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Coach Inc. (NYSE:COH)

F1Q07 Earnings Call

October 24, 2006 8:30 am ET

Executives

Lew Frankfort - Chairman and CEO

Mike Devine - CFO.

Mike Tucci - President of North American Retail

Andrea Shaw Resnick - IR

Analysts

Bob Drbul – Lehman Brothers

Jeff Evelyn – UBS

Paul Ojay – Credit Suisse

David Shik – Stifel Nicholas

Jim Hurley - Chelsea Advisory Group

Julie Shaw - Merrill Lynch

Margaret Major - Goldman Sachs

John Ruloux - Wachovia

Christine Chen - Pacific Growth Equities

Irwin Roberts – HSBC

Brad Stevens - Morgan Keegan

Presentation

Operator

Good day and 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 Vice President of Investor Relations at Coach, Ms. Andrea Shaw Resnick. You may begin.

Andrea Shaw Resnick

Good morning and thank you for joining us. With me today 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, including projections for all 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 or control costs.

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. 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 begin with an overall summary of our first fiscal quarter 2007 results and will also discuss our strategies going forward. Mike Tucci will review our key initiatives through 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 2007. Following that, we'll hold the Q&A session that will end by 9:30 a.m.

I'd now like to introduce Lew Frankfort, Coach's Chairman and CEO.

Lew Frankfort

Thanks Andrea, and welcome everyone. As you know, we once again announced excellent top line growth and even stronger bottom line results of 23% and 40% respectively for the quarter just completed. Our results are especially impressive as they represent an acceleration in our performance, notably in our US full-price businesses.

Clearly, there were two drivers of Coach's growth. First, the continued entry of new consumers to the franchise, many of whom are trading up to the Coach brand. And second, existing consumers with whom Coach is gaining a greater share of their growing accessory wardrobe. Both consumer groups are responding enthusiastically to the higher levels of what we call distinctive newness in FY '07 as two of three major lifestyle platforms planned for the year have been introduced other the last four months.

Some highlights of our first fiscal quarter were: first, earnings per share rose 40% to $0.34 compared with $0.24 per share in the prior year as net income rose 34% to $126 million.

Second, net sales totaled $554 million versus $449 million a year ago, a gain of 23%.

Third, direct to consumer sales rose 29% to $404 million from $315 million in the prior year.

Fourth, US same-store sales for the quarter rose 21.4% with retail stores up 16% and factory stores up 27.1%. It's worth mentioning that in US retail, we have achieved a double-digit comp in the first quarter in each of the last five fiscal years.

Finally, sales in Japan rose 21% in constant currency driven by new stores, mid-single digit retail comps and expansions as we continue to rapidly grow our market share.

During the quarter, we opened 12 US retail stores, including five new markets for Coach: Evansville, Indiana; El Paso, Texas; Greenville, South Carolina; South Bend, Indiana; and Mohegan Sun in Connecticut, as well as one net factory store. Thus far, the performance of these full-price, new stores are averaging $2.5 million on an annualized basis well ahead of our plan. At quarter end, there were 230 full-price and 87 factory stores in operations.

In Japan, eight locations were added while two were expanded. At quarter end, there were 130 total locations in Japan with 21 full-price stores, including eight flagships, 94 shop-and-shops, 11 factory stores and four wholesale locations.

Indirect sales increased 11% to $150 million from $134 million in the same period last year. Results were driven by strong POS gains in U.S. businesses, including department stores and B2B, while the timing of shipments to wholesale accounts negatively impacted top line results. In fact, U.S. department store results at POS continue to be excellent, running up in the mid-30s on a comp basis last year.

Most broadly, we once again effectively executed our growth plans and realized companywide performance that outpaced our stated goals. We were particularly pleased with the acceleration in Coach U.S. retail stores which enjoyed significant increases in traffic and conversion, while as expected, the average transaction remained unchanged from prior year.

Results in our full-price businesses, both Coach retail stores and U.S. department stores, continued to be driven by the monthly flow of innovative and relevant product notably in women's bags and small accessories. Our U.S. factory store business remained remarkably strong throughout this quarter, given the vibrancy of the Coach brand, the strength of our proposition and continued sales growth in premium factory malls.

We were also very pleased with the performance of Coach Japan this quarter where sales grew 21% in yen and 16% in dollars as our market share continued to increase rapidly. Last quarter, our growth in Japan was fueled primarily by distribution through both new stores and expansions augmented by mid single-digit, comparable retail locations sales.

Finally, as always, we were particularly pleased with the significant improvement in operating margins. While Mike Devine will get into more detail on our financials, I wanted to give you this recap and tell you how pleased we are with Coach's first quarter performance.

