The Daily Magic Formula Stock for 12/11/2008 is Coach Inc.According to the Magic Formula Investing Web Site, the ebit yield is 19% and the EBIT ROIC is >100 %.
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General Development of Business
Founded in 1941, Coach was acquired by Sara Lee Corporation (â€śSara Leeâ€ť) in 1985. In June 2000, Coach was incorporated in the state of Maryland. In October 2000, Coach was listed on the New York Stock Exchange and sold approximately 68 million shares of common stock, split adjusted, representing 19.5% of the outstanding shares. In April 2001, Sara Lee completed a distribution of its remaining ownership in Coach via an exchange offer, which allowed Sara Lee stockholders to tender Sara Lee common stock for Coach common stock.
In June 2001, Coach Japan, Inc. (â€śCoach Japanâ€ť) was formed to expand our presence in the Japanese market and to exercise greater control over our brand in that country. Coach Japan was initially formed as a joint venture with Sumitomo Corporation. On July 1, 2005, we purchased Sumitomoâ€™s 50% interest in Coach Japan, resulting in Coach Japan becoming a 100% owned subsidiary of Coach, Inc.
In May 2008, the Company announced that it had reached agreements to a phased acquisition of the Coach domestic retail businesses in Hong Kong, Macau and Mainland China (â€śGreater Chinaâ€ť) from its current distributor, the ImagineX group. These acquisitions will provide the Company with greater control over the brand in Greater China, enabling Coach to raise brand awareness and aggressively grow market share with the Chinese consumer. Coach expects these acquisitions will be completed in fiscal 2009.
Financial Information about Segments
Segment information is presented in Note 12 to the Consolidated Financial Statements.
Narrative Description of Business
Coach has grown from a family-run workshop in a Manhattan loft to a leading American marketer of fine accessories and gifts for women and men. Coach is one of the most recognized fine accessories brands in the U.S. and in targeted international markets. We offer premium lifestyle accessories to a loyal and growing customer base and provide consumers with fresh, relevant and innovative products that are extremely well made, at an attractive price. Coachâ€™s modern, fashionable handbags and accessories use a broad range of high quality leathers, fabrics and materials. In response to our customerâ€™s demands for both fashion and function, Coach offers updated styles and multiple product categories which address an increasing share of our customerâ€™s accessory wardrobe. Coach has created a sophisticated, modern and inviting environment to showcase our product assortment and reinforce a consistent brand position wherever the consumer may shop. We utilize a flexible, cost-effective global sourcing model, in which independent manufacturers supply our products, allowing us to bring our broad range of products to market rapidly and efficiently.
Coach offers a number of key differentiating elements that set it apart from the competition, including:
A Distinctive Brand â€” Coach offers distinctive, easily recognizable, accessible luxury products that are relevant, extremely well made and provide excellent value.
A Market Leadership Position With Growing Share â€” Coach is Americaâ€™s leading premium handbag and accessories brand and each year, as our market share increases, our leadership position strengthens.
Coachâ€™s Loyal And Involved Consumer â€” Coach consumers have a specific emotional connection with the brand. Part of the Companyâ€™s everyday mission is to cultivate consumer relationships by strengthening this emotional connection.
Multi-Channel International Distribution â€” This allows Coach to maintain a critical balance as results do not depend solely on the performance of a single channel or geographic area. The Direct-to-Consumer channel provides us with immediate, controlled access to consumers through Coach-owned stores in North America and Japan, the Internet and the Coach catalog. The Indirect channel provides us with access to consumers via North America and international wholesale department store and specialty store locations.
Coach Is Innovative And Consumer-Centric â€” Coach listens to its consumer through rigorous consumer research and strong consumer orientation. Coach works to anticipate the consumerâ€™s changing needs by keeping the product assortment fresh and relevant.
We believe that these differentiating elements have enabled the Company to offer a unique proposition to the marketplace. We hold the number one position within the U.S. premium handbag and accessories market and the number two position within the Japanese imported luxury handbag and accessories market.
Coach's product offerings include handbags, womenâ€™s and menâ€™s accessories, footwear, jewelry, wearables, business cases, sunwear, watches, travel bags and fragrance.
Handbags â€” Handbag collections feature classically inspired designs as well as fashion designs. Typically, there are three to four collections per quarter and four to seven styles per collection. These collections are designed to meet the fashion and functional requirements of our broad and diverse consumer base. During fiscal 2008, we introduced three major lifestyle collections: Bleecker, Heritage Stripe and Soho. In fiscal 2009, we plan to introduce additional lifestyle collections, including the Zoe handbag group and Madison. We will also launch a new design, Coach Op Art, which will provide us with an entirely new logo platform.
Accessories â€” Accessories include womenâ€™s and menâ€™s small leather goods, novelty accessories and womenâ€™s and menâ€™s belts. Womenâ€™s small leather goods, which coordinate with our handbags, include money pieces, wristlets, and cosmetic cases. Menâ€™s small leather goods consist primarily of wallets and card cases. Novelty accessories include electronic, time management and pet accessories. Key fobs and charms are also included in this category.
Footwear â€” Jimlar Corporation (â€śJimlarâ€ť) has been Coach's footwear licensee since 1999. Footwear is distributed through over 900 locations in the U.S., including leading Coach retail stores and U.S. department stores. Footwear sales are comprised primarily of womenâ€™s styles, which coordinate with Coachâ€™s handbag collections.
Jewelry â€” In November 2006, Coach launched a jewelry line, consisting primarily of bangle bracelets. During fiscal 2008, this category was expanded to include sterling silver jewelry and gold plated fashion jewelry.
Wearables â€” This category is comprised of jackets, sweaters, gloves, hats and scarves, including both cold weather and fashion. The assortment is primarily women's and contains a fashion assortment in all components of this category.
Business Cases â€” This assortment is primarily menâ€™s and includes computer bags, messenger-style bags and totes.
Sunwear â€” Marchon Eyewear, Inc. (â€śMarchonâ€ť) has been Coachâ€™s eyewear licensee since 2003. This collection is a collaborative effort from Marchon and Coach that combines the Coach aesthetic for fashion accessories with the latest fashion directions in sunglasses. Coach sunglasses are sold in Coach retail stores, department stores, select sunglass retailers and optical retailers in major markets.
Watches â€” Movado Group, Inc. (â€śMovadoâ€ť) has been Coach's watch licensee since 1998 and has developed a distinctive collection of watches inspired primarily by the women's collections with select men's styles.
Travel Bags â€” The travel collections are comprised of luggage and related accessories, such as travel kits and valet trays.
Fragrance â€” In March 2007, Coach launched its first fragrance in partnership with Beauty Bank, a division of EstĂ©e Lauder, Inc. This collection includes a perfume spray, a purse spray and a perfume solid and is sold exclusively in Coach stores and coach.com. During fiscal 2008, this category was expanded to include body lotion and lip gloss. Coachâ€™s second fragrance will be launched in fiscal 2009.
