Tech Investment Research Group

Analysis of Coach Inc.

Tech Investment Research Group April 28, 2005
Chris Cotten Cotten16@yahoo.com Jordan Butts Heather Stevens Ryan Kosarak Matt March

Tech Investment Research Group

Table of Contents
Executive Summary Company & Industry Overview Five Forces Model Key Success Factors Competitive Strategy Analysis Accounting Analysis Financial Ratio Analysis Forecasting Methods Valuations Method of Comparables Discounted Cash Flows Residual Income Model Abnormal Earnings Growth Results of Valuations Altmans Z-Score Final Thoughts on Coach Appendix Resources 2 5 6 9 12 14 23 33 36 38 39 40 41 42 43 44 45 58

Tech Investment Research Group

Coach Executive Summary

Investment Recommendation : Buy Date of Valuation : April 1, 2005

Exchange: NYSE
Price Per Share 52 Week Price Range Revenue (2004) Market Cap Shares Outstanding Dividend Yield 3m Avg Trading Volume % Institutional Ownership BVPS ROE ROA Est. 5 year EPS Growth

Symbol: COH
$55.58 $35.98 - $59.96 1.53B 10.45B 189,600,000 NA 2,459,000 42.67% 5.17 42.61% 32.49% 19.50%

EPS Forecast
FYE EPS 2004(A) $1.42 2005 $1.96 2006 $2.03 2007 $2.20

Valuation Ratio Comparison

Trailing P/E Forward P/E Forward PEG P/B Coach Industry 32.95 15.42 24.41 14.94 1.31 1.32 10.77 2.54

Valuation Estimates
Actual Price (April 1, 2005) Ratio Based Valuations P/E Trailing P/E Forward M/B PEG Forward Ford Epic Valuation $25.91 $33.77 $13.15 $48.15 $54.05 $55.58

Cost of Capital Estimations

Beta Ke Estimate Beta Since Oct 04 3 Year Beta 2 Year Beta Published Beta Kd WACC BT 1.23 0.0958 0.0493 1.3 R^2 17.32% 9.02% 0.02% Ke 7.00% 7.00% 3.57% 3.41%

Intrinsic Valuations
Discounted Cash Flows Residual Income Abnormal earnings Growth Long Run Residual Income $60.56 $63.78 $63.03 $55.76

3.27% 6.11%

Tech Investment Research Group

Executive Summary
Recommendation: BUY
Tech Investment Research Group is announcing their coverage of Coach Inc. After reviewing all aspects of the firm we have decided to give Coach a BUY rating with high future predictability and a price target of $64 at year end.

Industry Success
Coach is in the Luxury apparel and accessories industry and considers themselves a small company with large scales. The apparel and accessories industry has seen weak returns over the industry as a whole. Coach however has experienced extreme success over the past several years and seems to have found a niche in the highly competitive market. Coach has recorded very high profit margins and has emerged as a leader in the industry. Coach has achieved these results by selling high end quality products and establishing a well respected and solid brand image.

Marketing Strategy
Much of Coachs success comes from their successful marketing strategy. Coach has been able to avoid becoming the trendy one hit wonder company by carefully marketing their products. One thing that Coach deliberately does not do is market to teenagers or younger people. Coach feels that if they advertise to this group they endanger themselves of becoming the trendy or one hot item for a season and they fear that if they market to younger consumers they could begin to lose their large and loyal older customer base. 4

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Financial Position & Growth

Coachs current financial position is very strong and the company still has room for further growth. Coach is currently accumulating a sizeable cash base which they plan to reinvest into the company. Coach also has very little debt on their balance sheet and almost no long-term debt. As a result of this Coach has a very favorable current ratio of over 3 and a low debt to equity. Coach also has industry leading profit and selling margins. Coach has also been expanding their business in Japan where they have seen increasing success. Currently Japan accounts for about 20% of all of Coachs business.

Valuations
Coachs common stock is currently trading at about $56 and has traded as high as $59 over the past 12 months. Coachs fiscal year ends on the Saturday closest to June 30 and for fiscal year 2005 we estimate EPS of $1.93 and EPS of $2.06 for 2006.

Investment Risks
Although Coach is currently performing very well for their market, there are some risks for investing in stocks in the apparel and accessories industry. Since this industry is known to follow trends one must pay close attention to current news for the industry and the individual stocks. We currently believe that Coach provides a great buying opportunity but this could come to an end if Coach is not able to keep up with changing trends in the market or they could be hurt by emerging competitors. However, Coach is showing that they can be dominant in this type of market.

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Company & Industry Overview

Company Profile
Coach, Inc. is a leading designer, producer and marketer of classic leather goods, accessories and furniture which was a spin off of Sara Lee in the mid 1980s These products include handbags, mens and womens accessories, business cases, leather outerwear, gloves, scarves, travel accessories, and personal planning products. Coach also sells home and office furniture, footwear and watches with its licensing partners. The products are sold through direct mail catalogs, on-line store, e-commerce websites, 174 retail stores and its 76 factory stores. Coach focuses on continuous improvements and anticipating the needs of consumers lifestyles to maintain its stronghold of the market. Key success factors for Coach as a manufacturer include product quality as well as marketing and design. Coach has an exceptionally large and loyal customer base mostly due in part to product quality. Coach takes great pride in using skilled employees, quality natural materials, exceptional leathers, and only the finest hardware. Through the years Coach has earned a reputation for producing a product that is known for its durability, craftsmanship, and incomparable product quality. In 2004 Coach added 19 new stores alone. Coach has become one of the most well recognized brands in the United States and is rapidly gaining recognition internationally, especially in Japan.

Tech Investment Research Group

Industry Profile
The Apparel and Accessories Industry is very competitive because companies must find a way to constantly year after year capture market share in a market that is constantly changing to fit consumers taste. Many of the companys that enter this market fail because they come out with a very popular style for their product on year then they rapidly expand only to have their product fall quickly out of style. The ability to keep up with changes in fashion trends and find a niche in the market usually determines which companies can survive in this highly competitive market.

Five Forces Model

Competitive Force 1: Current Competitors
Currently there are very few competitors for Coach and no major competitors of their size. Coach currently has a market cap of $10.6B or just over 22% of the entire Apparel and Accessories Industry. Coach has done an excellent job of establishing their brand to consumers. This has enabled Coach to constantly attract new customers while retaining current customers year after year. Also, unlike its competitors has been able to drive their sales on rising prices which says that consumers are generally not concerned with the price of their products but more on product quality. This is why some of the lower priced brands like Dooney & Bourke have had little effect on Coach as a direct competitor. Coach has recently decided to keep their current prices ($229 average handbag price) after high-priced competitor Louie Vuitton raised prices 5%.

Tech Investment Research Group This increases the spread between Coach and their competitors which gives Coach more range in the affordable luxury segment.

Competitive Force 2: Threat of New Entrants

New entrants into the Apparel/Accessories industry pose an average risk to a company like Coach. Since brand image in this industry is very important, companies that have established themselves as leading brand have a distinct advantage over new companies. Coach has an even better advantage over new entrants into the affordable luxury because of the higher price range. This is true because when making expensive purchases people tend to stay with what they know and trust and are less likely to purchase a product they are unfamiliar with. Coach also has been able to hold off new entrants because of their marketing strategy. Coach markets to older consumers and deliberately does not market to younger consumers because when this happens the older customers will start moving away from the product if they believe that the brand has become too trendy to young people. Coach also avoids having the one hot item or trying to figure out the new trend for teens which is what many new entrants attempt to provide only to have the product fall out of favor the next year. By keeping their strategy of a constant line of quality products marketed to their more mature core group of customers we believe that Coach will remain popular and will also continue to strive in their market and separate themselves from new entrants.

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Competitive Force 3: Threat of Substitute Products

The threat of substitute products to a company such as Coach is relatively high depending on how you look at the situation at Coach. There are two types of substitute products that could pose a threat to the company: alternant brands and counterfeits. As stated earlier, brand name and product quality are what drive sales in the Apparel/Accessories industry which is why currently Coach is not threatened by other brand names. However, a few quarters of lousy product offerings or poor quality products can drive down the brand equity that Coach has created and alternant brands could benefit which would cause problems for the company. The second substitute product that could cause a problem for Coach is counterfeit products. Coach works very hard to minimize the amount of counterfeits in the market place by prosecuting individuals that make the products and they also provide an online form so customers can report counterfeits if they are found. These products are usually of poor quality and are manufactured in a way that violates decent labor standards such as child labor. Coach is very adamant about stopping counterfeiting because they can reduce sales and brand equity that in turn are detrimental to the company.

Competitive Force 4: Bargaining Power of Buyers

The effect of Coachs customers bargaining power on the company is relatively low. Their price sensitivity is low due to the fact that their customers buy specifically their products because of the brand image that Coach possesses, the quality of the products and the popular styling of the products. This has been proven to be true in the past because of Coachs 9

Tech Investment Research Group ability to increase sales and customer base while raising prices at the same time; something that hardly any of their competitors have been able to accomplish. Coachs customers also have a low relative bargaining power because they offer many different products at different prices to a very large, expanding customer base whose purchase volume is usually very small. Coach customers do have a few choices when it comes to alternative products but Coachs popularity and continued success keep the customers loyal to their products.

