The effective tax rate was 38.5% in the first nine months of fiscal 2007 as compared to 37.9% in the first nine months of fiscal 2006. The increase in the effective tax rate is attributable to incremental income being taxed at higher rates.
Net income from discontinued operations was $25.9 million in the first nine months of fiscal 2007 as compared to $25.6 million in the first nine months of fiscal 2006. Net sales related to the corporate accounts business were $63.4 million in the first nine months of fiscal 2007 as compared to $63.6 million in the first nine months of fiscal 2006. The company exited the corporate accounts business in the third quarter of fiscal 2007.
Net cash provided by operating activities was $522.3 million in the first nine months of fiscal 2007 compared to $401.4 million in the first nine months of fiscal 2006. The year-to-year improvement of $121.0 million was primarily the result of an increase in earnings of $126.4 million. In addition, depreciation and amortization increased $11.5 million, primarily as a result of new and expanded stores in both North America and Japan. These cash inflows were offset by a $9.7 million decrease in share-based compensation. The changes in operating assets and liabilities were attributable to normal operating conditions.
Net cash used in investing activities was $418.4 million in the first nine months of fiscal 2007 compared to $406.1 million in the first nine months of fiscal 2006. The $12.3 million increase in net cash used is attributable to a $13.6 million increase in the net purchases of investments, offset by a $1.2 million decrease in capital expenditures, related to the timing of payments primarily for new and renovated retail 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 by financing activities was $25.0 million in the first nine months of fiscal 2007 as compared to $34.6 million generated from financing activities in the first nine months of fiscal 2006. The change of $59.6 million in net cash used primarily resulted from a $36.2 million increase in funds expended to repurchase common stock in the first nine months of fiscal 2007 as compared to the first
nine months of fiscal 2006. In addition, there was a $35.5 million decrease in excess tax benefit from share-based compensation and a $16.7 million decrease related to an adjustment to reverse a portion of the excess tax benefit previously recognized from share-based compensation in the fourth quarter of fiscal 2006. These decreases were offset by an $18.3 million increase in proceeds received from the exercise of stock options and the non-recurrence of $10.5 million in repayments on the Japanese credit facility in the prior year.
Coach’s revolving credit facility (the “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 nine months of fiscal 2007 and fiscal 2006 there were no borrowings under the Bank of America facility. As of March 31, 2007 and July 1, 2006, there were no outstanding borrowings under the Bank of America facility.
Coach pays a commitment fee of 10 to 25 basis points based on any unused amounts of the Bank of America facility. Coach also pays interest of LIBOR plus 45 to 100 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 March 31, 2007, the commitment fee was 10 basis points and the LIBOR margin was 45 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 $62.8 million at March 31, 2007. Interest is based on the Tokyo Interbank rate plus a margin of up to 50 basis points.
These Japanese facilities contain various covenants and customary events of default. Coach Japan has been in compliance with all covenants since the inception of these facilities. Coach, Inc. is not a guarantor on these facilities.
During the first nine months of fiscal 2007 and fiscal 2006, the peak borrowings under the Japanese credit facilities were $25.5 million and $21.6 million, respectively. As of March 31, 2007 and July 1, 2006, outstanding borrowings under the Japanese revolving credit facility agreements were $0.
On October 20, 2006, the Coach Board of Directors approved a new common stock repurchase program to acquire up to $500 million of Coach’s outstanding common stock through June 2008. 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 nine months of fiscal 2007 and fiscal 2006, the Company repurchased and retired 5.0 million and 3.5 million shares, respectively, of common stock, at an average cost of $29.99 and $32.85, respectively, per share.
As of March 31, 2007, $500 million remained available for future repurchases under the existing program.
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We expect that fiscal 2007 capital expenditures will be approximately $160 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 40 new retail stores and seven net new factory stores, of which 26 and five, respectively, were opened by the end of the first nine months of fiscal 2007. In Japan, we expect to open 19 net new locations in Japan, of which 15 were opened by the end of the first nine months of fiscal 2007. We will also continue to invest in department store and distributor locations. We intend to finance these investments from internally generated cash flows, on hand cash, and by using funds from our Japanese revolving credit facilities.
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 nine months of fiscal 2007, Coach purchased approximately $463 million of inventory, which was funded by operating cash flow and by using funds from our Japanese revolving credit facilities.