Design and Merchandising
Coach's New York-based design team, led by its Executive Creative Director, is responsible for conceptualizing and directing the design of all Coach products. Designers have access to Coach's extensive archives of product designs created over the past 65 years, which are a valuable resource for new product concepts. Coach designers are also supported by a strong merchandising team that analyzes sales, market trends and consumer preferences to identify business opportunities that help guide each season's design process. Merchandisers also analyze products to edit, add and delete to achieve profitable sales across all channels. The product category teams, each comprised of design, merchandising/product development and sourcing specialists, help Coach execute design concepts that are consistent with the brand's strategic direction.
During fiscal 2008, the Company announced a new business initiative, internally referred to as Collection, to drive brand creativity. This initiative will be supported by a new team of designers and merchandisers and will encompass all womenâ€™s categories, with a focus on handbags, womenâ€™s accessories, footwear and jewelry. We expect to introduce Collection product in fiscal year 2010.
Coach's design and merchandising teams work in close collaboration with all of our licensing partners to ensure that the licensed products (watches, footwear and eyewear) are conceptualized and designed to address the intended market opportunity and convey the distinctive perspective and lifestyle associated with the Coach brand.
Coach operates in two reportable segments: Direct-to-Consumer and Indirect. The reportable segments represent channels of distribution that offer similar products, service and marketing strategies.
The Direct-to-Consumer segment consists of channels that provide us with immediate, controlled access to consumers: retail stores and factory stores in North America and Japan, the Internet and the Coach catalog. This segment represented approximately 80% of Coach's total net sales in fiscal 2008, with North American stores, Coach Japan and the Internet contributing approximately 59%, 19% and 2% of total net sales, respectively.
North American Retail Stores â€” Coach stores are located in regional shopping centers and metropolitan areas throughout the U.S. and Canada. The retail stores carry an assortment of products depending on their size and location. Our flagship stores, which offer the broadest assortment of Coach products, are located in high-visibility locations such as New York, Chicago, San Francisco and Toronto.
Our stores are sophisticated, sleek, modern and inviting. They showcase the world of Coach and enhance the shopping experience while reinforcing the image of the Coach brand. The modern store design creates a distinctive environment to display our products. Store associates are trained to maintain high standards of visual presentation, merchandising and customer service. The result is a complete statement of the Coach modern American style at the retail level.
North American Factory Stores â€” Coach's factory stores serve as an efficient means to sell manufactured-for-factory- store product, including factory exclusives, as well as discontinued and irregular inventory outside the retail channel. These stores operate under the Coach Factory name and are geographically positioned primarily in established outlet centers that are generally more than 50 miles from major markets.
Coach Japan, Inc. â€” Coach Japan operates department store shop-in-shop locations as well as freestanding flagship, retail and factory stores. Flagship stores, which offer the broadest assortment of Coach products, are located in select shopping districts throughout Japan.
Internet â€” Coach views its website as a key communications vehicle for the brand to promote traffic in Coach retail stores and department store locations and build brand awareness. During fiscal 2008, we completed a creative refresh of the coach.com website and launched coach.com in Canada. We also introduced store pickup, allowing a customer to purchase online and pick up her order in the store. With approximately 55 million unique visits to the website in fiscal 2008, our online store provides a showcase environment where consumers can browse through a selected offering of the latest styles and colors. During fiscal 2008, the Company sent approximately 67 million emails to strategically selected customers as we continue to evolve our internet outreach to maximize productivity while streamlining distribution. Revenue from Internet sales is recognized upon shipment of the product.
Coach Catalog â€” While direct mail sales comprise a small portion of Coach's net sales, Coach views its catalog as a key communications vehicle for the brand to promote store traffic, facilitate the shopping experience in Coach retail stores and build brand awareness. In fiscal 2008, the Company distributed approximately 7 million catalogs in Coach stores in North America and Japan and mailed approximately 3 million catalogs to strategically selected North American households from its database of customers.
Coach began as a U.S. wholesaler to department stores and this segment remains important to our overall consumer reach. Today, we work closely with our partners, both domestic and international, to ensure a clear and consistent product presentation. The Indirect segment represented approximately 20% of total net sales in fiscal 2008, with U.S. Wholesale and International Wholesale representing approximately 12% and 6% of total net sales, respectively.
U.S. Wholesale â€” This channel offers access to Coach products to consumers who prefer shopping at department stores. Coach products are also available on macys.com, dillards.com and nordstrom.com. While overall U.S. department store sales have not increased over the last few years, the handbag and accessories category has grown, in part due to the strength of the Coach brand. Net sales (shipments) to U.S. wholesale customers grew 16% in fiscal 2008 from fiscal 2007.
Coach recognizes the continued importance of U.S. department stores as a distribution channel for premier accessories. Department stores also continue to devote increased square footage to Coach, providing an additional driver to this channelâ€™s growth. We continue to fine-tune our strategy to increase productivity and drive volume by enhancing presentation, primarily through the creation of more shop-in-shops, and the introduction of caseline enhancements with proprietary Coach fixtures. Coach has also improved wholesale product planning and allocation processes by custom tailoring assortments to better match the attributes of our department store consumers in each local market.
Coach's products are sold in approximately 900 wholesale locations in the U.S. and Canada. Our most significant U.S. wholesale customers are Macyâ€™s, (including Bloomingdale's), Dillard's, Nordstrom, Lord and Taylor, Carsonâ€™s and Saks.
International Wholesale â€” This channel represents sales to international wholesale distributors and authorized retailers. Tourists represent the largest portion of our customersâ€™ sales in this channel. However, we continue to drive growth by expanding our distribution to reach local consumers in emerging markets. Coach has developed relationships with a select group of distributors who sell Coach products through department stores and freestanding retail locations in over 20 countries. Coach's current network of international distributors serves the following markets: Korea, United States (primarily Hawaii and Guam), Hong Kong, Taiwan, Japan, Singapore, Saudi Arabia, Mexico, China, Malaysia, Thailand, Australia, Indonesia, the United Arab Emirates, the Caribbean, Saipan, Turkey, Bahrain, New Zealand, France, United Kingdom, Greece and Russia. For locations not in freestanding stores, Coach has created shop-in-shops and other image enhancing environments to increase brand appeal and stimulate growth. Coach continues to improve productivity in this channel by opening larger image-enhancing locations, expanding existing stores and closing smaller, less productive stores. Coach's most significant international wholesale customers are the DFS Group, Lotte Group, Shilla Group, Tasa Meng Corp., Shinsegae International, and ImagineX. Following completion of the acquisition of the retail businesses in Greater China from ImagineX in fiscal 2009, sales in Coach-operated stores in this region will be reported in the Direct segment.
Lew Frankfort has been involved with the Coach business for almost 30 years. He has served as Chairman and Chief Executive Officer of Coach since November 1995. He has served as a member of Coachâ€™s Board of Directors since June 1, 2000, the date of incorporation. Mr. Frankfort served as Senior Vice President of Sara Lee Corporation from January 1994 to October 2000. Mr. Frankfort was appointed President and Chief Executive Officer of the Sara Lee Champion, Intimates & Accessories group in January 1994, and held this position through November 1995. From September 1991 through January 1994, Mr. Frankfort held the positions of Executive Vice President, Sara Lee Personal Products and Chief Executive Officer of Sara Lee Accessories. Mr. Frankfort was appointed President of Coach in July 1985, after Sara Lee acquired Coach, and held this position through September 1991. Mr. Frankfort joined Coach in 1979 as Vice President of New Business Development. Prior to joining Coach, Mr. Frankfort held various New York City government management positions and served as Commissioner, New York City Agency for Child Development. He also serves on the Board of Directors of Teach for America, a public-private partnership aimed at eliminating educational inequity in America, and Advanced Assessment Systems LLC (LinkIt!), a provider of online testing, data management, and intervention solutions serving the K-12 educational market, and he is a member of the Board of Overseers at Columbia Business School. Mr. Frankfort holds a Bachelor of Arts degree from Hunter College and an M.B.A. degree in Marketing from Columbia University.
