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Coach Profits Fall 14 Percent

Sales decline 1.8% in quarter.

Coach Inc. is changing course.

The New York-based Coach plans to open fewer stores and sell more moderately priced products as the brand that’s a symbol of “accessible luxury” adapts to weakening sales and lower earnings because of the recession.

Coach disclosed plans for a less aggressive approach to building its retail network and more customer-friendly price points in reporting a 14 percent decline in second-quarter earnings, to $216.9 million, or 67 cents a diluted share, from $252.3 million, or 69 cents, a year ago. Sales during the quarter ended Dec. 27 dipped 1.8 percent to $960.3 million from $978.0 million.

Direct-to-consumer sales inched up 2 percent to $818 million from $803 million, but North American comparable-store sales fell 13 percent. Sales in Japan dipped 1 percent on a constant currency basis, but gained 15 percent on a dollar basis. The second-quarter earnings per share performance was 2 cents better than the analyst consensus estimate of 67 cents.

The Coach results are perhaps a harbinger of what lies ahead in coming weeks as vendors and retailers report their quarterly numbers. While there have been a string of analysts’ downgrades and revised forecasts across the apparel sector, Coach is one of the first companies to release financial results that incorporate the dismal holiday period.

The company is pulling back on its North American expansion, opening just 20 stores this year compared with the usual 40. Six of the new stores will be in Canada. In contrast, Coach hasn’t changed plans for new stores in Japan, China and the Middle East, where its business remains robust, Lew Frankfort, chairman and chief executive officer, told analysts during a Wednesday morning conference call. He added that same-store sales increases in China were in the double digits.

Frankfort later told WWD that Coach’s U.S. business, which worsened during the second quarter, this month “has stabilized at reduced levels.”

He also said that, while it will have greater impact during the next fiscal year, the company has introduced more products in the $200-to-$300 price range, which will effectively reduce its in-store pricing average by 10 to 15 percent.

Speaking on the call, Frankfort emphasized EPS had declined only slightly “despite the most challenging holiday season our company has experienced during my 30-year tenure. The heavily promotional atmosphere against the deteriorating economic backdrop, impacted both traffic and conversion rates in our retail stores and department store locations, and ultimately led to weaker-than-expected sales.”

The ceo pointed out that the company’s multichannel distribution model reduces its reliance on its full-price U.S. business. He also noted the premium U.S. handbag and accessories category declined by 10 percent during the fourth quarter of calendar 2008, while Coach’s handbag sales fell by 6 percent and directly operated stores by only 1 percent.

“Obviously we are in uncharted waters, Coach and America as well,” he said. “We know our business well. We have a very strong franchise. We have a very excellent balance sheet. All of you know that we don’t borrow.”

In unspoken recognition of Coach’s profitable factory store operation, he added, “And when we talk about our inventory being currently equivalent to currency and our ability to repurpose it, it’s probably more true for Coach than any other company that I’m aware of.”

Frankfort noted that because Coach has done so well in past quarters, one of its toughest challenges is facing comparisons with its own historic metrics.

Shares of the company slid $1.15, or 7.3 percent, Wednesday to close at $14.72. More than 20.6 million shares changed hands, nearly three times the company’s three-month average volume of 7.3 million shares. The company declined to provide guidance for the remainder of the year.

Frankfort told analysts that the $200-to-$300 price range was historically where the company “did their best.”

Later, he told WWD that the firm is not lowering prices on existing styles, but will instead introduce new collections that feature more product in the so-called “sweet spot” price range. There are a few offerings, such as the Penelope Op-Art Shopper at $298, already in the stores.

The new designs to sell below the $300 price range will feature fewer decorative elements, have simpler construction and more modest fabrications, according to Frankfort. Last year the company, which previously had relied primarily on China for the manufacture of its bags, began sourcing in other areas for better pricing options and is now producing more in India and Vietnam due to the lower-cost base in those countries, he said. Coach is one of numerous companies seeking alternative sourcing options to China as that nation’s labor and other costs spiral.

To make room for the new collections, some older lines, such as Ergo, Bleecker and Hamptons, have been retired. The average life span of a collection varies from one to five years before rotation out of the assortment.

Frankfort said the company made a decision not to discount at its full-price stores during holiday so as not to dilute the brand, although there was some promotional activity at its factory stores to clear some inventory.

Gross margin during the quarter dropped to 72.1 percent from 75.4 percent in the second quarter of last year.

While some see the current retail landscape as a time to pull back to conserve cash, Frankfort sees it as a time for opportunity.

He said he believes sales of handbags and small leather goods will hold up better than apparel. “There is still substantial opportunity in small leather goods, the core business for us, [as well as in] watches, jewelry and fragrance. There are lots of opportunities for us to expand our offerings, particularly in jewelry,” he explained.

For the six months, profits fell 10.9 percent to $362.7 million, or $1.10 a share, from $407.1 million, or $1.09, last year. Sales inched up 3.5 percent to $1.71 billion from $1.65 billion.

Todd Slater, analyst at Lazard Capital Markets, is estimating third-quarter EPS at 32 cents, down from 43 cents, and fourth-quarter EPS at 38 cents, down from 47 cents. Both estimates assume a worst-case scenario for consumer spending patterns where traffic could remain down 10 percent or more and full-price same-store sales decline more than 10 percent for the foreseeable future.