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Coach, Inc. (NYSE:COH)

F1Q08 Sales and Earnings Call

October 23, 2007 9:00 am ET

Executives

Andrea Shaw Resnick – Senior Vice President Investor Relations

Lew Frankfort – Chairman & Chief Executive Officer

Michael F. Devine – Chief Financial Officer & Executive Vice President

Michael Tucci – President North American Retail

Analysts

Robert W. Baird – Lehman Brothers, Inc.

Sarah Lewis - Credit Suisse North America

Jeffrey Edelman – UBS Securities LLC

Kimberly Greenberger, CFA – Citigroup

Margaret Mager - Goldman Sachs & Company

Randy Konik - Bear, Stearns & Co., Inc.

Michelle Clark – Morgan Stanley

Erwan Rambourg – HSBC

Dana Telsey - Telsey Advisory Group

Christine Chen - Needham & Company, LLC

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 Senior Vice President of Investor Relations at Coach, Mrs. 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 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 [inaudible] costs. Please refer to our latest Annual Report on Form 10K for a complete list of each risk factor. 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 the topics for this conference call. Lew Frankfort will provide an overall summary of our first fiscal quarter 2008 results and will also discuss our strategies going forward. Mike Tucci will review our key initiative for the holiday season. Mike Devine will [inaudible] details on financial and operational highlights for the quarter as well as our outlook for the second quarter and full fiscal year 2008. Following that we will hold a Q&A session that will end by 9:30 AM. I’d now like to introduce Lew Frankfort Coach’s Chairman and CEO.

Lew Frankfort

Thanks Andrea and welcome everyone. As you know, we have once again announced excellent top line growth and even stronger bottom line results of 28% and 34% respectively for the quarter just completed. We were extremely pleased with our performance, especially in light of the weakening retail climate in the US as our innovated and relative product clearly resonated with consumers across channels and geographies. We were also encouraged with the continued strength of new stores that are coming online well ahead of expectations.

As you know, in today’s press release we moderated our guidance for North American Retail same store sales for the balance of the year. At the same time, we underscored our continuing positive outlook including the delivery of a 20% revenue gain this holiday season. Given the vitality of the Coach brand, category strength and our diversified multi channel international business model, we’re confident that the sales and earnings guidance for the year originally provided in July can still be achieved. In addition, our ability to act quickly and nimbly to curve spending during a period of uncertain sales trends will ensure continued expense leverage. While I will get into further detail of our current conditions and the outlook for the category in our business shortly, I did want to take the time to review our quarter first.

Some highlights of our first fiscal quarter were: first, earnings per share rose 32% to $0.41 compared with $0.31 in the prior year as net income rose 34% to $155 Million. Second, net sales totaled $677 Million versus $529 Million a year ago, a gain of 28%. Third, direct to consumer sales rose 26% to $508 Million from $404 Million in the prior year. Fourth, North American same store sales for the quarter rose 19.3% with retail stores up 10.8% and factory stores up 27.3%. Finally, sales in Japan rose 17% in constant currency driven by new stores and expansions, augmented by low single digit retail comps as we continue to grow our market share.

During the quarter we opened 13 US retail stores including four in new market for Coach. Rochester Minnesota, Augusta Georgia, Nashua New Hampshire and Jenson Beach Florida as well as three factory stores. In addition, nine retail stores and four factory stores were expanded. Thus, at the end of the period there were 272 full priced and 96 factory stores in operation in North America. In Japan, four locations were added while one was expanded. At quarter end there were 146 total locations in Japan with 23 full priced stores including eight flagships, 104 shopping shops, 14 factory stores and five distributor operated locations.

In direct sales increased 35% to $169 Million from $125 Million in the same period last year. Results were driven by strong POS gains in the US and internationally. In fact, US department store performance of POS continued to be excellent running up about 20% last quarter on the same location basis.

We were very pleased with the performance on Coach US retail stores which enjoy strong increases in conversion and average transaction size while traffic slowed most notably at the end of the period. Results in our full priced businesses both Coach retail stores and US department stores continued to be driven by the monthly flow of new product. Our year end factory store business remained remarkably strong through the quarter given the vibrancy of the Coach brand, the strength of our proposition and continued sales growth in premium factory malls. Finally, our Internet business rose 23% in total including, an 11% increase at www.Coach.com whiles sales through the introduction of Coach to the Macys and Dillards’ websites which were not in place in a year ago quarter contributed to balance.

