掛毯 (TPR) 2009 Q1 法說會逐字稿

Good day. Welcome to the Coach conference call. Today's call is being recorded.

At this time for opening remarks and introductions, I would like to turn the call over to Senior Vice President of Investor Relations and Corporate Communications at Coach, Andrea Shaw Resnick. You may begin.

Thank you, Shirley. Good morning, and thank you for joining us today. With me 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, projections for our business and the current or future quarters or fiscal years. These statements are based upon a number continuing assumptions, and future results may different materially from the 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 provide an overall summary of the fiscal first quarter 2009 results, and will also discuss our strategies going forward. Mike Tucci will review our key initiatives for 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 2009. Following that, we will hold a question-and-answer that will end by 9:30 a.m.

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

Thanks, Andrea, and welcome everyone.

As you know, we just reported that first quarter earnings met our EPS guidance but fell slightly short of our topline goals, due to the weakened retail landscape in North America. While we're enthusiastic about the level of product excitement that will be available for the holidays, and believe that Coach will remain a brand of choice, whether self-purchase or gifting, what concerned as to weak traffic trends across the US full-priced businesses will continue through the rest of the fiscal year. As a result, productivity gains over this timeframe will be difficult to achieve. Thus, we now expect to achieve sales growth of about 10% this year, to about $3.5 billion versus our previous estimate of 13% topline growth.

Importantly, we have been proactive in planning for a tough retail environment for some time, managing our business nimbly and acting quickly to curb spending. We believe that our earnings guidance for the year can still be achieved through a combination of distribution growth, a focus on innovation to support productivity, disciplined expense control, and the share repurchases to date. At the same time, we will continue to invest prudently for long-term profitable growth.

While I will get into further detail about 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 7% to $0.44 compared with $0.41 in the prior year. Second, net sales totalled $753 million versus $677 million a year ago, a gain of 11%. Third, direct-to-consumer sales rose 16% to $592 million from $511 million in the prior year, on the comparable basis. Fourth, North American same-store sales for the quarter rose 1%. Fifth, sales in Japan rose 12% in constant currency and 22% in dollars, driven by new stores and expansions. Finally, we successfully completed the first phase of the acquisition of our retail business in China from ImagineX, transitioning the 10 stores in Hong Kong and Macau.

During the quarter we opened 21 net North American retail stores, including six in new markets for Coach - Calgary and Ottawa, Canada; Baton Rouge, Louisiana; Appleton, Wisconsin; Bakersfield, California; and Ft. Myers, Florida, as well as one factory store. In addition, seven retail stores and three factory stores were expanded; thus, at the end of the period, there were 318 full-price and 103 factory stores in operation in North America. I think it is important to note that the performance of our new retail stores remained strong and ahead of the internal projections. This includes the stores opened in the first quarter for which we now have revised annualized volumes, which are running at $2.1 million compared with our expectation of $1. 9 million, about 11% ahead of plan. And as noted in the Press Release, we have seen this out-performance most notably in new markets such as Calgary and Baton Rogue, but also in existing markets such as San Jose. Clearly, these results reflect the strength of the brand and our ability to attract consumers, both in new and existing markets.

Moving to Japan, four locations were added while one was expanded. At quarter end, there were 158 total locations in Japan, with 20 full-priced stores, including eight flagships, 113 shopping shops, 20 factory stores and five distributor-operated locations. Indirect sales decreased 3% to $160 million from $166 million in the same period last year, on a comparable basis. This decline was due to reduced shipments into US department stores as we continue to tightly manage inventories into the channel given weakening sales at POS, which declined 8% for the quarter. International POS sales posted strong gains in the period, driven by both distribution and comparable location sales gains.

We estimate that the premium US handbag and accessory category grew at a mid-single digit pace of the third quarter of calendar 2008. At the same time, Coach's bag sales rose 9% across all channels in North America. Our total revenues in North America were up 8%, with our directly-operated stores generating a 15% gain, driven by both distribution and a slightly positive comp. We would note that full-priced stores our weak traffic patterns from the previous few quarters worsened, while conversion held at last year's levels and average transaction size fell slightly. In factory, we continued to see increases across all three metrics, driven in part by higher promotional activity on a year-over-year basis.

I also want to highlight another solid quarter for Coach's women's footwear. Our business and department stores, where we are now sold through about 900 locations, rose 6% at POS for the quarter.