Susan Kropf was elected to Coach's Board of Directors in June 2006. From 2001 to January 2007, Ms. Kropf served as President and Chief Operating Officer of Avon Products, where she had day-to-day oversight of Avonâ€™s worldwide operations. Before that, she was Executive Vice President and Chief Operating Officer, Avon North America and Global Business Operations, with responsibility for the company's North American operating business unit as well as global marketing, R&D, supply chain operations and information technology. Ms. Kropf also serves on the Boards of MeadWestvaco Corp., Sherwin Williams Co., Kroger Co., and the Wallace Foundation. Ms. Kropf holds a Bachelor of Arts degree from St. Johnâ€™s University and an M.B.A. degree in Finance from New York University.
Gary Loveman was elected to Coachâ€™s Board of Directors in January 2002. Mr. Loveman has served as Chairman of Harrahâ€™s Entertainment, Inc. since January 2005 and as its Chief Executive Officer and President since January 2003; he had served as President of Harrahâ€™s since April 2001 and as Chief Operating Officer of Harrahâ€™s since May 1998. He was a member of the three-executive Office of the President of Harrahâ€™s from May 1999 to April 2001 and was Executive Vice President from May 1998 to May 1999. From 1989 to 1998, Mr. Loveman was Associate Professor of Business Administration, Harvard University Graduate School of Business Administration, where his responsibilities included teaching M.B.A. and executive education students, research and publishing in the field of service management, and consulting and advising large service companies. Mr. Loveman also serves as a Director of Harrahâ€™s and Fedex Corporation, on the Board of Trustees at Joslin Diabetes Center in Boston and on the Trust Board at Children's Hospital Boston. He holds a Bachelor of Arts degree in Economics from Wesleyan University and a Ph.D. in Economics from the Massachusetts Institute of Technology.
Ivan Menezes was elected to Coachâ€™s Board of Directors in February 2005. Mr. Menezes has served as President and Chief Executive Officer of Diageo North America, the worldâ€™s leading premium drinks company, since January 2004, after having served as its President and Chief Operating Officer from July 2002, and as President of Diageo, Venture Markets since July 2000. Since joining Diageo in 1997 he has held various progressively senior management positions. Before joining Diageo, he held senior marketing positions with Whirlpool Europe in Milan and was a principal with Booz Allen Hamilton, Inc., both in Chicago and in London. Mr. Menezes holds a Bachelor of Arts degree in economics from St. Stephen's College, Delhi, a post graduate diploma from the Indian Institute of Management, Ahmedabad and an M.B.A. degree from Northwestern University's Kellogg School of Management.
Irene Miller was elected to Coach's Board of Directors in May 2001. Ms. Miller is Chief Executive Officer of Akim, Inc., an investment management and consulting firm, and until June 1997 was Vice Chairman and Chief Financial Officer of Barnes & Noble, Inc., the world's largest bookseller. She joined Barnes & Noble in 1991, became Chief Financial Officer in 1993 and Vice Chairman in 1995. From 1986 to 1990, Ms. Miller was an investment banker at Morgan Stanley & Co. Incorporated. Ms. Miller also serves as a Director of Barnes & Noble, Inc., Inditex, S.A. and TD Bank Financial Group. Ms. Miller holds a Bachelor of Science degree from the University of Toronto and a Master of Science degree from Cornell University.
Keith Monda has served as a member of Coachâ€™s Board of Directors since June 1, 2000, the date of incorporation. He served as Executive Vice President and Chief Operating Officer of Coach from June 1998 and as President of Coach from February 2002 until his retirement in July 2008. Prior to joining Coach, Mr. Monda served as Senior Vice President, Finance & Administration and Chief Financial Officer of Timberland Company from December 1993 until May 1996, and was promoted to, and held the position of, Senior Vice President, Operations from May 1996 until January 1998. From May 1990 to December 1993, Mr. Monda served as Executive Vice President, Finance and Administration of J. Crew, Inc. Mr. Monda holds Bachelor of Science and Master of Arts degrees from Ohio State University.
Michael Murphy was elected to Coachâ€™s Board of Directors in September 2000. From 1994 to 1997, Mr. Murphy served as Vice Chairman and Chief Administrative Officer of Sara Lee Corporation. Mr. Murphy also served as a Director of Sara Lee from 1979 through October 1997. Mr. Murphy joined Sara Lee in 1979 as Executive Vice President and Chief Financial and Administrative Officer and, from 1993 until 1994, also served as Vice Chairman. Mr. Murphy is also a Director of Civic Federation, Big Shoulders Fund, Metropolitan Pier and Exposition Authority, Chicago Cultural Center Foundation, GATX Corporation and The Joffrey Ballet. He is also a member of the Board of Trustees of Northern Funds (a family of mutual funds). Mr. Murphy holds a Bachelor of Science degree in Business Administration from Boston College and an M.B.A. degree in Finance from the Harvard Business School.
Jide Zeitlin was elected to Coach's Board of Directors in June 2006. Since December 2005, Mr. Zeitlin has served as founder of Independent Mobile Infrastructure (Pvt.) Limited, a privately held company that is focused on Indian telecommunications infrastructure. From 1996 until December 2005, Mr. Zeitlin was a partner at The Goldman Sachs Group, Inc.; he most recently held the post of Global Chief Operating Officer of the company's investment banking businesses, after joining the firm in 1983. Mr. Zeitlin is Chairman of the Board of Trustees of Amherst College, serves as a Director of Affiliated Managers Group, Inc. and is a member of several not-for-profit boards, including: Common Ground Community, Milton Academy, Montefiore Medical Center, Playwrights Horizons and Teach for America, as well as the Harvard Business School Deanâ€™s Advisory Committee. Mr. Zeitlin holds an A.B. degree in Economics and English from Amherst College and an M.B.A. degree from Harvard University.
MANAGEMENT DISCUSSION FROM LATEST 10K
Coach is a leading American marketer of fine accessories and gifts for women and men. Our product offerings include handbags, womenâ€™s and menâ€™s accessories, footwear, jewelry, wearables, business cases, sunwear, watches, travel bags 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 catalog. The Indirect segment includes sales to wholesale customers in the U.S. and international locations as well as licensing revenue. As Coachâ€™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 North America, Japan, and Greater China, and improved productivity. To that end we are focused on four key initiatives:
â€˘ Build market share in the growing North American womenâ€™s accessories market. As part of our culture of innovation and continuous improvement, we are implementing a number of initiatives to accelerate the level of newness, elevate our product offering and enhance the in-store experience. These initiatives will enable us to continue to leverage our leadership position in the market.
