Tapestry - Earnings Call - Q2 2012
January 24, 2012
Transcript
Speaker 5
Good day and welcome to the Tapestry Inc. 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 Senior Vice President of Investor Relations and Corporate Communications at Tapestry Inc., Ms. Andrea Resnick. You may begin.
Good morning, and thank you for joining us. With me today to discuss our quarterly results are Lew Frankfort, Tapestry Inc.'s Chairman and CEO, and Jane Nielsen, Tapestry Inc.'s CFO. Mike Tucci, President of North American Retail, is also joining us to discuss our holiday performance and spring initiatives. 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. These 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 to page for a complete list of these risk factors. Also, please note that historical growth trends may not be indicative of future growth.
Now, let me outline the speakers and topics for this conference call. Lew Frankfort will provide an overall summary of our second fiscal quarter 2012 results and will also discuss our strategies going forward. Mike Tucci will review the holiday season from a U.S. retail perspective and discuss key initiatives for the spring season ahead. Jane Nielsen will continue with details on financial and operational results of the quarter. Following that, we will hold a question and answer session where we will be joined by Jerry Stritzke, our President and Chief Operating Officer, and Victor Luis, our President of International Retail. This Q&A session will end shortly before 9:30 A.M. Lew will then conclude with some brief summary comments. I'd now like to introduce Lew Frankfort, Tapestry Inc.'s Chairman and CEO.
Speaker 4
Thanks, Andrea, and welcome, everyone. As noted in our release this morning, we're very pleased with our holiday results, including strong sales and earnings growth in our North American retail businesses. Our performance clearly demonstrates the strength of our franchise, our broad and diversified product platform, and our multi-channel international distribution model. Beyond the top line, we were also very pleased with our high levels of profitability and substantial cash generation. In addition, we made continued progress against our key global business initiatives, including expanding our share in the growing North American bag and accessory market, increasing our international presence, leveraging our heritage in the men's business, and expanding our digital presence. We've experienced a strong response to our new collections, and our pricing and assortment strategy continued to resonate with consumers worldwide. We're well situated to build upon our leadership position and continue to gain market share.
While I will get into more detail about the outlook for the category shortly, I did want to take the time to review our quarter first. Some key highlights of our second fiscal quarter were: first, earnings per share rose 18% to $1.18 compared with $1.00 in the prior year. Second, quarterly net sales totaled $1.45 billion versus $1.26 billion a year ago, an increase of 15%. Third, direct-to-consumer sales, which represent over 85% of total sales, rose 17% to $1.3 billion from $1.1 billion in the prior year on a comparable basis. Fourth, North American same-store sales for the quarter rose 8.8% from prior year, while total North American direct-to-consumer sales rose 17%. Fifth, sales in Japan were even to prior year in constant currency and rose 6% in dollars. Finally, we continue to generate very strong sales growth, significant double-digit comps in China.
During the quarter, we opened five retail stores and five factory stores in North America, including two men's retail stores and one men's factory store. At the end of the period, there were 350 full-price and 157 factory stores in operation in North America. Moving to Japan, six locations were open, including four men's locations. At the end, there were 184 total locations in Japan with 22 full-price stores, including eight flagships, 122 shop-in-shops, 33 factory stores, and seven distributor-operated travel retail locations. In China, we added nine locations, eight on the mainland and one in Hong Kong, our Nathan Road flagship, which I might add is doing very well. At the end of the quarter, there were 80 Coach locations in China, including 12 in Hong Kong, three in Macau, and 65 locations on the mainland in 28 cities.
As we discussed previously, we are building a multi-channel international distribution model in China, including flagships, retail stores, shop-in-shops, and factory stores. Indirect sales were even with prior year on a comparable basis at $166 million. Results reflected shipment timing differences from prior year in our international wholesale businesses. Sales for the quarter at retail and international wholesale locations increased at a double-digit pace, while sales at POS and U.S. department stores were even with last year's holiday quarter. We estimate that the addressable women's U.S. handbag and accessory category rose at a 5% to 10% rate in the holiday quarter, similar to the increase it experienced in the preceding nine months of the calendar year. At the same time, Coach's women's handbag and accessory sales rose about 12% across all channels in North America during the most recent quarter.
In our direct businesses in North America, handbag and accessory sales rose 15%. Separately, it's worth noting that we saw modest improvement in our customers' outlook for the economy compared to a quarter ago, with about 60% of those surveyed now believing that the U.S. economy is stable or getting better, up from 48%. Her intention to purchase Coach over the next year continues to be strong, with about two-thirds of consumers surveyed noting they probably or definitely would purchase a Coach product in the next 12 months. Our total revenues in North America rose 15%, with our directly operated businesses up 17%, driven by 8.8% in same-store sales increases and new distribution.
