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Here’s the entire text of the Q&A from Coach’s (ticker: COH) Q1 2006 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.

Question-and-Answer Session

Operator

Operator Instructions Question by Bob Drbul from Lehman Brothers.

Q - Bob Drbul

Hi ,good morning. A couple of questions. First, Lew, as you look at the macro environment heading into holiday, do you have any concerns that you guys are really focused on throughout the different channels that you participate in?

A - Lew Frankfort

First, Bob, as you know, we offer everyday excellent value, and we work hard to provide a diversified range of product at all price points so that even the value-oriented consumer can have an opportunity to enter the Coach franchise or purchase of product. So we think we're extremely well positioned for the holiday in all of our channels.

Q - Bob Drbul

And, Lew, when you look at average ticket this past quarter, traffic trends, this past quarter, can you talk about that a little bit and what your expectations are in the outlet channel as well as the full-price channel for the holiday season?

A - Lew Frankfort

Sure. As we indicated, our same-store sales were driven by a combination of higher-ticket and higher traffic, that's in full price, and we believe that will continue for the holiday season. Similarly, in factory, the trends that we had in the fall are continuing this quarter where we are enjoying higher traffic, higher ticket, and we think that, again, these trends will not change.

Q - Bob Drbul

Okay, great, thank you. Congratulations.

A - Lew Frankfort

You’re welcome.

Operator

Question by Dana Telsey from Bear Stearns.

Q - Dana Telsey

Good morning and congratulations, everyone. Can you talk a little bit about Special Edition products, Limited Edition product, where is it now as a percent of sales? Where do you see it going? And do you see any of the price points changing there? And also can you talk a little bit about Japan, and you had mentioned earlier about business processes, given the hiring of the COO, how is that doing and what do you see average pricing doing in Japan also? And then just, lastly, can you talk a little bit about the factory outlet channel and differentiated product there, how that's performing and what you're seeing in average price? Thank you.

A - Lew Frankfort

Okay, let me ask Mike Tucci to answer the first and last part, the first part being around special product, and the last part being around factory and what we're seeing there.

A - Mike Tucci

Sure. Good morning, Dana. Special Edition, we actually had a very strong quarter in Q1. When we look at Special Edition across handbag and women's accessories, where we focused on developing that product, it represented about 16% of our total sales versus 10 from a year ago, slightly higher than where we had planned it. And within that Limited Edition, which really speaks to the higher price point handbag opportunity at 498 and 598, was 4.6% this year versus 1.3 last year, so a very strong performance there in the Limited Edition portion. On the factory side, we really feel good about our product assortment there. We hit, in terms of the composition of inventory there, we hit 70% of our total sales in what we call "made for factory" product and about a third of that was in what we would call "made for factory" exclusive that is, styles that have been designed specifically for the factory channel and, clearly, that 70% overall number drove comp, ticket, as well as significant margin improvement in the factory channel. You know, we were less promotional there this quarter than we had been last year.

Q - Dana Telsey

Great, and then Japan?

A - Lew Frankfort

First, in terms of our prices in Japan, prices on average, the average transaction is up about mid-single-digits. We are tracking well there, and, as we indicated, our business is quite strong in Japan and just as an aside, Dana, the one thing that's also very encouraging in Japan, which we've noticed in our first quarter is a list in overall luxury sales and accessories, and we're hopeful that that trend is going to continue because it would mean that the category will begin to become more resilient, which will offer us an opportunity to grow within a growing category as opposed to just taking market share. So we're hopeful there. In terms of business process, as you know, we are looking to elevate our business processes in Japan to the level that they are in the United States. So we are working rapidly to implement, over the course of this fiscal year, a point-of-sale system in our stores, a new planning and allocation system, and other stops that may not be that visible to us outside of Coach but will enable us to run our business a lot more efficiently.

Q - Dana Telsey

Thank you very much.

Operator

Question by Margaret Mager from Goldman Sachs.

Q - Margaret Mager

Hi ,good morning everyone, a couple of questions, first of all, with regard to the factory outlet channel, just wondering what is the goal there in terms of total numbers of stores, and then could you talk about just the average handbag price? What is it running now versus a year ago, considering that you're factoring in more Limited Edition special type of bags? And then, lastly, if you could talk about the gross margin outlook. It was up 100 basis points. I think most people are starting to think that your gross margins can't keep going up, if you would talk about your outlook there. I actually have another one, marketing expenses, what percentage are they running and what kind of leverage are you getting on your marketing expenses, and then just a general, broad question, traffic in the malls, Lew. I know your traffic is up in your stores, which is a tremendous accomplishment, given what we're hearing about traffic trends, generally speaking. If you could just talk about the environment that you're working in and how you're attracting more traffic to your stores than we're generally hearing. Thanks.