Competitive Force 5: Bargaining Power of Suppliers

A very big positive advantage for Coach is that not only do their customers have minimal bargaining power but their suppliers also have limited power at the negotiating table. Coachs main material used in manufacture is leather, which can be bought from many different suppliers around the world which gives the company options when purchasing raw materials. Coach also buys manufactured products independently from different countries including China, Costa Rica, Mexico, India, Italy, Spain, Hungary and Turkey. Because of the large amount of goods Coach buys from different suppliers they have the ability to negotiate prices with several different suppliers.

Key Success Factors

Brand Image
The coach brand is one of the most recognized handbag and accessory brands in the World. Coach is committed to leading the fine accessories market by designing and producing the finest quality of accessories including 10

Tech Investment Research Group handbags, luggage, travel accessories, wallets, outerwear, eyewear, gloves, scarves, and fine jewelry for both men and women. Using a multi-channel distribution strategy Coach is presently able to have 200 stores in the United States alone with locations in eighteen countries outside the United States, as well as a full colored catalogue and an online store at www.coach.com.

Distribution
Coach currently uses a multi-channel distribution strategy. The products are sold through direct mail catalogs, on-line store, e-commerce websites, 200 retail stores and its 76 factory stores. The catalog has had increasingly popularity and has been an important advertising and sales tool for Coach, both domestically and abroad. In addition, Coach launched its online store at www.coach.com. Coach has also spread to various retailers and departments stores to increase sales. To improve and market the brand, boutiques have been set up in the department stores. Through this distribution strategy and advertising campaign Coach has become one of the most well recognized brands in the United States and is rapidly gaining recognition internationally, especially in Japan.

Foreign Markets
Coach is, Americas number one accessible luxury accessories brand, and the fastest growing imported handbag and accessory brand in Japan. Without marketing and design it would not be possible for Coach to receive such distinguished titles. In 2004 marketing and design costs reached 63.5 11

Tech Investment Research Group million. As a result Coach was able to penetrate new markets such as Japan and strengthen there position in existing ones. Coach recently announced the next phase of its growth strategy Japan. It involves capitalization on the significant growth opportunity that exists with the domestic Japanese consumers. The company expects sales to more than double during the next four years to over 80 billion yen by 2009. Furthermore, Coach announced that it is strengthening its leadership team at Coach Japan, or CJI, later this spring. Coach will also add two executives who will be responsible for all Coach retail and factory store strategy and operations. In addition, CJI will shortly be announcing the appointment of its first Executive Vice President and Chief Operating Officer, a new position for the company. The Chief Operating Officer will spearhead logistics initiatives as well as oversee administrative, finance and information technology functions.

Product Lines & Expansion

Coach, Inc. has consistently fashioned their product line to coexist with the newest styles and seasons. This Spring Coach is introducing a new scribble line that consists of a poly cotton material and bright colors. These new products were tested at fifteen stores and were enormously well received, says CEO Lew Frankfort. Coach Inc. is expecting to increase sales in February thanks to the new scribble line and Valentines Day. In an effort to keep up with the broadening competition Coach, Inc. has is planning to add up to nine more stores in the United States along with two more in Japan. Coach Inc. sales have been helped by the recent innovative accessories such as the PDA leather holder. 12

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Competitive Strategy Analysis

The retail industry is prone to constant changing market trends and consumer preferences. When selling an existing product to a new market creativity is the most important factor. That is why in April 2004 Coach hired a new designer to spruce up its image with fun designs so Coach could continue to compete in the fast pace industry. Coach piloted each new style in a select retail store to develop feedback on the new designs. Then, before the styles were launched they evaluated each ones success in the different stores and made changes based on the extensive evaluations. Coachs revamped image was a success and doubled their sales in a market with slow growth opportunities. Impartial customer feedback is the key to spotting changes in trends before competition. Coach conducts over 10,000 customer interviews a year, and their extensive study and use of the information gained from the customer feedback is the reason why Coach was able to gain market share and change their image. Back in 2000 Coach selected digital Impact, an internet direct marketing (emarketing) firm, to conduct their business services in order to better communicate with customers. Digital Impact helped Coach gain a better competitive advantage through mass personalization and conforming to the unique individual interests of its customers. Brand identification is another important success factor for Coach. Coach originally had a market advantage due to the high demand for the few classic styles of handbags they offered. However, as the market evolved and 13

Tech Investment Research Group Coach expanded from handbags to a full life style brand. Coach still continues to embody the original principles of there classic design in each added shape, style and material. The traditional hangtag on the side of Coachs handbags represents the original style and is distinct and recognizable to Coachs craftsmanship. Coach is the leading retailer of premier leather goods for both men and women in the United States. Even though Coachs products are expensive and its competitors are Gucci, Louis Vuitton, Fendi, and many other prestigious designers, Coachs brand is well know and distinguishable by its exceptional quality and classic American style. A solid emarketing strategy and brand loyalty has given Coach an upper-hand in the hyper competitive retail environment.

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Accounting Analysis
In order to gain an understanding of Coach we must first analyze their overall accounting quality. This includes several different types of qualitative and quantitative measures and indicators. These measures consist of examining key policies, accounting flexibility, accounting strategy, potential red flags and several sales and expense manipulation diagnostics.

1. Key Accounting Policies

The fiscal year for Coach Inc. ends on the Saturday nearest to June 30th of each year instead of the normal Dec, 31st. This is done in part because a large majority of Coachs business comes during the closing months of the calendar year. The fiscal year ending on July 3, 2004 was a 53 week year while fiscal years 2003 and 2002 were normal 52 week periods. The extra week of operations in 2004 provided for an additional $19.5 million in sales. Coachs inventories which consist of mainly finished products are valued using two different methods. All U.S. inventories are valued using the lower of cost or market (determined by FIFO), while all Japanese inventories are valued by using the lower of cost or market (determined by LIFO) method. At the conclusion of fiscal 2004, LIFO inventories were $2,409 higher and 2003 LIFO inventories were $650 higher that if they were valued using the FIFO method. LIFO inventory totals for the two years were $34,508 and $23,484 respectively. Coach also reevaluates its inventories quarterly based on changes in product demand resulting from changes in consumer purchasing habits which could affect older merchandise that may have gone out of favor. 15

Tech Investment Research Group At the beginning of fiscal 2002 the Coach adopted SFAS No.144 Accounting for the Impairment or Disposal of Long-Lived Assets. According to this rule, Coach examines the carrying value of all its long-lived assets for possible impairment depending on forecasted profitability and cash flows from the related business. In 2003 and 2004 Coach recorded no impairment losses but did write down some assets during their reorganizing in 2002. Coach records all sales at the point when the goods are delivered to the consumer or shipped to the wholesaler. Coach estimates which percentage of these sales will be discounts, returns or considered uncollectible based on extensive historical patterns and current trends in the marketplace. Coach also collects royalties from several different sources consisting of license agreements from other companies that produce goods that contain the Coach brand name.

2. Assess the Degree of Potential Accounting Flexibility

Since Coach is an apparel/accessories company there are a few areas under GAAP where they can decide between several different accounting policies to implement. Coach states that two main areas where they have the greatest flexibility are accounting for inventories and stock options. There are two methods that can be used when accounting for stock options: the intrinsic value method and the fair value method. Coach has adopted the intrinsic value method in their accounting for stock options. Under this policy there are no compensation costs for stock options and replacement stock options issued under the employee stock purchase plan. However, under the fair value method, the costs that are charged against 16

Tech Investment Research Group income for amortization of restricted stock units can make quite a difference towards net income. Coach also has the ability to choose which inventory method they would like to use when estimating inventories. Coach has chosen in the U.S. to use the FIFO method that tends to provide a more conservative estimate of actual inventories. In their Japanese operations they have decided to use the LIFO method of estimating inventory which tends to puff up or provide a more aggressive estimate of inventory value.

3. Evaluate Actual Accounting Strategy

Coach and other companies in their industry tend to have a similar accounting strategy. Coach spends a large amount of money on selling, design costs and marketing which account for about 35% of net sales. Coach also manages their inventory very efficiently by reevaluating their aging products each quarter in case they need to write down inventories that have become obsolete. Coach incurred some reorganization costs in 2002 when they closed their Lares, Puerto Rico manufacturing facility. Coach closed this facility and terminated 394 jobs and sold off all of their fixed assets at the facility. Coach closed the facility to take advantage of lower cost third party manufactures and recorded reorganization costs of $3,373 for the 2002 fiscal year. This cost included $2,229 for worker separation costs, $659 for lease terminations and $485 for the write-down of long lived assets to net realizable value. Coach has many leases that are for their retail, distribution and office locations. Many of these leases offer renewal options and are depreciated 17

Tech Investment Research Group over a straight line basis. Currently Sara Lee is a guarantor on many of Coachs current leases throughout the United States. Coach has begun to make efforts to remove Sara Lee from all of their leases. All of Coachs new or renewed leases are independent from Sara Lee and Coach has obtained a letter of credit equal to Sara Lees minimum obligation and must maintain this letter of credit until minimum payments are less than $2 million dollars annually which should be for about ten more years. Coachs facilities in Japan are leased and the leases include covenants that Coach must comply with and is something that they have done since the beginning of the leases. As mentioned earlier, Coach uses the intrinsic method of valuing employee stock based compensations which include no compensation costs. Coach does a sufficient job of noting the possible change in EPS data if they would have used the fair value method.