As noted in our press release, all direct channels benefited from our innovative digital media strategy, spanning our own websites, mobile platform, and social media, which enabled customers to purchase wherever they preferred to engage with our brand. Mike will provide additional details around some of these initiatives in just a moment. Fueling these overall strong comp results with similar gains in both store channels, driven by conversion and average transaction size, and continued strength in our e-commerce business, overall retail traffic rose with in-store trends consistent with prior quarters, while traffic on Coach.com continued to gain momentum. As we've discussed many times, outside of North America, China is our largest geographic opportunity, given the size of the market and the rate of growth. During the quarter, our sales rose again sharply from prior year, fueled by distribution and significant double-digit same-store sales.
Clearly, the Chinese consumer has embraced Coach, as evidenced by the excellent comps we're consistently generating and the extremely high new purchase intent among existing customers. Consistent with our strategy of building brand awareness in China, we took a number of important steps during the second quarter. First, we launched an integrated marketing campaign with our international brand ambassador, Gwyneth Paltrow, that included advertising across print, outdoor, and the web, as well as its 70th anniversary gala dinner and gallery event in Beijing. Another key component of the campaign was the successful launch of our presence on China Weibo, the leading social networking site in China. In December, we also became the first U.S. incorporated company to list on the Hong Kong Stock Exchange. All of these events helped to drive increased awareness for our brand.
While Jane will get into more details on our financials and I will discuss our outlook in some detail, I wanted to give you this recap. Now, I'll turn it over to Mike Tucci to discuss our North American retail business.
Speaker 1
Thanks, Lew, and good morning. Today, I'd like to review what was an excellent holiday season. Clearly, our balanced and more refined handbag assortment continues to drive sustainable growth in North America. There were three important productivity drivers within our North American business: overall product performance, our digital strategy and Coach.com results, and continued progress on our new men's initiative. During the holiday quarter, as always, we maintained a high level of product innovation and distinctive newness, ensuring that we had a steady flow of new product throughout the period. Our strategy to flow more product later in the quarter versus previous seasons was also very successful. To open the second quarter, we brought in Madison, our core holiday collection, completely updated and featuring several new silhouettes. Lindsay, a new style and feature of our holiday ad campaign, was an immediate hit with consumers.
Abigail was also a new fashion silhouette and key item. Also new to Madison were the mini Sophia, the flap carryall, and the Caroline Dowell satchel. This was our most fully developed Madison offering, and we saw the highest penetration level for the collection ever, eclipsing its highly successful launch three years ago. For November, Poppy was the focus, offered in new styles including two totes, a fold-over crossbody silhouette, a hippie, and a satchel. Liquid Gloss, a soft pattern, lightweight fabric with diamond quilting and chain straps, brought additional excitement and vibrant color to the collection. We also added some newness to Chelsea, only introduced last fall, with a classic tote featuring chain details at compelling price points.
Right before Thanksgiving, we refreshed our offering with updates to Madison and Kristen, along with a new drawstring tote in Chelsea, giving her additional reasons to revisit and repurchase during the key holiday season. Our mid-December significant Madison refresh also delivered newness closer to our peak selling period. Of course, we also had a comprehensive assortment of great gifts, from iPad covers to wristlets, and a wide range of items under $1. Our holiday product was supported by a comprehensive marketing plan, which began in mid-November, featuring a powerful gifting message. The emphasis of our marketing was product and item-driven across our core categories and other gifting ideas. Our campaign spanned Coach.com, social and rich media advertising, and compelling print and in-store marketing. Our addition of digital media to select high-profile store windows was a new element to our in-store marketing and was very well received.
Looking forward, we're excited about our spring product initiatives as well. Just last week, we launched an updated Poppy collection with a fresh point of view, with several new silhouettes, including the hippie, hobo, and the Poppy Willis, which harkens back to the classic Willis bags of the 1990s. We also introduced a fresh spring palette in Madison. In late February, the focus will be on Kristen, with four new styles across multiple fabrications and a beautiful new woven leather concept in soft, feminine colors. On the factory side, our strong results were fueled by a powerful combination of new product introductions, with key styles offered at great prices. Our product assortment was also supported by our in-store and direct marketing campaigns. I'd also like to take this opportunity to provide an update on our digital media strategy and the benefits that we're seeing from it.
