Coach Inc. Earnings: A Painful Turnaround

Source: Coach.

Coach stock was down 4.5% as of 10:55 a.m. Tuesday after the company released earnings for the quarter ending on March 28. Sales fell steeply, especially in North America, however, margins and inventory levels look much better when it comes to evaluating the health of Coach's turnaround efforts.

Weak sales in North America Total sales during the company's third quarter were $929 million, a decline of 15% compared with $1.1 billion in the same period last year. Wall Street analysts were on average forecasting $950 million in revenues, so sales came in considerably below expectations. Foreign currency fluctuations had a negative impact of 3% on revenue.

Most of the weakness in sales came from North America, where total sales decreased 24% to $493 million from $648 million last year. North American direct sales declined 23% for the quarter, with comparable-store sales down 23% including the impact of reduced eOutlet events, which pressured total comparable-store sales by about 11 percentage points. At POS (point of sale), sales in North American department stores fell nearly 30% versus prior year due to the elimination of promotional events.

Performance was much better in international markets, especially when adjusting for the impact of foreign exchange fluctuations. International sales decreased 3% to $428 million from $441 million last year. On a constant currency basis, international sales grew 4%.

China is being a strong spot for the company; sales in this market rose 10% on a constant currency basis and 8% in dollars, with positive comparable-store sales and slower distribution growth.

In Japan, sales declined 11% on a constant currency basis. This is probably related to accelerated purchases last year in anticipation of an increase in consumption taxes in Japan. U.S. dollar sales in Japan were 23% below the prior year, considerably hurt by the weaker yen.

Constant currency sales for the remaining directly operated businesses in Asia grew modestly, and Europe remained strong, growing at a double-digit pace. At POS, sales in international wholesale locations were essentially flat against 2014, while shipments rose significantly due to timing.

Coach closed 54 stores in North America during the last quarter, ending the period with a total of 478 locations. In Japan the company reduced the store count by 2 units, for a total of 198 stores in the country. On the other hand, Coach opened 4 new stores in China, reaching 165 units. The company opened 4 additional stores in the rest of Asia, for a total of 101 stores in the region. The store count in Europe was stable at 31 locations.

Healthy marginsIn spite of the considerable decline in sales, margins are doing quite well on the back of reduced discounts and tighter inventories. Gross profit margin was 71.6% of sales during the last quarter, an increase versus 71% of revenues in the same period last year.

Inventory levels stood at $457 million as of the end of the quarter; this represents a year-over-year decline of almost 22%. Inventories are falling at a faster rate than revenues, and this is a big positive, as it shows that Coach is making smart merchandising decisions and moving its products rapidly from the shelves.

Net income excluding transformation-related charges totaled $100 million, while adjusted earnings per diluted share came in at $0.36. The number was one cent above Wall Street forecast of $0.35 in earnings per share for the quarter.

Moving forward CEO Victor Luis provided an optimistic view of the company's performance in the company's press release:

Coach is going through a transformation process, and this means selling smaller volumes in North America, but doing so at higher prices. In international markets, the company seems to be betting on both growing volumes and strong prices, especially in countries like China.

This strategy is taking its toll on sales, and this is a big reason for concern. On the other hand, patience is not only a virtue, but sometimes even a necessity. While declining sales are not nice to see, they can be a necessary cost to building a stronger business over time.

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