I also want to highlight another spectacular quarter for Coach women’s footwear. Our business in department stores where we are now sold through about 800 locations rose about 75% at POS for the quarter. We were also very pleased with the performance of Coach Japan this quarter were sale rose 17% in Yen and 15% in Dollars as our market share continues to grow rapidly. Last quarter our growth in Japan was fueled primarily by distribution through both new stores and expansions augmented by low single digit comparable location sales.

Finally, we were particularly pleased with the significant improvement in operating margins. While Mike Levine will get in to more detail on our financials and of course, I will discuss our outlook in some detail, I wanted to give you this recount. As you’ve heard, Mike Tucci is with us today to discuss our product performance for Q1 and our holiday sales initiatives. Mike.

Michael Tucci

Thanks Lew. As mentioned in our release, our transitional and fall offerings were successful across all categories and collections. Each of our monthly introductions was well received started in July with Chelsea and the tiered off ring including novelty and limited edition styles. This was followed by Hamptons and Legacy in August and by fresh group of belted Ergo Silhouettes in September. Also, in September our jewelry assortment was expanded and introduced into an all store distribution. Once again, it is important to note the strength of our $400 and over handbag offering in the quarter which doubled, representing 25% of our North American retail store handbag sales.

To open October we introduced Bleecker, our first new major lifestyle collection of fiscal 2008. This collection which was inspired by Coach’s heritage is anchored by a new version of our iconic double sack and has been well received. Our Bleecker collection is a key focus and major investment for holiday. And, as always, we’re excited about our key items and concepts for holiday offered at a range of compelling price points. First, in handbags beginning with Carly, this was first introduced in January an important key item style with broad consumer appeal and has consistently represented over 10% of business since its debut. Second, Bleecker duffels inspired by our heritage and introduced earlier this month, this updated Silhouette is performing very well. The convertible strap, great capacity and opening price point of $298 makes it particularly compelling. Third, the Bleecker Flap starting at $348. This iconic style was also introduced this month and the adjustable strap and exterior pockets add to its functionality.

Finally, handbags over $400. As I mentioned earlier, this category continues to be our fastest growing and we are well positioned for holiday in this price segment of our offering. A few examples include the new Bleecker Elite Duffel at $748. The Hamptons Miranda Satchel priced between $798-$1200 and the Legacy Lee Shoulder Bag priced from $598-$798.

In other categories, gifts under $100. Whether an add on item or an introduction to the brand, she’ll find a range of great gifts at sharp price points. Included are fragrance and body lotion introduced this year, the best selling new capacity wristlet offered in a range of fabrics and mini skinnies in over 20 fabric and color choices just to name a few. Also, jewelry, the updated holiday assortment includes a range of bangle bracelets priced from $68-$148, leather boyfriend necklaces and bracelets with charms at $88 and $98 and the Daphne collection a glass and plated metal group of rings, earrings, necklaces and bracelets at opening price points of $98.

Our holiday gifting floor set will be installed in the Monday before Thanksgiving with a focus on our key holiday statements and items. The floor set will be refreshed to coincide with the launch of Resort on December 3rd. A capsule collection of best seller Bleecker silhouettes offered in a spring signature palette and complemented by a group of metallic woven leather handbags and accessories. Our holiday catalog in home in mid November has been expanded to include our new categories as well as the 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 key items.

And finally, on the in store experience, Coach service is an initiative we implemented three years ago to enhance our consumer shopping experience and ultimately drive conversion. As you know, this comprehensive training program teaches interactive selling and engagement techniques to our sales associates. For FY 08 the program has evolved providing enhanced leadership skills to our store managers enabling them to develop their teams more effectively.

Technology initiatives will be important this quarter and they include first time and attendance. A new time and attendance system is being implemented in advance of holiday. The system gives store leadership visibility to individual service leader productivity. Specifically, it allows us to be more targeted in scheduling our most effective service leaders during peak times and then measuring their effectiveness. Second, eRunner, during the first quarter we rolled out our enhanced line management and checkout process to an additional 75 high volume stores taking us to 98 stores for the holiday season. This system reduces transaction time and improves through put. Third, web store pick up. We expect that this initiative launched in July will be very popular with our holiday shoppers. Stores will be ready to serve these customers quickly and efficiently as they visit our stores to pick up purchases and do some additional shopping.

Staying on the topic of www.Coach.com for a minute, as mentioned during our Analyst Day Presentation, we are excited about two new web based initiatives. First, the very recent launch of www.Coach.com in Canada and second, in early November we will be rolling out an online exclusive www.Coach.com gift registry just in time for holiday.

Simply put, our objective this holiday is to leverage our improved systems and operating standards to move the lines through the store faster while providing additional web service options for our Internet shoppers. Naturally, many of these initiatives introduced for holiday will continue beyond.