As you know from previous calls, our digital objective in North America is to drive traffic and build brand awareness while maximizing e-commerce opportunities. Some of our key online initiatives are: first, mobile commerce. We launched our mobile commerce platform this past May, and almost 20% of our web traffic came through a mobile device this holiday season. Second, social media. With over 2.7 million Coach fans on Facebook, this social platform continues to evolve in its contribution to our overall brand message and success. Facebook provides us with additional marketing and potential revenue opportunities as we continue to learn how to engage with our customer in this space. Third, factory online. As mentioned in our last call in the U.S., we introduced our invitation-only flash sale site, targeted only towards our most loyal, factory-exclusive consumers.
This provides them with the convenience of shopping online while enjoying the same product and value as found in our stores. We're quite pleased with the results of this highly profitable initiative. This is a snapshot of our North American retail digital initiatives. Clearly, the internet will continue to increase in importance globally as both a marketing and communication vehicle and a sales driver. We now have a web presence in 20 countries, three of which are commerce-enabled, and we welcome several million visitors outside of North America in the quarter. In China, we're continuing to develop our digital programs and capabilities, which include a planned launch of e-commerce. Additionally, as we grow our international database, we're programmatically communicating with our international consumers via email and seeing engagement at the levels we enjoy here in the U.S.
We believe in digital and are clearly recognizing the benefits of this growth vehicle. Our intent is to drive further innovation in this channel, both in the near and long term. As we mentioned in our press release, we're also really excited about the results we're achieving in our men's business, which is on track to double again in fiscal year 2012 to over $400 million globally. We're experiencing success in men's across all concepts and store types, including dedicated stores, shopping shops, dual-gender locations, and expanded assortments in existing stores and across all geographies and channels. In North America, we see men's both as a way to drive and a substantial new distribution opportunity. We believe that in this fragmented category, where there is no dominant player, Coach has the opportunity to become the market leader.
Our approach to growing men's is to create great product, presented in exciting formats, combined with the rigor that we use to understand our consumer and his buying preferences. We also believe, based on our surveys, that beyond simply taking share, we will actually grow the men's category in North America. In summary, we're excited with the continued progress we've made in improving productivity and our men's initiative. We're feeling great about the spring season, given the current sales trends in our retail businesses. With that, I'll turn it back to Lew for a discussion of our strategies and opportunities for growth. Lew?
Speaker 4
Thanks, Mike. As most of you know, we have talked to three overarching growth strategies. First, building our women's business in the North America market. Second, leveraging the global opportunity. Third, tapping into the large and growing men's accessory category. A fourth has emerged as a global business driver and was also mentioned by Mike, and that is leveraging the growing power of the digital world. Coach's digital initiatives are an important and effective complementary strategy to our distribution growth as we continue to grow our store base in North America and worldwide. We expect that our square footage globally and across all channels will increase about 14% this year compared to 9% last year. Starting in North America, we will open about 40 new stores for this year, including the 21 opened in the first half.
The FY12 openings include about 15 full price and 25 factory outlets, with about half being dedicated men's locations. In total, we expect North American square footage growth of about 10 to 11% this year, driven by men's. Turning to China, this year, we're accelerating new store openings with about 30 locations planned, or at least an additional 15 for the balance of the fiscal year, with a vast majority on the mainland. Virtually all of these openings will be dual-gender stores due to the size of the men's opportunity. Given the continued strength we're experiencing in China, we remain confident that we will achieve at least $300 million in sales during the current fiscal year. In Japan, spending has remained stable after the first two quarters of volatility in the post-earthquake and tsunami period. Our focus continues to be on gaining market share, notably in the men's business.
During FY12, we expect to open about 15 net new locations in Japan or an additional seven net new stores for the balance of the year, nearly all of them dedicated men's locations. In total, we anticipate that net square footage growth in Japan will increase by about 10% this year, compared to 3% in FY11. Consistent with our strategy of directly operating select Asian markets, at the beginning of this month, we successfully transitioned our domestic retail businesses in Taiwan, which has about 25 locations and generates about $50 million of annual sales in retail to Coach in direct control. This follows our acquisition of the Singapore business last summer and will be followed by the acquisition of the Malaysia domestic retail operations next July.
It's important to note that these acquisitions allow us to leverage the investment we've already made in the region, utilizing the infrastructure created over the last few years, including our Asia shared services center and the Asian distribution center. In addition, we find these stores experience a significant improvement in productivity when they become directly managed, as we control the total brand experience. Outside of our directly operated markets, we continue to have thriving distributor-run businesses in other countries. During fiscal year 2012, we expect to open about 35 net new international wholesale locations, expanding to new markets, including Brazil, Vietnam, and Kuwait. We're also pleased to announce other distribution agreements for Latin America, initially including Colombia, Venezuela, Panama, and Chile, and to Indonesia, with the first stores opening next year. Touching on Europe, we are building a foundation for long-term growth.