â€˘ Grow our North American retail store base by adding stores within existing markets and opening in new markets. 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.
â€˘ 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 net new locations in fiscal 2009 and believe that Japan can support about 180 locations in total. We will also continue to expand key locations.
â€˘ 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 2009, through distributors, we intend to open at least 20 net new wholesale locations in emerging markets and five locations in Greater China.
The growth strategies outlined above will allow us to continue to deliver long-term superior returns on our investments and drive increased cash flows from operating activities.
Fiscal 2008 Highlights
During fiscal 2008, an increase in net sales continued to drive net income and earnings per share growth. The highlights of fiscal 2008 were:
â€˘ Earnings per diluted share from continuing operations increased 28.8% to $2.17 per diluted share. Excluding one-time items of $0.11 per diluted share, earnings per diluted share increased 21.9% to $2.06 per diluted share.
â€˘ Net income from continuing operations increased 23.0% to $783.0 million. Excluding one-time items of $41.0 million recorded in the fourth quarter, net income increased 16.6% to $742.0 million.
â€˘ Net sales increased 21.8% to $3.18 billion.
â€˘ Direct-to-consumer sales rose 21.0% to $2.54 billion.
â€˘ Comparable sales in Coachâ€™s North American stores rose 9.8%.
â€˘ Coach Japan sales, when translated into U.S. dollars, rose 23.4% driven primarily by expanded distribution. These increases in sales reflect a 9.0% increase due to currency translation.
â€˘ In North America, Coach opened 38 net new retail stores and nine new factory stores, bringing the total number of retail and factory stores to 297 and 102, respectively, at the end of fiscal 2008. We also expanded 18 retail stores and 19 factory stores in North America.
â€˘ Coach Japan opened 12 net new locations, bringing the total number of locations at the end of fiscal 2008 to 149. In addition, we expanded 11 locations.
During the fourth quarter of fiscal 2008, the Company recorded certain one-time items that resulted in a net gain of $41.0 million. These one-time items consisted of an initial $20.0 million contribution to the Coach Foundation, a $12.1 million increase in variable compensation expenses, a $10.7 million increase in interest income, net and a $50.0 decrease to the provision for income taxes.
The increase in interest income, net and decrease in the provision for income taxes were primarily a result of a favorable settlement of a tax return examination. As a result of the higher interest income, net and lower income tax provision, the Company incurred an additional $12.1 million of incentive compensation, as a portion of the Companyâ€™s incentive compensation plan is based on net income and earnings per share. Finally, the Company took advantage of the one-time net income favorability to create the Coach Foundation. The Company recorded an initial contribution to the Coach Foundation in the amount of $20.0 million.
Direct-to-Consumer â€” Net sales increased by 21.0%, driven by increased sales from new stores, comparable stores and expanded stores. Comparable store sales measure sales performance at stores that have been open for at least 12 months. Coach excludes new locations from the comparable store base for the first year of operation. Similarly, stores that are expanded by 15.0% or more are also excluded from the comparable store base until the first anniversary of their reopening. Stores that are closed for renovations are removed from the comparable store base.
In North America, net sales increased 22.0% driven by sales from new stores, a 9.8% increase in comparable store sales and an increase in sales from expanded stores. During fiscal 2008, Coach opened 38 net new retail stores and nine new factory stores, and expanded 18 retail stores and 19 factory stores in North America. In Japan, net sales increased 23.4% driven primarily by sales from new and expanded stores. Coach Japanâ€™s reported net sales were positively impacted by approximately $44 million as a result of foreign currency exchange. During fiscal 2008, Coach opened 12 net new locations and expanded 11 locations in Japan. These sales increases were slightly offset by store closures and a decline in the Internet and direct marketing channels.
Indirect â€” Net sales increased by 24.7% to $636.7 million in fiscal 2008 from $510.7 million in fiscal 2007, driven primarily by a 16.4% increase in sales in the U.S. wholesale division and a 40.3% increase in sales in the international wholesale division. Licensing revenue of approximately $27 million and $15 million in fiscal 2008 and fiscal 2007, respectively, is included in Indirect sales.
Operating income increased 15.5% to $1.15 billion in fiscal 2008 as compared to $993.4 million in fiscal 2007, driven by increases in net sales and gross profit, partially offset by an increase in selling, general and administrative expenses. Excluding one-time items of $32.1 million, operating income increased 18.7% to $1.18 billion. Operating margin was 36.1% in fiscal 2008 compared to 38.0% in fiscal 2007 as gains from increased net sales were offset by a decrease in gross margin and increase in operating expenses. Excluding one-time items, operating margin was 37.1%.
Gross profit increased 19.0% to $2.41 billion in fiscal 2008 compared to $2.02 billion in fiscal 2007. Gross margin was 75.7% in fiscal 2008 compared to 77.4% in fiscal 2007. The change in gross margin was driven by promotional activities in Coach-operated North American stores, the fluctuation in foreign currency translation rates and channel mix. Coachâ€™s gross profit is dependent upon a variety of factors, including changes in the relative sales mix among distribution channels, changes in the mix of products sold, foreign currency exchange rates, and fluctuations in material costs. These factors, among others, may cause gross profit to fluctuate from year to year.
Selling, general and administrative (â€śSG&Aâ€ť) expenses are comprised of four categories: (1) selling; (2) advertising, marketing and design; (3) distribution and consumer service; and (4) administrative. Selling expenses include store employee compensation, store occupancy costs, store supply costs, wholesale account administration compensation and all Coach Japan operating expenses. These expenses are affected by the number of Coach-operated stores in North America and Japan open during any fiscal period and the related proportion of retail and wholesale sales. Advertising, marketing and design expenses include employee compensation, media space and production, advertising agency fees, new product design costs, public relations, market research expenses and mail order costs. Distribution and consumer service expenses include warehousing, order fulfillment, shipping and handling, customer service and bag repair costs. Administrative expenses include compensation costs for the executive, finance, human resources, legal and information systems departments, as well as consulting and software expenses. SG&A expenses increase as the number of Coach-operated stores increase, although an increase in the number of stores generally results in the fixed portion of SG&A expenses being spread over a larger sales base.
During fiscal 2008, SG&A expenses increased 22.4% to $1.26 billion, compared to $1.03 billion in fiscal 2007, driven primarily by increased selling expenses. As a percentage of net sales, SG&A expenses were 39.6% and 39.4% during fiscal 2008 and fiscal 2007, respectively. Excluding one-time costs of $32.1 million, SG&A expenses were $1.23 billion, representing 38.6% of net sales, an improvement of 80 basis points over fiscal 2007, as we continue to leverage our expense base on higher sales.
The increase in selling expenses was primarily due to an increase in operating expenses of North America stores and Coach Japan. The increase in North America store expenses is attributable to increased variable expenses related to higher sales, new stores opened during the fiscal year and the incremental expense associated with having a full year of expenses related to stores opened in the prior year. The increase in Coach Japan operating expenses was primarily driven by increased variable expenses related to higher sales and new store operating expenses. The impact of foreign currency exchange rates increased reported expenses by approximately $19.2 million. The remaining increase in selling expenses was due to increased variable expenses to support sales growth in other channels.