Management believes that cash flow from continuingoperations 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 July 1, 2006 are those that
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depend most heavily on these judgments and estimates. As of March 31, 2007, there have been no material changes to any of the critical accounting policies contained therein.
Recent Accounting Developments
In February 2006, the Financial Accounting Standards Board (“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 the beginning of an entity’s fiscal year that begins after September 15, 2006. The Company does not expect the adoption of SFAS 155 to have a material impact on the Company’s consolidated financial statements.
In June 2006, the FASB ratified the consensus reached on Emerging Issues Task Force (“EITF”) Issue 06-3, “How Taxes Collected From Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is, Gross versus Net Presentation).” EITF 06-3 requires disclosure of a company’s accounting policy with respect to presentation of taxes collected on a revenue producing transaction between a seller and a customer. For taxes that are reported on a gross basis (included in revenues and costs), EITF 06-3 also requires disclosure of the amount of taxes included in the financial statements. EITF 06-3 is effective for interim and annual reporting periods beginning after December 15, 2006. As the Company did not modify its accounting policy of recording sales taxes collected on a net basis, the adoption of EITF 06-3 did not have an 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 fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact of FIN 48 on the Company’s consolidated financial statements.
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 (GAAP), and expands disclosures about fair value measurements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is currently evaluating the impact of SFAS 157 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. 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 statement is effective as of the end of the fiscal year ending after December 15, 2006, except for the requirement to measure plan assets and obligations as of the date of the employer’s fiscal year-end statement of financial position, which is effective for fiscal years ending after December 15, 2008. The
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Company is currently evaluating the impact of SFAS 158 on the Company’s consolidated financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements.” SAB 108 states that SEC registrants should use both a balance sheet approach and an income statement approach when quantifying and evaluating the materiality of a misstatement, contains guidance on correcting errors under the dual approach and provides transition guidance for correcting errors existing in prior years. SAB 108 is effective for annual financial statements covering the first fiscal year ending after November 15, 2006. The Company does not expect the adoption of SAB 108 to have a material impact on the Company’s 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 as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The Company is currently evaluating the impact of SFAS 159 on the Company’s consolidated financial statements.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
The market risk inherent in our financial instruments represents the potential loss in fair value, earnings or cash flows arising from adverse changes in interest rates or foreign currency exchange rates. Coach manages these exposures through operating and financing activities and, when appropriate, through the use of derivative financial instruments with respect to Coach Japan. The following quantitative disclosures are based on quoted market prices obtained through independent pricing sources for the same or similar types of financial instruments, taking into consideration the underlying terms and maturities and theoretical pricing models. These quantitative disclosures do not represent the maximum possible loss or any expected loss that may occur, since actual results may differ from those estimates.
Foreign Exchange
Foreign currency exposures arise from transactions, including firm commitments and anticipated contracts, denominated in a currency other than the entity’s functional currency, and from foreign-denominated revenues and expenses translated into U.S. dollars.
Substantially all of Coach’s non-licensed product needs during the first nine months of fiscal 2007 were purchased from independent manufacturers in countries other than the United States. These countries include China, Hungary, India, Italy, Korea, Mauritius, Spain, and Turkey. Additionally, sales are made through international channels to third party distributors. However, substantially all purchases and sales involving international parties are denominated in U.S. dollars and therefore are not hedged by Coach using any derivative instruments.
Coach is exposed to market risk from foreign currency exchange rate fluctuations with respect to Coach Japan as a result of its U.S. dollar denominated inventory purchases. Coach Japan enters into certain foreign currency derivative contracts, primarily foreign exchange forward contracts, to manage these risks. These transactions are in accordance with Company risk management policies. Coach does not enter into derivative transactions for speculative or trading purposes.
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Coach is also exposed to market risk from foreign currency exchange rate fluctuations with respect to Coach Japan as a result of its $231 million U.S. dollar denominated fixed rate intercompany loan from Coach. To manage this risk, on July 1, 2005, Coach Japan entered into a cross currency swap transaction, the terms of which include an exchange of a U.S. dollar fixed interest rate for a yen fixed interest rate. The loan matures in 2010, at which point the swap requires an exchange of yen and U.S. dollar based principals.
The fair value of open foreign currency derivatives included in current assets at March 31, 2007 and July 1, 2006 was $13.1 million and $2.6 million, respectively. For the nine months ended March 31, 2007, changes in the fair value of contracts designated and effective as cash flow hedges resulted in an increase to equity as a benefit to other comprehensive income of $4.1 million, net of taxes. For the nine months ended April 1, 2006, changes in the fair value of contracts designated and effective as cash flow hedges resulted in a decrease to equity as a charge to other comprehensive income of $1.2 million, net of taxes.