First, in the UK, we are beginning to build our multi-channel international distribution model. Today, we have three stores all opened in the last 12 months, including a mall store in Westfield, our new Bond Street flagships, and a factory store. We will be opening our second London flagship on Regent Street this spring. Importantly, we are gaining traction in this market as the UK consumer is embracing Coach, and the majority of our business is coming from local customers. Second, in France, where we are partnered with French Arms, our key Boulevard Haussmann women's and men's shopping shops are performing well with the global tourists, as we continue to grow our brand awareness with the Parisian shopper. In closing, we're confident that our four overarching growth strategies will continue to drive our business at a double-digit pace.
At this time, I would like to turn it over to Jane Nielsen, our CFO, for further detail on our financials. Jane.
Speaker 2
Thanks, Lew. Lew and Mike have been taking you through the highlights and strategies. Let me now take you through some of the important financials of our second quarter results. As we mentioned, our quarterly revenues rose 15%. Our direct-to-consumer, which represents over 85% of our business, was up 17%, and our indirect business was even with last year due to shipment timing into international wholesale accounts. Earnings per share for the quarter increased 18% to $1.18, as compared to $1.00 in the year-ago period, as net income rose to $347 million from $303 million. On a non-GAAP basis, our operating income totaled $521 million in the second quarter, up 15% from $453 million in the same period last year. Operating margin in the quarter was 36%, compared to 35.9% in the year-ago period.
In the second quarter, gross profit rose 14% to $1.05 billion, up from $915 million a year ago, and gross margin rate remained strong at 72.2%, compared to 72.4% the prior year. As expected, we showed a continued sequential improvement in the year-over-year variance. Moving to expenses, we were pleased that we were able to gain modest leverage in the holiday quarter, which was our toughest quarter to do so. Specifically, on a non-GAAP basis, FG&A expenses as a percentage of sales improved from the prior year levels in the second quarter and represented 36.2% of sales versus 36.5%. As mentioned in our press release, during the second quarter, we recorded certain items. They included the one-time effect of a reevaluation of deferred tax balances due to a change in the Japanese corporate tax laws and the favorable completion of a multi-year pricing agreement with Japan.
Taken together, they yielded a substantially lower tax rate of 30.4% for the quarter, which decreased our tax provision by $12 million. As a result, we made a contribution of $20 million to the Coach Foundation, increasing FG&A expenses by that amount and precisely offsetting the effect of the one-time tax benefits to net income and earnings per share. Moving on to the balance sheet, inventories at quarter-end were $429 million, up 17% from the end of last year's Q2 and consistent with our sales growth. This inventory level allows us to support 31 net new North American stores, 13 net new locations at Coach Japan, and 23 additional Coach China stores from the year-ago period, as well as the acquired stores in Singapore and Taiwan and our men's initiative. Further, it will support strong underlying business trends, enabling us to maximize sales this spring.
Cash and short-term investments stood at $1.1 billion, as compared with $940 million a year ago, despite repurchases of over $900 million worth of Coach common stock in the interim 12 months. During the second quarter, we repurchased and retired 4.8 million shares of our common stock at an average cost of $62.48, spending a total of $300 million, taking our first half's total to about $360 million. At the end of the quarter, about $600 million remained on our current repurchase authorization. Net cash from operating opportunities and activities in the second quarter was $604 million, compared to $408 million last year during Q2. Free cash flow in the second quarter was an inflow of $565 million versus $382 million in the same period last year. Our CapEx spending was $39 million versus $26 million in the same quarter a year ago.
Consistent with our previous expectations and reflective of our global growth initiative, CapEx for this year will be in the area of $200 million, driven primarily by the opening of new stores across all geographies and investments in technology necessary to enable our expansion. We were very pleased to once again report these strong financial results. As Lew and Mike said, we're well positioned for the rest of the fiscal year. To elaborate, first, we expect to see sales growth with earnings per share growth ahead of the top line. Our sales will be driven in part by at least mid-single-digit comp sales in North America for the second half of the fiscal year. Second, as we've said before, we expect our second half gross margin to improve over last year as we anniversary increase sourcing costs.