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 decreased primarily due to efficiency gains, partially offset by higher sales volume. Efficiency gains also led to an improvement in distribution and consumer service expenses as a percentage of net sales.
Administrative expenses increased primarily as a result of $32.1 million of one-time charges recorded in the fourth quarter of fiscal 2008. One-time charges consisted of a contribution to the newly created Coach Foundation of $20.0 million and $12.1 million of increased variable compensation expenses, attributable to the increase in net income as a result of a one-time tax benefit discussed below. Excluding these one-time charges, the increase in administrative expenses was driven by 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
Interest income, net was $47.8 million in fiscal 2008 as compared to $41.3 million in fiscal 2007. This increase was primarily due to a reduction of $10.7 million of interest expense, related to a one-time tax benefit discussed below. Excluding this benefit, interest income, net decreased primarily as a result of lower returns on our investments as a result of lower interest rates.
Provision for Income Taxes
The effective tax rate was 34.5% in fiscal 2008 compared to 38.5% in fiscal 2007. During the fourth quarter of fiscal 2008, the Company recorded a one-time benefit of $50.0 million, primarily related to a favorable settlement of a tax return examination. Excluding this benefit, the effective tax rate in fiscal 2008 was essentially flat as compared to the fiscal 2007 effective rate.
Income from Continuing Operations
Income from continuing operations increased 23.0% to $783.0 million in fiscal 2008 compared to $636.5 million in fiscal 2007. Excluding one-time items of $41.0 million discussed above, income from continuing operations was $742.0 million, a 16.6% increase over prior year. The increase is primarily attributable to increased net sales 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 Consolidated Statements of Income for all periods presented.
In fiscal 2007, net sales and net income from discontinued operations were $66.5 million and $27.1 million, respectively. In fiscal 2008, net sales and net income from discontinued operations were not significant.
The Companyâ€™s reported results are presented in accordance with U.S. Generally Accepted Accounting Principles (â€śGAAPâ€ť). The reported selling, general, and administrative expenses, operating income, interest income, net, provision for income taxes, income from continuing operations, net income and earnings per diluted share from continuing operations reflect certain one-time items recorded in the fourth quarter of fiscal 2008. These metrics are also reported on a non-GAAP basis to exclude the impact of these one-time items. The Company believes these non-GAAP financial measures are useful to investors in evaluating the Companyâ€™s ongoing operating and financial results and understanding how such results compare with the Companyâ€™s prior guidance. The non-GAAP financial measures should be considered in addition to, and not in lieu of, U.S. GAAP financial measures.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Coach is a leading American marketer of fine accessories and gifts for women and men. Our product offerings include handbags, womenâ€™s and menâ€™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, Japan, Hong Kong and Macau, the Internet and the Coach catalog. The Indirect segment includes sales to wholesale customers in over 20 countries and licensing revenue. As Coachâ€™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 China, and improved productivity. To that end we are focused on four key initiatives:
Build market share in the North American womenâ€™s accessories market. As part of our culture of innovation and continuous improvement we are implementing a number of initiatives to accelerate the level of newness, elevate our product offering and enhance the in-store experience. These initiatives will enable us to continue to leverage our leadership position in the market.
Continue to grow our North American retail store base by adding stores within existing markets and opening in new markets. 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. During fiscal 2009, we plan to open retail stores in 14 new markets, including six opened during the first quarter. In addition, we will continue to expand select, highly productive retail and factory locations.
Continue to 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 ten net new locations in each of the next few years and believe that Japan can support about 180 locations in total. We will also continue to expand select, highly productive locations.
Raise brand awareness in emerging markets to build the foundation for substantial sales in the future. Specifically, China, Korea and other such geographies are increasing in importance as the handbag and accessories category grows in these areas. In fiscal 2009, through distributors, we intend to open at least 20 net new wholesale locations in emerging markets. In China we plan to open five locations, four of which will be in mainland China and one of which will be in Macau. In addition, during the first quarter of fiscal 2009, Coach successfully completed the first phase of our acquisition of our retail businesses in China, transitioning eight stores in Hong Kong and two stores in Macau.
We believe the growth strategies outlined above will allow us to continue to deliver long-term superior returns on our investments and drive increased cash flows from operating activities.
The deteriorating macroeconomic environment presents a very challenging retail market in which it will be difficult to achieve productivity gains in the short term. However, the Company believes earnings per share growth can still be achieved through a combination of distribution growth, a focus on innovation to support productivity, disciplined expense control, and the already completed share repurchase, while we continue to invest prudently for long-term profitable growth.
FIRST QUARTER OF FISCAL 2009 HIGHLIGHTS
The highlights of the first quarter of fiscal 2009 were:
Earnings per diluted share from continuing operations increased 7.0% to $0.44 per diluted share.
Net sales increased 11.2% to $752.5 million.
Direct-to-consumer sales rose 15.9% to $592.2 million.
Comparable store sales in North America rose 0.6%.
Coach Japan sales, when translated into U.S. dollars, rose 22.2% to $136.9 million driven by expanded distribution. This 22.2% increase includes a 10.7% positive impact from currency translation.
In China, Coach completed the first phase of the acquisition of our retail businesses from ImagineX, transitioning eight stores in Hong Kong and two stores in Macau.
In North America, Coach opened 21 net new retail stores and one new factory store, bringing the total number of retail and factory stores to 318 and 103, respectively, at the end of the first quarter of fiscal 2009. We also expanded seven retail stores and three factory stores in North America.
In Japan, Coach opened four new locations, bringing the total number of Coach Japan-operated locations at the end of the first quarter of fiscal 2009 to 153. In addition, we expanded one location.
RESULTS OF OPERATIONS
FIRST QUARTER FISCAL 2009 COMPARED TO FIRST QUARTER FISCAL 2008
In North America, net sales increased 15.1% driven by sales from new stores, a 0.6% increase in comparable store sales and sales from expanded stores. Since the end of the first quarter of fiscal 2008, Coach opened 46 net new retail stores and seven new factory stores, and expanded 16 retail stores and 18 factory stores in North America. In Japan, net sales increased 22.2% driven primarily by sales from new and expanded stores. Coach Japanâ€™s reported net sales were positively impacted by approximately $12.0 million or 10.7% as a result of foreign currency exchange. Since the end of the first quarter of fiscal 2008, Coach opened 12 net new locations and expanded 11 locations in Japan.
Net sales decreased 3.4% to $160.3 million in the first quarter of fiscal 2009 from $165.9 million during the same period of fiscal 2008. The decrease was driven primarily by a 9.4% decrease in U.S. wholesale as the Company reduced shipments into U.S. department stores in order to manage customer inventory levels as the channel experienced weakening sales. The decrease was partially offset by a 12.7% increase in international wholesale. Licensing revenue of approximately $4.3 million and $4.1 million in the first quarter of fiscal 2009 and fiscal 2008, respectively, is included in Indirect sales.