Interest Rate
Coach faces minimal interest rate risk exposure in relation to its outstanding debt of $3.1 million at March 31, 2007. A hypothetical 1% change in the interest rate applied to the fair value of debt would not have a material impact on earnings or cash flows of Coach.
ITEM 4. Controls and Procedures
Based on the evaluation of the Company's disclosure controls and procedures, each of Lew Frankfort, the Chairman and Chief Executive Officer of the Company, and Michael F. Devine, III, Senior Vice President and Chief Financial Officer of the Company, has concluded that the Company's disclosure controls and procedures are effective as of March 31, 2007.
There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II
ITEM 1. Legal Proceedings
Coach is involved in various routine legal proceedings as both plaintiff and defendant incident to the ordinary course of its business, such as proceedings to protect Coach’s intellectual property rights, litigation instituted by persons alleged to have been injured upon premises within Coach’s control and litigation with present or former employees.
Although Coach’s litigation with present or former employees is routine and incidental to the conduct of Coach’s business, as well as for any business employing significant numbers of U.S.-based employees, such litigation can result in large monetary awards when a civil jury is allowed to determine compensatory and/or punitive damages for actions claiming discrimination on the basis of age, gender, race, religion, disability or other legally protected characteristic or for termination of employment that is wrongful or in violation of implied contracts. As part of its policing program for its intellectual property rights, from time to time, Coach files lawsuits in the U.S. and abroad alleging acts of trademark counterfeiting, trademark infringement, patent infringement, trade dress infringement, trademark dilution and/or state or foreign law claims. At any given point in time, Coach may have one or more of such
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actions pending. These actions often result in seizure of counterfeit merchandise and/or out of court settlements with defendants. From time to time, defendants will raise, either as affirmative defenses or as counterclaims, the invalidity or unenforceability of certain of Coach’s intellectual properties.
Coach believes that the outcome of all pending legal proceedings in the aggregate will not have a material adverse effect on Coach’s business or consolidated financial statements.
ITEM 1A. Risk Factors
There are no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the fiscal year ended July 1, 2006.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
The Company did not repurchase shares during the quarter ended March 31, 2007.
ITEM 4. Submission of Matters to a Vote of Security Holders
None.
ITEM 5. Other Information
None.
ITEM 6. Exhibits and Reports on Form 8-K
| | (a) | Exhibits |
| |
| | | 31.1 | Rule 13(a) – 14(a)/15(d) – 14(a) Certifications |
| |
| | | 32.1 | Section 1350 Certifications |
| |
| | (b) | Reports on Form 8-K |
| |
| | | Current report on Form 8-K, filed with the Commission on August 9, 2006. This report contained the Company’s preliminary earnings results for the fourth quarter and full fiscal year 2006. |
| |
| | | Current report on Form 8-K, filed with the Commission on October 26, 2006. This report contained the Company’s preliminary earnings results for the first quarter of fiscal year 2007. |
| |
| | | Current report on Form 8-K, filed with the Commission on November 3, 2006. This report announced that Lew Frankfort, Chairman and Chief Executive Officer of the Company, entered into a trading plan with Goldman, Sachs & Co. to comply with Rule 10b5-1 of the Securities Exchange Act of 1934. |
| |
| | | Current report on Form 8-K, filed with the Commission on January 29, 2007. This report contained the Company’s preliminary earnings results for the second quarter and first half of fiscal year 2007. |
| |
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Current report on Form 8-K, filed with the Commission on February 14, 2007. This report announced that Lew Frankfort, Chairman and Chief Executive Officer of the Company, entered into a trading plan with Goldman, Sachs & Co. to comply with Rule 10b5-1 of the Securities Exchange Act of 1934.
Current report on Form 8-K, filed with the Commission on April 24, 2007. This report contained the Company’s preliminary earnings results for the third quarter and first nine months of fiscal year 2007.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | COACH, INC. |
| | (Registrant) |
| |
| |
| |
| | By: | | /s/ Michael F. Devine, III |
| | Name: | Michael F. Devine, III |
| | Title: | Senior Vice President, |
| | | Chief Financial Officer and |
| | | Chief Accounting Officer |
Dated: May 4, 2007
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