Good day. Welcome to the Coach conference call. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Senior Vice President of Investor Relations and Corporate Communications at Coach, Ms. Andrea Shaw Resnick. You may begin.
Thank you. Good morning. Thank you all for joining us. With me today to discuss our quarterly results are Lew Frankfort, Coach's Chairman and CEO; Victor Luis, Coach's President and Chief Commercial Officer; and Jane Nielsen, Coach's CFO. Francine Della Badia, President North America Retail, is also joining us. Before we begin, we must point out that this conference call will involve certain forward-looking statements, including projections for our business in the current or future quarters or fiscal years. These statements are based upon a number of continuing assumptions. Future results may differ materially from our current expectations based upon risks and uncertainties such as expected economic trends or our ability to anticipate consumer preferences. Please refer to our latest annual report on Form 10-K for a complete list of these risk factors. Also, please note that historical growth trends may not be indicative of future growth.
Let me outline the speakers and topics for this conference call. Lew Frankfort will provide an overall summary of our first fiscal quarter 2014 results and will also discuss our progress on global initiatives. Francine Della Badia will speak to our North America business, product performance, and review our key programs for the holiday season. Jane Nielsen will conclude with details on financial and operational highlights for the quarter and outlook. Following that, we will hold a question-and-answer session where we will be joined by Stephanie Stahl, Coach's Executive Vice President of Marketing and Strategy. This Q&A session will end shortly before 9:30 A.M. We will conclude with some brief summary remarks. Of course, Victor Luis will also be discussing our international growth and our strategies for the future. I'd like to turn it over to Lew Frankfort, Coach's Chairman and CEO.
Thank you, Andrea. Good morning, everyone. I'd like to welcome everyone to my last call as Coach's CEO. As you all know, I will be moving on to Executive Chairman in January. I could not be more pleased with the choice of my successor, Victor Luis, who has demonstrated the passion, strategic vision, focus, superb execution, and strong values that makes an outstanding leader. Victor will have a strong partner in our new Executive Creative Director, Stuart Vevers, who officially joined us in September and is recognized as one of the world's leading accessories designer. Stuart's broad luxury experience focused on leather goods, and his creative expertise grounded in accessories will enable him to draw upon Coach's rich history to create innovative product and brand imagery, elevating the customer experience and creating a fuller expression of the brand.
I am confident that Victor, together with Stuart, will forge the ideal partnership, or as I like to say, the balance of logic and magic to advance Coach's transformation. Turning back to our quarterly results. As noted in our press release, we achieved slight overall sales gains in constant currency, benefiting from our geographic diversity. We continue to drive excellent growth in emerging markets in Europe, as well as in the men's business and in developing lifestyle categories such as footwear. Importantly, we moved forward with our transformation initiatives across all consumer touch points, product, store environments, and marketing focused on the competitive handbag and accessories category in North America. While we will get into further detail about current conditions and the outlook for our business shortly, I did want to take the time to review our quarter first.
Some key financials were, first, net sales totaled $1.15 billion versus $1.16 billion a year ago, a decrease of 1%. On the constant currency basis, sales rose 2% for the quarter. Second, earnings per share totaled $0.77, even the prior year. Third, North American sales decreased 1% to $778 million from $784 million last year, with direct sales also declining 1% on a 6.8% comparable store sales decrease. Fourth, international sales decreased 1% to $365 million from $367 million last year. On a constant currency basis, international sales rose 9%. Sales in China remained strong, increasing over 35% with a continuation of double-digit comps, while sales in our directly operated locations in Asia, ex-Japan, and Europe rose sharply as well. Looking first at global distribution During the quarter, the company closed one full price location and opened five North American factory stores, including one men's freestanding store.
At the end of the period, there were 350 full price and 198 factory stores in about 150 outlet malls in North America. Moving on to China. During the quarter, we opened six net new locations, all in the mainland, bringing the total number to 132 locations, including 114 on the mainland in 49 cities. In Japan, we opened one net new men's location during the quarter and reclassified four doors from temporary to permanent, bringing the total to 196 directly operated locations, which included 149 full price and 47 factory locations in about 30 outlet malls. During the first quarter, we opened two locations in Singapore and now directly operate a total of 94 locations in the balance of Asia, including 48 in Korea, 27 in Taiwan, 10 in Malaysia, and nine in Singapore. Moving on to sales and productivity.