While Mike Devine will get into more detail on our financials, and of course I will discuss our outlook in some detail, I wanted to give you this recap. As you know, I've also asked Mike Tucci to join us today to discuss our product performance for Q1 and our holiday sales initiatives. Mike?

Thanks, Lew.

As mentioned in our Press Release, each of our monthly introductions was well-received, starting in July, with Bleecker. This was followed but updated Hamptons and Legacy collections in August, and by Zoe, a new group of handbags and accessories in September. Also in September, we successfully introduced a new Coach fragrance, Legacy. Earlier this month, we launched Madison, a new major lifestyle collection, which is a softer, drapier and sophisticated group of handbags, accessories, and footwear across multiple fabrications, including a new logo platform, Coach OP ART. We are especially excited about Madison, as it represents the first collection that fulfills our strategy of compressing multiple years of product innovation into a single fiscal year. This is especially important at holiday, when our gifting opportunity is greatest. Our early reads on Madison show an improvement in handbag penetration as a percent to sales, and a better balancing of our assortment overall. Our key item in this group is the Sabrina satchel, performing very well in both sizes, with prices ranging $298 for the smaller version in OP ART, to $798 in limited edition styles.

Looking ahead to holiday, our customers will see three important changes from previous years. First, the dramatic intensification of newness, notably in handbags. In the past we tended to front-load the quarter, with the most significant delivery in October followed by more modest introductions in November and December. This holiday we'll build on October's Madison launch, with powerful new product throughout the quarter. Second, a focus on gifting, notably in a more bold accessory offering across a range of compelling price points. And third, a retail presentation that truly appeals to holiday gift-giving. Our in-store, web, packaging and advertising point of view will be more festive, colorful, and exciting this season, anchored by the Madison collection and great gifts.

Within handbags, Madison will remain front and center in the stores this holiday. We'll be updating the collection during the season with new colors in both OP ART and leather across key silhouettes, such as the Sabrina satchel. In November, we'll launch an updated Soho collection, driven by two new hobo silhouettes at core price points of $278 and $298, offering exceptional value. At the same time we'll be layering in Amanda, a chic whimsical collection of satin occasion handbags, clutches and accessories in bright colors, which sit side by side with Madison. In December, Leah will be a key item focus. Sophisticated and functional, the lightweight Leah tote will be available in coated canvas, embossed patent and leather, priced between $298 and $398. All silhouettes feature a detachable shoulder strap, providing over-the-shoulder to cross-body convertibility.

Moving on to gifting and our accessory focus, we will be dominant in small leather goods this holiday season. You'll see an item intensification to distort our gifting opportunities throughout the quarter and beyond. You'll also see more color, a wide range of price points, including our newest, best-selling Madison wallet at $98, and a key item focus around money pieces, wristlets, swing packs and pouches in our stores and on the web. In newer growth categories, we're expanding sterling silver to 120 additional stores in December, bringing the total to 220. And in fragrance and beauty, we'll be offering body lotion and gift set options as well.

Most broadly, our retail presentation in every way we touch the consumer will be infused with holiday energy and messaging. While our presentations will be straightforward and easy to shop, they'll also be more bold, colorful, and emotional. When she enters a Coach store or visits us at Coach.com, she'll clearly see newness in what we believe this as our key items. We're strengthening our visual merchandising, such as cropping and trim, making our stores more festive, and providing a strong, integrated gifting message supported by in-store marketing as well as our print and online holiday campaign, Holiday by Coach.

Finally it is important to note that we have achieved our targeted 10% to 15% reduction in handbag SKUs this quarter, enabling us to be more edited and productive in this challenging environment. Of course, in term of stores we'll continue to manage labor against traffic, ensuring an excellent shopping experience, while appropriately managing our payroll spend, and we'll fully leverage the technology initiatives put in place over the last few years, including eRunner, smart scheduling, Coach by Special Request, and webstore pickup, to name a few.

With that, I'll return the discussion to Lew to continue with our overarching strategies.

Thanks, Mike. Looking ahead, as we've discussed many timings, we have two sales drivers. First is distribution, as we expand our global network of store locations with an emphasis on North America, Japan, and China. Second is productivity, which we drive across all geographies through the introduction of innovative and relevant product in a compelling store environment.