Operating income decreased 2.2% to $233.5 million in the first quarter of fiscal 2009 as compared to $238.8 million in the first quarter of fiscal 2008. Operating margin decreased to 31.0% as compared to 35.3% in the same period of the prior year, as net sales gains were offset by a decrease in gross margin and an increase in selling, general, and administrative expenses.
Gross profit increased 7.7% to $558.2 million in the first quarter of fiscal 2009 from $518.2 million during the same period of fiscal 2008. Gross margin was 74.2% in the first quarter of fiscal 2009 as compared to 76.6% during the same period of fiscal 2008. The change in gross margin was driven primarily by promotional activities in Coach-operated North American stores and channel mix.
Selling, general and administrative expenses increased 16.2% to $324.7 million in the first quarter of fiscal 2009 as compared to $279.5 million in the first quarter of fiscal 2008. As a percentage of net sales, selling, general and administrative expenses increased to 43.1% during the first quarter of fiscal 2009 as compared to 41.3% during the first quarter of fiscal 2008. The increase as a percentage of sales was primarily driven by deleveraging on lower-than-expected sales, investment spending associated with the acquisition of our retail businesses in Hong Kong and Macau and new business initiatives.
Selling expenses were $232.3 million, or 30.8% of net sales, in the first quarter of fiscal 2009 compared to $191.9 million, or 28.4% of net sales, in the first quarter of fiscal 2008. The dollar increase in selling expenses was primarily due to an increase in operating expenses of North American stores and Coach Japan and operating expenses in Coach China. The increase in North American store expenses is primarily attributable to expenses from new and expanded stores opened since the end of the first quarter of fiscal 2008. The increase in Coach Japan operating expenses was primarily driven by new store operating expenses. In addition, the impact of foreign currency exchange rates increased reported expenses by approximately $5.4 million. Finally, the first quarter of fiscal 2009 includes operating expenses of Coach China, which consisted of investments in stores, marketing, organization and infrastructure.
Advertising, marketing, and design costs were $41.5 million, or 5.5% of net sales, in the first quarter of fiscal 2009, compared to $32.1 million, or 4.7% of net sales, during the same period of fiscal 2008. The increase in advertising, marketing and design costs was primarily due to increased staffing costs, design expenditures, and development costs for new business initiatives.
Distribution and consumer service expenses were $12.8 million, or 1.7% of net sales, in the first quarter of fiscal 2009, compared to $11.6 million, or 1.7%, in the first quarter of fiscal 2008. The increase in distribution and consumer service expenses is the result of an increase in net sales.
Administrative expenses were $38.1 million, or 5.1% of net sales, in the first quarter of fiscal 2009 compared to $43.9 million, or 6.5% of net sales, during the same period of fiscal 2008. The decrease in administrative expenses was primarily due to a decrease in performance-based and share-based compensation.
Interest Income, Net
Net interest income was $2.6 million in the first quarter of fiscal 2009 as compared to $15.0 million in the first quarter of fiscal 2008. This decrease was primarily due to lower returns on our investments due to lower interest rates and lower average cash balances.
Provision for Income Taxes
The effective tax rate was 38.25% in the first quarter of fiscal 2009 as compared to 39.0% in the first quarter of fiscal 2008. The decrease in the effective tax rate is attributable to incremental income being taxed at lower rates.
Income from Operations
Net income from continuing operations was $145.8 million in the first quarter of fiscal 2009 as compared to $154.8 million in the first quarter of fiscal 2008. This decrease is primarily due to a decrease in interest income, net and a slight decrease in operating income, offset by a decrease in the provision for income taxes.
Net cash provided by operating activities was $76.5 million in the first quarter of fiscal 2009 compared to $121.7 million in the first quarter of fiscal 2008. The year-to-year change of $45.3 million was primarily the result of a decrease in earnings of $9.0 million and a $3.2 million decrease in share-based compensation. These decreases were offset by a $6.0 million increase in depreciation and amortization, primarily as a result of new and expanded stores in North America and Japan. The remaining change in net cash provided by operating activities is due to changes in operating assets and liabilities that were attributable to normal operating conditions.
Net cash used in investing activities was $66.9 million in the first quarter of fiscal 2009 compared to $141.4 million provided by investing activities in the first quarter of fiscal 2008. The $208.3 million change is primarily attributable to a $180.1 million decrease in the net proceeds from maturities of investments. This decrease was offset by a $12.8 million cash outflow related to a deposit on the purchase of Coachâ€™s corporate headquarters, an $8.5 million cash outflow related to the acquisition of our retail business in Hong Kong and Macau, and a $6.9 million increase in capital expenditures related to new and expanded stores. Coachâ€™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.
Andrea Shaw Resnick
Thank you, [Shirley]. Good morning and thank you for joining us today. With me to discuss our quarterly results are Lew Frankfort, Coach's Chairman and CEO, and Mike Devine, Coach's CFO. Mike Tucci, President of North American Retail, is also joining us.
Before we begin we must point out that this conference call will involve certain forward-looking statements and certain projections for our business in the current or future quarters or fiscal years. These statements are based upon a number of continuing assumptions, and future results may differ materially from our current expectations based upon risks and uncertainties expectations based upon risks and uncertainties such as expected economic trends or our ability to anticipate consumer preferences or control costs. Please refer to our latest annual reports on Form 10-K for a complete list of these risk factors.
Also, please note that historical growth trends may not be indicative of future growth. We presently expect to update our estimates each quarter only; however, the failure to update this information should not be taken as Coach's acceptance of these estimates on a continuing basis. Coach may also choose to discontinue presenting future estimates at any time.
Now let me outline the speakers and topics for this conference call. Lew Frankfort will provide an overall summary of our first fiscal quarter 2009 results and will also discuss our strategies going forward. Mike Tucci will review our key initiatives for the holiday season. Mike Devine will conclude with details on financial and operational highlights for the quarter as well as our outlook for the second quarter and full fiscal year 2009. Following that we will hold a question-and-answer session that will end by 9:30 a.m.
I'd now like to introduce Lew Frankfort, Coach's Chairman and CEO.
Thanks, Andrea, and welcome, everyone. As you know, we just reported that first quarter earnings met our EPS guidance but fell slightly short of our top line goals due to the weakened retail landscape in North America.
While we're enthusiastic about the level of product excitement that will be available for holiday and believe that Coach will remain a brand of choice whether for self purchase or gifting, we're concerned that the weak traffic trends across our U.S. full price businesses will continue through the rest of the fiscal year. As a result, productivity gains over this timeframe will be difficult to achieve. Thus, we now expect to achieve sales growth of about 10% this year to about $3.5 billion versus our previous estimate of 13% top line growth.
Importantly, we have been proactive in planning for a tough retail environment for some time, managing our business nimbly and acting quickly to curb spending. We believe that our earnings guidance for the year can still be achieved through a combination of distribution growth, a focus on innovation to support productivity, disciplined expense control, and the share repurchases to date. At the same time, we will continue to invest prudently for long-term profitable growth.
While I will get into further detail about current conditions and the outlook for the category in our business shortly, I did want to take the time to review our quarter first.
Some highlights of our first fiscal quarter were:
First, earnings per share rose 7% to $0.44 compared with $0.42 in the prior year.
Second, net sales totaled $753 million versus $677 million a year ago, a gain of 11%.