A - Lew Frankfort

Sure, well, we'll divide the questions.

A - Mike Tucci

Why don't I take the first two.

A - Lew Frankfort

Hit it.

A - Mike Tucci

I think you have five there, Margaret, so I'm going to take the first two.

Q - Margaret Mager

I actually have a couple more. I'll come back at the end.

A - Mike Tucci

I'm sure. Okay, on the factory side, we see two things happening. One, we are targeting about 100 locations in factory over our planning horizon. We're going to be very, very measured there in terms of new-store opportunities. We know the channel very well. We do believe that within our current mix of 85 or so stores, there are significant opportunities to reposition within the best factory centers in a more dominant format, similar to what we've done up in Woodbury. So we're focusing in factory on really maximizing productivity in our best locations that exist and selectively going after new opportunities in the marketplace to about 100. And then on the handbag side in full price, we're seeing handbag retails hitting about the 255-range at this point in Q1 versus 233 from a year ago, about a 9% increase. As you know, our handbags business is a driver, it was a primary driver of our comp and productivity increases in Q1, and we do feel like we have a balanced assortment, going forward, for Q2, both at the opening price points, those gift-giving and entry-level price points as well as continuing to find opportunity at the more pinnacle price points that we've spoken to.

A - Mike Devine

Yeah, I'll take the one, Margaret, on gross margin, and while we were very excited about the year-over-year improvement of 100 basis points on that line, we're even more excited about the total margin expansion of about 240 basis points on the operating margin line. And I think it speaks to the overall operating efficiency of the business, I think factory can play a major role in that. On the gross margin line we talked about product mix and sourcing initiatives helping, but below that line, the SG&A leverage that was achieved, even though factory's gross margins somewhat offset the total growth in the quarter, they really helped to drive and deliver total profitability on the operating margin line, which was something we are very excited about. In terms of the follow-up question, or the second question in the financial area around them, our marketing spend, we did see leverage there on essentially very similar dollar-spend levels year-over-year in the quarter. We actually picked up significant leverage on what we call our "corporate communications line," which includes our media spend and our outreach to consumers, and I would add while we got leverage spending slightly less dollars, we actually increased our consumer contacts by more than 50% as we used a much more efficient delivery vehicle by using e-mails along the internet to supplement our mailed creative that we send to consumers in hard copy. So we're very pleased with what happened on that line as well.

A - Lew Frankfort

Thank you, Mike. Lastly, your fifth thought, Margaret, in terms of traffic and malls, nationally, during the first two weeks in September, there was a fall-off in traffic of about 5% from the rate that it had been trending. We also experienced a relative similar decline, although we were trending positively, so it impacted us much less. What we experienced since the first two weeks in full prices that our traffic levels have bounced back to the prior levels. However, more generally, mall traffic has not fully recovered nationally. On the factory side, we basically divide the malls into two sides, two categories. One is premium malls, where we play, and the others. On the premium malls, which are largely malls run by Tanger and selectively Chelsea, what we've noticed is that traffic is still trending positively. They're doing somewhat better than the full-price malls, low single digits. We, of course, are trending materially higher than that.

Q - Margaret Mager

Okay, thanks, Lew, and congratulations on a great quarter to you and everyone at Coach.

A - Lew Frankfort

Thank you.

Operator

Question by Neely Tamminga from Piper Jaffray.

Q - Neely Tamminga

Great, thanks, and let me add my congrats to the whole team. Hey, Mike Tucci, I have a question for you, and thanks so much for the rundown for the upcoming holiday. That's very helpful. Can you give us a sense in terms of the number of four sets and the timing of them heading into holiday. Are we comparable to last year or do you have something maybe up your sleeve for the extra Saturday pre-Christmas this year for December versus last year? I just have one follow-up.

A - Mike Tucci

Okay, it's a good question. We look at it very, very carefully. Within the quarter, you know there's so much activity at retail. We compact a lot of business into December. We all know that post-Christmas has become more important. Our schedule today is very similar to last year. We are advancing our November floor set, which we had planned to do on Monday, the 31st, a week from yesterday to Friday of this week. As I mentioned in our product lineup, we feel like we have an opportunity to catch the weekend here, get our stores set, and go into November very well positioned. We also feel like there's product opportunity with some of the novelty items that are showing in the November floor set. We will do a floor set refresh pre-Thanksgiving. Resort will come in, to be exact, on the 5th of December, and where we have flexibility is we'll always look at how the business is running going into December 26th, and if we have to call an audible and pull goods in early to take advantage of sell-throughs that may be coming in, we will absolutely do that. We will also refresh the front of the store mid-month in December, which’s really not driven with new product, necessarily, but is more of a hard-hitting gifting message that we do on our front table in mid-December, just to put a veneer on the store and freshen up the store. So, one, we've built in a lot of flexibility to move. We have that flexibility built into our supply chain from a delivery standpoint. Two, it's about equal to last year, and we will do whatever it takes to meet the demand that the consumer puts out there.

