掛毯 (TPR) 2004 Q2 法說會逐字稿

Good day and welcome to the Coach conference call. Today's call is being recorded. (technical difficulty) -- remarks and introductions, I would like to turn the call over to Vice President of Investor Relations at Coach, Ms. Andrea Shaw Resnick.

Good morning and thank you for joining us. With me today to discuss our quarterly results are Lew Frankfort, Coach's Chairman and CEO, and Mike Devine, Coach's CFO.

Before we begin, we must point out that this conference call will involve certain forward-looking statements, including projections for our business in the current or future quarters or fiscal years. These statements are based upon a number of continuing assumptions. Future results may differ materially from our current expectations, based upon risks and uncertainties -- (technical difficulty) -- expected economic trends or our ability to anticipate -- (technical difficulty). 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 (indiscernible) on a continuing basis. Coach may also choose to discontinue presenting future estimates at any time.

Finally, please note that all per-share and historical numbers that will be discussed have been adjusted to give effect for the Company's 2-for-1 stock split, which was effective in early October of 2003.

Now, let me outline the speakers and topics for this conference call. Lew will begin with an overall summary of our second fiscal quarter 2004 results as well as our strategies, going forward. Mike will then follow with details on financial and operational highlights for the quarter as well as our outlook for the third quarter, second half and full fiscal year 2004. Following Mike's prepared remarks, we will hold a question-and-answer session, which will conclude by 9:30 AM.

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

Thanks, Andrea, and good morning, everyone. I'm happy to be speaking with you today about another strong Coach holiday performance that reflects the increasing vitality of our brand for both gifting and self-purchase.

As you know, this morning, we announced strong quarterly results ahead of our recently revised guidance and analyst estimates. Our net income and EPS increased about 50 percent versus prior year levels, as a 33 percent increase in sales, combined with an improvement in margins, continued to drive the bottom line.

The highlights of our second fiscal quarter were -- first, net income rose 53 percent to $95.4 million, or 50 cents per diluted share. This compared to 62.4 million, or 34 cents per share, in the year-ago period. The recently revised consensus estimate for the quarter was 49 cents per share.

Second, net sales totaled $411.5 million, up 33 percent.

Third, Direct-to-Consumer sales, which consist primarily of sales at U.S. Coach stores, rose 24 percent to $237.1 million during the second quarter.

Finally, comp-store sales in the U.S. rose 13.7 percent with retail stores up 16.4 percent and factory stores up 9.4 percent.

During this quarter, we opened three U.S. Coach retail stores, including a 7,200 square foot flagship in Waikiki, our third store this year in the rapidly growing L.A. market, and one in Columbia, Maryland.

Per our strategy to launch our most productive locations, we expanded our 84th and Broadway location here in New York, as well as relocating our Center City, Philadelphia store to Walnut Street. Finally, we renovated two retail locations, Woodland Hills and Beverly Center, both in Southern California, as well as renovating ten factory stores.

At the end of the fiscal quarter, there were 165 Coach retail stores and 77 factory stores in operation in North America.

Indirect sales rose 49 percent to $174.4 million from 117.1 million in the same period last year -- all in direct businesses, including Coach Japan, business-to-business, international wholesale and U.S. department stores, contributed to this significant increase (sic).

To date in this fiscal year, we have opened five new full priced locations in Japan, including two in the first fiscal quarter and three in the second. At the end of last quarter, we had a total of 99 locations in Japan.

In U.S. retail, our 16 percent comps reflected increases in both traffic and average transaction size, the latter driven by our broader price points and tiered merchandising strategy. These factors were somewhat offset -- as expected -- by a modestly lower conversion rate, attributable to surging traffic bringing in increasing numbers of browsers.

In factory stores, we also saw very strong comp-store sales, truly reflecting brand strength, as our promotional activity in this channel was down considerably from year-ago levels.

We also experienced significant increases in sales at U.S. department stores, which reflected both market share gains and growth in the overall accessories category. During the holiday quarter, sales at POS rose nearly 25 percent.

We are especially pleased with our performance in Japan, as sales rose nearly 70 percent in dollars and over 50 percent in yen terms. We experienced double-digit comps for the 11th time in the last 12 quarters. Our new stores also took on exceptionally well, as the stylish Japanese consumer continued to embrace our fashion innovation.