As we discussed, given the weak retail climate in North America, productivity gains will remain challenging through the remainder of our fiscal year. That said, we have been implementing four key strategies that focus on sustaining growth within our international framework. Our largest opportunity during our planning horizon continues to be in North America. First, we're building share in the $8.7 billion North American women's accessories market. As we've already discussed, we're implementing a number of initiatives to accelerate product innovation, elevate our offering, and enhance the in-store experience. These plans will enable us to continue to strengthen our leadership position in this market.

Our second strategy is the continued growth in North American retail. As you know, given the compelling returns we're continuing to generate, we plan to add about 40 retail stores a year in North America, including FY '09. This year, this will include a total of 14 new markets for Coach. Prior to holiday, we expect to have open a total of 28 full-priced stores, including a total of six this quarter. We will, also, continue to relocate and expand stores where appropriate. As I mentioned, based on the performance of our new stores, which have consistently outpaced their performance even as the economy has weakened, we believe that North America in total can easily support 500 retail stores, including at least 20 in Canada.

Third, outside of the US we're continuing to increase market share with the Japanese consumer, driving growth in Japan primarily by opening new locations and by expanding existing ones. IN FY '09 and in each of the next few years, we plan to add about 10 net new locations in Japan, and as has been our practice, we'll also continue to expand our most productive locations.

Our fourth strategy is to raise brand awareness in emerging markets to build the foundation for substantial sales in the future. Specifically, China, Korea, and other such geographies are increasing in importance as the category is growing rapidly, and Coach is taking hold. In FY '09 we're on target to open, through distributors, at least 20 net new wholesale locations in total. In China, we expect to open five new locations, four on the Mainland and one in Hong Kong. As mentioned, during Q1 we successfully completed the first phase of our acquisition of our retail businesses in China, transitioning 10 stores in Hong Kong and Macau to Coach China. Over the next five years, we expect to open 50 new locations in China, aggressively growing our sales and market share in this rapidly expanding region. Our goal is to be one of the top three imported handbag and accessory brands. With the investments we plan to make in stores, marketing, organization, and infrastructure, we're striving to replicate our success formula in Japan since taking control of that business there in 2001.

As you would expect, we're tightly managing our business. We have been addressing the unfolding economic crisis for more than a year now, and while it is not possible to fully insulate Coach from its effects, we've been pragmatic and forward-thinking in our business strategies. We are closely managing inventories, controlling costs, and of course safeguarding our strong and loyal consumer franchise. We will continue to deliver innovative product, offering compelling value and intensify intensifying our clientelling efforts, ensuring that Coach is top of mind this holiday season. By being proactive, maintaining our focus, and continuously delivering on our brand promise, we firmly believe we will emerge from this adversity a stronger company.

At this time I will turn it over to Mike Devine, our CFO, for further detail on our financials. Mike?

Thank you, 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 11%, with direct-to-consumer, which represents over three-quarters of our business, up 16%, and indirect down 3%. Strong international sales and shipments were offset by weakness at US department stores. Earnings per share for the quarter increased 7% to $0.44 as compared to $0.41 in the year-ago period, as net income declined to $146 million from $155 million. Our operating income totaled $233 million in the first quarter versus $239 million in the same period last year. Operating margin in the quarter was 31% flat compared to 35.3% in the year-ago quarter. In the first quarter, gross profit rose 8% to $558 million from $518 million a year ago, and gross margin continued to be strong and on target at 74.2% versus 76. 6% in the prior year.

As expected promotional activity, notably in the factory channel, which has yet to anniversary the overall higher levels of promotions which began in last year's second quarter, was the primary driver of the year-over-year change. Channel mix, and the sharper pricing initiative, also dampened gross margin. As expected, SG&A expenses as percentage of net sales rose from prior-year levels in the first quarter and represented 43.1% of sales versus 41.3%. Inventory levels at quarter end were $402 million, up about 19% from prior-year levels on a comparable basis, driven in part by an investment in key initiatives, which position us well for the holiday season. In addition, the increase included the purchase of $5 million of inventory in China as part of the transition, and was also impacted by the strengthening of the yen over the period. Excluding these items, inventories would have been up 16% year-over-year.

It should be noted we have changed our method of accounting for inventories of Coach Japan, from Last In, First Out, or LIFO, to First In, First Out, or FIFO. As a result, as was noted in the Press Release, our prior-year inventory number was restated by $25 million to be presented on a comparable FIFO basis. This inventory increase allows us to support 53 net new North America stores, 12 net new locations of Coach Japan, and increase sales levels from the year-ago period.