Before I turn it over to Lew I wanted to briefly touch on the performance of our new stores which has been truly exceptional and well ahead of our internal projections. During our Analyst Day Presentation we talked about the out performance of stores opened in the first three quarters of 2007. Good news is that the stores opened in the fourth quarter which we now have revised annual volumes are running at $2.4 Million dollars versus our expectation of $1.7 Million, 40% ahead of plan. And, the four stores opened early enough in the first quarter to have been revised, including two in new markets and two in developing markets are running at volumes of $2 Million on average versus pro forma volumes of $1.4 Million. Clearly, these results speak to the vibrancy of the brand and our ability to attract new consumers both in new and existing markets. With that, I will return the discussion to Lew to continue with our over arching strategies.

Lew Frankfort

Thanks Mike. During the last five years we have seen same store traffic increase by 50% in our North American retail stores. At the same time, we generated double digit same store sales gains in each of these five holiday seasons capped by last year’s comp of 20.8% of which about half came from higher traffic. While we had initially expected that we could deliver another double digit holiday season at retail, the recent deceleration in traffic and moderation in category growth from the torrid 20% growth levels we have seen since 2003 to a rate closer to 10% this fall has lead us to be more conservative in our outlook.

At this point, for planning purposes we also think it is prudent to project that the category will grow at a 10% level for the remainder of our fiscal year. With that said, we remain confident in our long term strategies and our prospects remain intact. Our results both top and bottom line are determined by a multiple of factors. Even with a modest North American retail comps our significant growth in US department stores and Coach factory stores along with Japan and other international markets in combination with strong new store performance will allow us to continue to achieve excellent revenue gains. In addition, our strict financial controls will enable us to achieve superior earnings growth as well.

As most of you know, we have two primary sales growth drivers, each plan to achieve about 10 points of growth. First, is distribution; as we expand our global network of store locations with an emphasis on North America, Japan and greater China. Second, is productivity which we drive across all geographies through the introduction of innovative relative product offer excellent value. We have been implementing five key strategies that focus on sustaining growth within our global framework. Clearly, our largest opportunity continues to be in North America. First, most generally we are building market share in the growing North American woman’s accessories market by leveraging our leadership position as a top of mind and preferred brand to self purchase and gifts. As part of this strategy we have been emphasizing new usage occasions within in our handbag offering and developing new flanked categories such as jewelry and fragrance. There is also a continuing opportunity to elevate our handbag offering as we have seen the so called white space between our price points and those of the European luxury brands continue to widen. Our first legacy boutique opening this Friday on Bleecker street here in New York will feature a more elevated product assortment including, an exclusive group of bags and accessories. This store will allow us to test merchandising, service and product initiatives.

Our second strategy is the continued rapid growth in North American retail. We plan to add about 40 retail stores in North America in each of the next several years. Based on the performance of our new stores and the greater number of new consumers we’re attracting we believe that North America in totally, can easily support about 500 retail stores including up to 20 in Canada. This road map for expansion is based upon a build up of individual malls and locations that meet our demographic requirements and economic hurdles. Statistically, during FY 08 we expect to open about 40 new North American retail stores including the 13 already opened in the first quarter. The new openings will include 11 completely new markets and we expect to open at least six new factory locations including, the three opened in the first quarter. In addition, we will be expanding at least 10 retail stores and several factory stores. Taken together, we expect total square footage to grow at about 20% in FY 08, a bit above last year.

Third, outside the US we are continuing to increase market share with the Japanese consumer driving growth in Japan primarily by opening new retail locations and by expanding existing ones. FY 08 we plan to open about 10-15 net new retail locations as well as a few factory outlets as this channel becomes more important to Japanese consumers. We will also continue to expand key locations. Overall, we expect to increase our square footage in Japan at a slightly lower rate in FY 08 than we did last year. Also, we’re continuing to target overall constant currency sales growth of between 10-15% for the balance of the year in Japan driven primarily by distribution growth and those single digit comps.

Our fourth strategy is to raise brand awareness in emerging markets to build a foundation of substantial sales in the future. Specifically, greater China, Korea and other such geographies are increasing in importance as the category is growing rapidly and Coach is taking hold. During the first quarter eight new Coach locations opened internationally excluding Japan, including three in greater China. In FY 08 we will open three distributors, about 30 new net locations focused on greater China, Southeast Asia and the Middle East. We plan to open at least three more locations in major cities in mainland China later this year bringing our total to 16.

And lastly, of course, we continue to have an overall focus on improving the rate of profitability so our bottom line results continue to out pace top line performance.