Q - Neely Tamminga

Great, and then I just have one quick follow-up for you, Mike, and then a question for Andrea. First, for you, in terms of the 10 categories that you listed, where would the electronics-related items fall in that. I'm just wondering kind of what your commitment is to the iPod covers, et cetera, for this year. And then, Andrea, if you can comment on, have you discussed with First Call what presentation Coach will be having in terms of the numbers? Are you going to be doing including or excluding the options expensing? Thanks.

A - Mike Tucci

Okay, on iPod cases, that's actually a business that I didn't include in the 60% key item target. It is a new business for us in that we are putting iPod cases out in a more meaningful way. We have about 16 customer choices in the store right now for the mini and the original iPod as well as the Shuffle. We've projected it to be possibly a 2% idea with some upside, and we feel good about where that's going early in October. It is a business that we'll build as we get closer to gift-giving. I also mentioned that we've built in capability into our service commitment around what we're calling "multiple gifting," and the idea there is to take some of these small category items like iPod cases, charms, key fobs, where we see people coming in and requesting multiple units on that. Take that burden off of the store and actually execute that sale through Coach by Special Request, gift-wrapped and sent from Jacksonville, and we believe that iPod cases, charms, small accessories, lanyards, and the like are perfect opportunities with our gifting strategy.

A - Andrea Shaw Resnick

In terms of First Call, Neely, right now, these seem to be taking the lead with the analysts and 21 out of our 24 covering analysts are reporting pre-option expense. So they have been using those numbers, the pre-option expense, to calculate First Call consensus. My expectation is, as you guys move towards it, and it shifts, they will move to post-option expense, certainly, the first of the year if not before then. So until then, we are going to be guiding you both ways with an emphasis on looking at post-option expense, as that's the way the world is going.

Q - Neely Tamminga

And just as a clarification, Andrea, you guys have not changed your options value model, correct? I mean, the options expense from last year. Okay, excellent thank you.

Operator

Question by Jeff Edelman from UBS Securities.

Q - Jeff Edelman

Thank you, good morning. A question on Japan, how much of the sales now are being generated from comp store sales versus last year? Or how many stores are included in that comp base versus last year? Because, as I remember, there were very few in there last year.

A - Lew Frankfort

I think it was a significant majority last year, but someone is looking up the --

A - Mike Devine

We're looking it up, Jeff. The number is in the neighborhood of 70 to 80 but give us a moment, and we'll come up with that.

Q - Jeff Edelman

My question is, what has been the pattern of the store openings? Very, very high volume and then trailing off or high volume, leveling, because just sort of playing devil's advocate here, if one is expanding your store base rapidly, that usually generates above-average comp store sales. Are you getting the same kind of handbag penetration as you are in the U.S. and what's happening to the average selling price of the handbags there?

A - Lew Frankfort

Okay, well, let me answer the easiest parts first. In terms of our handbag penetration, handbag penetration is running roughly equal to the level in the United States and somewhat higher than on the level in Coach retail stores. It's running about, close to about 70% in Japan, and that's for new stores and existing stores. In terms of sales in year two, Jeff, it depends on the nature of the store. If it's a flagship store, we tend to have a stronger first year than we do second year because of the noise and activity around the opening. And then in year three, we recover to the first-year levels. If it's a retail store, non-flagship, or shop-in-shop, it starts at its level and in year two comps very favorably, and it continues to. So it depends on the nature of the store itself in terms of what happens in year two. Mike, do you have some numbers?

A - Mike Devine

Yeah, on our comping store, Jeff, 89, actually, are in the comp of 107 including both full-price and factory stores in Japan.

Q - Jeff Edelman

And last year?

A - Mike Devine

Last year was --

Q - Jeff Edelman

Well, it would have been 18.

A - Andrea Shaw Resnick

Last year was 62 full price were in the base, and 9 factory in the base.

A - Lew Frankfort

So 18 last year.

Q - Jeff Edelman

Right, okay, good. And just, secondly, again, playing devil's advocate, I assume your sales momentum has not slowed in October based on your comment in the press release?

A - Lew Frankfort

As you know, Jeff, we don't give exact numbers. Our business is extremely strong, and we're running on plan to deliver an outstanding holiday season.

Q - Jeff Edelman

Okay, so, as usual, your run rate does not necessarily correlate with the at least expectations for the quarter?

A - Mike Devine

We are fairly conservative planners, and you know the history of our actual results against guidance.

Q - Jeff Edelman

I know, just kidding you. Thanks a lot, good luck.

Operator

Question by Pauline Reader from Thomas Weisel Partners.