4. Evaluation of the Quality of Disclosure

Coach is superior in the way they disclose financial information to investors. The details included go far beyond the requirements for GAAP. The large additional amounts of information describe all aspects of Coachs accounting quality and clearly portray the nature of their business activities to the public. Coach includes a section in its disclosure that lists the financial highlights for the year. It is a clear comparison of financial data that shows the increase/decrease from the previous years allowing investors to gain an overall grasp of the years success. In Coachs letter to their shareholders many important elements are discussed such as sales and the percentage increase in gross margin. It also 18

Tech Investment Research Group includes supplementary information on the selling, general and administrative expenses. Coach informs its investors with reasons why the corporation was successful in comparison to previous years. Overall the letter lists the accomplishments for the year and expresses extreme confidence for the years to come. Coach also incorporates a section of specific selected financial data. Similar to its segment of financial highlights, this part however, includes additional historical data collected from the audited consolidated financial statements over a five year period. The management discussion and analysis gives an exceedingly in depth summary of Coachs financial condition and results of their operations. It incorporates how its revenues are generated, where the costs come from, the factors that caused its gross margin to fluctuate and added information from past years. The analysis also mentions the four categories of Coach are selling general and administrative expenses: selling and advertising; marketing and design; distribution and customer service; administrative and information services. This section moreover includes a discussion of the operating income and net income in addition to a description of the main factors driving net sales. Coach also lists the consolidated statements of income for the previous three years. Coach includes notes to the consolidated financial statements with 21 components describing accounting policies, specific account activities, and reasons for their balances.

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Tech Investment Research Group Lastly, Coach includes a segment containing information for stockholders. This section provides general information on owning stock is an excellent resource of its market divided history. Coach is extremely informative in its methods of disclosure to the public. Although the many segments are very long and in-depth the quality of information displayed is accurate and key to understanding Coachs business activities and future expectations.

5. Potential Red Flags

Coachs financial statements do not reflect many suspect practices. There was one related party transaction in the past year that could raise a red flag but the loan was settled and properly disclosed in the notes to financial statements. Another interesting item we found was the increasingly large gap between income and cash flows from operations. This probably is not that suspect since the income has been steadily increasing and it had quite a significant jump last year. Overall, the company does not put up very many red flags. Most of their accounting and reporting practices are standard and do not raise suspicion.

6. Quantitative Measures & Indicators: Explanation

To effectively analyze Coach, quantitative measures and indicators must be analyzed. By working out several diagnostics on the companys financial reports, it is possible to see if they have any flaws in their accounting. The sales manipulation diagnostics show the behavior of the sales relative to the cash from sales, inventory, and accounts receivable. The

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Tech Investment Research Group core expense manipulation diagnostics show the earnings relative to expenses.

Sales Manipulation Diagnostics

Year Net Sales / Accounts Receivable Net Sales / Inventory Net Sales / Cash From Sales
Note: There is insignificant information on Coachs financial statements for other ratios.

2004 23.70

2003 26.874

2002 23.2628

2001 29.1387

2000 34.5406

8.159 1.044

6.6285 1.0386

5.2741 1.045

5.7102 1.0355

5.2665 1.0298

The Net Sales / Accounts Receivable is steadily getting smaller, indicating that people are not buying on a cash basis, or that Coach is not collecting on their accounts receivable as quickly. However, since the numbers are still relatively high, Coach shows few bad debts and more money currently in the budget. The Net Sales / Inventory is steadily increasing, with the exception of 2002. The relatively low numbers indicate that Coach is holding a big inventory. However, the rising numbers could be a result of questionable accounting but after reviewing the statements we believe that this only shows

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Tech Investment Research Group efficiency and a lack of over-anticipating sales which also indicates that sales are growing faster than inventory. The Net Sales / Cash From Sales would ideally be equal to one, which Coach is very close to currently and has remained steady over the past five years. This means that there is little to account for in terms of bad debt.

Core Expense Manipulation Diagnostics

Year Asset Turnover Changes in CFFO/OI 2004 2003 2002 2001 2000

1.2843 1.543 1.6329 2.3205 1.8125 1.0009 .9092 .8077 .3817 .4531 1.2226 1.5166 .4189 .5790

Accruals / Change in Sales .5696

Note: There is insignificant information available on Coachs financial statements to determine a value for net operating assets, pension expenses, or other employment expenses

Asset Turnover has fairly high numbers which is favorable. However, the ratios have been decreasing indicating that Coach has a large amount of money tied up in assets. This could be a potential problem but most of the money is invested into short term securities that are very liquid. Changes in CFFO / OI declined from 2000 to 2002 and then steadily began to steadily increase after completing their restructuring at the end of 2002. This indicates an increase in cash flow from operations. Total Accruals / Change in Sales is another that has varied over the past five years. This ratio shows the number of sales made without the exchange of 22

Tech Investment Research Group inventory and the change in total sales. Coach remains well below 1.0, indicating quick recognition of sales and related expenses. After examining all of Coachs accounting methods we feel very confident about the quality of Coachs accounting practices. Coach does a very good job of explaining which policies they use and disclose the differences if other accounting methods were employed. Coach also minimizes potential red flags and also performs well when analyzed using sales and core expense manipulation diagnostics.

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FINANCIAL RATIO ANALYSIS

In order to properly evaluate a firms financial condition and forecast future performance you have to first gain and understanding of the firms past financial performance. In this section we will analyze sever key ratios. These ratios help examine the firms liquidity, profitability, and capital structure. We will then use these ratios to compare Coach to its competitors in their industry. We will also forecast Coachs future performance in the market place.

Liquidity Analysis
The liquidity ratios make it easier to understand how well a company meets its current liabilities by analyzing the ability to maintain enough cash on hand to meet their upcoming debts. The results for Coach have been improving over the past several years and have become a very liquid company. Coach has been able recently to build up their current assets while keeping liabilities at a minimum.

Profitability Analysis
The profitability ratios show how well a company manages its net sales to convert them into profits. Coach has increased profitability dramatically over the past several years. Coach has been constantly increasing their gross profit and net profit margins while achieving a declining operating expense ratio which is very positive.

Capital Structure Analysis

The capital structure ratios tell how the firm is financing its operations. Coachs debt to equity ratio has been gradually declining since their 24

Tech Investment Research Group restructuring in 2001. Coach is currently comprised of about 75% equity with most of their debt being short term liabilities. One main reason that Coach has very little long-term liabilities is because they use operating leases for most of their store locations.

Industry Competitors
Coachs main competitors such as Dooney & Bourke, Gucci, Louie Vitton, and Prada are either privately held or they are traded in foreign markets. Since we cant find a direct competitor we have decided to compare Coach to retailers Ralph Lauren and Liz Claiborne because like Coach, they offer a more expensive and higher quality product line. Coachs ratios compared to that of its competitors are very favorable at the moment as they have greater liquidity and high selling and profit margins. Even though Coach is doing very well in the mean time it is expected that their growth will level off and become more stable. However, if their growth levels off this does not necessarily mean that Coach will become less efficient at handling their business.

Curre nt Ratio 5.00 4.00 CR 3.00 2.00 1.00 0.00 2000 2001 2002 YEAR 2003 2004 Coach Liz Claiborne Ralph Lauren Industry

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Tech Investment Research Group The current ratio of a firm is its ability to cover its current liabilities using cash flows from its current assets. Coachs current ratio has previously been lower than its competition. However, since the middle of 2002 it has exceeded the competitions and industrys current ratio. Since the current ratio is well over one, Coach can proficiently cover its current liabilities from the cash gained from its current assets. Having their assets liquid makes it easier to pay off current liabilities.

Quick Ratio
3.00 2.50 2.00 QR 1.50 1.00 0.50 0.00 2000 2001 2002 YEAR 2003 2004 Coach Liz Claiborne Ralph Lauren Industry

The quick asset ratio examines only highly liquid assets as a percentage of current liabilities. Coachs quick asset ratio has exceeded the industry average since 2002. The quick asset ratio is important because it shows how much of Coachs current liabilities can be covered by their quick assets: cash, accounts receivables, and securities. This solidifies the assumption that coach can effectively pay off its current liabilities and get cash in case of an emergency.

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Accounts Recieveable Turnover
40.00 35.00 30.00 25.00 20.00 15.00 10.00 5.00 0.00 2000 2001 2002 Year 2003 2004

AR Turnover

Coach Liz Claibourne Ralph Lauren Industry

Over the past five years Coachs accounts receivable turnover ratio has been above the industry average considerably. This means they are collecting their accounts receivable faster than their competitors and industry, which allows them to reinvest that money more efficiently.

Days Supply of Recieveables 70.00 60.00 Days Supply 50.00 40.00 30.00 20.00 10.00 0.00 2000 2001 2002 Year 2003 2004 Coach Liz Claibourne Ralph Lauren Industry

Coach has maintained well below the industry average in days to receivable.