As you know I have also asked Mike Tucci to join us today to discuss our product performance for Q1 and our holiday sales initiatives.

Mike Tucci

Thank you, Lew. As mentioned in our release, our transitional and fall offerings were remarkably successful across all categories and collections. We began the quarter with Signature Stripe, our new weekend casual collection, and the first of three completely new lifestyle platforms for FY '07. This collection was immediately embraced by our customers who loved the lightweight, reversible Coach silhouettes and great matching accessories at sharp price points.

Also in July, we brought back an updated Soho collection in leather, suede and classic signature, which included novelty lace styles. In August, the Chelsea handbag group offered in leather, nubuck and optic signature for the first time offered a satchel and was very well-received. In September, our popular Hamptons collection returned for its seventh season and performed strongly against all fabrications, leather, suede and signature, as well as embossed leather.

To open October, we brought in Legacy, our second new lifestyle platform for FY '07. The collection represents a return to our craftsmanship heritage with truly iconic Coach elements in a broad assortment of handbag, accessories and wearables. Our Legacy collection is a key focus and major investment for holiday.

As always, we're excited about the ten key item concepts for the holiday season. Collectively, we estimate that they will represent over 50% of our business in the holiday selling period. They are:

  1. Legacy alley bag and shoulder zip. Already bestsellers, these two new silhouettes introduced in October from our Heritage collection will continue to be available in a range of fabrications and colors.
  2. Satchels, offered in Legacy, Chelsea, Soho and Hamptons collections, this is an important silhouette for the season. We will continue to offer it in a range of sizes, fabrics and colors with price points ranging from $328 to $698.
  3. Duffels, our classic duffel shape has been updated in vintage leather and signature, many embellished with beautiful stitch details. All styles are fully functional with adjustable straps.
  4. Gallery totes, beautifully interpreted in rich patent leather, exploded classic signature and embossed suede with beading.
  5. Holiday patchwork, a perennial favorite, this year interpreted in vintage leathers and rich browns and reds, coupled with our Signature pattern and hair-cap prints. Patchwork will be offered in bestsellers such as the shoulder tote, gallery tote and duffels.
  6. Soho hobos. In addition to our core offering in leather and classic signature, we'll offer a range of hobos called Soho Stitch, which will feature interesting embellishments including lacing, piecing and studs.
  7. Wallets, offered in several shapes and functions to fit every need, wallets are the perfect add-on to any handbag purchase. This month, we introduced our $98 multi-function wallet, which is doing quite well.
  8. Mini skinnies, our popular key ring and coin case offered in a range of fabrics and colors and easily accessible at $38 to $48.
  9. Scarves and gloves, a balanced assortment from unlined or cashmere lined gloves to a range of novelty scarf in silk, wool and cashmere.
  10. And lastly, Pet is returning this year. In November, we'll introduce a range of novelty collars and leashes, which will be complemented by a Legacy stripe pet sweater.

As we have mentioned before, we're introducing the Castle collection of jewelry in November, primarily bracelets and a few necklaces in select stores. Of course, we'll also have a number of gifts under $100 geared to our more price-sensitive customers. As always, our holiday floor set will be installed on the Monday before Thanksgiving with a focus on clean and bold presentations of our key holiday statements and items. A front table change in all stores will take place in early December to coincide with the launch of Resort, a tight capsule of Legacy Signature silhouettes.

On the marketing front, our expanded holiday catalog featuring the world of Coach will be in homes in mid-November and will include our Resort collection. We're also looking forward to introducing our special holiday gift guide, which will be used as an in-store selling tool focused on our important key items and collections. It will be in stores in early November and it will be put in each Coach consumer's shopping bag with their purchase.

Finally on the in-store experience, as you know, Coach service is an initiative we implemented two years ago to enhance our consumer's in-store experience and ultimately drive conversion. This comprehensive training program teaches interactive selling and engagement techniques to our sales associates. For FY '07, the program has evolved, focusing on new opportunities to deliver consistent customer service during the holiday season.

Our Q2 service strategy reinforces the key behaviors for holiday success, customer engagement, effective fulfillment of product and gifting needs and graciously assisting multiple customers at the same time. At Coach, we want to be as well known for great service as we are for our products.

In Q1, we introduced an enhanced ClientTrack with more sophisticated features and capabilities to support our field team. This automated client selling tool keeps track of customers, their product needs, lifestyle and shopping preferences and recent purchases. The program also helps the store manager facilitate timely follow-up to customer requests, communicating to our customers regarding the arrival of new or out-of-stock items in store, in-store events and gift-giving occasions.