Our total revenues in North America declined 1% for the quarter, with our directly operated businesses also down 1%. As noted, total Q1 same-store sales declined 6.8%, while digital, men's, and our newly relaunched footwear categories performed well. We were disappointed by our overall performance in women's handbags and accessories. More generally, we continue to achieve sales gains on the internet while in-store trends, notably traffic, remained weak. On these lower traffic levels, in-store conversion was up and transaction size held. In department stores, sales trends at POS were modestly below prior year, while shipments into department stores declined slightly. Overall, we estimate that the North American premium women's handbag and accessories market rose at a high single-digit rate in the first quarter. This was a modest deceleration from recent trends, impacted like all consumer categories by the cautious spending environment.
As we've discussed, we're also continuing to drive our men's business globally through new standalone and dual-gender stores, and by dedicating more space for a broader men's assortment in existing retail stores. In the first quarter, Coach's sales of men's bags and accessories increased over 25% globally. Looking ahead, we remain bullish about the prospects for our global men's business. We're targeting about $700 million in sales in FY 2014, up about 20%, and $1 billion in sales in three years. Before we discuss international sales and progress on transformation, Francine Della Badia has joined us today to discuss our product performance for the first quarter and our holiday sales initiatives. Fran?
Thanks, Lew. Starting with product. As Lew mentioned, we continue to feel pressure in our North America business in traffic in our retail stores, impacting women's handbags and accessories. I'm going to give some underlying texture to the comp performance, both in our successful and strong product initiatives, which are resonating with consumers, and where we see the opportunities to strengthen our product positioning in North America. We were pleased with the relaunch of Madison this quarter. Madison was completely redesigned with a sophisticated and elevated attitude, featuring refined and timeless elements, feminine details, rich leathers and beautiful textures, and understated branding. The new silhouettes, especially the smaller version of our popular Phoebe shoulder bag, the new Madeline satchel in two sizes, and the Kimberly carryall are best sellers.
Customers are responding to the prettier and more emotional sensibility, the thoughtfully integrated function to support our customers' busy lifestyle, and therefore the overall effortlessness of these products. For more casual, less dressy handbag choices, we also introduced new shapes and Legacy, such as the drawstring shoulder bag and the turnlock tote. As expected, trends continue to favor leather handbags across all price segments. In particular, the above $100 segment continued to perform well at over 20% of handbag sales. Our overall handbag penetration to our women's business was about even to last year. We see opportunities in women's handbags and accessories in continuing to infuse more emotion into our product, leveraging our distinctive brand.
Stuart's unique luxury experience and his passion to make the Coach aesthetic relevant for today, where ease, creativity, and superior functionality are crafted into beautiful Coach leather bags, will allow us to speak to a more aspirational consumer and continue to inspire our customers globally. We continue to see strength in our lifestyle categories in Q1. Footwear, which we launched this spring in about 170 full price locations, doubled in penetration from about 4% to over 8%. higher AURs, reflective of the compelling assortment. This category performance highlights our consumers' desire for more emotional trend-right fashion products. We are seeing strong performance across heels, flats, and booties. We're focused on building our market share within the fragmented, nearly $25 billion global premium footwear category. This fall, we've introduced more dominant fashion footwear assortments in our international and wholesale locations and continue to focus on building our key items.
We're evolving our mix and growing both AURs and overall penetration levels across all of our businesses. At the end of Q1, over 100 Coach international retail locations offered the elevated collection, and the response from customers has been excellent. I also want to touch on watches. We're revamping and expanding our collection, repositioning to a fashion assortment, and focusing our sweet spot on an average $225 price point. In our Factory channel, as planned, new designs represented the majority of our handbag assortment last quarter. Park, a stylish leather-based collection, came in in July and sold extremely well. Campbell, a more sophisticated group of iconic Coach turnlock hardware, offered in multiple fabrications, including exotic, performed strongly. During August, we launched an assortment of made-for-Factory footwear in 20 stores, and we're very pleased with customer response. We will be significantly expanding the distribution and offering starting in the spring.
More broadly, we're expanding the role that lifestyle categories play in Factory, including outerwear, watches, jewelry, and swimwear. In addition, we have remodeled a majority of our Factory stores into our new Factory design concept, including enhanced visual merchandising and marketing elements. Moving to digital. As mentioned, our North America online business continues to be strong, with traffic growing at a double-digit pace, driven by engagement from tablet and mobile devices, which represent over 50% of our site visits. Optimization of these devices has been a key focus for us, creating more compelling customer experiences. Turning to holiday, we continue to focus on increasing the level of innovation across all product categories, adding emotion while strengthening fashion credibility and relevance to the brand.