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Inventory Turnover
6.00 Inventory Turnover 5.00 4.00 3.00 2.00 1.00 0.00 2000 2001 2002 YEAR 2003 2004 Coach Liz Claiborne Ralph Lauren Industry

Inventory turnover is a useful ratio in analyzing a firms capital management. This ratio shows how many days it takes for inventory to complete a cycle, from buying inventory until it leaves the balance sheet. This below average ratio can be attributed to high acquisitions of assets leaving inventory very large.

Days Supply of Inventory

250.00 200.00 Coach Days 150.00 100.00 50.00 0.00 2000 2001 2002 YEAR 2003 2004 Liz Claiborne Ralph Lauren Industry

Days supply of inventory is determined by the days in a yearly cycle (365) over the inventory turnover. Since Coachs inventory turnover is lower than

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Tech Investment Research Group the industry average it is no surprise that their days supply of inventory is higher than the industry average.

Working Capital Turnover

9.00 8.00 7.00 6.00 5.00 4.00 3.00 2.00 1.00 0.00 2000 2001 2002 YEAR 2003 2004 Working Capital Turnover

Coach Liz Claiborne Ralph Lauren Industry

Working capital turnover is calculated by dividing sales by working capital. Coachs working capital average has stayed below the industry and their competition for the past five years.

Gross Profit Margin

80.00% Gross Profit Margin 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% 2000 2001 2002 YEAR 2003 2004

Coach Liz Claiborne Ralph Lauren Industry

Gross profit margin is determined by two key factors: the price premium that a firms product or service command in the marketplace, the efficiency of a 29

Tech Investment Research Group firms procurement and production process. Coachs gross profit margin has steady climbed above and beyond the competitors and industrys average. This means the company is turning nearly 80% of its sales into gross profit. The steady increase can be attributed to reducing their cost of goods sold in relation to their revenue. By having a good profit margin, Coach has been able to re-invest back into the company to generate future revenues.

Operating Expense Ratio

60.00% 50.00% O E Ratio 40.00% 30.00% 20.00% 10.00% 0.00% 2000 2001 2002 YEAR 2003 2004 Coach Liz Claiborne Ralph Lauren Industry

Coach is considerably above the industry average, as well as their main competitors. This suggests that Coach is not effectively managing its selling, general, and administrative expenses. This ratio shows how much their operating expenses are diluting the great sales that they have put together. Future focus should be directed towards spending less on selling, general, and administrative expenses in generating each sales dollar.

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Net Profit Margin
25.00% Net Profit Margin 20.00% 15.00% 10.00% 5.00% 0.00% 2000 2001 2002 YEAR 2003 2004 Coach Liz Claiborne Ralph Lauren Industry

Coachs net profit margin has completely destroyed its competition. This ratio show that their sales are generating more net income, which leads to the assumption that less expenses are being used in comparison to sales.

Asset Turnover
3.50 3.00 Asset Turnover 2.50 2.00 1.50 1.00 0.50 0.00 2000 2001 2002 YEAR 2003 2004 Coach Liz Claiborne Ralph Lauren Industry

Asset turnover show how well a company is turning over their assets in relation to their sales. Inventory management, allocation of goodwill, accounts receivable policies, and investment in PP&E are all crucial in 31

Tech Investment Research Group maintaining a desirable asset turnover ratio. Coach has been fairly good in all of these elements. However, Coach has continued to stay below the industry average since the beginning of 2002.

Return On Assets
30.00% Return On Assets 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% 2000 2001 2002 YEAR 2003 2004 Coach Liz Claiborne Ralph Lauren Industry

ROA is the largest measure of how much profit a firm is able to generate for each dollar of assets invested. Coach is well above the industrys average, displaying that it is able to generate a higher percentage of profit for each dollar invested in assets. Their ROA also shows that Coach is using its assets more efficiently than others in the industry.

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Re turn On Equity
50.00% Return On Equity 40.00% 30.00% 20.00% 10.00% 0.00% 2000 2001 2002 YEAR 2003 2004

Coach Liz Claiborne Ralph Lauren Industry

Return on equity ratio is the overall measure of profitability in any firm. This ratio gives you the return for the owners of the company, the shareholders, as a part of net income. Coachs investors are receiving a higher return on their investment in the company than its competition and the industry. Their return of equity shows how effectively they are using funds to generate funds. Their return on equity ratio has consistently beaten its competitors, making it more intriguing to investors.

Debt to Equity
1.20 Debt to Equity 1.00 0.80 0.60 0.40 0.20 0.00 2000 2001 2002 YEAR 2003 2004

Coach Liz Claiborne Ralph Lauren Industry

33

Tech Investment Research Group The Debt to Equity illustrates how much debt a company is carrying compared to its equity. Since This dropping percentage shows that Coach has a low credit risk. This gives Coach opportunities to finance other activities instead of worrying about how they are going to pay off their debt. However, a low debt to equity ratio can lead to a low sustainable growth rate.

Forecasting Methods
We have also forecast what we believe will be an accurate estimate of Coachs future market performance over the next ten years. We have forecasted the balance sheet, income statement, and the statement of cash flows. On our statements we had to be careful about forecasting with the use of the past financial ratios because of the rapid growth that Coach has experienced over the last several years. On the sales forecast we have started our estimated future sales growth at 20% and gradually lowered it down to about 8%, which is much lower than the near 40% sales growth that Coach has experienced over the past several years. Coach is currently enjoying a gross margin of 76% and a net profit margin of 22%. We have forecasted that these ratios will lower to about 60% and 14% over the next ten years as the company becomes more settled in the market and their growth levels off. We have also noticed that with Coachs sales reaching over a billion dollars in sales last year that their business growth will have to level off in the near future because these growth rates are near impossible to maintain over a long period of time. This is in agreement with most financial analysts but we do not think that Coachs business will slow faster than we have estimated over the next two years. We have placed our estimates higher than 34

Tech Investment Research Group most analysts because of Coachs history of beating estimates. Coach has out preformed analyst estimates over the past ten quarters. Coach also has a current ROE of about 33% which we have lowered to around 22%. Recently Coach has been investing heavily into short and long term assets while they are also beginning to accumulate a rather large sum of cash and many analysts are interested to see what the company will do with the money. There are several different possibilities for Coach. The most obvious would be for Coach to begin issuing a cash dividend since that is what their parent company Sara Lee did but this is currently impossible since Coachs revolving credit facility currently prohibits the company from issuing dividends. In 2001 the board of directors authorized a stock repurchase program to buy back $80 million of the companys common stock. In 2003 the board authorized an additional $100 million towards the program that expires in 2006. At the end of 2004 the share repurchase program had $65 million left in the program. Another interesting possibility is that just recently an article about Tiffany & Co. stated that they could possibly be bought out by another firm. Coach was main company mentioned in this article as a possible buyer of Tiffany & Co. which has experienced some management and internal problems as of late. We believe that this could be a potentially good move for Coach since Tiffany is in the same industry as Coach and Coach has shown strong performance as a leading retailer. We believe that Coach will continue their strong performance in the market and that the prospects look good for the retailer. Coachs stock is currently trading a little high but we believe that due to their strong profit

35

Tech Investment Research Group margins and accumulating cash pile and possibilities for expansion the stock will continue to trade higher and see increasing profits.

Valuation of Coach
Valuation Models
In essence our entire report over Coach Bags has been to analyze the companys financial statements and to make predictions of future earnings based on the historical and forecasted data used to predict the firms overall value. We have tried to stay true and honest in our predictions because in reality so much decision making in corporations relies on what the predictions say. The purpose of this section of the report is to convert the forecast predictions into an estimate of the value of our companys stock. We will then 36

Tech Investment Research Group compare our calculation of the intrinsic value of the stock to the market price of the stock to see if it is overvalued or undervalued. To make a precise valuation of Coach our valuation models took into account two different time horizons. We have forecasted financial information over a restricted period of ten years and then considered the terminal value by making estimates of the firm to infinity. Once these forecasts were made, we estimated the cost of capital to use as a discount rate for the two different forecasts. To ensure our estimated value of Coach was precise and free from error we used many different approaches in the valuation process. This also allowed us to consider all the external factors that negatively affect forecasted data. To apply the various models, we forecasted financial data based on irregular earnings and book value, in addition to free cash flows. These particular forecasts were made for a time period that spans the life of the firm. The non-intrinsic method we used was the Method of Comparables. While the more intrinsic methods include the Discounted Dividends Model, Discounted Residual Income, Discounted Free Cash Flows, Long-Term Residual Income Model, and the Abnormal Earnings Growth Model. The different models analyze information about Coach and give those analyzing the firm an idea about how it current market price relates to its estimated price derived from each of the different models. All preceding discounted models are discounted using the estimated weighted average cost of capital. When the models are complete, a sensitivity analysis will be used to test any discrepancies in our valuation results compared to the market value. The sensitivity analysis should compare our assumptions made in our valuation 37

Tech Investment Research Group and the assumptions made by the market and analysts. Depending on the level of confidence we have in our forecasts and assumptions about the future business strategy of the firm, we will determine how accurate the valuation model is. If there is great variation in our valuation of the price and the market price, we will further examine how the differences transpired. Next, we will vary the discount rate and growth rate to establish how changes in our estimates would affect the outcome of our valuation. Then after our predictions seem truthful and realistic, we will determine if the market value of our company is overvalued or undervalued. This decision is very important to analysts, both internal and external, to allow entities to determine the real value of Coach. After the valuation models are finished and the exactness of the estimated value has been considered and looked at more closely, the proper business strategy decisions can be made. In addition, the evaluation will give the firm and investors a competitive advantage in influencing the firm in the right direction for the future. However, the competitive advantage will only arise if the analysts can determine the basis for the difference in the market price and the estimated value. Since each model encompasses different financial data that is forecasted based on certain assumptions about business strategies, analysts must be cautious in determining what a realistic valuation of the company is.