Therefore, we anticipate the gross margin for FY12 will be essentially level with prior year. Third, on FG&A, we expect our developed businesses to continue to deliver leverage while we also continue to invest in global growth for the future. Fourth, we are committed to delivering an operating margin similar to what we've generated over the past two years at about 32%. Fifth, our tax rate is still likely to be in the area of 33% for the remainder of the year. This was an excellent quarter for Coach. Clearly, our holiday results bode well for the future, and we're confident that we will continue to deliver very strong sales and earning gains over the balance of the fiscal year and beyond. Thank you for participating in our conference call today.
Lew, Mike, Andrea, and I, joined by Jerry Stritzke and Victor Luis, will take some questions, which will be followed by a brief comment from Lew.
Speaker 5
Thank you. At this time, to ask a question, please press star followed by one on your touch-tone phone and record your first and last name when prompted. If it's your request, you may press star followed by two. Our first question today is from Bob Durbell with Barclays.
Speaker 0
Hi, good morning. The question I have is, on the men's, you talked about a lot of the growth and a lot of drivers for the growth. You talked about the $400 million for FY2012. Can you update us on what you think the long-term opportunity is for that business and the timing of it?
Speaker 4
Sure. The first word that comes to mind is it's boundless. To actually try to dimensionalize it, as Mike said, we're experiencing success wherever we're offering a comprehensive assortment of men's, again, across all geographies and all channels. It's extremely exciting for us. Second, men's spending globally represents about 15% of the global luxury spend. For Coach, with our sales expected at men's sales expected at $400 million, that will represent about 8% of our overall sales for this fiscal year. We believe that we can very comfortably get to our rightful share of at least 15% of a larger business over the next few years. We think $1 billion is well within reach over the next three to five years, and that's our internal mantra.
Speaker 0
Great. Thanks, Lew. The other question I have, just a quick follow-up. Did you guys give ticket and traffic for North American comps?
Speaker 4
I'm sorry, Bob. Your question?
Speaker 0
Can you give ticket and traffic for the North American comps?
Speaker 1
Ticket in North America, from a comp standpoint, was up slightly. Traffic, as we said, was very consistent with prior quarters. Overall, traffic was greater when you factor in across all channels. Our store traffic in factory and full-price stores sequentially improved from Q1, which was a benefit to us. However, it was still down in full price and up in factory.
Speaker 0
Thanks, Mike. Thanks, Lew. Congratulations.
Speaker 4
Thank you.
Speaker 5
Thank you. Our next question is from Neely Tamminga with Piper Jaffray.
Speaker 0
Great. Good morning. Let me add my congratulations to the whole team as well. I also have a question, a very specific question on your mantra on your men's business, Lew and Mike Tucci. Maybe if you guys could give us some explanation in terms of the rollout on the North American side. It's been our understanding that you guys are actually pretty underpenetrated within the North American retail footprint. I am just wondering more specifically what kind of the game plan is, you know, maybe as we head into Father's Day this year, in terms of getting more product in the stores. Thanks.
Speaker 1
Sure. There are a lot of components to that. I think what we plan to do with the investor community is share a very detailed global view of our approach to men's expansion for FY13. Let me give you some grounding and some headlines on what we're doing. First, we're very pleased with the results of our freestanding men's stores. There are a handful of them out there. They are great learning platforms for us, and the performance in those stores is excellent. The larger opportunity that we see is actually expanding our men's business in existing retail locations through shop-in-shops, what we call concept shops, and in fact, selling more men's products in all stores globally. We're doing this through increased presentations, through actually selling our product via our website enabled in-store through laptops. There is a very broad opportunity for us to sell more product in men's.
Where I see us going in Father's Day is several new men's shops, which will be installed this spring, the opening of our Pentagon dual-gender location, which will happen in May. That's a women's and men's side-by-side location. As we enter FY13, a significant rollout of men's shops in existing retail locations. Where we see the growth is driving productivity in our existing stores, taking advantage of the men's momentum that we're seeing through CBSR, our Coach by Special Requests program, as well as growing freestanding men's stores. Victor, if you want to add a little bit on the global side, what we're doing in Asia.
Speaker 6
Sure. When we look at Lew had mentioned in his remarks that the men's opportunity globally is approximately 15% of the global premium handbag and accessories market, which is at about $28 billion. The Asia opportunity today is about 25% of a $12 billion market. Of that, Japan is approximately $4.4 billion, China at $3.2 billion, including Hong Kong, Macau, including Duty Free, and then the rest in the rest of Asia. Japan, the men's penetration is at about 25%, and we're still very much in a rollout phase. Today, we have 14 dedicated men's locations, seven in full price, seven in factory. As many of you know, most of our distribution in Japan is within department stores where we are on the women's handbag floor. There, the opportunity will be to increase distribution with the men's floors, which we are now commencing. Initial results have been quite promising.