This will be most notable with the arrival of Capsule, a curated product assortment across categories focused on key items in bags, footwear, and outerwear, which started arriving in stores last week. All stores in North America have now received the new Capsule handbag silhouette, The Borough, in two sizes and three colors. A tiered offering of more fashion handbags in additional colors and materials are offered in select flagship locations, with the full assortment, including ready-to-wear, available in 25 global flagships, including 11 in North America. This Capsule collection supports our lifestyle imagery featured in our new fully integrated marketing campaign, Coach New York Stories, showcasing top fashion models wearing Coach set against recognizable New York backdrops. This campaign communicates a more aspirational and consistent brand story, reinforcing the bond with our existing consumer while driving new consumer engagement globally.
The campaign has already generated significant buzz in the fashion press and in social media channels around the world. At the same time, we're enhancing our store environments, unveiling a new store concept in two key flagship locations in New York and Southern California during the holiday quarter. In department stores, we're also elevating our presence with new shop-in-shops and converting our case line presentations to open sell. In fact, we've seen a significant lift in sales in about a dozen locations where we have transitioned from case line to open sell format. In summary, we will continue to drive our women's business through fashion innovation across lifestyle categories, supported by dynamic, integrated marketing. We will also leverage the opportunity in men's and evolve our store and digital concepts to provide a brand-right shopping experience for our consumer wherever she chooses to shop.
With that, I will turn it over to Victor for a discussion of our international business, strategies, and further opportunities for growth. Victor?
Thanks, Fran. Starting with our international segment, which represents about a third of Coach's business, sales rose 9% on a constant currency basis in the first quarter, but declined 1% on a reported basis due to the weak yen. China sales rose over 35% from prior year, fueled by distribution and double-digit same-store sales. We are very pleased by the continuing strength in this market, which bodes well for our global travel retail business, where the mainland Chinese tourist plays an increasingly important role. You may remember that our e-commerce site in China launched a year ago, and while still in early stages, the internet customer within mainland China is shopping us from over 200 cities, including more than 150 where we have no bricks-and-mortar presence. This is another sign of the substantial distribution opportunity for the brand beyond the top-tier markets.
Further, as Coach is a relatively young brand in China, we are already recognized as a dual gender and lifestyle, as men's products and women's lifestyle categories taken together represented a third of sales in the first quarter. Our other Asia direct businesses outside of China and Japan, Korea, Taiwan, Malaysia, and Singapore also posted strong aggregate growth, increasing at a double-digit rate for the quarter with robust comparable store sales as we anniversaried the purchase of our retail operations in Malaysia and Korea during the quarter. In Japan, we posted a 2% decrease in constant currency as the market growth slowed, while sales in USD were down 22%, reflecting the weaker yen. As discussed in our release, in early July, we completed the purchase of our partner's 50% interest in our European joint venture.
In addition, also in July, we transitioned the two Printemps Boulevard Haussmann locations to our direct control. Today, we operate 20 locations across the U.K., France, Ireland, Spain, Portugal, and Germany. During the first quarter, under our direct control, we saw significant sales growth at POS and strong comps in these locations. Also, we just opened our first location in Galeries Lafayette yesterday and look forward to opening our first flagship location in Spain in mid-November, along with the men's shop in Galeries Lafayette. We continue to believe that Europe represents a significant long-term opportunity for Coach, both with domestic shoppers and the international tourist, notably in key European cities where the accessible luxury segment is outperforming traditional luxury. Looking forward to the balance of FY 2014, our strategic focus remains on the four pillars of growth we have previously shared.
First and most broadly, growing our business in North America and throughout the world by transforming into a global lifestyle brand. Second, leveraging the global opportunity by aggressively growing our international businesses. Third, tapping into the large and growing men's accessories category, which we've already touched on. Fourth, harnessing the growing power of the digital world. While focusing in productivity, we will selectively continue to expand our distribution. As our plans haven't changed materially from what we outlined on the July earnings call, I'll be brief. We continue to expect that our square footage globally and across all channels will increase about 9% in FY 2014. In North America, our square footage will be up about 7%, driven by 20 new store openings focused on factory, 15-20 previously announced full price closures, and about 20 total expansions across both channels within the context of our transformation.