Before moving onto our key growth strategies, I did want to discuss our product, which, of course, is at the heart of our brand. While we mentioned that handbags and women's small leather goods continue to drive our business, we wanted to note that these results are generated from a broad platform of accessories that target our extremely diversified consumer base.

During the quarter, we were particularly pleased with the Soho collection, most notably the Soho Duffle, which was a key item for holiday. We were also quite happy with the performance of the kids' Capsule (ph) collection, especially with the popularity of children's accessories, such as backpacks and swing bags. In addition, as you may know, occasion bags and accessories were also a new initiative for the second quarter and we were pleased by the strong consumer response. Both of these areas represent growth opportunities.

In addition, we piloted a resort package in December. In U.S. retail stores, this package represented 18 percent of sales in those 20 locations. In department stores, we achieved remarkable sell through as well. Next year, we will be introducing a resort presence in all U.S. retail stores and in all warm-weather and flagship department store locations.

Other initiatives this holiday included the Coach gift card, which provided a slight lift from gift certificates, although the penetration remained modest -- a bit over 2 percent of full price sales. We were also pleased with the performance of the (indiscernible) favored program, which was driven primarily by men's business cases and classic handbags.

Looking forward and as noted in our releases, customer reaction to our transitional spring offerings of vibrant colors and new styles has been extremely strong. Our updated Soho collection has quickly become a customer favorite, highlighted by the instant success of the Soho flat hobo in signature leather and suede fabrications; this style on represented between 7 and 8 percent of sales in U.S. retail stores, month to date.

Next week, we will be introducing updates to our ever popular Hamptons collection in several new styles and an array of fresh pastel suede colors trimmed with (indiscernible) patent leather.

Our key items for February will be the Hamptons carryall and flat satchels in suede and classic signature fabrications.

Later next month, we will also launch our spring version of our popular patent gallery tote in vivid brights.

For March, we are reinvigorating our Hamptons Weekend and Soho Twill collections by broadening our color choices and adding new styles to enhance Coach's appeal in the casual weekend market.

Later this spring, we will see an expanded offering of straw and new key items in Soho Twill, including the garden tote and (indiscernible) satchel.

In terms of U.S. retail store merchandising, during the January-to-June period, we are increasing the number of floor sets (ph) to 6 from 5. This monthly spring rhythm will better coincide with the four-week intervals between visits from our best customers. Also, we will be refreshing our retail stores the day after Mother's Day, bringing our expanded Beach Collection to the front table of all stores.

Over the last few years, the wind has clearly been at our pack. We've experienced exceptionally strong comp-store sales gains in our U.S. retail stores and double-digit same-location sales in Japan. This, combined with our distribution growth, both through new stores and expansions, led to a near-doubling of our sales since the end of calendar year 2000.

We are confident that we will continue to enjoy further market share gains over our planning horizon through store growth in our retail businesses in the U.S. and Japan and increased productivity, driving double-digit topline growth. In addition, we expect further operating margin improvement, which will enable earnings growth to continue to outpace sales gains.

I believe it's important to reiterate that our business model is unique and is based upon the underlying principle that Coach offers accessible luxury, American lifestyle accessories to a loyal and growing consumer base. We provide consumers with relevant, aspirational products that are extremely well made at a fair price. By doing so, we are able to continually strengthen Coach's leadership position by building lasting market share. This premise is essential to our belief that we will achieve sustained growth in the years ahead and continue to expand our market share within the premium accessories market. As I have said on many occasions, clearly Coach is more than a comp-store sales story.

Our key growth strategies remain unchanged and are all focused on achieving accelerated and sustained growth. As most of you know, they are -- first, we are driving market share by leveraging our leadership position as an accessible luxury-lifestyle brand and capturing a greater share of our consumers' accessories wardrobe; we are intensifying Coach's awareness as an everyday lifestyle accessories resource to sell purses and gifts. As part of this strategy, we are emphasizing new usage occasions, such as weekend and evening, and offering items at a broader range of prices.