China is really a massive opportunity for us. When we look at mainland China, for many of our competitor brands, men's represents 50% or more of their sales. There, of our 65 mainland China locations today, 28 of them are dual-gender locations where we have basically standalone. We are opening this fiscal year dual-gender locations. We're starting with very early stages as basically a global men's and women's brand. We're seeing truly terrific results with very early stages, 25% to 30% penetrations for men's in these locations, at a point where we really still don't have an awareness as a men's brand. As many of you know, in the past, we've discussed our brand awareness, our unaided brand awareness at 16%, up from 8% last year. We're really just starting in the men's space. To achieve these penetrations this early is truly exciting and bodes well for the future.
In the rest of Asia, we're still at our very early stages. We have, of course, as Lew announced, just taken back our Singapore business and Taiwan only a few weeks ago. There, we are commencing the men's rollout as well and expect to see similar penetrations to what we're seeing in China in the medium term in the next two to three years.
Speaker 4
Thank you, Victor.
Speaker 5
Thank you, Victor. Thank you, Mike.
Speaker 3
Check with Stefil Nicholas.
Speaker 0
Hi, good morning, and congratulations. Let's congratulate you by asking the third question. The growth is so dynamic, and I'm sure we all have these questions because it sounds like we are going to be talking about it for a long time. Maybe some other metrics we could get into. Gift versus self-purchase, is it bringing in a new customer, or is it a customer making a different trip? Is there a different proportion of gift versus self-purchase for the men's as you're seeing it? This is just shorter term, but the comp versus distribution growth just in the number you're talking about, the $400 million. Lastly, anything you'd tell us about ticket, just to sort of round out our view a little bit more, again, about the characteristics of the men's business. Thanks.
Speaker 4
Sure. First, gift versus purchase channel. At present, I would say in North America, a slightly greater proportion of men's is for gift than self-purchase. We estimate self-purchase. I'm sorry, gifting for women is about 20% of our sales. It's obviously a great marketing opportunity for us, and you will see us distorting a good portion of our marketing media as well as social networking towards men to both build awareness and to encourage gifting. In terms of existing consumers versus new consumers, we are, in North America, attracting a higher rate of new customers into the franchise through men's than we are women's. That should be expected because the women's business is, of course, extremely developed with growth opportunities ahead. In the men's, it's early days. In terms of distribution growth versus same-store sales growth, I am being cautioned not to provide much detail.
What I would say is that we are achieving significant double-digit same-store growth in the men's area.
Speaker 1
One minute. Okay. I can, let me come in on this one. What we understand is that the concept is proven. We have enough exposure in the marketplace and enough experience with consumers to know that the concept is a very proven concept, and the category is very real. We need a little more time to very tactically break out the opportunity from a distribution standpoint, our digital opportunity with our men's website, our global opportunity in terms of store footprint, both the existing opportunity in large-format flagship stores to add men, the new opportunity to develop men's and women's dual-gender stores, and how we can provide a men's presence in all stores where we trade that are currently women's stores. It's something we need to sort out. We need to really work through the entire fleet. In full price in North America, we own that 350 stores.
We're doing that work today, and we have traction in each of the formats, which gives us a path for growth. On the product side, what's interesting is that as we expand this category, it's not all about bags. Bags are still the anchor, but we're seeing very strong response to accessories, to lifestyle categories, to emerging categories like footwear, outerwear, small travel pieces. We believe that this concept hangs very well on its own and drives very strong productivity metrics, comparable to our women's business in terms of ticket size and from a margin structure, very comparable as well.
Speaker 4
You probably heard more about men's just now than you wanted to.
Speaker 0
No, very helpful. Thank you.
Speaker 4
Going well.
Speaker 5
Thank you. Our next question is from Christine Chen with Needham & Company.
Speaker 3
Thank you, and congratulations on another good quarter.
Speaker 4
Thanks, Christine.
Speaker 3
I wanted to ask in women's, you know, handbags, $400 and up. Was curious if you were able to increase the penetration for the holiday season, and I'm wondering what your outlook is for that part of the handbag business going forward for the rest of the year. Thank you.
Speaker 1
Sure. Our overall handbag performance was actually very strong. Comps were positive. We saw growth there. Our mix in handbags, average unit retail was about flat for the quarter, and that was very intentional around our gifting strategy and a mix strategy where some of our core price points at $298 and $198 were extremely successful. The handbag performance at over $400 is actually down from prior year, although our outlook going forward would suggest that that is still a growth opportunity for us.