With ClientTrack, we've added the ability to create customer wish lists, accessible in stores across the country. We expect these enhancements to play a significant role in our holiday service strategy.

In addition, during this year's holiday season, we will incorporate key Coach service learnings and operational best practices from last year, including:

  1. An enhanced service leader role and use of daily coverage tools to support smart scheduling as well as additional investments in labor hours in over 50% of our stores.
  2. A refined and enhanced line management and checkout process, including a pilot in 12 of our high-volume stores of handheld wireless devices to improve transaction times.
  3. The use of ClientTrack to support gift giving through customer follow-up regarding new products and in-store wishlisting.

Simply put, our objective this holiday is to leverage our POS transaction speed with improved service and operating standards to move the lines through the store faster and improve conversion. Naturally, many of these initiatives introduced for holiday will continue in our second half.

With that, I'd like to return the discussion to Lew to discuss our overarching strategies.

Lew Frankfort

Thanks, Mike. Over the last several years, we have generated consistently strong results by staying true to our proven formula for success. Our proposition is based upon five differentiating elements, which together set us apart from the competition: our distinctive brand, our leadership position, our very loyal consumer base, our multi-channel international distribution and our focus on innovation, value and the consumer.

We have a well-articulated roadmap and clearly defined growth strategies implemented by a seasoned management team who share a common vision with considerable experience working together as a team.

As most of you know, we have been implementing four key strategies that focus on sustaining growth. First, most generally, we're building market share in a rapidly growing North American women's accessories market by leveraging our unique position as an accessible luxury lifestyle brand. As part of this strategy, we've been emphasizing new usage occasions, such as weekend, through such collections as Signature Stripe and more sophisticated products such as Legacy to heighten our cachet especially with our top-tier customers.

Our second strategy is the continued rapid growth in North American retail. We plan to add about 100 U.S. retail stores over the next three years, bringing the retail store base to over 300. During this year, we intend to open at least 30 new retail stores. These will include ten new full-price store markets for Coach, five of which we mentioned already opened during the first quarter and five coming in the balance of FY '07. In aggregate, these 30 new stores will add nearly 80,000 square feet or 14% to our full-price retail store base during FY '07.

In keeping with our strategy to expand our most productive locations, we will also be expanding at least eight retail stores. These expansions will add a total of about 7,000 additional square feet or a bit over 1% to our total full-price retail space. In addition, we are also planning on opening three more factory stores in FY '07 and expanding two more outlets, given the success we've experienced through our previous outlet store expansions. In total, factory store development in FY '07 will add nearly 26,000 square feet or 9% to our factory store base. Thus in total, the square footage of our North American Coach stores will grow over 13% in FY '07.

Third, outside the US, we're continuing to rapidly grow market share with the Japanese consumer from about 9% this past year to a goal of 15% during the next few years. We are driving growth in Japan primarily by opening new retail locations and by expanding existing ones. Overall, we expect that eventually we will have a total of at least 180 Coach locations in Japan.

During this fiscal year, we expect to open 15 to20 net new locations in Japan, a net increase of at least 25,000 square feet or at least 13% to the store base. We also plan to expand about 15 of our most productive retail and factory locations in FY '07 adding over 7,000 square feet or about 4% to our retail base.

Thus, in FY '07, overall, we're targeting Coach Japan's constant currency sales to increase about 20% from the prior year. Our increases will primarily come from distribution growth with mid single-digit comps expected for the year. As we've said previously, the opportunities of our core markets of North America and Japan are abundant. Notably in East Asia and especially in Greater China, we're intensifying our efforts to build awareness by creating a presence that will position us for meaningful sales in the future.

During the first quarter, a net of five new Coach locations opened internationally including our first in Shenzhen, China, along with our first in the UAE. We also renovated and expanded our Shanghai Times Square location, which is experiencing substantial sales increases. It remains our intention to open at least 10 locations in the major cities on the mainland of China during the next two years, while also continuing to expand our retail store base in Hong Kong.

Lastly, of course, we continue to have an overall focus on improving the rate of profitability so that our bottom line results continue to outpace top-line performance. In closing, these strategies and actions are designed to enable us to achieve excellent financial results through our planning horizon.

I will now turn it over to Mike Devine for further detail on our financials.

Mike Devine

Thank you, Lew. Lew and Mike T have just taken you through our 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 23% with direct to consumer which represents over three-quarters of our business, up 29%; and indirect of 11%. While our POS sales in U.S. department stores actually accelerated in the mid 30s for the quarter. The timing of shipments to wholesale customers muted our reported revenues for the indirect channels.