Accounts receivable balances remained well-controlled, as they rose less than $8 million or 5%. Cash and short-term investments stood at $410 million as compared with $1.2 billion a year ago, reflecting the aggressive buyback activity over the last year. During the first quarter, we repurchased 10.5 million shares of common stock, at an average cost of $28. 53. At the end of the period, $863 million was available under the current repurchase authorization. Free cash flow in the first quarter was inflow of $10 million versus $83 million in the same period last year, primarily driven by changes in working capital, the investment in China, and the timing of new store openings. CapEx spending for new stores and renovations, as well as investment spending for the China acquisition, was $54 million versus $39 million in the same quarter a year ago.

Now I'd like to provide you with some of our updated goals for fiscal 2009. For the second fiscal quarter, we're targeting net sales of about $1.05 billion, representing a year-on-year increase of about 8%; an operating margin of about 39%, with a gross margin similar to the first quarter's rate of about 74%; and an expense ratio of about 35%; resulting in operating income up about 2% year-over-year, and earnings per share of $0.77. As we've noted, we are maintaining our $2.25 EPS guidance for the full fiscal year.

Our goals regarding the other key financial metrics are net sales growth of about 10% to about $3.5 billion driven by distribution gains; as mentioned, we expect to open at least 46 new stores in North America, including about 40 full-priced stores and about six factory stores; 10 to 15 net new locations in Japan; about five new locations in China; and at least 20 net new international wholesale locations; while we continue to expand select, highly-productive locations globally. In Japan, we expect to achieve constant currency growth of about 5% to 10%. While we continue to focus on profitability, we expect gross margin to be impacted by both ongoing promotional activity, notably in factory, as well as the shorter margins we will take on select new product in our full-priced business to deliver exceptional value to our consumers.

As a result, we are continuing to project a gross margin rate of about 74% for the full year. Similarly, given the investment spending we've outlined, we're anticipating an SG&A expense ratio of about 40% for FY '09. Therefore, we are targeting an operating margin of about 34% to 34.5%, resulting in more modest operating income growth of about 2% for the year. In addition, significantly lower interest income due to lower rates, and a lower cash balance due to share repurchases, will also impact net income, while our tax rate in FY '09 should be at 38.25%. Taken together, this brings us to our $2.25 EPS guidance for the year.

For FY '09 we expect CapEx to rise to about $250, primarily for new stores and expansions both here and in Japan, as discussed, and including the $65 million purchase of one-half of our headquarters building in New York. This reflects a $15 million decrease from our previous guidance, excluding the building purchase, as we have deferred certain projects with longer-term paybacks. While these are our current goals, our actual results may vary from the targets, based upon a number of factors, including those discussed under the business of Coach, Inc. and risk factors in our Annual Report Form 10-K. Coach also does not assume any obligation to update the 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. And, now, Lew, Mike, Andrea and I will be happy to take some questions.

Thank you.

(OPERATOR INSTRUCTIONS)

One moment for our first question. First question comes from Robert Drbul. You may ask your question. Please state your company name.

Barclays Capital. Good morning.

Good morning.

Lew, the question that I have for you is - is more forward-looking in terms of the holiday quarter and then sort of the rest of this fiscal year. What are your assumptions around the category growth? You talked about what you saw so far this calendar year. How are you planning that within your forecast for the business?

We're assuming little or no category growth, even though the category did grow mid-single digits last quarter, we're really focused on Coach's growth. As you know, we do have nearly 25% market share in the category, so as we go so will the category. So it is hard for us to speak to other players, but we're confident that we will continue to grow our bag business through the holiday season and the rest of the fiscal year.

Great. Thank you very much.

You're welcome.

Thank you. Next from Michelle Clark. You may ask your question, and please state your company name.

Sure, Morgan Stanley. Congratulations on a solid quarter in a very difficult environment.

Thank you.

The first question I had is for Mike Devine. Mike, your expense levels were better than I would have expected given the level of sales. Has your leverage point changed at all, or is it still that 7% for the retail business?