In summary, we’re well positioned to continue to capitalize on the many opportunities available to us and have the vision, strategies and tactics in place to realize our long term growth plans in respective of the near term environment. I will now turn it over to Mike Devine for further detail on our financials. Mike.

Michael F. Devine

Thanks Lew. Lew and Mike have just taken you through the highlights and strategies. Let me now take you through some of the important financial details of our first quarter results. As mentioned, our quarterly revenues increased 28% with direct to consumer which represents over ¾ of our business up 26% and in direct up 35% driven by strong gains in US department stores and international POS sales.

Net income for the quarter increased 34% to $155 Million or $0.41 per share as compared to $115 Million or $.31 per share in the year ago period. Our operating income rose 32% to $239 Million in the first quarter versus $181 Million in the same period last year. Operating margin in the quarter was 35.3% compared to 34.1% in the year ago quarter. A 120 basis point improvement. In the first quarter gross profit rose 28% to $518 Million from $406 Million a year ago. As our gross margins continue to be exceptionally high essentially flat to last year at 76.6% versus 76.7% in the prior year.

SG&A expense as a percentage of net sales were well below prior year levels in the first quarter representing 41.3% of sales versus 42.6% as we continue to deliver spending leverage against strong top line growth.

Inventory levels at quarter end were $363 Million and were well controlled up only 21% from prior year levels but do include investments in key holiday initiatives which position us well for the season. Further, this inventory level allows us to support 51 net new US stores, 15 net new locations in Japan and substantially increase sales levels from the year ago period.

Accounts receivable balances also grew more slowly than sales rising $31 Million or 26%. Cash and short term investments stood at $1.2 Billion as compared with $456 Million a year ago. During the quarter the company repurchased 3 Million shares of common stock at an average cost of $43.72 per share. At the end of the period $368 Million was available for repurchase under our current authorization.

Net cash from operating activities in the first quarter was $129 Million compared to $81 Million last year during Q1. Free cash flow in the first quarter was an in flow of $90 Million versus $44 Million in the same period last year mainly due to higher net income. Cap ex spending, primarily for new stores and renovations was $39 Million versus $36 Million in the same quarter a year ago.

Now, I’d like to provide you with some of our updated goals for fiscal 2008. For the second fiscal quarter we are targeting net sales of about $970 Million, representing a year-on-year increase of about 20% with low single digit North American comparable sales in the retail channel and at least the mid teens in the factory channel with a low single digit comp gain at Coach Japan. Operating income will also be up over 20% year-over-year and an earnings per share target of $0.68.

Our current goals for the full fiscal year are net sales growth of over 21% to over $3.17 Billion driven by distribution gains and productivity growth. As mentioned, we expect to open at least 46 new stores in North America, 15-20 new locations in Japan and about 30 new international locations while we continue to expand select highly productive locations globally.

Our second half sales expectations include mid single digit comparable store sales gains in North American retail stores and at least 10% comparable store gains in the factory channel and a total sales increase in Japan of between 10 and 15% in constant currency driven primarily by distribution growth through new stores opening and expansions augmented by low single digit same location sales growth. We’re targeting an operating margin of about 38.3% which assumes a gross margin close to last year’s extraordinary levels over the balance of FY 08 and further SG&A leverage. Operating income dollar growth of over 22% above FY 07 levels. Interest income levels of about $70 Million will add to pre-tax income. Our net income will be somewhat offset by both higher share count and a higher tax rate rising to about 39% 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 about 22% which will produce earnings per share of about $2.06 in line with previous guidance.

For FY 08 we continue to expect cap ex to rise to about $200 Million, primarily for new stores and expansions both here in Japan as discussed. In addition, as mentioned in our last call we will be expanding our distribution center in Jacksonville Florida by about 50% to support Coach’s projected sales growth over the next five years. While we upgraded the technology at this facility a year ago, a physical expansion is now necessary to accommodate the expected growth of our business. This will require cap ex of about $12-15 Million in FY 08.

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 10K. 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 everyone for your attention and now Lou, Mike, Andrea and I will be happy to take your questions.

Question-and-Answer Session

Operator

Thank you. At this time if you would like to ask a question you may press star one on your touch tone phone. If you would like to remove yourself from the queue you may press star two. Once again, star one if you would like to ask a question. Our first question comes from Robert W. Baird of Lehman Brothers, you may go ahead sir.

Robert W. Baird – Lehman Brothers, Inc.

Hi good morning.

Lew Frankfort

Good morning Bob.

Robert W. Baird – Lehman Brothers, Inc.