Net income for the quarter increased 34% to a $126 million, or $0.34 per share as compared to $94 million, or $0.24 per share in the year ago period. This was ahead of the analysts' consensus estimate of $0.31 for the quarter. Our operating income rose 36% to a $198 million in the first quarter versus a $145 million in the same period last year. Operating margin in the quarter was 35.7% compared to 32.3% in the year-ago quarter, a 340 basis improvement. In the first quarter, gross margin increased by 70 basis year-over-year from 76% flat to 76.7%. For the quarter, gains from product mix and supply chain initiatives drove this improvement, while channel mix and a weak yen remained negatives.

SG&A expenses as a percentage of net sales were well below prior year levels in the first quarter and represented 41% of sales versus 43.7% last year. We were very happy to deliver significant leverage from our U.S. store base driven by the strong comps reported for both channels. We also saw excellent leverage on what I call our semi-fixed corporate functions.

Inventory levels at quarter end were $301 million, up about 40% above prior year levels, driven by both the investment in key holiday initiatives Mike T discussed, which position us well for the expected well strong selling season as well as the timing of receipts. It should be noted that our two-year inventory growth of 47% is well under our two-year sales growth of 61%. Further, this two-year inventory increase allows us to support 57 net new U.S. stores and 25 net new locations in Japan, and substantially increased sales levels over the two-year period.

Accounts receivable balances rose $13 million, or 13%, while days sales outstanding declined by three days from 36 to 33 days. Cash and short-term investments stood at $456 million, as compared with $448 million a year ago. It should be noted that the quarter end cash balance reflects the repurchase of about $720 million of Coach common stock during the interim 12 months.

The company repurchased 5 million shares of common stock at an average cost of $29.99 during the first fiscal quarter, thereby completing the existing program. As noted in our release, our Board of Directors has authorized a new $500 million program effective through June of 2008.

Net cash from operating activities in the first quarter was $81 million compared to $55 million last year during Q1. Free cash flow in the first quarter was an inflow of $44 million versus $33 million in the same period last year, primarily due to higher net income. CapEx spending, mainly for new stores and renovations was $36 million, versus $22 million in the same quarter a year ago.

Now, I'd like to provide you with some of our updated goals for fiscal 2007. For the second fiscal quarter, we are targeting net sales of about $785million, representing a year-on-year increase of about 21%. With US comparable store sales gains of at least 10% in the retail channel and mid-teens in the factory channel, and at least mid single-digit total comp gapes at Coach Japan.

For Japan, we've previously reported full price Coach Japan comps only. Going forward, we plan to increase our disclosure to combine full price and factory, or total comps. This will provide a better bridge to our overall direct-to-consumer sales results. For the first quarter of '07, our total comps were up high single-digits, consistent with last year's first quarter when full price comps rose at a mid single-digit pace and total comp was high single-digit.

Second quarter operating income is targeted to be up over 22% year-over-year and earnings per share of $0.56, an increase of about 26%. Our current goals for the full fiscal year are net sales growth of over 20% to about $2.55 billion with at least 10% comparable store sales gains in both the U.S. retail and in factory channel in the second half of the year; and a total sales increase in Japan of about 20% in constant currency, driven primarily by distribution growth through new store openings and expansions augmented by at least mid single-digit total same location sales growth.

We're targeting an operating margin up about 37.5%, which assumes the gross margin at last year's extraordinary levels over the balance of FY '07 and further SG&A leverage. Operating income dollar growth of over 25% above FY '06. Interest income of about $35 million, or about flat to FY '06 will add the pre-tax income, while net income will be somewhat offset by a higher tax rate rising to about 38.5% for the year, due to the fact that incremental taxable income is being taxed at higher rates.

Including these factors, we expect to generate EPS growth of at least 28% which will produce earnings per share of at least $1.63 compared with analysts' consensus estimate of $1.58. For FY '07, we continue to expect CapEx to rise to about $150 million, primarily for new stores and expansions, both here and in Japan. As Lew noted, we will be opening at least 35 new US retail factory stores, and continuing our North American expansion programs. In Japan, we plan to open about 15 to 20 net new locations.

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. Now Lew, Mike, Andrea and I will be happy to take some questions.

Andrea Shaw Resnick

Thank you. With the Q&A, please note that each questioner is asked to keep their questions to a single one. Thanks and let's open it up for Q&A.

Question-and-Answer Session

Operator

Your first question comes from Bob Drbul – Lehman Brothers.

Bob Drbul – Lehman Brothers

Hi, good morning.

Lew Frankfort

Good morning, Bob.