Yes. Michelle, thank you for the question. We really are very pleased with our SG&A management. As you mentioned, our spending actually came in for the first quarter about $5 million below the level that we shared on our last call, when we gave guidance for the quarter, and really helped us to deliver that $0.44 EPS. And in fact, the guidance that we've given now to the $2.25, as you dive into it, you'll actually see we've taken out about $40 million in SG&A spend versus that initial guidance. So we really have - are tightening our belts, looking only at short payback spending initiatives. We actually have what we're calling here at Coach a hiring frost underway. We're virtually only doing hiring for the growth initiatives, most notably China, and our collections initiative on the merchandising side. So there's a number of things that we're doing by taking out - - taking our revenue guidance down, of course, there's a variable component that contributes to the $40 million decline, things like percentage rent and store wages as traffic is off, Unfortunately, our bonus has also come down as earnings and net income come down.

So we feel really good. We're negotiating hard with vendors. We're looking at at T&E spend, we're also looking at capital spending, which has resulted in lower depreciation. So all in all, I think what we're seeing, Michelle, is that the 7% comp in the retail division is probably still a pretty good number, because of the highly variable nature of Mike's division there. But what we are impacting is the overall growth that we need to deliver SG&A leverage across the entire company, by more closely managing corporate expenditures and also delivering more leverage from CJI 's P & L.

So again, I repeat myself, we're very pleased with the way we've been able to manage SG&A. With this $40 million decline, if you allow us to just out the spending initiatives for China and for collections, we now actually will deliver based on these latest - this latest guidance of flat to slightly down SG&A rate as a percentage of sales. So there's a number of things going on here that are helping us to protect our earnings guidance.

Right. That's very helpful. The second question I had is on the weakness in the department store channel, I was hoping that you guys could give us some color there. Is it with a particular retailer? Any regional callouts that you can give us? Thank you.

First, for contact, department stores are very important to Coach because they do offer consumers who we target who shop in department stores an opportunity to purchase Coach. But having said that, they do only represent about 11% of our global sales. So everything that I'm about to say needs to be in the context that it is a minor portion of our sales. We're experiencing weakness across all of the chains that we deal with; however, the weakness is more exaggerated, of course, in Florida and California. At the same time we have relative strength in the Tri-State area, in sections of the midwest and southeast.

Great, thank you.

You're welcome.

Our next question is from David Schick. You may ask your question, and please state your company name.

Good morning, Stifel Nicolaus. So Lew, you talked about how - I think you talked about how those were department store markets doing by region. Can you talk about your full-priced stores by region, if there is anything vastly different or more disparity than typical? I have a follow-up as well.

We're finding the same geographical patters. We're primarily affected geographically in same stores by the varying economic conditions. So Tri-State area is doing well. Canada, of course, continues to do exceptionally well. Sections of the midwest are doing better than other regions as well.

Okay. Great. And, then, separately, could you talk a little bit in more depth about the online business? How's online doing? Email open rates? Sort of things we might want to look at for customers' interest with either researching your product or doing business with you online?

Sure. David, it is Mike Tucci, how are you?

Good morning.

We have - - we've spent an enormous amount of time on Coach.com, and I think you'll notice that what we would call the skin and architecture of the site has been significantly revamped from an experience standpoint, look and feel. We've managed our shopping path much more aggressively, trying to get the consumer more effectively to key places that she visits. Obviously, our handbag business categories that are not as important in the stores, such as men's and footwear and online, have all been targeted for growth. It is part of a multi-pronged effort, including the full re-platforming of Coach.com, which will now happen in the beginning of the calendar year. And what we're seeing is a huge opportunity around segmentation and customization which will begin to - effort against the holiday. So you'll see us doing a more tailored approach around email.

In terms of open rates and email response rates, we are very, very disciplined there. We don't bombard people with a lot of emails that they choose not to engage. So we control that very, very carefully. Our email productivity is very strong. It is important to note we've also expanded our online presence with key department store resources out there, where we now have Nordstrom, Macy's, Dillard's offering Coach products within their websites. That's been very important to us to maintain growth, or certainly protect growth, within the online category overall.

Okay. So - so, you said you're careful about it, but are you still pleased, you know, as we head into the later part of the year with open rates and things like that?

Absolutely.

Okay.

In fact, what I want to underscore is that we are not - while email can be an effective way to get a lot of messaging out there, because it is virtually cheap - virtually free from a cost standpoint, we're not going to use that irresponsibly. We're very careful to not bombard consumers with email messaging that we actually believe to be intrusive. It is not an enormous piece of our overall online business, but it is an important messaging tactic for us.