In China, we expect to grow square footage about 25% in FY 2014, with about 30 net new dual-gender stores. We expect sales to total about $530 million, driven by both distribution and double-digit comparable location sales. In terms of our other direct Asia markets of Korea, Taiwan, Malaysia, and Singapore, while we expect to open a few stores, our primary focus remains productivity. We have begun to see the results of Coach's direct management, as well as the successful expansion of lifestyle categories in these markets. In Japan, we expect that net square footage growth will increase slightly and expect to open about 5-10 net new locations, most of them dedicated men's doors. In Europe, including the U.K., we expect to open 10 retail locations focused on key European capitals and about 50 wholesale locations in FY 2014.
As you know, we also have significant and growing distributor-run businesses in other countries. Our primary areas of focus are, first, Latin America, including Mexico, Brazil, Venezuela, Colombia, Panama, Chile, Peru, and Argentina. Second, other Asia Pacific markets such as Australia, Thailand, Indonesia, and Vietnam. Third, in the Middle East. These are in addition to the significant global travel retail opportunity that continues to exist for Coach as the brand's recognition continues to grow globally. I've just reviewed our strategies to drive growth while taking steps to improve productivity in North America. At this time, I will turn it over to Jane Nielsen, our CFO, for further detail on our financials. Jane?
Thanks, Victor. Lew, Fran, and Victor 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. Our quarterly revenues decreased 1%, with both North America and international declining 1% in USD. As noted, on a constant currency basis, revenues rose 2% overall, with international sales up 9%. Net income from the quarter totaled $218 million, with earnings per diluted share of $0.77. This compares to net income of $221 million and earnings per share of $0.77 in the prior year's first quarter. Our operating income totaled $322 million. 3% below the $332 million reported last year, while operating margin was 27.9% versus 28.6%. During this quarter, gross profit totaled $827 million versus the $845 million a year ago, a decrease of 2%. Gross margin was 71.8% versus 72.8% for the prior year.
Our expense ratio in Q1 totaled 43.9%, improving from the 44.2% reported in the year-ago quarter. Inventories at the end of the quarter were $637 million, a 6.5% increase over the $598 million reported at the end of last year's Q1. Cash and short-term investments totaled $855 million, as compared with $761 million a year ago. During the first quarter, we repurchased and retired nearly 3.3 million shares of common stock at an average cost of $53.17, spending a total of $175 million. At the end of the period, about $1.2 billion remained under the company's current repurchase authorization. Net cash from operating activities in the first quarter was $164 million, compared to $202 million last year during Q1. Free cash flow in the first quarter was an inflow of $118 million versus $146 million in the same period last year.
Our CapEx spending was $46 million versus $56 million in the same quarter a year ago. Looking forward at the balance sheet, we are deploying international cash into high-quality investments with higher yields and with some durations over a year, and expect a shift between cash and short-term investments into other non-current assets. Consistent with our guidance last quarter, we expect that CapEx will be in the area of $280 million, primarily due to new store openings and expansions across all geographies, elevating our store environments within our existing stores, and investments in the technology and infrastructure necessary to enable our global expansion and transformation. While we are encouraged by the initial iterations of our transition to a lifestyle brand, we recognize that the full reflection of this positioning is part of a multi-year journey.
In addition, the retail environment remains challenging, with soft mall traffic and volatility in consumer sentiment. Therefore, as you think about the remainder of 2014, our updated outlook is as follows. We expect to deliver flat to low single-digit sales growth in constant currency. Assuming the yen remains close to JPY 100, this would equate to sales growth about even with last year in dollars, with currency more of a factor in the first half. Also, we are forecasting our North America comp run rate to be down high single digits for the balance of FY14. Gross margin is projected at about 70%-71% for the year. The primary impacts compared to last year will be increased factory clearance levels, the weaker yen, rising sourcing costs, as well as inventory amortization from the JV acquisition in Coach Europe.
We expect modest SG&A dollar growth with increased investments in Europe, marketing, and other brand transformation initiatives generally funded by the restructuring actions taken in Q4, with some deleverage on a lower sales forecast. Taken together, we would expect operating margin to be about 28%. Finally, our tax rate is expected to be around 32% for the year. Regarding our balance sheet, cash flow, and capital allocation, we continue to have a strong balance sheet and substantial operating free cash flow of over $1 billion annually. As always, we will prudently invest in the growth of our business while also returning cash to shareholders through dividends coupled with share repurchases. Our current FY14 outlook continues to reflect about $700 million in share repurchases, approximately equivalent to our prior three-year average. Most importantly, our long-term commitment to growth and shareholder value are unchanged.