Bob Drbul – Lehman Brothers

Congratulations on the terrific results. The question that I have is, you talked a little bit about your ability to attract new consumers to the franchise during this quarter. Can you elaborate a little bit more on some of the comments you made last month around what you view as the current market size and the growth opportunities in both units and dollars domestically?

Lew Frankfort

Sure. First, our department store sales grew about 30% at POS in the United States this past quarter. When we look at it, we realize that from a dollars perspective, while our market share is about 25% or was 25% last year, the actual units that we sold in department stores only represented about 10% of their sales. As a result, with our increase of about 30% in a category growing between 10% and 15% in department stores, our actual units sold is only about 12% of total units sold in department stores.

In all of our discussions with department store leadership as well as in our consumer research, what we're finding is that many consumers are trading up from lower, both private label brands as well as brands that we have not considered part of our overall set.

So overall, where we have historically said the market is about $5 billion, that does not take into account any consumers trading up from brands such as the Le Sport Tech, DKNY, Liz Claiborne, Banana Republic and so on. When we add these brands in as well as private label, it looks as if the market is probably somewhere between $7 billion to $7.5 billion; that is the addressable market.

So instead of having overall market share of about 25%, it looks to us that our market share is probably somewhat less than 20%, which suggests that the opportunity for us to have sustained, excellent growth in North America is larger than we had contemplated ourselves.

Bob Drbul – Lehman Brothers

Great. Thank you.

Lew Frankfort

You're welcome.

Operator

Your next question comes from Jeff Evelyn – UBS.

Jeff Evelyn – UBS

Thank you, good morning. My congratulations also. Lew, a question, sort of a follow-up on what Bob had asked. This was the first quarter, I believe, your average transaction stabilized versus the prior year. Was there a shift in the product offerings on the floor? Was there something unique to this quarter? Could it reflect that maybe you are getting more new consumers trading up?

Then as part of this, if your average transaction does not keep increasing, what happens to the resultant lack of operating leverage per transaction? Thank you.

Lew Frankfort

First off, I think you pretty much answered it. There are a lot of new consumers entering our franchise. We estimate that as much as 30-35% of our sales in our first quarter are consumers new to our franchise.

What happens, Jeff, is when we actually pass higher traffic, we focus much more heavily on conversion rather than UPTs. What we enjoyed this quarter, against higher traffic, is higher conversion. Also, there was not as much of a focus on UPT growth. We think, actually, average transaction is going to grow in the second quarter, by mid single-digits, low to mid single-digits.

Jeff Evelyn – UBS

Okay, thank you.

Mike Devine

Jeff, if I could speak to the operating margin comments, you can see actually if you look at our SG&A leverage that we were able to convert this traffic at very profitable levels and drove increased operating margins through the P&L.

Jeff Evelyn – UBS

Okay, thank you.

Operator

Your next question comes from Paul Ojay – Credit Suisse.

Paul Ojay – Credit Suisse

Thanks. I had a question on Legacy. Can you talk about what percent of shop Legacy has represented here in its early days? Can you update us on where you are with the Legacy shop-and-shops? How many are you planning to do? Where are you in that process, and also, if you could just share with us the ending diluted share count?

Mike Tucci

Sure. On Legacy, I think it's important to understand, step back just for a minute. We actually piloted Legacy in the spring season which indicated to us a significantly greater appetite for Legacy products; albeit at higher price points and a more sophisticated offering. We went back in and did invest more heavily particularly in key silhouettes like the Alley and the Shoulder Zip. It's early, you know, we're in our third full week of the Legacy installation, which includes 15 in-store shops in the United States in our premier locations.

But we're very, very pleased with what's happening, penetrations in Legacy including wearables and related categories are consistently north of 20% in our stores. We do believe it is a driver of transaction size given the price point. The Legacy shops are consistently outperforming the overall average of 20% on a week-in and week-out basis. So that focus in the stores, the defined merchandising area with service elements and presentation highlights is really helping.

I think the last piece on Legacy is that it's not simply a Q2 initiative. This is a major platform that we will continue to focus on throughout the year. We'll look at in-store opportunities in the back half of FY'07. We're currently looking at opportunities for FY'08 for additional locations within our stores. Concept ideas that we can expand on and really give the customer an opportunity to see Coach in a more broad spectrum and product offering.

Mike Devine

Paul, your question on share count, the quarter end was very close to the quarterly average; about 1 million shares lower at 372.3.

Paul Ojay – Credit Suisse

Thanks a lot, guys. Good luck

Lew Frankfort

Thank you

Operator

Your next question comes from David Shik – Stifel Nicholas.

David Shik – Stifel Nicholas

As you discussed ClientTrack and it's part of the suite of things that you are talking about going into holiday, how much of ClientTrack this year for holiday is ramping up on the learnings you developed? How much is new functionality of the system or things you are trying within ClientTrack?