Second, we are adding 100 U.S. retail stores over the next four to five years, bringing the retail store base to at least 250. This includes about 20 new stores in FY '04, of which ten will open in the first half, and about ten more are planned for the second half. Included in this spring stores (sic) are three new markets for Coach -- Rochester, Toronto and Jacksonville, Florida. In addition, early next month, we will be opening a 5,300 square foot west side Coach flagship at the new AOL Time Warner project in Manhattan.

During this fiscal year, as part of our strategy to enlarge our most productive locations, we will expand a total of eight retail stores, which, taken together, will add 14,000 square feet, or almost 4 percent, to our retail store square footage. In the second half, these expansions will include Plaza Las Americas in Puerto Rico and Garden State Plaza in New Jersey.

As we've said before, we now believe that the Coach franchise can comfortably support 300 to 350 total retail stores in the U.S. due to our strong market share gains, as reflected in our same-store sales increases over the last few years.

Third, we are aggressively expanding market share with the Japanese consumer from over 3.5 percent today to our goal of 6 to 8 percent during the next few years. This increase will be driven by continued improvement in same-location sales, new shops, including the opening of additional flagship stores, and by expansions.

This fiscal year, we expect to open a total of seven to eight new locations in Japan. Similar to the U.S., we are also relocating and enlarging some of our most productive locations, primarily shop-in-shops, where we believe we have an opportunity to significantly increase sales. In fact, we expect to expand a total of 15 shops of this fiscal year, increasing their square footage and sales by about 50 percent. These expansions will add about 5,400 square feet for the fiscal year, or about 6 percent, to retail square footage in Japan.

Fourth, we are continuing to drive gross margin higher and leverage our expense base, as I mentioned before.

The strategies and actions I've just outlined build on the strength of our core brand and business equities. They are designed to reinforce Coach's leadership position as an American classic lifestyle accessories brand, offering accessibility to our consumers worldwide.

Now, I will turn it over to Mike Devine, our CFO. Mike?

Thank you, Lew. Lew has just taken you through the highlights and strategies. Let me now take you through some of the important financial details of our second-quarter results.

As Lew mentioned, our quarterly revenues increased by 33 percent, with Direct-to-Consumer up 24 percent and indirect up 49 percent.

In the second quarter, our gross profit margin expanded by 390 basis points over the comparable period of the prior year to 74.2 percent of sales. There are two primary contributors to this quarterly improvement. First, channel mix, as our highest gross margin channels grew faster than the business as a whole; and second, product mix driven by increased penetration of higher margin mix materials.

The Selling, General & Administrative expense ratio declined in the quarter and represented 35.1 percent of sales, versus 37 percent of sales in the year-earlier period. This reduction was primarily due to leverage in our corporate and centralized functions, as well as traction in core selling business units.

Our operating income rose 56.6 percent to $160.7 million in the second quarter, versus the same period last year. Operating margin in the quarter was 39.1 percent, a quarterly high for Coach, compared to 33.3 percent in the year-ago quarter.

Net income increased 52.9 percent to $95.4 million, or 50 cents per diluted share, as compared to 62.4 million, or 34 cents per share, in the year-ago period.

Results for the second quarter were ahead of the recently-revised consensus estimate of 49 cents per share.

Inventory levels at quarter end were $157.2 million, $21.3 million, or 15.7 percent, above prior-year levels. Inventory management programs allowed us to realize only moderate growth in inventories while supporting a significantly increased sales levels (sic) and 16 net new U.S. stores and 10 net new locations in Japan opened in the last year.

Accounts Receivable balances rose approximately $27 million, primarily related to increases in our indirect businesses and open credit card receivables at our quarter end on 12/27, due to a late Christmas. Days of Sales Outstanding and trade receivables at quarter end actually declined to 37 days versus 39 days a year ago.

We ended the quarter with $373 million of cash. Only Coach Japan's revolver borrowing of $34.4 million remained a short-term debt on the consolidated balance sheet at quarter's end. We would note that this is $8 million lower than last year's level, reflecting earnings and positive cash flow generated at Coach Japan.

As noted in our releases, during the quarter, the Company repurchased and retired 1.5 million shares of common stock at an average cost of $36.36. At the end of the quarter, approximately $65 million remained available for future repurchases under Coach's authorized repurchase program, which expires in January of 2006.

Net cash from operating activities in the second quarter was $174.2 million, compared to 118.9 million generated last year during Q2.