We have a business model that generates significant cash flow, and we are in a position to invest in our brand while continuing to return capital to shareholders. I'd now like to open it up to Q&A.
Thank you. At this time, to ask a question, please press star one on your touch-tone phone. You will be prompted to record your name. To withdraw your request, you may press star two. The first question today is from Irwin Boruchow with Sterne Agee.
Hi. Good morning, everyone. Thanks for taking my question. Lew, congratulations on a great run and best of luck in your new role.
Thank you.
It sounds like conversion in the U.S. has actually been pretty good the past six months, which is a good sign, but people just aren't coming in the doors. Is there anything you think you can do to pull them back inside come holiday? I guess Jane, in regards to the new outlook, I guess maybe when would you anticipate some improvement in North America and in your new outlook, why don't you assume any improvement in the North America comp over the next nine months? Thank you.
Let me begin by saying that first and foremost, we have a broad and comprehensive program across product marketing and environments, which is kicking in now. If you visit our stores today, you will see, as Francine mentioned, the arrival of the Borough bag capsule. You will see a complete head-to-toe look in our marketing and enhanced environments. Traffic is a lagging indicator. What we expect to see, which is occurring and has been occurring, is higher conversion and steady or somewhat higher ADT. With an intensified media program across both digital and traditional, we are hopeful that we will see an increase in our traffic levels. Having said that, until this occurs, we are not going to forecast an improvement in our trend rates here within North America. We're actually waiting for it to occur, and when it occurs, you will know about it.
Thank you.
Thank you. The next question is from Oliver Chen with Citigroup.
Hi, everyone. This is Nancy Hellicher filling in for Oliver Chen. I wanted to follow up on just what Ike was talking about also. Can you give us any information in terms of why maybe the new lifestyle program and new Capsule collection, et cetera, wouldn't maybe help comp guidance going into holiday? Also, if you could talk a little bit about SKU rationalization, just if you're planning to sort of focus more on certain products, et cetera, that would be great. Thank you.
Victor?
Sure. Good morning. In terms of Capsule, as we have communicated in the past, it is a very small collection. There are five handbag SKUs that go across all stores, and this is a collection that only launched three, four days ago, and the initial results are very promising. That we can share. Obviously, given the size of the launch, we do not expect it to be providing a major inflection alone to the business. In terms of SKU rationalization, that will certainly be something that we look at moving forward, especially as we look at bringing other categories into our fleet. As you have heard Fran report earlier, our shoe relaunch continues to take hold, where we have seen footwear move from a 4% penetration to 8% of the business. Most of that has come in the expansion within the 70 locations where we have added fashion assortments.
As you also heard Fran refer to, we're very pleased with the fact that it is the fashion assortments that is checking with consumers and not just the typical sneaker and flip-flop business of the past.
Great. Thank you.
The next question is from Brian Tunick with J.P. Morgan.
Hi. Thanks. This is Viden Boyner filling in for Brian today. First question on SG&A came in better than what we would have expected given the sales decline. Still wondering if there were any timing shifts, maybe from marketing perspective or anything we should think about coming in the big holiday quarter. On inventory at the channel, would be very helpful if you could provide some more color around how you feel about the inventory levels at department stores or wholesale accounts like Zappos, given that you mentioned POS sales were down modestly and selling was down slightly. Thanks.
Sure. Just let me comment on the 30 basis points of SG&A leverage that you saw. It's largely timing. As you think about Legacy last year, the marketing was more predominantly in the first quarter. New York Stories is going to hit in the second quarter, that accounts for all the difference in SG&A leverage. It's simply timing. We are calling for, as you heard in the guidance, modest SG&A dollar growth. That's very consistent. It's an element of timing. In terms of overall inventory, if you think about inventory, we don't guide to inventory. You saw our inventory is up about 6.5%. If you think about inventory, think about the increased overall AUCs or average unit cost is driving overall inventory. Obviously, our sales were below our expectations. Those are the two primary drivers.
Thanks. Best of luck.
Thank you. The next question is from Lorraine Hutchinson with Bank of America.
Guidance Trust.
Thank you. Good morning.
Good morning.
Just following up on the Factory question. Can you talk about some of the promotions that you've tested within Factory, and how much excess inventory you expect to
To manage to clear over the coming quarters.