Lew, I guess just a couple of questions around your consumer, you know the Coach consumer. When you look at the trends that you’re seeing how concerned are you about your specific consumer in the high end? And, do you have the right quality of inventory to match the trends that you are seeing within your product offerings?

Lew Frankfort

First, we’re confident that the luxury consumer as well as the accessible luxury consumer which is our consumer Bob, is continuing to spend. What we’re experiencing in our stores for example, is much higher levels of conversion on lower levels of traffic this year. So, she is spending and based upon what she’s buying she’s also responding very well to our elevated product offering. In addition, when we look at our stats in terms of ongoing attitude consumer research from an attitude perspective, the Coach consumer has never been more vibrant than she is today. She has actually the highest levels of metrics in terms of her belief and confidence in Coach relative to ranking Coach as one of her favorite brands, excellent value, a brand that she trusts, a brand that she would recommend. So, we believe both the Coach consumer and more generally, the high end consumer is still out there and she spends when she shops.

Michael F. Devine

In terms of inventory position Bob, we feel very good about our position going in to the holiday season. Mike referenced key initiatives that he has planned into his business and our inventories are well positioned to support those initiatives, we feel very good about it.

Robert W. Baird – Lehman Brothers, Inc.

Great. Thank you very much. Good luck.

Lew Frankfort

Thank you.

Operator

Our next question comes from Margaret Mager, you may go ahead. One moment please. Our next question comes from Paul Leslie of Credit Suisse. Your line is open sir, you may go ahead.

Sarah Lewis - Credit Suisse North America

Hi, this is Sarah Lewis calling on behalf of Paul. I was just wondering, you highlight in your press release the ability to curb spending during this period of uncertain sales trends. I was wondering if you can break up some of the bigger buckets that you’ve been able to cut back on and also where we can expect some of the spending to be curbed going forward? Thanks.

Michael F. Devine

The areas where we are able to act most quickly in terms of adjusting SG&A, is in Mike’s business actually in the retail stores. He talked about the investment we’ve made in the time and attendance system as the most recent investment in technology that we’ve put in place. So, we are able to quickly match our stores staffing levels with the traffic that we’re seeing coming into the stores. So, that’s one of the first levers that we’re able to use so that we can optimize that relationship to drive conversion without over spending. Secondly, many of our stores, in fact, the vast majority are in a variable percentage rent scenario with kick above breakpoints. So as traffic and sales performance moderates so do our occupancy levels. Beyond that we’ve gone back into the business and are looking at all of our spending dollars and are looking for those that do not have near term immediately paybacks as we ride out this near term decline in traffic. So, there are many levers that we have available to us and we feel good about the financial controls and how nimble we are in our ability to react to continue SG&A leverage.

Operator

Thank you. Our next question comes from Jeff Edelman from UBS. Your line is open.

Jeffrey Edelman – UBS Securities LLC

Thank you. Good morning.

Lew Frankfort

Good morning Jeff.

Jeffrey Edelman – UBS Securities LLC

Could Lew or Mike give us a little more color in terms of your recent traffic trends was? Were there any geographical differences or age of store? To give us some sense whether or not it is really a weather or economy issue that is resulting in the reduced store traffic and mall traffic.

Michael Tucci

Sure. Jeff, we’re seeing really at the tail end of September the early part of October and I want to ground you from the standpoint of where we are for the quarter. We’ve got over 90% of the quarter in front of us as a significant portion of our volume comes post Thanksgiving but, what we’re seeing in the immediate past few weeks is pressure in the northeast, some pressure in parts of the south, specifically our Florida market and pressure on the west coast. We’re actually very pleased with the continued relative success of our business in the mid west, parts of the southwest. So, there is some geography. I’m not going to get into the weather because it’s been well documented and that’s really a factor that we have to manage through. So, we’re looking at some slight variation from a geographic standpoint and we’re managing it very, very closely across all stores. Age of store does not appear to be a factor at this stage in the game.

Jeffrey Edelman – UBS Securities LLC

Okay. Great. And then, as a follow up, could you discuss your average selling price and units per transaction?

Michael Tucci

Sure.

Jeffrey Edelman – UBS Securities LLC

And again, whether there’s any variation by geography there.