Great.

We are very, very optimistic about engagement and open rates within Coach. com.

Excellent. Thanks.

Thank you. As a reminder, please limit yourself to one question. Our next question comes from Kimberly Greenberger. You may ask your question, and please state your company name.

Great, thank you, Citigroup. My question is on square footage growth beyond the current fiscal year. Obviously, business here in North America is tough for everybody and it feels like it is getting worse. Do you think it might be prudent to slow down the square footage growth, at least in North America, until we see some sort of stabilization in the North America economy?

The short answer is that we continue to be significantly profitable incrementally. As I mentioned earlier, when we open new stores they are profitable from day one. We have a long view; we will obviously weather this economic crisis and we believe that we will come out of this adversity a stronger brand and business.

Okay. Great. Thanks, Lew. Congratulations here on a very fine result in a tough environment.

Thank you.

Thank you. Our next question comes from Liz Dunn. You may ask your question, and please state your company name.

Hi, this is actually Christina Colone for Liz Dunn at Thomas Weisel. I just have a follow-on to that last question. So we understand that your new stores are still very productive and profitable, and you remain committed to open the 40 new stores. But we were just wondering, do you think, so far, that your growth in the market impacted your comps by causing cannibalization in gross margin pressure? And then, also, has there been any discussion internally about slowing the growth to preserve margin and comp and potentially improve returns? Thanks.

Mike Tucci?

Sure. It is, obviously, an area that we manage very carefully. In terms of new store development, we have been very careful to open new stores in a very balanced way across new - - what we would call developing and existing markets. And I think what you'll see us doing going forward is managing that open divide. What we're very, very pleased with is the performance of new stores, in particular in new and developing markets, which have little to no cannibalization impact on our business. We are currently, to be clear, and we had a sense this would be a topic of discussion, we are currently managing the opening pattern for the stores that open within this fiscal year. We've got a handful to open in this quarter, 12 to open in the back half, and we're managing our real estate open to buy for next year. We're fairly confident that we can achieve our opening plans.

The mix of stores for next year is likely to be more skewed towards new and developing markets than it has been in the past, which we see as a very high opportunity for distribution growth for us going forward. We also continued to be - - we also continue to be very pleased with the pure levels of performance in these stores; as we said, we're averaging $2 million to $2.1 million dollars in new stores through the openings this year, that's a very, very strong number, in markets where we have introduced the Coach brand to the customer with a full-line store.

Thank you. The next question from Christine Chen. You may ask your question, and please state your company name.

Needham & Company. Good morning, and congrats on navigating a difficult environment quite well.

Thank you.

I wanted to ask, you mentioned that average transactions were only down slightly. Is that because customers are gravitating toward lower price point bags? Or is it because the mix has shifted because of jewelry and fragrance? How are handbags $400 and up doing? Thank you.

The - - our average transaction size is being impacted mostly by mix, within the quarter that we just reported. And as we've introduced certain categories with lower price points, like jewelry and fragrance, and as we've seen some very significant growth in small leather goods, that has impacted our average transaction. Handbags over $400 continue to do very well. We actually, within the quarter, had penetrations of north of 30% in handbags over $400 within the handbag category. That's a tremendous number. I might add that what we're seeing with Madison, which is a very, very well-priced collection from an elevation standpoint, is an improvement in handbag penetration, which is impacting the average transaction positively. It is very early in the launch, but we're pleased with our efforts around Madison to give us handbag growth.

Great. Thank you. Good luck for the holidays.

Thank you.

Thank you. The next question from Stacey Widlitz. You may ask your question, and please state your company name.

Thanks, Pali Research. Can you just comment on your approach to discounting in the full price environment? For example, when consumers receive $50 off in the mail, and how you sort of strike a balance between training consumers to wait for that discount in the mail? Thanks.

Sure. We should really give context on this. We are a full-priced proposition, a 365-day-a-year full-priced proposition. We have one price in our stores, and we manage our business accordingly. We have, I think, done a very good job of offering targeted opportunities to preferred customers to shop in our stores and receive discount incentives. And we're currently finding opportunities to manage that, I think, more effectively. Our target for Q2 is to manage that portion of our business in a very disciplined way. I want to ensure you that our current plans actually assume a lower level of activity, which is a small portion of our overall business, a lower level of activity in that piece of our business, within the quarter.

Great. Thank you.