Hi. As you know, Factory is our promotional channel, and there are a number of different levers that we use during the year to manage our Factory business and drive revenue. This quarter, we did take additional promotion on our clearance business in Factory, and that was mostly to offset higher AURs that we experienced with the new product that we've been launching to balance the business for the quarter.
Thank you. The next question is from John Morris with BMO Capital.
Thanks. Good morning. Wanted to get a little bit more color from you guys on maybe comparing, contrasting the business between the retail stores and the Factory, specifically traffic trends and the like. Maybe a little bit more color there beyond what you've already commented on. Thanks.
First, as reported, traffic trends in Factory stores and retail stores have been tough. Indeed, in full price stores, our traffic slightly worsened in the quarter. Overall conversion has remained strong, and in fact, is higher than last year.
Between the two channels, Lew, was Factory worse than retail in terms of traffic or in terms of conversion? I'm looking for sort of a-
We don't disaggregate that, the two channels. What we can tell you is that the patterns that existed in the prior quarter and in the prior 12 months remain consistent.
Can Francine give us a little bit more color on where she sees the holiday opportunity this year versus last year? Some of the specific initiatives that you might be doing around holiday to help drive the business. Thanks.
For holiday, on the full price side, I think actually more broadly, we have this fully integrated marketing campaign across both marketing in our stores and our windows and also across all of our digital channels, who are very active in social media right now. Those are efforts to continue to drive traffic into all of our stores during the holiday quarter. I think specifically to Victor's comment about the recent launch of Capsule, we are feeling good about the Borough bag, and that's a good indicator for our product initiatives as we go forward. As we've spoken to, we are excited to continue to drive our lifestyle categories, specifically footwear and men's. On the Factory side, I can tell you that we continue to see great consumer response with the new product that we've been launching. That product has performed well.
We'll continue to be promotional more around our clearance, at any given point in time, we are continually testing and piloting promotional levers in Factory.
Let me I'd like to also add, in terms of advertising spend, we are intensifying spending in the quarter. You'll be seeing, in both traditional media and digital, a much stronger presence of Coach communicating the broader expression of the brand.
Thanks very much. Good luck.
Thank you.
Thank you. At this time, please limit yourself to one question per request. The next question is from Edward Yruma with KeyBanc.
Hi, thanks and good morning. I was wondering what you could tell us about the customer that's in the stores buying some of the new lifestyle product, if it be shoes or watches. Is it the existing customer? Are you capturing new customers? Are they also making a purchase of a bag at the same time? Thanks.
Hi.
Francine.
Thanks for the question. We're experiencing both. It is an existing consumer. We do find that consumers who buy handbags from us also participate in a significant way in other parts of the business and then the other lifestyle categories. We are also attracting new customers, especially with some of the repositioning, moving watches to a more fashion assortment at a $225 average price point, and also footwear with the new trend right fashion product assortment. We're definitely seeing new customer engaging in the footwear category for us.
Great. Thanks so much.
Thank you. The next question is from Liz Dunn with Macquarie.
Hi, good morning. Thanks for taking my question. I was just wondering, on gross margin, if you could give us a sense of where merchandise margin or markdowns shook out in the quarter relative to last year. As I look at the guidance sort of versus last time, is the delta there just increased promotion at Factory? Because all of the other sort of items that you'd mentioned had been pressures that we were expecting before, or have any of those sort of intensified? Thank you.
Yeah, sure. Liz, let me break it down for you to equate to our guidance now. There will be heightened promotional levers in our North America Factory channel, as Fran mentioned, largely related to clearance. Especially during the holiday season. That's one of the largest changes from our previous guidance. As we've noted before, we expect the yen to be about 50 basis points of pressure on us, and that is reflected in channel mix, that we don't get the benefit because of the yen of the higher gross margin in Japan. Overall, we've also seen some rising sourcing costs. We called out labor in the fourth quarter. We're also seeing some overall sourcing cost increases. We have the inventory amortization from the acquisition of our JV in Coach Europe.
If I break it out into those four buckets, that encompasses the margin pressures both versus prior year and versus our previous guidance.
Thank you, Jane.
Thank you. The next question is from Barbara Wyckoff with CLSA.
Hi. Could you talk about the key differences between China and North America in terms of conversion? Men's we know is stronger. In terms of just the big business buckets.
Sure. Good morning, Barbara.
Hi.