Michael Tucci

Sure. Sure. You know, one pocket of strength for us, by the way, recently has been Manhattan and that’s be driven by what we see a robust fashion market here in Manhattan, some increase in international and domestic tourism and some pricing opportunity in what I would call our higher tiered stores. Some real important factors: one, AUR improvement in handbags in the quarter was up almost 8%. So, in a challenging cycle in terms of footsteps we’re able to see significant improvement from a pricing standpoint and that will carry and help us tremendously as we go forward through the balance of the year. ADT was up modestly in total because some of that AUR improvement was mitigated or offset by the introduction of jewelry and fragrance and some of the sharper priced items that we’ve put into the assortment in small accessories. So, we continue to see pricing power in the brand. We also continue to see improved conversion levels on a lower index of traffic and that allows us to continue to get comp growth albeit against a weaker back drop from a traffic standpoint.

Jeffrey Edelman – UBS Securities LLC

Okay. Great. Thank you.

Operator

Thank you. Our next question comes from Kimberly Greenberger of Citigroup. Your line is open.

Kimberly Greenberger, CFA – Citigroup

Great. Thank you. I was hoping you could give us a little bit more color on your department store POS sales. Are there any in particular that you can call out as being stronger or by contrast weaker? And then, Mike I was hoping you could give us just some color on your merchandise margin by channel and if you’re seeing continued gains in organic gross margin by channel? Thanks.

Michael Tucci

First, with regard to department stores, we actually have experienced good growth across the board during the first quarter. Interestingly, the greatest growth actually during the first quarter came from Dillards which, as you know, is a regional department store which grabbed about 35% ahead of POS.

Michael Tucci

So Kimberly, let me take the – I assume you’re speaking to gross margin rate and it was our Q1 performance we were once again very pleased with in terms of organic gross margins rate. You saw that we were essentially flat, actually off 10 blips off of Q1 of a year ago and we were almost fully able to offset with organic gross margin rate improvement about 20 blips of dampening impact from channel mix and about 20 blips coming out of CJI as we sold through inventory that was purchased with a weaker Yen in Q1 of this year than Q1 of a year ago. So, we had 40 blips if you will of bad news to overcome and we essentially did that by getting back to essentially flat with organic margin rate improvement, gross margin rate improvement.

Kimberly Greenberger, CFA – Citigroup

Thanks and good luck for holiday.

Lew Frankfort

Thank you.

Operator

Our next question comes from Margaret Mager of Goldman Sachs. Your line is open, you may go ahead.

Margaret Mager - Goldman Sachs & Company

Hi. My apologizes on technical difficulties there, I hope I didn’t miss too much. But, the question I’d like to hear you respond to is on the traffic why do you think it is weaker and why has it weakened in the past several weeks in your opinion? And then, as you look out towards the second half of the year with your comp guidance going from low single digit back up to mid single digit, what do you see on the horizon that would encourage you to pick back up? And then, related, on the department store front when you outline your expectations for the rest of the year, one of the things you called out is continuing to see strength is on the department stores. Given that the traffic issues seem to be broader based environmental across all of retail, wouldn’t you expect your department store business to start to weaken as well? And, is that incorporated into your outlook? Thanks.

Lew Frankfort

Let me take the second part of the question first. In department stores which have not been a strong channel in terms of traffic year-on-year for several years now, Coach has out performed our competitors and have continued to have grown, as you know, very substantially in these periods. The reason for that is that we deal with a less qualified consumer in department stores. When a consumer is looking to buy a bag in a department store she might be loyal to Coach or she might not. But, if she’s looking for a bag we have an opportunity to compete with the other resources and even though we have 30% market share in department stores, there’s another 70% we don’t have. So, we’ve been fortunate that consumers continue to see our product and our offering as superior as our competitors and we believe that will continue. So, we’re very confident in our estimates in department stores that we will out pace their performance and that we will out pace other categories performance. With regard to the retail environment, Mike touched on it earlier, the weather situation is well documented so we won’t talk about that but, the overall retail environment has been soft. It particularly started to affect us in late September and that has continued through October and when we look at it, we also look at our comparisons with last year. The reality is that our traffic was up 11% or so this past quarter, the quarter we’re in now and when we move into the second half of our fiscal year we’re up against easier traffic comparisons and we also don’t believe that the unusual retail environment is influenced by whether it is going to continue at this level. Consumers will be back shopping once weather turns cooler on a sustained bases, consumers will remember that most of us do live in a tempered climate and there are seasons.

Margaret Mager - Goldman Sachs & Company

Okay Lew, can you tell us what you’re building into your expectations for department stores as far as maybe where it has been and where you see it going in terms of rate of growth? If I recall correctly, I think that channel has been growing about 30% for you?

Lew Frankfort

We’re very comfortable with our 20% plus growth expected during the rest of the fiscal year at POS in department stores.

Margaret Mager - Goldman Sachs & Company

Okay. Thanks and good luck.