Method of Comparables
The Method of Comparables is a non-intrinsic model that is the least reliable because it takes only the competitions information and neglects all 38

Tech Investment Research Group firm specific data. This method is especially insignificant to our project because Coach has outperformed its competition so much in almost every aspect. Coachs closest competition is Liz Claiborne, but more than one competitor is required for the Method of Comparables valuations. The Method of Comparables is not considered to be one of the most precise measures, which is seen by the range of values in the table. This range is caused by a lack of close competitors due to Coachs superior earnings. The price to earnings ratio most accurately estimates the actual price of Coachs shares. On the other hand, the price to book was the furthest off. The price to sales multiple depicts a much lower price than Coachs actual price. All the competitors have a lower price to sales multiple than Coach. This can be attributed to them paying out less compared to what they earned. There is no real intrinsic valuation to these ratios; therefore it fails to support the analysis.
Method Of Comparables Coach Liz Claibourne Ralph Lauren Tiffany & Co Industry (Excluding Coach) Coach Suggested Price Price 56.29 Price $56.29 $40.08 $38.32 $33.21 Trailing P/E 32.95 14.01 16.16 16.09 15.42 EPS 1.68 $25.91 Forward P/E 24.41 11.93 13.59 19.31 14.94 Forward EPS 2.26 $33.77 P/B 10.77 2.41 2.39 2.83 2.54 BPS 5.17 $13.15 P/S 7.17 0.95 1.24 2.2 1.46 Sales 7.848 $11.48

Discounted Cash Flow Model

This model uses the weighted average cost of capital (WACC) to estimate a share price for the firm based on a stream of free cash flows. This model seems like a fair representation of Coach given the results of the 39

Tech Investment Research Group industry comparables. The characteristic of the cash flows from operations and financing is to report these items when the cash moves around rather than when expenses actually occur or revenues are actually earned. For this method to reach the estimated share price of $60.56 we estimate that Coach will need a 3.5% future growth rate. We used a beta of 1.2397 to estimate the long term WACC of 6.11%, while the short term WACC was estimated at 3.45%. When computing the R-Squared, the beta over the long term better explains the long term cost of equity of 6.11%. This share price of $60.56 is about $4.00 over the current market price showing that Coach might be undervalued.
Sensitivity Analysis g 2.50% 3.50% $67.24 $106.10 $44.63 $60.56 $34.62 $42.28 $27.29 $31.73

WACC 5.00% 6.11% 7.00% 8.00%

4.00% 5.00% $154.67 NA $70.46 126.47 $48.03 68.14 $34.79 $43.95

Residual Income Model

The Residual Income Model is an accounting based model in which we use data from the past to help determine the values of the firm to see if the firm is overvalued or undervalued. The Residual Income Model uses the relationships between earnings per share and the cost of equity to find the residual income. The residual income is the amount of earnings left over after stock holders cost of equity is met. Next, we took the present value of the future cash flows and add them together to give us the total present value of residual income for the ten year forecast. Then we will compute a terminal

40

Tech Investment Research Group value for the Residual Income Model. To complete this we need to calculate a perpetuity that is discounted back to the present. Our Residual Income Valuation Model for Coach had a cost of equity of 6% and with a growth rate of 4% in residual income. We calculated a present value that is $63.78. The results show that Coach is about $9 undervalued at these rates and as the growth rate moves closer to 4.5% Coach could potentially be even more heavily undervalued.
Sensitivity Analysis g 0.035 0.04 0.045 0.05 NA NA $320.30 NA $97.99 $138.61 $260.49 NA $54.12 $63.78 $79.88 $112.08 $35.69 $39.25 $44.24 $51.71 $25.70 $27.26 $29.26 $31.92

Ke

0.04 0.05 0.06 0.07 0.08

Abnormal Earnings Growth Valuation

The Abnormal Earnings Growth Model calculates the book value of equity plus the present valued of expected future abnormal earnings. Abnormal earnings consists of expected not income less the normalized income multiplied by the discount rate. Therefore, it applies that if a firm has no difference in its expected net income and the normalized earnings, then the amount invested in the stock should not be more than the book value. Stock is overvalued or undervalued depending on whether a companys expected earnings is more or less than the normal income. A low value for abnormal earnings indicates that a firm shows negative future stock returns, while a high value for abnormal earnings indicates that a firm shows positive abnormal future stock returns.

41

Tech Investment Research Group In our calculation of Coachs AEG we found that there was an implied Ke of 7% and once again a growth rate of 4%. This provided us with a share price of $63.03 or about $7 dollars undervalued.
Sensitivity Analysis g 0.035 0.04 0.045 0.05 $231.87 NA NA NA $109.34 $78.40 $79.40 NA $82.11 $78.40 $79.40 $88.94 $72.04 $63.03 $56.03 $50.43 $60.07 $54.15 $49.95 $47.14

Ke

0.04 0.05 0.06 0.07 0.08

Results of Valuations
After performing each of the valuation models you can see that not all of the models provide a reasonable view of the firm. The method of comparables was very far off from the results of the other models. We can conclude that our initial estimate for Coachs Ke of 7% was relatively accurate since the implied Ke we found in our valuations was 7% or just a bit lower. We also found that our growth rate at this Ke is 3.5%-4% which we feel is appropriate for the Company. The DCF, DRI, and AEG models all seem to be performing fairly accurately since they all show that Coach is slightly undervalued. We have also noticed that there are other combinations of Ke and g that would show that company is even more undervalued. Many other analysts agree that the stock will continue to climb for some time as Coach has shown not shown any signs of slowing business. Currently we are confident that the stock is slightly undervalued but we believe that further price appreciation will continue due to Coachs ability to outperform their industry, maintain higher profit margins and grow their already accumulating amounts of cash and marketable securities. In addition 42

Tech Investment Research Group Coach has historically traded at about 34X earnings which would also support our findings. Coach also just released a report stating that they expect their Japanese sales to more than double over the next four years to over 80 billion yen or about 700 million U.S Dollars which gives us further evidence that the stock price will continue to appreciate.

Z-Score
Z-score=1.2[499,372/1028658]+1.4[430,461] +3.3[447,657/1,028,658] +0.6[782,286/246,372] +1.0[1,321,106/1,028,658] =7.058

After using Altmans Method for calculating the Z-Score for Coach, we found that Coach has a relatively high z-score of 7.058 (see figure above). Since a value greater than 2.7 is needed for a good credit rating, Coach demonstrates a high credit rating and reiterates the idea that coach can take on some debt and not operate with so much on cash on hand. Also, this high Z-Score indicates that Coach will not face potential trouble regarding bankruptcy in the future. Coachs high Z-Score can be attributed to its strong financial performance throughout the life of their company. In addition, the availability and cost of financing for Coach is definitely above the competition.

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Tech Investment Research Group

Final Thoughts on Coach

Although our valuation of Coach is for April 1, 2005, there have been recent developments that I believe should be noted and confirm some of the forecasting that we have done for Coach. Coach released their third quarter earnings on April 26, 2005 above analysts expectations for the 12th straight quarter. They announced EPS of $0.23 per share (adjusted for April 15th 2 for 1 stock split) and raised their estimate for the fourth quarter to $0.23. Coach also said that they expected sales for FY 2006 to pass $2 billion and EPS of over $1.13 which is over our forecasted estimates. This positive information could possibly raise our estimated share price even higher. Coach also announced that they will be buying the remaining 50% of their Japanese joint venture for $225 million. I see this as a positive move for the company because they have more than enough cash on hand for the purchase and the additional earnings from owning all of their Japanese operations will be shown in 2006 EPS. This is all positive news for a company that already has lots of momentum going in the right direction.

44

Tech Investment Research Group As stated earlier you need to be very careful when investing into this industry but Coach is beginning to show that they are going to be a company that is going to be around for a while. They have a very strong management team, they continue to build their brand image and were added to the S&P 500 in the past year and I believe that Coach will continue their success and be a good investment for at least the next several years.