Speaker 3
Okay, great. Thank you and good luck.
Speaker 4
Thank you.
Speaker 5
Thank you. Our next question is from Barbara Wykoff with CLSA.
Speaker 0
Hi, everyone. I'd like to have some more color on China. What are they selling versus the other markets? You talked about men's and women's, which is fine. How many stores do you think you can have in China in the next three to five years? Is there a chance that travel retail would be a candidate for you to take in-house?
Speaker 6
Victor?
Speaker 0
Sure. First, maybe we can talk a little bit about the distribution. We are, as Lew mentioned in his opening remarks, today at 80 doors with the vast majority of those 65 on the mainland. When we look at the opportunity, it is truly boundless. Barbara, you know well the sociodemographic, socioeconomics of the market, 1.3 billion population, of which 50% is urban and continuing to urbanize. Already 120 cities with a population of a million or more. We are today only in 28 of those cities. With our broad collection from a style perspective, as well as our broad price points, we're able to much more easily than traditional luxury brands, of course, to go into these second and third-tier cities where we're seeing some success. We are also seeing a rapidly growing middle class, and we're not seeing many limitations from a distribution perspective.
When we start looking at Coach's strategy towards the multi-channel rollout, China really fits nicely. We have approximately 600 department store doors today in China, of which already over 110, 120 are doing incredibly well in the imported luxury cosmetics space, which serves as a barometer for us. Malls are continuing to develop nicely, both in the full price as well now, and increasing rollouts of factory outlet malls, of course, which we know well. Looking at the rollout for this year, as we've announced, 30 doors, and we see us continuing at that pace for the foreseeable future. I think the second question was on products. There, we really don't see a tremendous difference globally, quite frankly, in terms of our collections. Madison, Poppy, Kristen are truly global collections for us.
The difference in what truly differentiates Coach from many of our competitors is that we have a group of very talented merchants in each of our markets who are supported by a truly superb consumer insight team. We're constantly listening to our consumers, and that allows us to tweak our collections, whether it be from color, size, shape, style, and therefore maximize the opportunity in each of our markets. The difference, as I touched to earlier, in China is really the men's opportunity. We're starting out from the beginning in these very early stages as a dual-gender brand.
Whereas we had been three, four years earlier opening 1,000 to 1,500 square feet locations that were basically women's-only locations, today we're targeting 2,000 to 2,500 square feet on average locations with a men's and women's entrance in most cases and getting truly terrific results and seeing our product resonate, even though we still have a very low awareness level at these early days. Touching on Duty Free, specifically, we're looking at, I would say, two parts of the travel retail piece. Of course, for China, the big opportunity is outside of China. Approximately half of Chinese luxury sales occur outside of China. We're very active in developing our distribution in Asia, and we're seeing tremendous benefits from that, of course, within China itself in Hong Kong and Macau, and beginning to see some of that in other markets as well.
Within China, domestically, at the airports, there will be opportunities both in the duty paid as well as in the Duty Free spaces as airport authorities begin to put the infrastructure in place. It's something we're investigating. We haven't made a move in that space at the moment because there's so much opportunity in the urban areas themselves that we're going after, but it is something that we're paying attention to.
Speaker 5
Great. Can I just ask one more question about the China outlets? How many malls are there now? How many are you in?
Speaker 0
We today are in nine malls, including Hong Kong and Macau, seven in mainland China. Only a few months ago, I attended a conference with global factory outlet developers in the city of Suzhou, where there were talks of 100 or so outlets being developed in the next 5 to 10 years. We expect the channel to develop rather quickly and to be a substantial opportunity.
Speaker 5
Great, thanks so much.
Speaker 4
You're welcome.
Speaker 5
Thank you. As a reminder, to ask a question, please press star one, and please limit yourself to one question per call. Our next question is from Randy Connick with Jefferies.
Speaker 0
Yeah, thanks a lot. First, Lew, how do you think about the U.S. consumer for 2012 versus 2011? What's your thoughts there? I guess, Lew or Jane, if we kind of think about the various moving pieces of increasing China as a % of sales, increasing men's as a % of sales, and then taking back these various Asian geographies, how do we think about the long-term operating margin structure for the company? We've been very consistent in the low 30% for the last couple of years. How can we think about where those operating margins end up over the next few years? Thanks.