Third, Direct to Consumer sales rose 16% to $592 million from $511 million in the prior year on a comparable basis.
Fourth, North American same-store sales for the quarter rose 1%.
Fifth, sales in Japan rose 12% in constant currency and 22% in dollars, driven by new stores and expansions.
And finally, we successfully completed the first phase of the acquisition of our Retail business in China from ImagineX, transitioning the 10 stores in Hong Kong and Macau.
During the quarter we opened 21 net North American retail stores, including six in new markets for Coach: Calgary in Ottawa, Canada; Baton Rouge, Louisiana; Appleton, Wisconsin; Bakersfield, California, and Fort Myers, Florida, as well as one factory store. In addition, 7 retail stores and 3 factory stores were expanded. Thus at the end of the period there were 318 full price and 103 factory stores in operation in North America.
I think it's important to note that the performance of our new retail stores has remained strong and ahead of our internal projections. This includes the stores opened in the first quarter, for which we now have revised annualized volumes which are running at $2.1 million compared with our expectation of $1.9 million, about 11% ahead of plan. And as noted in the press release, we have seen this outperformance most notably in new markets such as Calgary and Baton Rouge, but also in existing markets such as San Jose. Clearly, these results reflect the strength of the brand and our ability to attract consumers, both in new and existing markets.
Moving to Japan, four locations were added while one was expanded. At quarter end there were 158 total locations in Japan, with 20 full price stores including 8 flagships, 113 shop in shops, 20 factory stores, and 5 distributor operated locations.
Indirect Sales decreased 3% to $160 million from $166 million in the same period last year on a comparable basis. This decline was due to reduced shipments into U.S. department stores as we continue to tightly manage inventories into the channel given weakening sales at POS, which declined 8% for the quarter.
International POS sales posted strong gains in the period, driven by both distribution and comparable location sales gains.
We estimate that the premium U.S. handbag and accessory category grew at a mid single-digit pace during the third quarter of calendar 2008. At the same time, Coach's bag sales rose 9% across all channels in North America.
Our total revenues in North America were up 8%, with our directly operated stores generating a 15% gain driven by both distribution and a slightly positive comp. We would note that in full price stores our weak traffic patterns from the previous few quarters worsened, while conversion held at last year's levels and average transaction size fell slightly.
In Factory, we continued to see increases across all three metrics, driven in part by higher promotional activity on a year-over-year basis.
I also want to highlight another solid quarter for Coach's women's footwear. Our business in department stores, where we are now sold through about 900 locations, rose 6% at POS for the quarter.
While Mike Devine will get into more detail on our financials - and of course I will discuss our outlook in some detail - I wanted to give you this recap. As you know, I've also asked Mike Tucci to join us today to discuss our product performance for Q1 and our holiday sales initiatives. Mike?
Thanks, Lew. As mentioned in our press release, each of our monthly introductions was well received, starting in July with Bleecker. This was followed up updated Hamptons and Legacy Collections in August and by Zoe, a new group of handbags and accessories, in September. Also in September we successfully introduced a new Coach fragrance, Legacy.
Earlier this month we launched Madison, a new major lifestyle collection which is a softer, drapier and sophisticated group of handbags, accessories and footwear across multiple fabrications, including a new logo platform, Coach Op Art. We are especially excited about Madison as it represents the first collection that fulfills our strategy of compressing multiple years of product innovation into a single fiscal year. This is especially important at holiday, when our gifting opportunity is greatest.
Our early reads on Madison show an improvement in handbag penetration as a percent of sales and a better balancing of our assortment overall. Our key item in this group is the Sabrina satchel, performing very well in both sizes, with prices ranging from $298 for the smaller version in Op Art to $798 in limited edition styles.
Looking ahead to holiday, our customers will see important changes from previous years. First, a dramatic intensification of newness, notably in handbags. In the past we tended to frontload the quarter with the most significant delivery in October followed by more modest introductions in November and December. This holiday will build on October's Madison launch with powerful new product throughout the quarter.
Second, a focus on gifting, notably in a more bold accessory offering across a range of compelling price points.
And third, a retail presentation that truly appeals to holiday gift giving. Our in-store, web, packaging and advertising point of view will be more festive, colorful and exciting this season, anchored by the Madison Collection and great gifts.
Within handbags, Madison will remain front and center in our stores this holiday. We'll be updating the collection during the season with new colors in both Op Art and leather across key silhouettes such as the Sabrina satchel.
In November we'll launch an updated Soho Collection driven by two new hobo silhouettes at core price points of $278 and $298 dollars, offering exceptional value. At the same time we'll be layering in Amanda, a chic whimsical collection of satin occasion handbags, clutches and accessories in bright colors which sit side by side with Madison.
And in December, Leah will be a key item focus. Sophisticated and functional, the lightweight Leah tote will be available in coated canvas, embossed patent and leather, priced between $298 and $398, all silhouettes feature a detachable shoulder strap, providing over the shoulder to cross body convertibility.
Moving on to gifting and our accessory focus, we will be dominant in small leather goods this holiday season. You'll see an item intensification to distort our gifting opportunity throughout the quarter and beyond. You'll also see more color, a wide range of price points, including our newest best-selling Madison wallet at $98, and a key item focus around money pieces, wristlets, swing packs and pouches in our stores and on the web.
In new growth categories, we are expanding sterling silver to 120 additional stores in December, bringing the total to 220. And in fragrance and beauty, we'll be offering body lotion and gift set options as well.
Most broadly, our retail presentation in every way we touch the consumer will be infused with holiday energy and messaging. While our presentations will be straightforward and easy to shop, they'll also be more bold, colorful and emotional. When she enters a Coach store or visits us at Coach.com, she will clearly see newness and what we believe in as our key items.
We're strengthening our visual merchandising such as propping and trim, making our stores more festive and providing a strong integrated gifting message supported by in-store marketing as well as our print and online holiday campaign, Holiday by Coach.
Finally, it's important to note that we have achieved our targeted 10% to 15% reduction in handbag skews this quarter, enabling us to be more edited and productive in this challenging environment.
Of course, in terms of stores, we will continue to manage labor against traffic, ensuring an excellent shopping experience while appropriately managing our payroll spend. And we will fully leverage the technology initiatives put in place over the last few years, including ERunner, smart scheduling, Coach by Special Request, and web store pickup, to name a few.
With that I'll return the discussion to Lew to continue with our overarching strategies.
Thanks, Mike. While looking ahead, as we've discussed many times, we have two sales drivers. First is distribution, as we expand our global network of store locations with an emphasis on North America, Japan and China. And second is productivity, which we drive across all geographies through the introduction of innovative and relevant products in a compelling store environment.
As we discussed, given the weak retail climate in North America, productivity gains will remain challenging through the remainder of our fiscal year. That said, we have been implementing four key strategies that focus on sustaining growth within our international framework. Our largest opportunity during our planning horizon continues to be in North America.
First, we're building share in the $8.7 billion North American women's accessories market. As we've already discussed, we're implementing a number of initiatives to accelerate product innovation, elevate our offering and enhance the in-store experience. These plans will enable us to continue to strengthen our leadership position in this market.