Appendix
All of the information on forecasts and evaluations has been recorded in the Appendix. Previous and Forecasted Balance Sheets Previous and Forecasted Income Statements Common Sized Income Statements Previous and Forecasted Cash Flow Statements Ratio Analysis of Coach and Competitors Cost of Debt Calculation Computations of WACC & Beta Valuation Models 54 46 47 47 48 49 52 53

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Tech Investment Research Group

COACH FORECASTED BALANCE SHEET (IN THOUSANDS) Year 2000 2001 ASSETS Cash and cash equivalents $162 $3,691 Short-term investments $0 $72,388 Trade accounts receivable, less $15,567 $20,608 allowances of $5,456 and $6,095, respectively Inventories $102,097 $105,162 Deferred income taxes $8,996 $13,921 Prepaid expenses and other current assets $6,866 $8,185 Total current assets $133,688 $151,567 Property and equipment, net $65,184 $72,388 Long-term investments $15,809 $0 Deferred income taxes $18,189 $19,061 Goodwill $0 $4,924 Indefinite life intangibles $0 $9,389 Other noncurrent assets $63,783 $1,382 TOTAL NONCURRENT ASSETS $162,965 $107,144 Total assets $296,653 $258,711 LIABILITIES AND STOCKHOLDERS EQUITY Accounts payable $7,866 $14,313 Accrued liabilities $71,693 $82,390 Revolving credit facility $0 $7,700 Current portion of long-term debt $40 $45 Total current liabilities $79,599 $104,448 Deferred income taxes $0 $0 Long-term debt $3,735 $3,690 Other liabilities $511 $2,259 Minority interest, net of tax $0 $0 TOTAL NONCURRENT LIABILITIES $4,246 $5,949 Total liabilities $83,845 $110,397 Commitments and contingencies (Note 6) Stockholders equity Preferred stock: (authorized $0 $0 25,000,000 shares; $0.01 par value) none issued Common stock: (authorized $350 $874 500,000,000 shares; $0.01 par value) issued and outstanding - 189,618,201 and 183,009,256 shares, respectively Capital in excess of par value $0 $125,277 Retained earnings $212,753 $22,650 Accumulated other comprehensive income (loss) ($295) ($487) Unearned compensation $0 Total stockholders equity $212,808 $148,314 Total liabilities and stockholders equity 2002 2003 2004 $262,720 $171,723 $55,724 2005 $359,536 $257,585 $117,578 2006 $494,362 $378,649 $128,969 2007 $623,390 $526,777 $159,577 2008 $810,408 $684,810 $169,052 2009 2010 2011 2012 2013 2014

$93,962 $229,176 $90,589 $0 $30,925 $35,470

$976,622 $1,201,245 $1,445,699 $1,734,839 $2,047,109 $2,417,636 $797,803 $877,584 $921,463 $974,908 $1,023,653 $1,100,427 $203,329 $226,385 $242,232 $258,704 $275,520 $304,582

$136,404 $14,123 $12,174 $287,588 $90,589 $0 $25,031 $13,006 $9,389 $14,968 $152,983 $440,571

$143,807 $161,913 $205,180 $273,414 $335,113 $397,770 $486,465 $530,873 $593,469 $21,264 $34,521 $42,116 $52,645 $66,859 $80,230 $100,288 $125,360 $150,432 $18,821 $19,015 $23,769 $31,018 $40,944 $51,180 $66,534 $86,494 $108,118 $448,538 $705,616 $1,005,763 $1,359,057 $1,752,660 $2,193,450 $2,631,042 $3,047,942 $3,461,413 $118,547 $148,524 $175,258 $210,310 $238,050 $274,829 $305,060 $347,768 $386,023 $0 $130,000 $282,999 $396,199 $511,096 $592,872 $687,731 $795,017 $922,220 $9,112 $0 $13,009 $13,605 $14,421 $15,863 $16,657 $17,489 $18,364 $19,282 $20,246 $9,389 $9,788 $10,865 $12,060 $13,386 $14,859 $16,493 $18,308 $20,321 $19,057 $21,125 $24,505 $28,181 $32,408 $37,269 $42,859 $49,288 $56,682 $169,114 $323,042 $508,048 $662,613 $811,597 $937,318 $1,070,507 $1,229,663 $1,405,492 $617,652 $1,028,658 $1,513,812 $2,021,669 $2,564,257 $3,130,768 $3,701,549 $4,277,605 $4,866,904 $44,771 $135,353 $1,699 $115 $181,938 $15,791 $3,420 $5,025 $40,198 $64,434 $246,372 $0 $70,846 $209,705 $2,550 $283 $283,386 $19,183 $6,394 $4,796 $49,556 $79,929 $363,315 $94,614 $280,058 $3,406 $378 $378,456 $25,619 $8,540 $6,405 $66,181 $106,744 $485,201 $120,007 $355,221 $4,320 $480 $480,029 $32,494 $10,831 $8,124 $83,944 $135,393 $615,422 $146,520 $433,699 $5,275 $586 $586,080 $39,673 $13,224 $9,918 $102,489 $165,305 $751,384

$633,825 $662,437 $699,016 $180,518 $216,622 $259,946 $135,147 $168,934 $211,168 $3,917,941 $4,394,276 $4,992,775 $424,625 $462,841 $509,125 $1,060,553 $1,219,636 $1,414,777 $21,259 $22,321 $23,884 $22,557 $25,038 $28,293 $65,184 $74,961 $87,705 $1,594,177 $1,804,798 $2,063,784 $5,512,117 $6,199,073 $7,056,559

$25,819 $26,637 $99,365 $108,273 $34,169 $26,471 $75 $80 $159,428 $161,461 $0 $0 $3,615 $3,535 $2,625 $3,572 $14,547 $22,155 $20,787 $29,262 $180,215 $190,723 $0 $0

$173,233 $200,192 $227,771 $257,967 $290,117 $344,007 $512,768 $592,568 $674,202 $763,583 $858,745 $1,018,262 $6,236 $7,207 $8,200 $9,287 $10,444 $12,384 $693 $801 $911 $1,032 $1,160 $1,376 $692,930 $800,768 $911,084 $1,031,868 $1,160,466 $1,376,029 $46,906 $54,206 $61,673 $69,850 $78,555 $93,147 $15,635 $18,069 $20,558 $23,283 $26,185 $31,049 $11,727 $13,551 $15,418 $17,462 $19,639 $23,287 $121,174 $140,032 $159,323 $180,445 $202,933 $240,629 $195,442 $225,858 $256,973 $291,040 $327,311 $388,111 $888,372 $1,026,625 $1,168,057 $1,322,908 $1,487,778 $1,764,140

$895

$1,830

$1,896

$1,896

$1,896

$1,896

$1,896

$1,896

$1,896

$1,896

$1,896

$1,896

$1,896

$357,026 $357,026 $357,026 $357,026 $357,026 $357,026 $357,026 $357,026 $357,026 $357,026 $357,026 $430,461 $791,575 $1,177,547 $1,589,913 $2,020,462 $2,454,255 $2,892,058 $3,339,925 $3,830,287 $4,352,374 $4,933,497 $2,195 ($9,292) $782,286 $1,150,497 $1,536,469 $1,948,835 $2,379,384 $2,813,177 $3,250,980 $3,698,847 $4,189,209 $4,711,296 $5,292,419 $361,180 $385,983 $412,461 $430,534 $433,895 $437,776 $448,047 $490,109 $522,366 $582,578 $296,653 $258,711 $440,571 $617,652 $1,028,658 $1,513,812 $2,021,669 $2,564,257 $3,130,768 $3,701,549 $4,277,605 $4,866,904 $5,512,117 $6,199,073 $7,056,559

$155,403 $214,484 $105,509 $217,622 $215 ($1,359) ($1,666) ($5,648) $260,356 $426,929

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Tech Investment Research Group

PREVIOUS INCOME STATEMENTS YEAR Net sales Cost of sales Gross profit SG&A Reorganization costs OI Interest income Interest expense Net interest expense (income) EBIT Provision for income taxes Minority interest, net of tax Net income 2000 2001 2002 2003 2004 $331,024 $545,617 $0 $444,465 ($4,000) $808 ($3,192) $447,657 $167,866 $18,043 $261,748 FORECASTED INCOME STATEMENTS 2005 $414,464 $723,107 $0 $626,105 ($13,889) $889 ($13,000) $613,105 $232,980 $18,945 $361,180 2006 $546,828 2007 $670,225 2008 $811,451 2009 2010 2011 2012 2013 2014

$537,694 $600,491 $719,403 $953,226 $1,321,106 $1,763,677 $2,063,502 $2,393,662 $2,704,838 $2,948,273 $3,169,394 $3,391,251 $3,621,856 $3,857,277 $4,111,857 $220,085 $218,507 $236,041 $275,797 $317,609 $381,984 $483,362 $677,429 $261,592 $275,727 $346,354 $433,667 $0 ($33) $420 $387 $55,630 $17,027 $0 $38,603 $4,569 ($305) $2,563 $2,258 $35,400 $0 $64,030 $3,373 $0 $56,017 $101,688 $133,635 $243,762 ($825) ($1,754) $1,124 $299 $47,325 $184 $695 ($1,059) $90,585 $7,608 $972,930 $1,061,747 $1,186,938 $1,267,650 $1,350,047 $1,398,031 $990,082 $1,349,213 $1,516,674 $1,723,436 $1,893,386 $1,975,343 $2,107,647 $2,204,313 $2,354,207 $2,507,230 $2,713,826 $846,036 $1,005,338 $1,136,032 $1,208,792 $1,331,145 $1,407,369 $1,484,961 $1,581,484 $1,685,861 $0 $670,638 ($16,978) $978 ($16,000) $654,638 $248,762 $19,892 $385,983 $0 $718,099 ($20,225) $1,075 ($19,149) $698,949 $265,601 $20,887 $412,461 $0 $757,355 ($22,822) $1,183 ($21,639) $735,716 $283,251 $21,931 $430,534 $0 $766,551 ($24,887) $1,301 ($23,586) $742,965 $286,041 $23,028 $433,895 $0 $776,501 ($26,787) $1,431 ($25,355) $751,146 $289,191 $24,179 $437,776 $0 $796,944 ($28,705) $1,575 ($27,130) $769,814 $296,378 $25,388 $448,047 $0 $869,246 ($30,707) $1,732 ($28,975) $840,271 $323,504 $26,658 $490,109 $0 ($32,763) $1,905 ($30,858) $894,888 $344,532 $27,991 $522,366 $0 ($34,991) $2,096 ($32,895) $995,069 $383,102 $29,390 $582,578 $925,746 $1,027,964

