.5% in the first six months of fiscal 2007. The increase in the effective
tax rate is attributable to incremental income being taxed at higher rates.
Income
from Continuing Operations
Net
income from continuing operations was $407.1 million in the first six months
of
fiscal 2008 as compared to $329.7 million in the first six months of fiscal
2007. This increase is attributable to an increase in net sales and operating
income, as discussed above.
Income
from Discontinued Operations
In
March
2007, the Company exited its corporate accounts business in order to better
control the location and image of the brand where Coach product is sold.
Through
the corporate accounts business, Coach sold products primarily to distributors
for gift-giving and incentive programs. The results of the corporate accounts
business, previously included in the Indirect segment, have been segregated
from
continuing operations and reported as discontinued operations in the Condensed
Consolidated Statements of Income for all periods presented.
In
the
first six months of fiscal 2007, net sales and net income from discontinued
operations were $55.2 million and $23.4 million, respectively. In the first
six
months of fiscal 2008, net sales and net income were not
significant.
FINANCIAL
CONDITION
Cash
Flow
Net
cash
provided by operating activities was $514.9 million in the first six months
of
fiscal 2008 compared to $425.6 million in the first six months of fiscal
2007.
The year-to-year improvement of $89.3 million was primarily the result of
an
increase in earnings of $54.0 million. In addition, depreciation and
amortization increased $10.2 million, primarily as a result of new and expanded
stores in North America and Japan. The changes in operating assets and
liabilities were attributable to normal operating conditions.
Net
cash
provided by investing activities was $521.2 million in the first six months
of
fiscal 2008 compared to $234.6 million net cash used in investing activities
in
the first six months of fiscal 2007. The $755.8 million change is attributable
to a $768.5 million change in net purchases and maturities of investments
offset
by a $12.8 million increase in capital expenditures, primarily related to
new
and expanded stores in North America and Japan. Coach’s future capital
expenditures will depend on the timing and rate of expansion of our businesses,
new store openings, store renovations and international expansion opportunities.
Net
cash
used in financing activities was $725.6 million in the first six months of
fiscal 2008 as compared to $68.9 million in the first six months of fiscal
2007.
The increase of $656.7 million in net cash used is attributable to a $689.2
million increase in funds expended to repurchase common stock, a $1.0 million
decrease in net borrowings on the Coach Japan revolving credit facility and
a
$1.2 million decrease in the excess tax benefit from share-based compensation.
The impact of these changes were offset by an increase in cash proceeds from
exercise of stock options of $18.0 million in the first six months of fiscal
2008 as compared to the first six months of fiscal 2007 and from the
non-recurrence of a $16.7 million adjustment recorded in the first quarter
of
fiscal 2007 related to a previously recognized excess tax benefit.
Revolving
Credit Facilities
On
July
26, 2007, the Company renewed its $100 million revolving credit facility
with
certain lenders and Bank of America, N.A as the primary lender and
administrative agent (the “Bank of America facility”), extending the facility
expiration to July 26, 2012. At Coach’s request, the Bank of America facility
can be expanded to $200 million. The facility can also be extended for two
additional one-year periods, at Coach’s request.
Coach’s
Bank of America facility is available for seasonal working capital requirements
or general corporate purposes and may be prepaid without penalty or premium.
During the first six months of fiscal 2008 and fiscal 2007, there were no
borrowings under the Bank of America facility. As of December 29, 2007 and
June
30, 2007, there were no outstanding borrowings under the Bank of America
facility.
Coach
pays a commitment fee of 6 to 12.5 basis points on any unused amounts of
the
Bank of America facility and interest of LIBOR plus 20 to 55 basis points
on any
outstanding borrowings. Both the commitment fee and the LIBOR margin are
based
on the Company’s fixed charge coverage ratio. At December 29, 2007, the
commitment fee was 6 basis points and the LIBOR margin was 20 basis
points.
The
Bank
of America facility contains various covenants and customary events of default.
The Company has been in compliance with all covenants since the inception
of the
Bank of America facility.
To
provide funding for working capital and general corporate purposes, Coach
Japan
has available credit facilities with several Japanese financial institutions.
These facilities allow a maximum borrowing of 7.4 billion yen, or approximately
$65.6 million at December 29, 2007. Interest is based on the Tokyo Interbank
Rate plus a margin of up to 50 basis points.
During
the first six months of fiscal 2008 and fiscal 2007, the peak borrowings
under
the Japanese credit facilities were $26.8 million and $25.5 million,
respectively. As of
December
29, 2007
and
June 30, 2007, the outstanding borrowings under the Japanese facilities were
$14.2 million and $0, respectively.
Common
Stock Repurchase Program
On
November 9, 2007, the Company completed its $500 million common stock repurchase
program, which was put into place in October 2006. Concurrently, the Coach
Board
of Directors approved a new common stock repurchase program to acquire up
to $1
billion of Coach’s outstanding common stock through June 2009. Purchases of
Coach stock may be made from time to time, subject to market conditions and
at
prevailing market prices, through open market purchases. Repurchased shares
become authorized but unissued shares and may be issued in the future for
general corporate and other uses. The Company may terminate or limit the
stock
repurchase program at any time.
During
the first six months of fiscal 2008 and fiscal 2007, the Company repurchased
and
retired 23.5 million and 5.0 million shares, respectively, of common stock,
at
an average cost of $35.70 and $29.99, respectively, per share.
As
of December 29, 2007, $661 million remained available for future purchases
under
the existing program.