Our second strategy is the continued growth in North American Retail. As you know, given the compelling returns we are continuing to generate, we plan to add about 40 retail stores a year in North America, including FY '09. This year this will include a total of 14 new markets for Coach. Prior to holiday, we expect to have opened a total of 28 full price stores, including a total of 6 this quarter. We will also continue to relocate and expand stores where appropriate.
As I mentioned, based on the performance of our new stores, which have consistently outpaced their pro formas even as the economy has weakened, we believe that North America in total can easily support 500 retail stores, including at least 20 in Canada.
And third, outside the U.S. we're continuing to increase market share with the Japanese consumer, driving growth in Japan primarily by opening new locations and by expanding existing ones. In FY '09 and in each of the next few years we plan to add about 10 net new locations in Japan and, as has been our practice, we will also continue to expand our most productive locations.
Our fourth strategy is to raise brand awareness in emerging markets to build a foundation for substantial sales in the future. Specifically, China, Korea, and other such geographies are increasing in importance as the category is growing rapidly and Coach is taking hold. In FY '09, we're on target to open through distributors at least 20 net new wholesale locations in total.
In China we expect to open 5 new locations, 4 on the mainland and one in Hong Kong. As mentioned, during Q1 we successfully completed the first phase of our acquisition of our retail businesses in China, transitioning 10 stores in Hong Kong and Macau to Coach China. Over the next five years we expect to open 50 new locations in China, aggressively growing our sales and market share in this rapidly expanding region.
Our goal is to be one of the top three imported handbag and accessory brands. With the investments we plan to make in stores, marketing, organization and infrastructure, we're striving to replicate our success formula in Japan since taking control of that business there in 2001.
As you would expect, we're tightly managing our business. We have been addressing the unfolding economic crisis for more than a year now, and while it's not possible to fully insulate Coach from its effects, we've been pragmatic and forward thinking in our business strategies. We are closely managing inventories, controlling costs, and of course safeguarding our strong and loyal consumer franchise.
We will continue to deliver innovative products offering compelling value and intensifying our clienteling efforts, ensuring that Coach is top of mind this holiday season. By being proactive, maintaining our focus, and continuously delivering on our brand promise, we firmly believe we will emerge from this adversity a stronger company.
At this time I will turn it over to Mike Devine, our CFO, for further details on our financials. Mike?
Michael F. Devine
Thank you, Lew. Lew and Mike have just taken you through the highlights and strategies. Let me now take you through some of the important financial details of our first quarter results.
As mentioned, our quarterly revenues increased 11%, with Direct to Consumer, which represents over three-quarters of our business, up 16% and Indirect down 3%, strong International sales and shipments, offset by weakness at U.S. department stores.
Earnings per share for the quarter increased 7% to $0.44 as compared to $0.41 in the year ago period as net income declined to $146 million from $155 million.
Our operating income totaled $233 million in the first quarter versus $239 million in the same period last year.
Operating margin in the quarter was 31% flat compared to 35.3% in the year ago quarter.
In the first quarter, gross profit rose 8% to $558 million from $518 million a year ago, and gross margin continued to be strong and on target at 74.2% versus 76.6% in the prior year.
As expected, promotional activity, notably in the factory channel, which has yet to anniversary the overall higher levels of promotions which began in last year's second quarter, was the primary driver of the year-over-year change. Channel mix and the sharper pricing initiative also dampened gross margin.
As expected, SG&A expenses as a percentage of net sales rose from prior year levels in the first quarter and represented 43.1% of sales versus 41.3%.
Inventory levels at quarter end were $402 million, up about 19% from prior year levels on a comparable basis, driven in part by an investment in key initiatives which position us well for the holiday season. In addition, the increase included the purchase of $5 million of inventory in China as part of the transition and was also impacted by the strengthening of the yen over the period. Excluding these items, inventories would have been up 16% year-over-year.
It should be noted that we have changed our method of accounting for inventories of Coach Japan from last in first out or LIFO to first in first out or FIFO. As a result, as was noted in the press release, our prior year inventory number was restated by $25 million to be presented on a comparable FIFO basis.
This inventory increase allows us to support 53 net new North American stores, 12 net new locations at Coach Japan, and increase sales levels from the year ago period.
Accounts receivable balances remained well controlled as they rose less than $8 million or 5%.
Cash and short-term investments stood at $410 million as compared with $1.2 billion a year ago, reflecting the aggressive buyback activity over the last year. During the first quarter we repurchased 10.5 million shares of common stock at an average cost of $28.53. At the end of the period, $863 million was available under the current repurchase authorization.
Free cash flow in the first quarter was an inflow of $10 million versus $83 million in the same period last year, primarily driven by changes in working capital, the investment in China, and the timing of new store openings.
Capex spending for new stores and renovations as well as investment spending for the China acquisition was $54 million versus $39 million in the same quarter a year ago.
Now I'd like to provide you with some of our updated goals for fiscal 2009. For the second fiscal quarter we are targeting net sales of about $1.05 billion, representing a year-on-year increase of about 8%, an operating margin of about 39%, with a gross margin similar to first quarter's rate of about 74%, and an expense ratio of about 35%, resulting in operating income up about 2% year-over-year and earnings per share of $0.77.
As we've noted, we are maintaining our $2.25 EPS guidance for the full fiscal year. Our goals regarding the other key financial metrics are:
Net sales growth of about 10% to about $3.5 billion, driven by distribution gains.
As mentioned, we expect to open at least 46 new stores in North America, including about 40 full price stores and about 6 factory stores, 10 to 15 net new locations in Japan, about 5 new locations in China, and at least 20 net new international wholesale locations while we continue to expand select highly productive locations globally.
In Japan we expect to achieve constant currency growth of about 5% to 10%.
While we continue to focus on profitability, we expect gross margin to be impacted by both ongoing promotional activity, notably in factory, as well as the shorter margins we will take on select new product in our full price business to deliver exceptional value to our consumers. As a result, we are continuing to project a gross margin rate of about 74% for the full year.
Similarly, given the investment spending we've outlined, we're anticipating an SG&A expense ratio of about 40% for FY '09. Therefore, we are targeting an operating margin of about 34% to 34.5%, resulting in more modest operating income growth of about 2% for the year.
In addition, significantly lower interest income due to lower rates and a lower cash balance due to share repurchases will also impact net income, while our tax rate in FY '09 should be at 38.25%.
Taken together, this brings us to our $2.25 EPS guidance for the year.
For FY '09 we expect Capex to rise to about $250 million, primarily for new stores and expansions both here and in Japan, as discussed, and including the $65 million purchase of onehalf of our headquarters building in New York. This reflects a $15 million decrease from our previous guidance, excluding the building purchase, as we have deferred certain projects with longer-term paybacks.
While these are our current goals, our actual results may vary from these targets based upon a number of factors, including those discussed under the Business of Coach, Inc. and Risk Factors in our annual report on Form 10-K. Coach also does not assume any obligation to update these targets as the year progresses.
In summary, we're confident that our growth strategies will enable us to continue to gain share in the large and growing global market for fine accessories and gifts. Thank you all for your attention and now Lew, Mike, Andrea and I would be happy to take some questions.