Free cash flow in the second quarter was $158.3 million versus 105 million in the same period last year, primarily due to increased earnings.

CapEx spending, primarily for new stores and renovations, was $15.8 million, versus 13.9 million in the same quarter a year ago.

Now, I'd like to provide you with our goals for the second half and full fiscal year. First, for the full fiscal year 2004, we are targeting the following -- net sales growth of at least 33 percent to at least $1.26 billion; an operating margin that is more than 500 basis points above prior year levels, driven by a 300 basis points improvement in gross margin rate, in combination with about 200 basis points of SG&A leverage. This will result in an operating income growth of at least 56 percent in fiscal year '04 over fiscal year '03.

As we've noted on previous calls, three factors will somewhat moderate that growth on the EPS line in 2004. First, a higher share count brought about by options exercises; second, a larger minority interest payment to our Coach Japan joint venture partner as a result of higher profits at Coach Japan; and lastly, a higher tax rate of 37.5 percent, versus last year's 37 percent. All of this, taken together, is expected to generate earnings per share of at least $1.20, an increase of 50 percent from prior year levels and 5 cents above current consensus. Therefore, for the second half of fiscal 2004, we are targeting -- first, sales growth of at least 30 percent to about $595 million with third-quarter sales of at least 290 million and fourth-quarter sales of at least 305 million; second, at least 10 percent U.S. comp-store sales increases in each quarter and continued double-digit same-location sales in Japan; third, an operating margin for the half which will be at least 350 basis points above the year-ago level with gross margins increasing and a declining SG&A expense ratio; finally, earnings per share of at least 48 cents, or 4 cents above analysts' consensus and 45 percent above year-ago results with the third and fourth quarters approximately equal at 24 cents, given that operating margins are historically higher in the third quarter than in the fourth.

Clearly, these operating margin gains for the year are well ahead of our October 21st conference call guidance. I believe that it's important to note that the profitability dynamics we have spoken to previously remain intact. We believe and are confident that we still have room to grow our operating margin by an additional 100 basis points per year through our planning horizon.

While these are our current goals, our actual results may vary from these targets, based upon a number of factors, including those discussed under the business (indiscernible) and risk factors in our annual report on Form 10-K. Coach also does not assume any obligation to update these targets as the year progresses.

In summary, we are 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 for your attention. Now, Lew, Andrea and I will take some questions.

Thank you. At this time, we are ready to begin the question-and-answer session. (OPERATOR INSTRUCTIONS). Our first question comes from Bob Drbul. Please state your company name.

Lehman Brothers, good morning. I've just got a couple of questions. On the operating margin guidance and the update that you just gave us, consistent with what you said in the prior and the 100 basis points per year, where do you think you are in the longer term operating margin potential in terms of who are you comping yourself against and sort of what gives you that level of confidence that you spoke about that you can continue to just make this consistent progress that you're making?

Bob, if I could, the guidance we just spoke to in '04 gets us to an operating margin for the year comfortably above 30 percent, probably 30.4, 30.5-ish. As we talked about, we are confident for our planning horizon that we can add another 100 basis points a year to that, primarily driven by increased gross margins in channel mix -- driven by channel mix. As we've said on other occasions, as our most highly gross margin channels grow more quickly than the business as a whole, of course, (inaudible) full priced retail in the U.S. and Coach Japan.

So we believe channel mix alone will us to continue to expand gross margin rates and as our topline grows at double digits, we are also quite confident that we can begin to add SG&A leverage throughout all of our business units, and those will be the two primary contributors to our operating margin growth.

Let me just add one or two things, Mike. First, you had asked us, Bob, who do we compare ourselves with. We are a unique proposition. When we look at our operating margins today at 30 percent, there is no other apparel or accessories brand in the United States that has these operating margins. We are confident that they are sustainable. A key to our growth is continued focus. We are in a sweet spot with accessories and we cherish our very strong consumer base and the very diversified product platform within the world of accessories. We do believe we can get into the mid 30s.

Thank you. Good luck.

Jeff Edelman.

Good morning, UBS. If I look at what's been happening in Japan, Mike, it appears as if that EBIT margin this year will maybe touch close to 19 percent, which is a good bit above, I think, where you originally led us to where you thought this business could ultimately be.