Speaker 4
First, Randy, as I mentioned, consumer sentiment has really improved over the last 90 days. Actually, 60% of consumers now in North America believe the economy is stable or improving, and that's up from 48% just three months ago. It's also evident that consumers are beginning to borrow more and save somewhat less. Savings rates, as you know, are down to about 3.5% from 5%. Year-on-year, non-mortgage borrowing is increasing, which says that the consumers are more encouraged than they at any point than they have been in the last 6 to 12 months. We feel, barring any unexpected event, that consumer sentiment will continue to be positive. Obviously, the recovery is very uneven. While unemployment is still at a terribly high rate of 8.5%, unemployment for college graduates over the age of 25, who is our primary consumer, is only in the mid-4% range.
We're benefiting from our positioning, which is to offer an excellent product at accessible and affordable price points. Our very diversified consumer base is responding well. Guardedly optimistic.
Speaker 2
I think as we look at the components of operating leverage, the net long-term positives that we have are our growing international business driving overall operating margin as it continues to grow and achieve scale. Our men's business, as it grows internationally and achieves scale, will also be a positive operating driver and will continue to drive the productivity initiatives and efficiency initiatives that we've delivered over time to keep our high operating profit and to continue to invest in growth. As we've talked before, as we take over markets like Taiwan, Singapore, and Malaysia, there is the initial few quarters as we purchase the inventory at wholesale rates and we cadence our flow of merchandising and take over the store operations.
Over time, those become very good businesses for us, but we have the first few quarters of transition before their operating margin stabilizes and becomes a net benefit for us.
Speaker 0
Can you hear me?
Speaker 2
Yes.
Speaker 0
Is there just a number we could look towards? Is there like a 35 number or anything like that you would want us to look towards?
Speaker 4
We have an aspirational goal. You know us well. We drive to build a lasting franchise and give our shareholders an excellent return. Obviously, we're working in all areas to maximize operating income consistent with building a lasting franchise.
Speaker 0
Fair enough. Thanks, guys.
Speaker 4
You're welcome.
Speaker 5
Thank you. Our next question is from Brian Tunick with JPMorgan.
Speaker 0
Thanks. I'll add my congrats to everyone as well. Questions a little on the gross margins here. It still sounds like we're hearing that double-digit labor cost increase in China. Just trying to understand sort of where is your gross margin improvement coming from? If you can just give us a little more color there. Is it channel mix? Is it all relief in sourcing and how that's happening? On the new headquarters that we've been hearing about, can you maybe talk about any cash flow implications from that? Does that change your commitment towards continued share repurchases or dividends? Maybe just talk about the cash flow and your minimal cash balance requirements.
Speaker 4
Sure. Let me ask Jerry Stritzke to jump in here. On the sourcing opportunities, we're very pleased with the job that our team has really done trying to mitigate some of those challenges. It's hard work. We've done a lot of work trying to get raw material sourced into place to help offset, you know, working on where we're doing our manufacturing, how we're doing it. It is still a pressure that we have to cope with that pushes the wrong way and creates some pressure on our margin. We're fortunate in that as our international business does grow, particularly in Asia, that's a plus. We have puts and takes. As we expand to other markets, we go the other direction. We are really striving to kind of lose points, to hold the ground. There are puts and takes, and we fight that battle every other time.
We've talked, I think, before about our countersourcing activities in Vietnam, India. We're actually continuing to expand that and aggressively look at that. We've had some great successes that have worked to our benefit. I think it's a reflection of the talent we have offshore, which we think is unique to Coach, to really build manufacturing capabilities and our hands-on activity to do that in a way that ensures that we continue to deliver a high-quality product.
Speaker 2
In the next quarter or two, as with our practice, we'll come back and talk to you about our next year's outlook on gross margin.
Speaker 0
Okay. How about the headquarters and the cash flow thoughts?
Speaker 2
Yes. I think that, you know, in what you've seen in our Q2 repurchase activity, we remain committed to two things. One is investing in our business to continue to drive long-term growth and return. The second is we remain committed to returning capital to shareholders. We're doing that through a combination of dividends, which you've seen increase over time since our initiation, and through stock repurchases. I don't anticipate that our building would stop that in any meaningful way.
Speaker 4
Thank you, Jane.
Speaker 2
Thank you all for joining us on our conference call today. It is now 9:30 A.M. The market's about to move in. As is our tradition, I'd like to turn it back to Lew for a few closing words. Lew?
Speaker 4
Thank you, Andrea. Obviously, a lot of good discussion around men's, China, our stabilizing gross margins, which I think is a testimony to the nimbleness of our team. The digital world is extremely powerful, and it's now, for us, an overarching strategy. We do feel good about where we are, and we feel excited about our prospects. Have a good day, everybody. Thank you.
Speaker 5
This does conclude the Tapestry Earnings Conference. We thank you for your participation.