$99,430 $133,336 $244,821

$85,827 $146,628

COMMON SIZED INCOME STATEMENTS YEAR 2000 2001 2002 2003 Net sales 100.00% 100.00% 100.00% 100.00% Cost of sales 40.93% 36.39% 32.81% 28.93% SG&A 48.65% 45.92% 48.14% 45.49% Net interest expense (income) 0.07% 0.38% 0.04% -0.11% Provision for income taxes 3.17% 5.90% 6.58% 9.50%

2004 100.00% 25.06% 41.30% -0.24% 12.71%

2005 100.00% 23.50% 41.00% -0.74% 13.21%

2006 100.00% 26.50% 41.00% -0.78% 12.06%

2007 100.00% 28.00% 42.00% -0.80% 11.10%

2008 100.00% 30.00% 42.00% -0.80% 10.47%

2009 100.00% 33.00% 41.00% -0.80% 9.70%

2010 100.00% 33.50% 42.00% -0.80% 9.12%

2011 100.00% 35.00% 41.50% -0.80% 8.74%

2012 100.00% 35.00% 41.00% -0.80% 8.93%

2013 100.00% 35.00% 41.00% -0.80% 8.93%

2014 100.00% 34.00% 41.00% -0.80% 9.32%

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Coach's Forecasted Cash Flows (In Thousands) YEAR CASH FLOWS FROM OPERATING ACTIVITIES Net income Adjustments to reconcile net income to net cash from operating activities: Depreciation and amortization Minority interest Reorganization costs Tax benefit from exercise of stock options Decrease (increase) in deferred taxes Other non cash credits, net Changes in current assets and liabilities: Increase in trade accounts receivable Decrease in receivable from Sara Lee Increase in inventories Increase in other assets and liabilities Increase in accounts payable Increase in accrued liabilities Net cash from operating activities CASH FLOWS USED IN INVESTMENT ACTIVITIES Purchases of property and equipment
Acquisitions of distributors, net of cash acquired Proceeds from dispositions of P&E

2000 $38,603

2001 $64,030

2002

2003

2004

2005 375,663

2006 402,383

2007 430,859

2008 454,413

2009 459,931

2010 465,901

2011 478,166

2012 521,547

2013 555,448

2014 616,779

$85,827 $146,628 $261,748

$22,628 $0 $0 $2,661 ($1,688)

$24,131 $4,569 $1,405 ($5,797) ($192)

$25,494 $30,231 $42,854 $184 $7,608 $18,043 $3,373 $0 $0 $13,793 $41,503 $106,458 ($4,969) $8,778 $11,646 $1,482 ($969) $3,372

68,872 25,044

73,770 26,826

78,991 28,724

83,309 30,294

84,321 30,662

85,415 31,060

87,664 31,878

95,617 34,770

101,832 37,030

113,076 41,119

$21,914

$23,472

$25,133

$26,507

$26,829

$27,178

$27,893

$30,424

$32,401

$35,979

($3,751) ($5,041) ($5,855) ($4,545) ($20,254) $22,442 $31,437 $0 $0 $0 $22,442 ($3,065) ($16,638) ($7,403) ($18,106) ($90) ($357) ($12,843) ($9,933) ($2,408) ($6,279) $6,447 $8,671 $818 $18,134 $11,154 $6,762 $9,418 $8,908 $27,080 $37,566 $40,238 $43,086 $45,441 $45,993 $84,955 $124,329 $107,937 $221,624 $448,567 $688,716 $737,702 $789,908 $833,090 $843,206

$46,590 $854,152

$47,817 $876,638

$52,155 $55,545 $61,678 $956,170 $1,018,321 $1,130,761

Purchases of investments Net cash used in investment activities CASH FLOWS USED IN FINANCING ACTIVITIES Partner contribution to joint venture $0 $0 $14,363 $0 $0 Repurchase of common stock $0 $0 ($9,848) ($49,947) ($54,954) ($61,463) ($62,603) Repayment of long-term debt ($35) ($190,040) ($45) ($75) ($80) ($172) ($175) Borrowings from Sara Lee $541,047 $451,534 Repayments to Sara Lee ($573,122) ($482,971) Equity distribution ($29,466) $0 Borrowings on revolving credit facility $0 $68,300 $200,006 $63,164 $168,865 $236,565 $240,952 Repayments of revolving credit facility $0 ($60,600) ($186,967) ($70,862) ($193,637) ($283,695) ($288,956) Proceeds from exercise of stock options $0 $2,046 $20,802 $28,395 $34,141 Net cash (used in) from financing activities ($61,576) ($89,731) $38,311 ($29,325) ($45,665) ($56,230) ($57,273) Increase in cash and cash equivalents $14 $3,529 $90,271 $135,214 $33,544 $96,816 $134,826 Cash and cash equivalents at beginning of period $148 $162 $3,691 $93,962 $229,176 $262,720 $359,536 Cash and cash equivalents at end of period $162 $3,691 $93,962 $229,176 $262,720 $359,536 $494,362

($26,000) ($31,868) ($42,764) ($57,112) ($67,693) ($107,134) ($109,121) ($119,619) ($116,939) ($122,535) ($113,945) ($114,425) ($120,732) ($127,795) ($137,602) $0 $0 ($14,805) $0 $0 $2,695 $799 $1,592 $27 $58 $84 $86 $94 $92 $96 $89 $90 $95 $100 $108 $0 $0 ($301,723) ($437,580) ($445,695) ($488,576) ($477,629) ($500,487) ($465,398) ($467,362) ($493,123) ($521,969) ($562,026) ($23,365) ($31,069) ($55,977) ($57,085) ($369,358) ($535,669) ($545,603) ($598,096) ($584,696) ($612,677) ($569,723) ($572,127) ($603,662) ($638,975) ($688,012)

($68,626) ($67,089) ($70,299) ($191) ($187) ($196)

($65,371) ($182)

($65,647) ($183)

($69,265) ($193)

($73,317) ($205)

($78,943) ($220)

$264,135 $258,217 $270,574 $251,605 $252,666 $266,593 $282,188 $303,844 ($316,757) ($309,660) ($324,479) ($301,731) ($303,004) ($319,705) ($338,407) ($364,377) ($62,784) $129,028 $494,362 $623,390 ($61,377) $187,017 $623,390 $810,408 ($64,314) ($59,805) ($60,058) ($63,368) ($67,075) ($72,222) $166,215 $224,623 $244,453 $289,140 $312,271 $370,527 $810,408 $976,622 $1,201,245 $1,445,699 $1,734,839 $2,047,109 $976,622 $1,201,245 $1,445,699 $1,734,839 $2,047,109 $2,417,636

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Ratio Analysis
YEAR COACH LIQUIDITY ANALYSIS Current Ratio Quick Ratio Accounts Receiveable turnover Days Supply of receiveables Inventory Turnover Days supply of inventory Working capital turnover PROFITABILITY ANALYSIS Gross Profit Margin Operating Expense Ratio Net Profit Margin Asset Turnover Return on Assets Return on Equity CAPITAL STRUCTURE ANALYSIS Debt to Equity Ratio Times Interest Earned Debt Service Margin 0.39 133.37 2123.88 0.74 39.68 2762.87 0.69 118.89 1439.16 0.45 350.74 2770.30 0.31 550.08 3900.58 59.07% 48.65% 7.18% 1.81 13.01% 18.14% 63.61% 45.92% 10.66% 2.32 24.75% 43.17% 67.19% 48.14% 11.93% 1.63 19.48% 32.97% 71.07% 45.49% 15.38% 1.54 23.74% 34.34% 74.94% 41.30% 19.81% 1.28 25.45% 33.46% 2000 2001 2002 2003 2004

1.68 0.20 34.54 10.57 2.16 169.32 4.02

1.45 0.93 29.14 12.53 2.08 175.67 3.96

1.80 1.35 23.26 15.69 1.73 210.93 2.50

2.78 1.64 26.87 13.58 1.92 190.32 2.13

3.88 2.69 23.71 15.40 2.04 178.53 1.87

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YEAR LIZ CLAIBOURNE LIQUIDITY ANALYSIS Current Ratio Quick Ratio Accounts Receiveable turnover Days Supply of receiveables Inventory Turnover Days supply of inventory Working capital turnover PROFITABILITY ANALYSIS Gross Profit Margin Operating Expense Ratio Net Profit Margin Asset Turnover Return on Assets Return on Equity CAPITAL STRUCTURE ANALYSIS Debt to Equity Ratio Times Interest Earned Debt Service Margin