Overall, I would say that, of course, what we're experiencing in China is a much lower conversion rate that is due to our lack of awareness. As awareness grows, of course, so will our conversion as consumers discover more fully the Coach story. Saying that, our lack of history, of course, has the advantage, as I addressed in the speaker's notes, of allowing us from the very early stages to position the brand as a lifestyle brand. As I mentioned, this past quarter, approximately, in fact, almost exactly one-third of our sales in China came through other categories, men's and other lifestyle categories, including footwear and women's outerwear. We expect that that will continue to increase as we further develop in the quarters ahead our lifestyle categories through transformation.
This really speaks to our previous comments that the impact of transformation on the brand, of course, is not only going to provide the context and relevance for Coach to achieve renewed growth in the North American market, but also to help position us more fully to compete more successfully in emerging and international markets where we don't have a history.
Great. Could you also talk about the tests in the U.S. to add more footwear using a pool stock for shipment to customers? What is going on with that? Build footwear in more stores?
Sure. Fran will address that.
Yes, I can address that. We do have footwear in 175 locations right now, what we have been doing is testing footwear in having a smaller assortment in about 10 additional doors to see if we can service the customer with sizing and inventory and then order from Jax. We'll continue to test and probe more around distribution opportunities footwear. The other thing that I will say is as we continue to look at the fleet and have remodeled store opportunities, we will take advantage of mobile POS technology and remove cash wraps, put in mobile POS technology, and dedicate more square footage on the selling floor to categories like footwear. In terms of Jacksonville, we have a very active program right now in our distribution center where customers can order shoes from any store in the fleet.
By the end of the year, you'll have how much footwear, you think, and the ability to buy footwear in how many locations?
You can buy footwear in any location today off of our program, CVSR, which is a Coach by Special Request. You can order from any store.
Thank you. As a reminder, please limit yourself to one question per request. The next question is from Dana Telsey with Telsey Advisory Group.
Good morning, everyone. As you think about inventory planning as you go into the balance of the year, how are you planning inventory? As you think about the collections, what should we be looking for in terms of updates to collections, new collections until Stuart comes out with his own collections? Thank you.
Yes. Why don't I address the inventory question? I think, as I said, we don't provide guidance on inventories. We expect based on square footage growth that you will see continued inventory growth through FY 2014. We have a few factors that I outlined. AUC cost increases, the acquisition of Coach Europe, and also our expansion into lifestyle categories. Those are three things that are driving inventory growth. As you know, though, we have a proven track record of managing our inventory very profitable over time. Our inventory is current, it's current, and we feel that we're in a reasonable position.
In terms of your question on newness moving forward, we see in the second half as we go beyond holiday, an increasing presence in Capsule. That will be a further rollout of Borough and other Capsule silhouettes across the entire fleet, both in terms of new fabrications as well as a couple of new styles. In addition, in the second half of the year, we will be bringing out new silhouettes
Including a dome satchel and other collections from the spring that will lead into Stuart's first collection, which will be in stores from fall of next year. We expect it to run across the entire fleet from September. Stuart, of course, is very busy currently in developing that collection, and we will have more to share on that in the spring.
Thank you. The next question is from Kimberly Greenberger with Morgan Stanley.
Great. Thank you. Good morning.
Morning, Kimberly.
My question is just about the 1, 2, 3-year outlook. Could you help us understand how you view Coach's go-forward strategy, in terms of either stabilizing market share in the U.S. and what do you think the drivers there might be? Or if rather you are just going to progress with the lifestyle conversion of the brand, perhaps let a little bit of that market share slide away in hopes of stabilizing the business potentially at a slightly smaller level. I'm just looking for your big picture thinking on the kind of 3-year outlook for the business.
Our objective has been and will always be to grow with the category. Handbags and accessories has been and will continue to be a key core category for Coach and the main driver of our business. Transformation is truly about providing context and emotion for the Coach brand. We do not see us evolving into a ready-to-wear resource first and foremost. As we've stated previously, our focus will be in driving the other key categories around handbags and accessories that provide some context with footwear and outerwear being key drivers. We've talked about this being a multi-year strategy. We believe it's the right strategy and the right one to drive long-term growth. We have a great team in place, and certainly, we don't know of another brand in our core space that has the experience and the execution of transformations in their past as we do.
We're excited about writing this chapter and the journey ahead.
Thank you.
Thank you. The next question is from Michael Binetti with UBS.
Hey, good morning, guys.
Good morning.