Mike Tucci

On Client Track, we are in our 16th month of ClientTrack as a performance tool and a customer service tool in our stores. Now the big enhancements this year are around integration of our database, so that basically all of our consumer data and systems can talk to one another, and you can easily toggle back and forth to help identify customer needs. Purchase history, as an example, is an enormous aid in helping to convert customers and get them what they want, and that is a new enhancement that will be available to our customers for Q2, we launched it in Q1.

Things like wishlisting and gifting opportunities. All of these actions result in what we call customer follow-ups, or to-dos. To give you an idea of the ramp-up, in Q1 we saw almost 60,000 customer follow-ups in our stores versus around 30,000 from a year ago. So we know that this is a tool with the enhancements that is being used. We measure against it at a store level on a daily basis, and it's essentially an electronic client selling book, very modern and very efficient and very much in keeping with how our sales associates think. So we see it as a real opportunity for us within Q2.

Just to give you a little flavor, some of the things that are most popular are customers asking to be notified on new products launches in store. Our editorial database, where anything that is featured on an editorial basis is cross-referenced to ClientTrack, so should a customer call and ask about an item that they might see in the press, we can immediately reference them and contact them when we get that item for them. So we're feeling like it's a major tool for us and the stores have embraced it and it's performing well.

David Shik – Stifel Nicholas

So just to boil it down for me, so in the 16th month, we shouldn't look at it as lapping. It's grown in its usefulness year-over-year?

Mike Tucci

No question.

David Shik – Stifel Nicholas

Okay. Great. Thank you.

Operator

Your next question comes from Jim Hurley - Chelsea Advisory Group.

Jim Hurley - Chelsea Advisory Group

Good morning and congratulations to all.

Lew Frankfort

Thank you, Jim.

Jim Hurley - Chelsea Advisory Group

You're welcome. My question is about Japan. Obviously very good results out of that region, which has not been the case for some of your competitors, and I just wanted to understand the integration efforts with CJI, and specifically if you are able to see operating expense leverage in the first fiscal quarter?

Mike Devine

I'll take the latter part, the financial answer, Jim, is that we did not see leverage there. We're continuing as we guided the Street to build infrastructure in Japan and we'll see that happen throughout '07. So in none of our projections or any of our forward-looking guidance have we planned on that happening in '07 and we are continuing to build that infrastructure so we can capture some of the integration opportunities that we believe we have there.

Lew Frankfort

Was there another part to your question, Jim?

Jim Hurley - Chelsea Advisory Group

Just in terms of how that business is developing. It seems like the strength has been maintained when that's not been the case for the rest of the market. Anything that you're doing on a merchandising front?

Lew Frankfort

I think the most important thing to appreciate Jim, and I know you do, is that we have an alternative to the established brands. We offer a value-based proposition. Our accessible luxury proposition resonates especially well in Japan with the younger consumers and what we're finding, as we open in regional markets as well as our continued presence in existing markets is a very strong penchant towards Coach. They're embracing our monthly product flow, the innovation that we're offering in product responding very well.

Jim Hurley - Chelsea Advisory Group

Great. Thanks and congrats.

Lew Frankfort

You're welcome.

Operator

Your next question comes from Julie Shaw - Merrill Lynch.

Julie Shaw - Merrill Lynch

Good morning. I had a question regarding operating margins. Your guidance seems to have a little bit less margin expansion built in from Q1 significant increases. How much expansion do you think is left and how do you get to these peak operating margins?

Mike Devine

Well, we're guiding, Julie, to 37.5% operating margin level for the company for the full year. I don't think there are too many other retailer fashion stories that are achieving that. That's 150 basis points approximately above what we had last year. We believe that there is opportunity beyond that as we talked about many times, particularly being driven through the SG&A leverage that you saw us capture in Q1. We see with top line growth in the high-teens to 20% that we're guiding to through our long-range planning horizon, we can continue to deliver SG&A leverage well into the future and see an operating margin that at some point will begin to approach a 40% level.

Julie Shaw - Merrill Lynch

Great. And how much has mix, the product mix of legacy played into the gross margin expansion this quarter?

Mike Devine

Yes. That, that collection is consistent with our extraordinary gross margin levels across our product offerings. So it's on balance equivalent to the levels we're achieving throughout our product offering.

Lew Frankfort

Although, it had no impact in Q1 since we introduced legacy at the beginning of October.

Julie Shaw - Merrill Lynch

Right, right. Of course. Thank you very much.

Lew Frankfort

You're welcome.