Liquidity
and Capital Resources
We
expect
that fiscal 2008 capital expenditures will be approximately $200 million
and
will relate primarily to new stores and expansions both in North America
and
Japan as well as investments in corporate systems and infrastructure. In
North
America, we expect to open about 40 new retail stores, of which 23 were opened
by the end of the first half of fiscal 2008. We also plan to open a few more
factory stores, in addition to the six opened during the first half of fiscal
2008. In Japan, we expect to open 10 to 15 net new locations, of which five
were
opened by the end of the first half of fiscal 2008. We will also continue
to
invest in department store and distributor locations. In addition, we will
invest in corporate infrastructure and expand our Jacksonville distribution
center. We intend to finance these investments from on hand cash and operating
cash flows.
Coach
experiences significant seasonal variations in its working capital requirements.
During the first fiscal quarter Coach builds inventory for the holiday selling
season, opens new retail stores and generates higher levels of trade
receivables. In the second fiscal quarter, working capital requirements are
reduced substantially as Coach generates greater consumer sales and collects
wholesale accounts receivable.
During
the first six months of fiscal 2008, Coach purchased approximately $409 million
of inventory, which was funded by operating cash flow.
Management
believes that cash flow from continuing operations and on hand cash will
provide
adequate funds for the foreseeable working capital needs, planned capital
expenditures and the common stock repurchase program. Any future acquisitions,
joint ventures or other similar transactions may require additional capital
and
there can be no assurance that any such capital will be available to Coach
on
acceptable terms or at all. Coach’s ability to fund its working capital needs,
planned capital expenditures and scheduled debt payments, and to comply with
all
of the financial covenants under its debt agreements, depends on its future
operating performance and cash flow, which in turn are subject to prevailing
economic conditions and to financial, business and other factors, some of
which
are beyond Coach’s control.
Reference
should be made to our most recent Annual Report on Form 10-K for additional
information regarding liquidity and capital resources.
Seasonality
Because
Coach products are frequently given as gifts, the Company has historically
realized, and expects to continue to realize, higher sales and operating
income
in the second quarter of its fiscal year, which includes the holiday months
of
November and December. In addition, fluctuations in sales and operating income
in any fiscal quarter are affected by the timing of seasonal wholesale shipments
and other events affecting retail sales. However, over the past several years,
we have achieved higher levels of growth in the non-holiday quarters, which
has
reduced these seasonal fluctuations. We expect that these trends will continue
and we will continue to balance our year round business.
CRITICAL
ACCOUNTING POLICIES AND ESTIMATES
Our
discussion of results of operations and financial condition relies on our
consolidated financial statements that are prepared based on certain critical
accounting policies that require management to make judgments and estimates
that
are subject to varying degrees of uncertainty. We believe that investors
need to
be aware of these policies and how they impact our financial statements as
a
whole, as well as our related discussion and analysis presented herein. While
we
believe that these accounting policies are based on sound measurement criteria,
actual future events can and often do result in outcomes that can be materially
different from these estimates or forecasts. The accounting policies and
related
risks described in our Annual Report on Form 10-K for the year ended June
30,
2007 are those that depend most heavily on these judgments and estimates.
As of
December 29, 2007, there have been no material changes to any of the critical
accounting policies contained therein, except for the adoption of the Financial
Accounting Standards Board (“FASB”) Interpretation (“FIN”) 48, “Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement 109,” which is
discussed in Note 9 of the Condensed Consolidated Financial
Statements.
Recent
Accounting Developments
In
February 2006, the FASB issued Statement of Financial Accounting Standards
(“SFAS”) 155, “Accounting for Certain Hybrid Financial Instruments - an
amendment of FASB Statements 133 and 140.” SFAS 155 permits fair value
measurement for any hybrid financial instrument that contains an embedded
derivative that otherwise would require bifurcation. This statement is effective
for all financial instruments acquired or issued after July 1, 2007. The
adoption of SFAS 155 did not have a material impact on the Company’s
consolidated financial statements.
In
June
2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes - an
interpretation of FASB Statement 109,” which clarifies the accounting for
uncertainty in income taxes recognized in an enterprise’s financial statements
in accordance with SFAS 109, “Accounting for Income Taxes.” FIN 48 prescribes a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken
in a
tax return. FIN 48 is effective for the fiscal year beginning on July 1,
2007.
The impact of adopting FIN 48 is described in Note 9.
In
September 2006, the FASB issued SFAS 157, “Fair Value Measurements.” SFAS 157
defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles and expands disclosures about fair
value measurements. This statement is effective for Coach’s fiscal year
beginning June 29, 2008. The Company does not expect the adoption of SFAS
157 to
have a material impact on the Company’s consolidated financial
statements.
In
September 2006, the FASB issued SFAS 158, “Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements
No. 87, 88, 106 and 132(R).” SFAS 158 requires an employer to recognize the
funded status of a benefit plan, measured as the difference between plan
assets
at fair value and the projected benefit obligation, in its statement of
financial position.
This recognition provision and the related disclosures were effective as
of the
end of the fiscal year ended June 30, 2007. For a complete description of
the
Company’s adoption of SFAS 158, refer to the Notes to Consolidated Financial
Statements in the Company’s Annual Report on Form 10-K for the fiscal year ended
June 30, 2007.
SFAS 158
also requires an employer to measure defined benefit plan assets and obligations
as of the date of the employer’s fiscal year-end statement of financial
position. This measurement provision is effective for Coach’s fiscal year ending
June 27, 2009. The Company does not expect the adoption of the measurement
provision to have a material impact on its consolidated financial statements.
In
February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial
Assets and Financial Liabilities - Including an amendment of FASB Statement
No.
115.” SFAS 159 permits entities to choose to measure many financial instruments
and certain other items at fair value. This statement is effective for Coach’s
fiscal year that will begin on June 29, 2008. The Company does not expect
the
adoption of SFAS 159 to have a material impact on the Company’s consolidated
financial statements.