I wanted to ask you about the U.S. store count and I guess the full-price stores, and you guys gave some updated language on that. It sounds like it's still tracking to the plan you gave us 90 days ago. I want to think about that in the context of where the comps are and how you see the trajectory of the comps over the next few quarters, Lew, and perhaps maybe why it makes sense to continue growing footage here until we see more of a stabilization in the U.S. same-store sales numbers.
I'm sorry, the last part. You did a review of the comps?
Why are we still opening stores?
Right. Why, I guess, the square footage growth rate in the U.S. is staying where it's at as far as the plan, considering where comps are right now and the trajectory that Jane laid out for us over the next few quarters. Does it make sense to continue the footage growth in the U.S. until we see more of a stabilization in the comps?
The answer is that we're very thoughtful about the way in which we look at distribution. We have a situation where we do have markets both on the factory side and extremely selectively on the full-price side, where there are opportunities for us to develop freestanding dual-gender stores as well as men's stores. At the same time, we are focused on productivity measurements, particularly being sensitive to our full-price fleet, which needs to lead. What we're not showing in comp, of course, what comp does not show is the benefit of the revenues that we're achieving in the first 12 months of these new store openings. We might say when we look at these new store openings to a store, they are very productive.
Michael, just to build on what we called out in Q4, is that we do continue. What you saw us do in Q4 is we continue to look at our overall real estate positions as things come under lease renewal and expiration. We make a judgment based on each store and the trading area, and we'll continue to do that. That's been our practice, and we'll continue to do that across our fleet.
Maybe would you mind telling us a little bit about. I'm a little bit interested to hear where some of the good SG&A control came from in the quarter, particularly with the square footage growth being up. I know we'll get some detail when the 10-Q comes out, but maybe you could just talk about it qualitatively. Thank you.
Jane?
I think that what we called out in Q4 was that the actions we took in the restructuring were going to fund investments that we were making in the brand. You saw that play out in Q1 with the improvement in our SG&A ratio really coming from an issue of timing of marketing spend. You'll see that be about consistent through the year, should be up through the year. Q1 was below Q1 last year because of the difference in timing between Legacy and Coach New York Stories.
Thank you, Jane.
Thank you. The next question is from Paul Lejuez with Wells Fargo.
Thanks. It's Tracy Kogan filling in for Paul. I had a question about your launch of more lifestyle categories within the factory channel. If you could just help us out with when we might see these categories in the stores, and how many stores will get them, how many SKUs, et cetera? Then if you could just tell us maybe in the, I think you said 20 stores where you had footwear, how did the productivity of those stores compare to those without the footwear? Thanks.
Yeah, sure. Thanks for the question. Right now, we have outerwear in 140 factory stores. The initiative in outerwear is rolled out, and it's performing quite well. We're seeing good improvement to last year in that category. We just recently launched women's and men's Made for Factory watches. That is a new launch this quarter. We're excited about the growth opportunity in the watch category in factory stores. Related to footwear in the 20 stores, we are going to be rolling out to an additional 70 stores later in the spring. In the 20 stores where we currently have footwear, we're looking at optimizing the footwear presentation in these locations and adding additional assortment to these locations starting in the third quarter. In terms of productivity in these stores, the productivity is incremental and they're performing quite well.
We're also seeing the same type of fashion appetite coming out of our factory division that we're seeing in full price.
We invite you to visit factory and full price stores near you. What you will see in the factory fleet, in particular, is our new design concept, which has been extremely well received and actually provides the environment for a much fuller expression of the brand.
Thank you. This does conclude the question and answer session. I would like to turn the call back over to Andrea Shaw Resnick for closing remarks.
Thank you all for joining us today. As our practice, we like to close the call before the market opens, so I'd like to turn it back to Lew and Victor for some closing comments. Gentlemen?
Thank you, Andrea. I would first just like to thank everyone for joining us and want to congratulate Lew on his last call as CEO. We at the management team, of course, are very much looking forward to partnering with him in his new role. This leadership team inherits a fantastic, iconic brand that is grounded in authenticity and heritage with a proven history and success in reinventing itself. We're all very excited about working together and partnering to write the next chapter of the Coach brand. As I mentioned earlier, very few, if any, brands in our space indeed have the success of reinvention that this brand and this company has. We are excited about resetting ourselves for a period of sustained growth.
What I've said on previous calls from time to time, just stay tuned, everybody. Have a good day, and enjoy the rest of the week. Thank you, everybody.
Thank you.
Thank you. This does conclude the Coach earnings conference. We thank you for your participation.