Operator

Your next question comes from Margaret Major - Goldman Sachs.

Margaret Major - Goldman Sachs

Congratulations on the great results. I have a question about the pricing strategy for your full-price stores. Can you just talk about what's possible in terms of the upside for price points? I read a while back in one of the trade publications that Reed thinks that your prices, your stores and your customer would be accepting of even higher prices than what you're at right now, with regard to say $800 being the upper limit. So if you could talk about that and how you might evolve the pricing in stores?

And then, I would like to ask about Japan, too. If you wouldn't mind running through how FX impacts the Japanese results, not just on the translation of the top line, but on gross margin. Because if you are sourcing in dollars and selling in a strong yen, wouldn't that be a positive?

Lastly, with regard to the inventory, why do you think you needed to bring things in earlier this year versus last year? Is that just a sign of how bullish you are about holiday? Thanks.

Lew Frankfort

Mike, why don't you take the second and third question?

Mike Devine

We will take them in reverse order, Margaret. On the inventory, the timing is more about last year. We actually as we closed the September quarter last year, we were about $25 million light on receipts. So it's more about last year being light. Let me just say, this time of year as we're gearing up for holiday, we can receive as much as $4 million in receipts in a single day. So just so you can gauge, that's maybe just a little more than a week's worth of timing.

That being said, we have heavied up our inventory investments to speak to the ten strategies that Mike talked to especially in the Legacy opportunity, and we're feeling great and that our inventories are exceptionally clean and well positioned going into the multi-robust selling period. And you'll see inventories back in line year-over-year, I think, at the close of the next quarter.

Your next question was about FX, and we actually have that as a gross margin negative because we're buying inventories now with a weaker yen and therefore it costs us more yen to convert to dollars to buy the bags. So although, we've hedged pretty effectively, there still is a modest negative impact to our gross margin rate as a result of the weaker yen. In the prepared remarks, I talk about weaker yen and channel mix driven by the success of factory being negative. The two combined hurt us about 30 bp in Q1.

Margaret Major - Goldman Sachs

Thanks. And then, the pricing strategies, Lew?

Lew Frankfort

Sure. First, Margaret, as you well know, we position ourselves as a brand that will always give consumers excellent value. Our pricing strategy remains consistent, that is wherever we are able to pass along to consumers in terms of our lower cost structures resulting in lower prices, we're pleased to do. More generally, what we are finding is that we have a capacity because of the breadth of our franchise to offer price points much higher than we do, with great success.

Mike Tucci was talking about Legacy running over 20%. The average handbag in Legacy is over $400. Conversely in Signature Stripe, which we introduced in July, the average handbag price was in the low $200s, and what we're trying to do is strike a very fine balance by not alienating the value conscience consumer and yet at the same time, doing a better job attracting the luxury consumer.

That’s why we tier our stores by the type of consumer and in addition, we have a rapidly growing Coach by special request business that the luxury oriented consumer, even who shops in one of our core stores can purchase an item that might not be available, through Coach by special request. We think the potential is basically boundless. We just have to be careful in the way in which we move.

Margaret Major - Goldman Sachs

Great. Did you sell out of the $10,000 alligator bag in the catalog?

Lew Frankfort

So far, three out of five have sold.

Margaret Major - Goldman Sachs

I'm sure there will be gone by Christmas.

Operator

Your next question comes from John Ruloux - Wachovia.

John Ruloux - Wachovia

Hi, guys, great quarter. My question really goes back to the comments about the new stores running ahead of plan. Why do you think that is? Are you getting better locations? Maybe opening in markets where the business has been a little bit stronger historically? I wonder if you could comment on that and what it means for your return on investment? Is that creeping up on the new store side?

Mike Tucci

I do believe that we are getting very strong locations within the malls and complexes that we are going into. We focus on that. We are a preferred brand for mall developers and we attract, I think, a very strong consumer to the enterprise, so let's leverage that we think about all day long.

We like to think that our Coach stores are a beacon for the mall developers and for consumers and I think most important what we see happening is this idea that consumers are trading up. There is a very, very strong awareness of Coach as a brand in market s like El Paso and Rogers, Arkansas, and when we open a store there, we have people waiting for us. Woo offer the same commitment, same merchandise presentation that is consistent with stores in the rest of the country, and they're immediately coming in. We're converting them and we are developing relationships with them.

John Ruloux - Wachovia

Do you have a little bit more leverage when signing a lease on the cost side so net-net better productivity combined with perhaps better expense control as your ROI, you know, up pretty significantly on the new store side?

Mike Devine

That would be accurate.