Thanks. Our next question comes from David Glick. You may ask your question, and please state your company name.

Buckingham Research Group. Good morning.

Good morning.

Mike, I was wondering if you could continue a little bit on Madison and give us a little more color about the successes you're seeing there? Also, whether your strategy to shorten the IMU on selected items is giving you the sell-throughs, accelerated sell-throughs that you had anticipated, and if so, are you increasing the penetration of that strategy for holiday and spring?

Sure. I'm going to start with the last piece first. You know, one of the things that we're learning with Madison, and it is so - - it really gives us a lot of conviction, great product is a real differentiator. We spent an awful lot of time on the positioning of Madison, and what it would say to a consumer when she entered our store. I think for those of you who have been in our stores, you can really cut through to a very different proposition in terms of emotion, feel, and pure product offer.

Now, in terms of hard numbers, Madison is anchored by Sabrina. It is a collection where we have a singular style offered in two sizes across price points from $298, which we see as a real key, broad price point, all of the way up to $798. Sabrina, in and of itself, is representing about 20 points of penetration. That's a heck of a number, a heck of a number on one stock, and something we believe we can build a new business around from a platform standpoint. A very balanced effort from a selling standpoint across what we would say is is multiple fabric messaging, so we have a very strong leather penetration. The introduction of OP ART, which is a new logo platform for us, and right now OP ART executions and all other fabrications are roughly 50/50. That's a tremendous win for us in terms of a balanced offer. We're not overly dependent on one fabrication versus another.

We also think that Madison gives us an opportunity to provide a more broad view into the business through other categories. So we see the extension of Madison from handbags into strong small leather good selling. You will see Amanda, which hits the stores this Friday with our November floor set, offering a different point of view within Madison around small leather goods, what we would call occasion pieces and great giftables. In addition to that, we've seen strong response to Madison in footwear.

So we're very pleased with it. Of course, the world is a different world today. We're operating in a very tough climate, but we believe that we can offer innovation and product newness to the consumer, and she will respond.

And in terms of your pricing strategy on the shorter IMU, what kind of results are you seeing with where you've taken that strategy? Are you looking to expand that strategy going forward?

I think for the moment, we should - - we should, really concentrate within Q2, we've done some sharp pricing and you see some of the price points within Sabrina being very, very smart. Soho offers a more core price positioning for us at $278 and $298, and I would say that that is a tremendous balance for us from Madison to a more core offering. That collection hits on Friday with our floor sets. So we believe that that is - that will further reinforce a more balanced price offer. Then we follow up with December - in December, with Leah, which a strong key item tote, and that begins with a $298 offering.

All of these price points are baked into our forward guidance around margin. We've built our turn plans based on these price points, and I think will speak to our positioning on pricing as we learn from Q2 later in the year, in Q3 and Q4, and we'll share that with you in future calls.

Great.

David, Mike Devine, just to build on what Mike said, there is an assumption going forward into the second half that smart pricing will continue, and that is baked into our guidance. For the full year, the gross margin rate is 74%.

Mike, just real quick, the $2.25 guidance, does that include any share repurchases, typically doesn't. I just wanted to confirm that?

We're consistent on that one. Just the completed share repurchase activity that we shared with everyone in the release for Q1, nothing beyond that.

Okay. Great. Thank you very much, good luck.

Thank you. Our next question comes from Dana Telsey. You may ask your question, and please state your company name.

TAG. Good morning, everyone, and congratulations on maneuvering through this tough environment. As you look at some - as you look at product costs, are you seeing a difference in product costs that allow you to get these sharper prices also? Secondly, any updates on the gallery format that you had rolled out in footwear or watches, any of the ancillary categories? Thank you.

Why don't I take the product cost issue firstly, and then we'll handle the second question later. I think, Dana, the cost environment is pretty consistent with the snapshot we gave you at the end of Q1. Certain raw material input costs are actually helping, most notably leather, because of what worldwide demand is we're able to buy leather today for slightly below what we were paying for it at last-year levels. We also have, through Jerry Stritzke's supply chain organization, many, many initiatives ongoing around qualifying new sources and alternative sources for different raw goods that go into the production of our product, and those continue to proceed, that is the blocking and tackling, but there's a long, long list of items that we're working on to try to squeeze cost savings out. At the same time, there are other inflationary pressures, the Chinese currency and minimum wage, fuel surcharges, et cetera.