Q - Pauline Reader

You commented this quarter and last quarter that most of the growth, or the comp growth in Japan was coming from an increasingly average ticket. Can you just kind of back up and kind of tell us how that's trended before the last six months and then how you expect that to be for the rest of '06? And then also just your four- and five-year growth targets, kind of where the comp is going to be coming from. Is it just a continuation of, again, that average ticket increase or are you going to see transaction growth as well?

A - Lew Frankfort

Okay, well, first, we are seeing transaction growth, and we have in same stores as well as overall, of course. The average ticket is misleading, because unless you break it apart to take into account the shift towards a greater role of handbags relative to overall assortment, you don't really get at the full granularity. So when we talk about an average ticket increase, a very good part of that has to do, in fact, the vast majority, has to do with an increase in make as well as a Special Edition product as well as an assortment mix change to greater, to more greatly emphasize bags.

Q - Pauline Reader

Okay, so it's fair to say you're seeing a transaction growth in handbags is what you're seeing?

A - Lew Frankfort

First, are we talking same-store sales?

Q - Pauline Reader

Yeah, sorry, same-store sales.

A - Lew Frankfort

Over any extended period, we are seeing an increase in handbags. One of the things in the number of units sold that's over a period of time. We don't look at it every single month. What you're going to notice, though, this holiday season, with the increase in our small giftable items such as lanyards, ID charms, and the like, is a lower level of increase in average ticket, and we're looking to also see an increase in the role that small accessories play in our overall assortment.

Q - Pauline Reader

Okay, great, it’s helpful. Thank you.

A - Lew Frankfort

I am sorry, so, going forward, we don't expect handbags to increase as a percentage of the total mix.

Q - Pauline Reader

Okay, thanks.

A - Lew Frankfort

You’re welcome.

Operator

Question by Elizabeth Montgomery from SG Cowen.

Q - Elizabeth Montgomery

Hi, everyone, congratulations on another great quarter. I have a question about your indirect results. They were a little bit stronger than what we were looking for now, since they don't include Coach Japan, and I wondered if you could parse out the difference between your sales into U.S. department stores and your international sales.

A - Mike Devine

We haven't typically broken that previously. I think we said in our prepared remarks the overwhelming strength of the U.S. wholesale channel where, during the quarter, at PoS, our sales were up 30% over Q1 a year ago, very strong performance, and that is really what's driving and is the biggest business within that indirect segment. So that is really the most important business unit in that channel. International, though, is exhibiting similar strong growth, both at the register PoS, and also in our shipments to our distributing partners around the world.

Q - Elizabeth Montgomery

What is your share right now of the handbags and accessory sales in the department stores that you sell into?

A - Mike Devine

It's about 20 to 22%.

Q - Elizabeth Montgomery

Okay. My last question was can you just remind us what the key items, including the Resort, made up of Q2 sales last year?

A - Andrea Shaw Resnick

Over 50%.

Q - Elizabeth Montgomery

Over 50?

A - Andrea Shaw Resnick

Yes.

Q - Elizabeth Montgomery

Okay, another small question, you guys didn't mention the footwear assortment at all. I wondered if there were any plans or any updates on that this quarter?

A - Mike Tucci

Just to highlight, footwear, actually, in the stores that it's in, comped at about 13%. It was about 7% penetration. We feel like the driver behind that was absolutely the boot category, and we're well positioned for boots going into Q2 as well.

A - Lew Frankfort

In addition, the footwear category, footwear has performed very well in U.S. department stores also running up in the teens at PoS.

A - Andrea Shaw Resnick

We have time for one more question, I apologize, and I know I set up CQ all the sell-side analysts after the call. So let's proceed with one more.

Operator

Question by Christine Chen from Pacific Growth Equity.

Q - Christine Chen

Congratulations on another great quarter. Maybe I missed this, but can you quantify how much average ticket was up?

A - Mike Tucci

Full price retail was up about 10%.

Q - Christine Chen

And then factory?

A - Mike Tucci

Factory slightly below 10%.

Q - Christine Chen

Okay, and then the overlap between your factory and retail customer base? I know it's pretty small. Has that changed overall, changed at all over the last--?

A - Lew Frankfort

It hasn't. We monitor it monthly, and the overlap continues to be just under 20%.

Q - Christine Chen

Okay, alright. Thank you.

A - Lew Frankfort

You’re welcome.

Andrea Shaw Resnick, VP of Investor Relations

At this time, it is 9:38. We try to complete these conference calls before the market opens at 9:30. Of course, we'll take your follow-up questions. I believe, as I said, I am speaking to all of you after the call. Thanks for participating and have a great day.

Operator

Thank you, That concludes today's conference call. Thank you for your participation. You may disconnect at this time.

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