2000

2001

2002

2003

2004

2.96 1.33 10.06 36.29 3.24 112.73 5.26

2.44 0.96 9.39 38.88 4.09 89.35 8.33

2.47 1.25 8.63 42.29 4.14 88.11 6.51

2.04 1.17 8.93 40.88 4.55 80.23 5.37

2.56 1.48 9.71 37.57 4.85 73.32 5.43

39.32% 10.16% 6.68% 1.82 12.16% 17.26%

39.10% 10.68% 6.85% 1.99 13.63% 21.33%

41.38% 9.62% 5.57% 3.12 9.84% 18.18%

43.56% 10.48% 6.22% 3.09 10.06% 17.97%

44.55% 11.10% 6.59% 3.15 10.72% 17.72%

0.42 20.63 N/A

0.56 16.35 12.31

0.85 11.80 N/A

0.79 15.52 19.18

0.65 15.43 20.73

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YEAR RALPH LAUREN LIQUIDITY ANALYSIS Current Ratio Quick Ratio Accounts Receiveable turnover Days Supply of receiveables Inventory Turnover Days supply of inventory Working capital turnover PROFITABILITY ANALYSIS Gross Profit Margin Operating Expense Ratio Net Profit Margin Asset Turnover Return on Assets Return on Equity CAPITAL STRUCTURE ANALYSIS Debt to Equity Ratio Times Interest Earned Debt Service Margin

2000

2001

2002

2003

2004

2.09 0.9 8.4 43.45 2.56 142.57 4.65

2.05 0.84 7.37 49.52 2.73 133.69 5.34

2.57 1.55 6.36 57.38 3.47 105.18 3.87

2.33 1.47 6.23 58.58 3.38 107.98 3.31

2.53 1.61 5.72 63.81 3.64 100.27 3.28

55.00% 15.00% 8.00% 1.06 9.00% 18.00%

53.00% 6.00% 3.00% 1.22 3.00% 7.00%

48.00% 12.00% 7.00% 1.35 9.00% 17.00%

49.00% 11.00% 7.00% 1.19 8.00% 14.00%

49.00% 10.00% 6.00% 1.16 7.00% 12.00%

1.09 17.56 1.66

1 4.66 0.69

0.75 15.4 8.9

0.68 21.36 2.66

0.59 27.37 N/A

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Cost of Debt Calculation

BALANCE SHEET Percent of Total Liabilities Computed Interest Value Rate Weighted Rate

2004/05/30 LIABILITIES FOR COACH CURRENT LIABILITIES: Accounts payable Accrued liabilities Revolving credit facility Current portion of long-term debt TOTAL CURRENT LIABILITIES Deferred income taxes Long-term debt Other liabilities Minority interest, net of tax TOTAL NONCURRENT LIABILITIES TOTAL LIABILITIES

$44,771,000 $135,353,000 $1,699,000 $115,000 $181,938,000 $15,791,000 $3,420,000 $5,025,000 $40,198,000 $64,434,000 $246,372,000

18.17% 54.94% 0.69% 0.05% 73.85% 6.41% 1.39% 2.04% 16.32% 26.15% 100.00%

0.00% 3.50% 4.00% 8.77% 0.00% 8.77% 6.50% 6.50%

0.0000% 1.9228% 0.0276% 0.0041% 0.0000% 0.1217% 0.1326% 1.0605%

Weighted Average Cost of Debt

3.2694%

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Wacc & Beta Estimations

Beta Estimate 1.23970 R-Squared 17.3218516% Average Risk Free Rate 0.03283 Historical Yahoo Market Risk Published Beta Premium 1.299 0.03

Estimated Ke Find an implied Ke Estimated Cost of Debt

7.003% 6% 3.2694%

Short Horizon Estimated Ke 0.0739 R^2

3.505% 0.042%

WACC LONG TERM BT WACC SHORT TERM BT WACC LONG TERM AT WACC SHORT TERM AT

6.11% 3.45% 5.81% 3.15%

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Method of Comparables
Method Of Comparables Coach Liz Claibourne Ralph Lauren Tiffany & Co Industry (Excluding Coach) Coach Suggested Price Price 56.29 Price $56.29 $40.08 $38.32 $33.21 Trailing P/E 32.95 14.01 16.16 16.09 15.42 EPS 1.68 $25.91 Forward P/E 24.41 11.93 13.59 19.31 14.94 Forward EPS 2.26 $33.77 P/B 10.77 2.41 2.39 2.83 2.54 BPS 5.17 $13.15 P/S 7.17 0.95 1.24 2.2 1.46 Sales 7.848 $11.48

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Discounted Cash Flows

Coach Free Cash Flows (In Millions Except Per Share Data) YEAR 1 2 3 2007 $789 ($598) $191 0.837 $160 4 2008 $833 ($584) $249 0.789 $196 5 2009 $843 ($612) $231 0.743 $172 6 2010 $854 ($569) $285 0.701 $200 7 2011 $876 ($572) $304 0.660 $201 8 2012 $956 ($603) $353 0.622 $220 9 2013 $1,018 ($638) $380 0.586 $223 10 2014 $1,130 ($688) $442 0.553 $244 Perp Forecast Years 2004 2005 2006 $688 $737 ($535) ($545) $153 $192 6.11% 0.942 0.888 $144 $1,930 WACC=6.11% Ke = 6.45% Kd = .13% $171

Cash Flow From Operations Cash Provided (Used) by Investing Activities Free Cash Flow to Firm PV Factor BT WACC of 6.11% Present Value of Free Cash Flows 6.11% Total PV of Annual Cash Flows 6.11% Continuing (Terminal) Value 3.5% Growth Present Value of Continuing (Terminal) Value 6.11% Value of Coach (end of 2004) 6.11% Book Value of Debt and Preferred Stock Value of Equity (end of 2004) 6.11% Estimated Value Per Share 6.11% Book Value Per Share EPS Actual Price Per Share

$1,150 ($700) $450

$9,907.76 $11,838 $356 $11,482 $60.56 $4.13 $1.57 $56.00 $1.83

$1.97

$2.06

$1.89

$2.04

$2.19

$2.35

$2.52

$2.71

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Residual Income Model

Residual Income Model for Coach YEAR 2004 2.66 1.47 4.13 0.06 1 2005 4.13 $1.93 6.06 0.25 1.68 1.58 4.13 10.69 Implied Ke =6% 46.23 $61.05 $63.78 Growth Rate = 4% 2 3 4 5 6 7 8 9 10 2014 25.04 $3.11 PERP Forecast Years Beginning BE (per share) Earnings Per Share Dividends per share Ending BE (per share) Ke "Normal" Income Residual Income (RI) Present Value of RI BV Equity (per share) end 2004 Total PV of RI (end 2004) Continuation (Terminal) Value PV of Terminal Value (end 2004) Estimated Value (end 2004) Capitalize 9 months value (april 1 2005 price) Actual Price per share end 2004 Actual Price per share Growth $56.00 4.00% 2006 2007 2008 2009 2010 2011 2012 2013 6.06 8.11 10.31 12.61 14.92 17.25 19.64 22.25 $2.06 $2.20 $2.29 $2.31 $2.33 $2.39 $2.61 $2.78 8.11 10.31 12.61 14.92 17.25 19.64 22.25 25.04 0.36 1.69 1.51 0.49 1.71 1.44 0.62 1.68 1.33 0.76 1.56 1.16 0.90 1.44 1.01 1.04 1.35 0.90 1.18 1.43 0.90 1.34 1.45 0.86 1.50 1.61 0.90

1.66

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Abnormal Earnings Growth

Abnormal Earnings Growth 2004 EPS DPS Cum-Dividend Earnings Normal Earnings Abnormal Earning Growth (AEG) PV Factor PV of AEG Core EPS Total PV of AEG Continuing (Terminal) Value PV of Terminal Value Total PV of AEG Average Perpetuity Capitalization Rate (perpetuity) Value Per Share April 1 2005 Ke g Actual Price per share 0.07 0.04 $56.00 YEAR Forecast Years 2005 $1.93 $0.00 1 2006 $2.06 $0.00 $2.06 $2.06 ($0.00) 0.935 2 2007 $2.20 $0.00 $2.20 $2.20 ($0.00) 0.873 3 2008 $2.29 $0.00 $2.29 $2.35 ($0.06) 0.816 4 2009 $2.31 $0.00 $2.31 $2.46 ($0.14) 0.763 5 2010 $2.33 $0.00 $2.33 $2.47 ($0.14) 0.713 6 2011 $2.39 $0.00 $2.39 $2.50 ($0.11) 7 8 9 Perp

2012 2013 $2.61 $2.78 $0.00 $0.00 $2.61 $2.78 $2.56 $2.80 $0.06 ($0.01)

2014 $3.11 $0.00 $3.11 $2.98 $0.13 $0.04

0.666 0.623

0.582 0.544

($0.00) ($0.00) ($0.05) ($0.11) ($0.10) ($0.07) $0.04 ($0.01) $1.93 ($0.30) $0.78 $2.40 0.04 $63.03

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Resources
UBS.com Yahoo! Finance MSN Money Edgar Scan Wall Street Journal Coach.com

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