Two questions -- one, what is the currency impact in that number? Then secondly, as you start building volume, what kind of an incremental takedown could we see on the SG&A level going out over the next couple of years?

Yes, Jeff, we have achieved levels of profitability at Coach Japan that even we did not think were attainable this fiscal year. I think it's largely been driven by the topline performance that we've realized exceeding our own expectations, allowing us, on planned spending levels, to provide more SG&A leverage to the Coach Japan's P&L than we had anticipated.

The second factor is one that you called out -- is the strength of the yen. That is clearly helping Japan's P&L. As they buy dollars with their yen to pay Coach New York, if you will, to buy product. So as a result of gross margin rates (inaudible) been helped by this stronger yen on a consolidated basis in the quarter, that the strength of the yen helped the gross margin rate roughly 40 basis points of impact on the CJI stand-alone P&L was even greater (sic).

The third thing is that we have taken a price increase since last year's Q2, which also helped to drive the increased EBIT margins that you point out.

So the 19 percent is a number we feel pretty good about for this fiscal year. What I just described are a lot of dynamics, some of which are outside of our control, so it remains to be seen where that rate will go in '05 and beyond. The one thing we are confident about is that our topline growth in '05 should outpace our spending levels versus '04 and we should see continued SG&A leverage on the CJI P&L next year.

Great, thank you.

Margaret Mager.

It's Margaret Mager from Goldman Sachs. Another great quarter. Congratulations! I actually have a couple of questions on Japan. Can you talk about the penetration that you expect Japan to achieve in fiscal '04, now that it's running, I think, well ahead of what most of us might have expected the growth to be?

Sorry, Margaret, just on that question, you mean penetration of handbags and accessories within Japan?

No, I mean Japan as a percent of total Coach for the end of this year. Then I have a related question. In the quarter, I am just wondering what was Japan versus last year in terms of a percent of total sales? If you can give any kind of quantification of the 400 basis point improvement in gross margin, how much did Japan contribute to that? I'm just trying to get a sense of how Japan is impacting the numbers.

Well, first, Japan will represent about 22 percent of our worldwide sales, and I believe it was in the area of 19 or 20 percent, but we can be more precise off-line with you.

With regard to the 400 basis points, Mike?

Yes, the 400 basis points of gross margin rate improvement we talked about coming from channel mix and product mix. It was really almost 50-50 between the two, so about 200 points came from the channel mix. Of the channel mix, the lion's share of it came from improvement in gross margin rates and the growing mix to our total sales of Coach Japan. Probably maybe three-quarters of that (indiscernible) we could attribute to Japan.

Wow, okay. Mike, or Lew, is there any notable seasonality for Japan by quarter? You know, I know Golden Week is important but I don't know if their sales are evenly spread across the quarters, or if they have a big quarter like we do in the U.S. with the holiday season.

Good question. Actually, Japan is much more evenly spread than our U.S. sales. All 12 months in Japan are robust, unlike the U.S., where July and August are very slow. December is a holiday month but where in the United States it represents 20 percent of Coach sales at POS, or 18 to 20 percent, in Japan, it represents about 12 or 13 percent.

Do you know when Golden Week is this year?

We know it's in April, but we can give you the exact dates in a second -- April 28th to May 5th.

Thank you very much and congratulations again on a great quarter and stacking up to be another great year.

Mark Friedman.

Merrill Lynch. Thank you. Good morning, everybody. Great job! A couple of questions -- on this extra flow, how are you planning that? Is there anything being done from a product specific that you're adding to the line, or are you just spreading it out into six versus five?

Lew, if you can give us an update on shoes' performance and plans for shoes? And then finally, just on the competitive area, we are certainly seeing some players, such as Cole Haan, trying to, I think, address your niche in the marketplace. Any kind of commentary about the competition and what you're seeing out there? Thank you.

First, on product flow, as you know, Mark, we do have 12 introductions a year basically divided into our four seasons. We are getting smarter as we get more experienced. There is not additional product, but there is a different flow to the product.

What's key for us is to continue to keep our stores fresh, surprise and delight our visitors who come increasingly to our stores. Now, the best visits, as I mentioned, come as often as once every three to four weeks, so it's basically just a change in the way product flows.