Lew Frankfort

Thank you.

Operator

Thank you. Our next question comes from Randy Konik of Bear Stearns. Your line is open.

Randy Konik - Bear, Stearns & Co., Inc.

Great. Thank you very much. Lew, you talk a lot about, in your comments, about the sic down turning traffic and reduced category growth sic locality for the remainder of the year. Can you talk in balance about [inaudible] versus secular, how do you think about the longer term secular process for the industry and what makes you so confidence there? And, how long is the cycle, is your cycle forecast for a weaker back half picking up into the next year of calendar 08.

Lew Frankfort

Randy, first for context we don’t really see this [inaudible] shift. The reality is handbags, during the course of these last several years has become an ever increasing important component of women’s wardrobes. You know the drill, she’s now buying over four handbags a year compared with just two several years ago. The reality is that accessories remain very important to our consumer, she’s extremely loyal to them and we have every reason to believe that she is going to continue to purchase them at levels equal to, if not higher than she has in the past. The reality is that we have experienced over 20% growth in the category since the second half of 2003. We expected it to slow down, we just didn’t know when it would occur. It seems to have occurred this fall and we’re looking for the category to continue to grow at about a 10% level. Naturally, it could pick up or it could slow somewhat but, our assumptions going forward are built upon 5% growth although we’re planning the category to grow about 10%. The other thing that we need to keep in mind is that overall retail spending has declined and we don’t know to what expense the drop in growth rate from 20% to between 10-15% is a factor of the sudden decline in retail spending. Anything else Randy?

Randy Konik - Bear, Stearns & Co., Inc.

I’m fine. Thank you.

Operator

Our next question comes from Michelle Clark from Morgan Stanley. Your line is open you may go ahead.

Michelle Clark - Morgan Stanley

Thank you. Mike, do you still need about a 5% comp growth at North America retail to leverage SG&A? Or, will that decline as you roll out these new technologies? And then secondly, you gave us POS, department store POS at Dillards, can you also give it to us for both Nordstrom as well as Macys? Thank you.

Michael Tucci

This is Mike. I’ll take the questions on the comps and then Lew maybe can take the question on department store POS. I don’t think typically we’ve given that level of granularity across the board. But, in terms of the comp basis, you know, we talked to a 5-7% comp rate leading to the leverage to the retail P&L in quarters past. We still feel good about that. To answer your specific question, assumed in that guidance from quarters past was continued investment and technology and continuing ability to leverage our spend and become more efficient over time so, that had always been in our thoughts and guidance.

Michelle Clark - Morgan Stanley

And then, the other question on POS department stores?

Lew Frankfort

Actually, we’re looking for them.

Michelle Clark - Morgan Stanley

Oh, okay. Thank you.

Lew Frankfort

We’re looking for the numbers. What we’re going to need to do is get back to you separately on the other numbers. We don’t have them available.

Michelle Clark - Morgan Stanley

Okay. Great. Then, just one last question on the traffic weakness. Are you seeing that both on your off mall stand alone stores as well as your in mall retail stores?

Lew Frankfort

In general, we are.

Michelle Clark - Morgan Stanley

Okay. Thank you.

Operator

Thank you. Our next question comes from Erwan Rambourg of HSBC. Your line is open, you may go ahead.

Erwan Rambourg - HSBC

Hi good morning. Irwin Rabu from HSBC in London. Coming back to traffic, if the traffic levels remain slow could this theoretically effect your store network expansion plans? i.e. could you cut your plans or on the contrary accelerate openings to compensate for this weaker traffic?

Michael F. Devine

It’s highly theoretical at the moment. Clearly, if there’s a key change over a number of years, or over a much longer period things could change. But, the reality is that we’re talking about a very short term trend that we believe is going to correct itself as we move into the holiday season and we have no reason to believe otherwise. So, we’re very confident and comfortable with our roll out strategies and our trends. Our new stores as we said, are performing exceptionally well 30-40% ahead of our pro formas.

Michael Tucci

And then, just as a reminder when I think many of you have seen our prepared materials at our more conservative pro forma levels we’re getting cash paybacks on these store openings of a year and a half so when we’re out performing by 20-40%, you can do the math these are outstanding investments we would not consider slowing.

Erwan Rambourg - HSBC

Okay. Thanks. Just a follow up question on the comp levels of full price retail because actually the figure was close to 11% for the quarter you were mentioning weakness at the end of the quarter. Can you confirm that the comp level was still positive? Or, can you give a bit of flavor on the differences between beginning of quarter and end of quarter.