Lew Frankfort

I’ll just say one last thing. The thing that is most exciting, like when Mike and I visited El Paso, we spoke with consumers and the staff, they told us 30% to 40% in the first few months were new to Coach. When we spoke to individual consumers, they told us they welcomed us to El Paso. They were really enthusiastic. We have long queues outside of our store the day we opened.

John Ruloux - Wachovia

Thanks, keep it up.

Operator

Your next question comes from Christine Chen - Pacific Growth Equities.

Christine Chen - Pacific Growth Equities

Thank you. Congratulations on another fabulous quarter. Can you give us the percentages of limited edition product in the quarter versus the quarter before in novelty?

Mike Tucci

Total special product as we define it, was around 14%which is consistent with where we were a year ago in Q1. Within that, limited edition product was around 4%. Again, consistent with where we were last year in Q1.

Christine Chen - Pacific Growth Equities

Are there plans to try to grow that percentage over time? I mean, I think this is probably the first time where it's been consistent versus it growing as a percentage of sales.

Mike Tucci

I think we're constantly looking at our pricing mix, and importantly , we're actually talking internally about reviewing our definitions. One of the things that's happening out there is that we're seeing tremendous performance of what we call limited edition and special product in all stores and in particular, in core stores. So maybe what we've done is brought the consumer up and we raised our game. We may need to be more surgical internally about what we define as limited edition so that we can really push ourselves to find what those upper price boundaries are . So I think stay tuned on that one. We're pleased with where we are , but it's a constant review and it's driven by our investments and the product that we develop .

Christine Chen - Pacific Growth Equities

Okay, and with respect to factory doing so well, are you attempting to cross market to the factory customer and the Coach customers? I mean, I know there's a small percentage that cross-shops. Do you try and separate that when you market, or do you try and target , you know, that customer both ways ?

Mike Tucci

We don't. We do not cross market at all. We do have a consistent service standard that we believe we treat customers graciously and with respect in any Coach store, be it a factory store or full price store, but we do not cross-market between full price and factory stores in any way.

Christine Chen - Pacific Growth Equities

It is still about 25%?

Lew Frankfort

Further, we don't do any outreach for factory.

Christine Chen - Pacific Growth Equities

Okay. It's still about 25% crossover?

Lew Frankfort

20%.

Christine Chen - Pacific Growth Equities

Thank you, good luck for the holidays.

Lew Frankfort

Thank you.

Operator

Your next question comes from Irwin Roberts – HSBC.

Irwin Roberts – HSBC

Good morning and congratulations. I just wanted to come back to the margin guidance , operating margin . You said it should be up about 150 basis points this year and. essentially linked to SG&A leverage . I think you have repeated quarter after quarter that the gross margin levels should be about the same as last year , but it was up 70 basis points in Q1 . I was under the impression that there should be a convergence of the comp rates between full price and outlets in, say, six to nine months . Is there a reason why gross margin can't continue to expand on a full year basis?

Mike Devine

The biggest factor is if you look at the compares year over year, what you will see is the Q1 compare was the easiest that we have faced in '07 . The Q1 rate was 76% in Q1, and 78% for the remaining three quarters of '06. So we're up against a tough compare, and we feel very good about being able to meet that challenge and get to the 78% level for our year-ago period.

Irwin Roberts – HSBC

Thanks.

Lew Frankfort

You’re welcome.

Operator

Your next question comes from Brad Stevens - Morgan Keegan.

Brad Stevens - Morgan Keegan

Congratulations on a great quarter. Going back to the premium product question , what percentage of your Japanese business is now at the premium price points , and is there potential longer term to increase your 70% markup for doing business there ?

Lew Frankfort

Do the second part, Mike, in terms of the markup and I will talk about the premium. I am not quite sure what he is saying. Is there an opportunity for to us increase the markup? Is that what?

Brad Stevens - Morgan Keegan

Yes.

Lew Frankfort

I mean, there's always an opportunity that we have to weigh that against the cost and we're very comfortable with the relative positioning between the United States and Japan, and we're not looking to make any adjustment in the relative pricing of Japan to the United States.

In terms of our limited edition product, in Japan, we're only scratching the surface . For example , last quarter, as part of our 65th anniversary, we presented a series of four bags that were numbered and I believe the total quantity was 2,000, and we sold through that enormously quickly. The Japanese consumers are particularly appreciative of limited edition product and again, we're in early days there.

Brad Stevens - Morgan Keegan

All right. Thank you.

Lew Frankfort

You're welcome.

Andrea Shaw Resnick

Thank you all for joining us today. That concludes the conference call . Of course, Mike and I will be available for questions throughout the day . Thanks and have a great one.

Operator

Thank you. That does conclude today's conference call.

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