In terms of our shoe performance, shoes represented about 6 percent of sales in our Coach stores -- those Coach stores that had shoes compared to, I believe, 5 percent last year. Overall, shoes do represent about 1.5 percent of our worldwide company sales. It's important to us because it does bring visitors to our stores more often, since women, as you know, buy more shoes than they do handbags.

Overall, we were pleased with our performance although in U.S. department stores at POS, sales were somewhat lower than they were the prior year.

With regard to the competitive arena, I've been in this business for 25 years now and competitors come and go. We study them, we worry about them, and we continue to do our own thing with a singular focus and that is our intention.

Okay, great. Thank you.

Dana Telsey.

Bear Stearns. Good morning, everyone, and congratulations on a terrific quarter and what looks to be a fabulous year also. Can you talk a little bit about the average transaction? Obviously, you introduced some higher priced items that when we saw in the stores, they looked to be doing very well. Also, the amount of newness in what you see, going forward.

First, on the average transaction, you are correct; the new items and special addition items did well. The average transaction in the holiday quarter in our retail stores was up about 9 percent to $180 from $165 the prior year.

The average handbag was actually up about the same amount -- about 10 percent to $225. Clearly, our consumers are embracing out-of-water (ph), more sophisticated offering, and I think you will continue to see us develop our offering in these premium areas while being mindful that we do need to have attractive sharp entry price points. (multiple speakers).

To answer your question on newness, for the quarter, it continued to be a very important story -- fashion innovation driving more frequent visits by our customers. Newness came in at about 65 percent for the quarter, and that is all newness. About half, or a little more than half of that were new styles. The balance were color adds or updates of previous styles.

Thank you. What about floor sets, going forward? Obviously, you added the one in mid-September. Should the number of floor sets change as we move forward throughout the year?

I mentioned earlier, Dana, that would this spring, we actually will have six floor sets, compared to five last year.

In addition, we are going to continue to explore different ways that modestly reflects our floor sets within months. So for example, after Mother's Day, as I mentioned, the day after Mother's Day, we're going to move Beach up to the front table. So I think that the rhythm of one floor set a month with an interim change in December is a rhythm that we will keep with modest modifications as we continue to measure how frequently our best customers visit our stores.

Just lastly, is CapEx still 70 million for the year? How much of that would be for Japan? How is that infrastructure building going? Thank you.

Sure. Dana, we've taken advantage of some opportunities; we do look now to see CapEx be a little north of 70 million, probably 72 to 75 million. One of the increases that has occurred since our last guidance was in fact in Japan; we did an office relocation and took on some new space there to handle the opportunities that we have in Coach Japan. That's about a $2 million incremental CapEx spend this year that was not in our thinking during our last guidance.

The yen also -- the strength of the yen is causing our CapEx spending in Japan to convert back into higher U.S. dollars. So we're looking at about 22 million in Japan for the year and roughly $50 million in the US. Our projects, though, are little changed, largely around new doors and expansions.

On the systems side, we still have our POS project that is moving forward successfully and the re-systemization of Japan -- applying Coach New York systems at Coach Japan in that $22 million as well.

David Schick.

Legg Mason. Good morning and I add my congratulations as well. I have two questions. First, the cash question -- it's a good problem to have but cash continues to build -- thoughts on that, going forward?

Then secondly, if you could update us on limited edition plans, you know, the limited edition merchandise you're going to be putting out through the year. As you've sharpened the view for calendar '04, what does that look like? What are you planning?

Our feeling on the cash is really little-changed since last time the question was asked. It is a high-quality issue that we are dealing with. We continue to invest in opportunities as they become available to us in a way that makes sense to us to deliver controlled earnings growth to our investors. That feels to us like about 20 to 25 new stores a year in the U.S. and 10 in Japan while we continue to look for expansion opportunities at a pace of 5 to 8 in both markets as well. But with the success and the incredible operating margins that we are generating, we are in a cash build mode at this time.

With regard to limited edition, clearly, consumers want more sophisticated products from us and they want products that are also available with a level of scarcity.

What we have found is that a lot of our seasonal product has sold out very rapidly. For example, we introduced the gallery tote, both in patchwork and in patent leather, and when it was in stock, it represented about 7 or 8 percent of sales in Coach stores; we thought it would be 2 or 3. So what we are doing is we are translating that -- as I mentioned earlier -- into a program for all stores, which we're going to begin to rollout in late February.