So, we don't see a significant change from where we were a quarter ago. We think that there's enough proactive activities embedded to hold gross margins pretty steady to that 74% guidance that we've had all fiscal year long. So nothing too terribly different now versus 90 days ago.

Dana, on Gallery, we're spending a lot of time in Short Hills. That store is performing very well. We believe in the concept. We are in the final stages of build-out on our second Gallery store, which opens mid-November in King of Prussia. That format will be a larger format, it is about 5,500 square feet. A little more width allows us to do a more impactful men's presentation within the Gallery concept, which we're anxious to learn about, and we've already made some small modifications within Short Hills around positioning.

To your question around footwear, we've actually repositioned footwear within that store, which has been very successful business for us, towards the center of the store. Footwear overall has been a nice story for us, and what we're very pleased with is we've been able to manage productively a handful of footwear styles from an all-store point of view, and it allows the customer, particularly around some of the more casual executions and things like sneakers, to really get a multiple-purchase, more head-to-toe Coach experience. We will be adding footwear selectively to stores going forward. It is not an enormous rollout, but here and there we'll add footwear shops into a handful of stores as we expand.

On the watch side, we are actually focusing our watch growth to the 110 top stores in the company with a full presentation, and we're looking at the balance of stores to reposition watches to allow us some additional room for growth around small leather goods. We think that's a tremendous productivity opportunity for us.

Any update on the jewelry side, or the real estate environment in dealing with the real estate developers? Are you getting better deals?

Thanks for limiting it to one question there, Dana.

Sorry.

Jewelry is actually an opportunity for us in Q2. I spoke earlier about sterling silver rolling to more stores, and I think we've really spent enough time in terms of development environment. This is not a big deal-making time for us, we're focused on executing Q2 and holiday.

Thank you.

Thank you. As a reminder, please limit yourself to one question. Our next question comes from Jennifer Black. You may ask your question, and please state your company name.

Jennifer Black & Associates. Let me add my congrats. Lew, I wanted to know what your thoughts are as far as this less conspicuous environment that we're in? It seems like it would be beneficial to you. Then also you've talked about, over the years, the number of handbags the woman purchases in a year. For a while it was up to four to five. What do you anticipate this number to be over the next six months to a year in this kind of tough economy? Thank you.

Well first, Jennifer, we don't expect any change in the rate of handbag purchase. It will be more or less the same. It could be more, depending on how "wowed" she is by Coach product. That's why we decided to compress multiple years of innovation into one year, so that we can give her a particularly compelling offering when she's reluctant to spend, to emotionally entice her. In terms of us being a particular beneficiary, candidly no one benefits from an economic climate such as the one we're in. Everyone is affected. As we said throughout our discussion, we're looking to continue to navigate jointly through these waters.

Lew?

Yes.

It just seems as though - that women, from what I heard, are trading down from, say, a $2,400 handbag, and that's kind of what I was referring to, and it seems as though your brand would be in a position to benefit from that?

Well, certainly we would benefit from that. We would.

Can I ask one more question? I wanted to know your initial responses to the SLGs, your little shops that you've set up, and what are the margins compared to handbags?

Okay. Mike Tucci?

Jennifer, it's very early in terms of our SLG intensification. We're actually just completing it this week. It will be fully executed with the launch of Amanda and the Soho floor set, which happens on Friday. From a margin standpoint we've said many, many times that SLG margins are very consistent with our handbag margins. It is a growth opportunity for us, and you'll see us attacking that very aggressively.

Great. Good luck.

Thank you.

Thanks. Our final question comes from Antoine Belge. You may ask your question, and please state your company name.

Yes. Antoine Belge, HSBC. Could you comment on the performance of factory versus full-priced in the quarter, and how you see it evolving in the final quarter?

Sure. As we said, within the quarter we actually saw a weakening of traffic patterns from the previous few quarters within full price. The good news against that was converging - basically held at last year's levels, with average transaction down slightly. IN factory, we continued to see increases across all three metrics, and that is driven in part by higher promotional activity within the factory channel and, obviously, the discount environment within factory, and a slightly better traffic pattern there.

Thank you.

Thank you. That will conclude our Coach Earnings Conference Call. It is now 9:31, and the markets are open. Thanks, everyone, and have a great day.

Thank you. This does conclude the Coach earnings conference. We thank you for your participation.