Michael Tucci

The way that we look at it within the quarter on the 11 comp primarily driven by conversion and a modest improvement in tickets, we did see a slow down in traffic at the end, at the very end of the quarter but the traffic in total was down slightly for the quarter.

Erwan Rambourg - HSBC

Okay. And then, maybe just a last quick question, it seems that the Coach consumer is much more resilient at the higher price points. Is it safe to say this and if it is the case will you accelerate focus on these higher price points?

Lew Frankfort

Let me just jump in here and first say that our factory business, contrary to our full price, traffic, that is our traffic in our factory stores continues to run extremely high year-on-year comparisons. We’re seeing no slowdown at all in her spend in the factory arena. In fact, we think the unusual warm weather, of course, has contributed to a pattern where our factory shoppers are behaving like its still summer. Visiting for weekend jaunts their regional malls and tourist areas. So, we’ve seen no slow down in spending in our factory stores, again our most valued sensitive of the channels. With regard to full price, we see that consumers are buying at all prices points. The challenge that we’re experiencing in the first part of this quarter as we said a number of times now is our traffic levels. But, once she’s in the stores she’s buying at a significantly higher level than she did last year.

Erwan Rambourg - HSBC

Okay. Thank you.

Operator

Thank you. Our next question comes from Dana Telsey of Telsey Advisory Group. You may go ahead.

Dana Telsey - Telsey Advisory Group

Good morning everyone. Can you talk a little bit about inventory planning given the lower comp expectations, how you’re planning inventory going forward. And also, any update on Japan both either on your own retail stores in department stores in terms of what your seeing there. Thank you.

Lew Frankfort

Let me answer the second part first which is Japan. Our October business continues strong in Japan and the trends that we were experiencing in the first quarter continue on date.

Michael Tucci

So Dana, to speak to inventory planning you know as well and have heard us talk and come to understand our supply chain and how nimble it is. So yeah, as we’ve moderated our expectations around top line growth we’ve gone in and to a small degree moderated our production plans as well. You know our operating model. Inventory is just a non issue for us here at Coach. The flexibility of the factory channel at all will allow us to keep inventories very well controlled. So, as I talked about the Q1 inventory levels were actually up much less than sales growth was up so we feel very good about inventory levels and production planning and will be nimble and react to the business as appropriate.

Dana Telsey - Telsey Advisory Group

Thank you.

Operator

Thank you. Our next question comes from Christine Chen of Needham & Company. You may go ahead.

Christine Chen - Needham & Company, LLC

Thank you. I wanted to follow up on the question about traffic. You spoke a little bit about the differences in geography. Has there been any difference between your fashion flagship versus core stores? And then, I have a follow up question on how jewelry has been performing.

Michael F. Devine

Actually when I had mentioned, the question earlier was on age of store and we have not seen any significant difference in age of store and when we look across attributes core, fashion, flagship the band on variation is very, very slight. There’s really not a difference.

Lew Frankfort

Ah yeah. Let me at Christine we didn’t have no evidence to believe that this was a Coach specific issue. We believe it is a function of the overall retail environment based on all the diagnostics that we’ve undertaken.

Dana Telsey - Telsey Advisory Group

And then with respect to jewelry now that it’s in all stores? I know it’s early but, how as performance been?

Michael Tucci

We’re actually very pleased with jewelry it’s going to be an important element of our gifting strategy for Q2 operating above or on plan in all the stores it has rolled out to. Percent contribution levels between 2.5-3.5% depending on the store type and the assortment and the difference there is we have the capsule group for select flagship stores of a sterling line that has been excellent that has been driving some penetration. We’re actually looking at reacting to that to be in a good inventory position for holiday and add a few stores as we have inventory and capacity available to do so. So, it looks like a nice category for us and generating a lot of interest in the stores.

Dana Telsey - Telsey Advisory Group

And then on the non Japan international front, maybe I missed it, could you possibly comment on how much that was up because it’s blended into the wholesale category or direct category?

Lew Frankfort

We’re just checking the numbers. As our POS, I believe our sales were up double digits. I was looking for the exact number.

Michael Tucci

And in terms of impact to our financial statements the net sales or shipments are in that 35% in direct number so we had a very good quarter with our international distribution partners as well.

Dana Telsey - Telsey Advisory Group

Okay. Great. Thank you and good luck for the holidays.

Andrea Shaw Resnick

It is now 9:32, the market is open and we’re going to conclude this conference call. As always, we’ll be available for questions throughout the day and the week. Thanks everybody for joining us and have a fabulous day.

Operator

Thank you. That will conclude your conference for today you may disconnect at this time and thank you for participating.

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