I think the larger question for us is really focused around the higher end consumer, that top 25 percent of our consumer base, which is the top 4 or 5 percent of U.S. households who historically, typically by European luxury brands. Those consumers we're targeting. They live in all of the markets that we serve, much more so, of course, in the urban areas. You will see more limited edition product, broadly defined, as we go forward into the rest of the calendar year. It's a key part of our strategy and in Japan, we have very successfully leveraged our distribution of limited edition product. It has the added benefit of creating a lot of editorial, a lot of buzz and basically, a lot of cachet.

Jeff Kleinfelter.

Piper Jaffray. A couple of questions for you -- first of all, in terms of the department store business, which appears to be trending very well here in the U.S., can you talk a little bit about the kind of average productivity of your department stores at this point? I know you've been trimming some of the less productive doors and just focusing on the focusing production doors. Can you talk about how that effort has increased the kind of average productivity of the doors you're in?

Then also, the follow-up question would be on your surging traffic but slightly declining conversion. Lew, can you talk maybe historically about when you have seen that same pattern develop when the traffic starts to build, and then what follows -- how much time does it take to actually build that conversion rate back up?

Let me do the second question first. As I said, we were not surprised by the slightly lower conversion rates because our traffic was materially more. When we look at our increased traffic and try to understand what it the complexion of this traffic, it really is two types of consumers. One, our Coach loyalists, who come to us (indiscernible) Coach and they are coming more often. And they are coming to Coach because it's entertainment; they are coming for the surprise.

The second are an increasing number of new consumers, first-time visitors. We are very, very pleased with our conversion levels and believe, next year, that, unless traffic continues to surge at significant double-digit levels as it has been, that our conversion will grow. It's, in fact, down just very modestly; it's hardly worth mentioning, candidly. We've seen this pattern in the past and it's very predictable. We feel very good about our franchise. We measure consumers' attitudes about the brand and every indicator tells us the consumers are feeling better about Coach today than they did even a few years ago.

With regard to our department stores, what's interesting to note and we're excited about this is that department store sales this holiday season in the United States grew by about 10 percent -- overall department stores sales and it's the first-time we've seen the category grow in the last two years; we grew 25 percent during the same period. When I say handbags and small leather goods, it's what I'm referring to. So we do believe that consumers in America are spending more on accessories. Candidly, we are told through our research that one of the reasons is Coach -- that people are buying more accessories because of their interest in Coach, often substituting an accessory for what might have been a jewel repurchase previously.

We do believe that we can continue to grow our U.S. department store sales and in fact, our sales are up over a two-year period, two-year calendar period at retail about 80 percent.

Now, we are doing this in markedly fewer doors. We are increasingly productive, and some of our -- I would say, on average, (indiscernible) our POS sales are up 25 percent, the average productivity is up about 30 to 35 percent because of the reduced number of doors.

Lee Backus.

Buckingham Research. First, let me add my congratulations to a terrific quarter and a terrific year. At what point -- with the sales growth you've seen in the U.S., do you have need for additional infrastructure, either organization or distribution (indiscernible) capacity?

One of the keys, Lee, to our model is to leverage our infrastructure, and we anticipate more growth than we actually planned for in looking at our infrastructure.

With regard to our distribution center, for example, where we just added a second permanent shift, we are only at 55 percent of our capacity. We have the systems, technology and team in place to drive the business 2X this size.

And the organization?

That's what I mean. We have a team, an organization. Yes, we're adding staff as we're adding stores, but the incremental additional staff is coming in at a lower rate than our sales are growing. But the senior level positions are filled; we're not going to be adding significant new officers and directors to our company.

Could you also discuss advertising and marketing as a percentage of sales -- where it is now and what you see, going forward?

We continue to leverage our advertising and marketing, and the way we look at it, as a percent of sales for the second quarter, it declined to 4.6 percent from 5.9 percent last year. Dollars were pretty much constant at around $19 million.

A major source of our SG&A leverage.

Paula Kalandiak.

Good morning and congratulations -- with Wells Fargo Securities. I was wondering if you could point to any standout locations this quarter. I believe that last quarter, you said that both Boston and Los Angeles where the top performers, and I was wondering if --.

Sure, I would be glad to. Boston continues to be an extremely strong market. In fact, our same-store sales in those markets over two years, for the quarter, was up 50 percent. San Francisco was also a very strong market for us this quarter, as was Florida again, and Los Angeles. So what we're finding, interestingly, is that some of our most developed markets, like Boston, and some of our least developed markets, like Los Angeles, are continuing to experience very high levels of growth.

New York City rebounded. We told you last holiday that our same-store sales were basically flat in Manhattan. This last quarter, they approached 20 percent.

Okay, thank you.

Elizabeth Montgomery.

From S.G. Cowen. I have two questions. First, going back to the gross margin, can you give us an update as to what percentage of your sales are now coming from mixed material and signature products versus leather and what your strategy is to maintain that penetration versus leather, going forward?

Secondly, could you talk about how gift cards performed relative to your expectations -- any changes you would have made to that program? Those sales are not booked until the purchase is completed. Is that correct?

Let me do the second one first. On gift cards, I commented that our sales in U.S. retails stores were modest -- about 2 percent. We thought that it would run 2 to 3 percent. What we realize as we go into this whole area is that people like to touch and feel our products; they are not buying a book or a CD. I do believe that gift cards will grow materially but will be a lower portion of our sales than many other concepts.

On the signature penetration, which is the lion's share of our mixed-material business, for Q2 in our full-priced sales, we are about 10 points per penetration higher at approximately 50 percent this Q2 versus 40 percent Q2 of fiscal year '03.

Going forward, what's so clear to us -- when we look at other extremely successful international brands, we see that fabric and leather handbags represent as much as 80 and 90 percent of our overall sales. We do believe that, as we move forward, 100 percent leather fabrications will likely decline, slowly -- grow in absolute dollars but decline slowly as we become more of a 12-month resource, evening out all of our quarters as we add weekend and travel and so on.

Great, thank you.

(OPERATOR INSTRUCTIONS). Eric Bader.

good morning, Northeast Securities. Just a quick question -- what's the square footage for the units now in the U.S.?

Sure, Eric. Square footage for full-priced stores -- 401,445. Our square footage for factory stores -- 235,894.

Great. You were talking about that your customers are now coming more to the stores; they are coming once a month. How has that expanded, since you've really done this, in terms of your customers coming to the stores and really being driven by the newness?

It's a remarkable transformation. Customers used to come, on average -- the best customers -- I'm referring to best customers now coming every three to four weeks. Best customers used to come every eight weeks and average customers, who now come every two months, used to come twice a year. There's no relationship between the frequency of visits today than what it was several years ago. We are truly a very strong destination shop -- store visits, when people go to malls or they are walking down their main streets.

With all of these new categories, do you think there's going to be a need eventually to increase the average size of the stores?

It's a good question. We struggle with this continuously with a view that we do not want to increase our square footage unless it becomes absolutely necessary, so what we do is we continue to shuffle the ways in which we merchandise our stores.

We mentioned a while ago, for example, that we have focused on men's and business in 35 or 40 stores to free up space in the other 130 stores of our expanding women's handbags and accessories business.

Our future depends upon a singular focus and that is in accessories -- handbags, small leather goods and related areas. Those are the areas that are experiencing the highest levels of growth.

Now, having said that, in Japan, where we are undersized in general, expanding locations is a very critical part of our strategy. When we've said we are expanding 15 locations, it's noteworthy to know that we only have about 90 full price locations, and the locations we are expanding are the locations that do 3,4 or $5000 per square foot. And even though we are expanding space by 50 percent on average, we expect sales to grow by 50 percent -- unlike the US, where the ratio is 50 percent of sales growth to 100 percent of space growth.

Thank you.

Janet Kloppenberg (ph).

Janet Kloppenberg (ph), JJK (ph) Research. Good morning. Congratulations. I wanted to just touch base on the higher priced product and talk a little bit about its success and your thoughts about moving prices upwards, going forward, via (indiscernible) 25 percent the customer in the higher income brackets. Can you do that under the same label? Would you consider a collection label, those sorts of things? Thank you.

First, we believe the Coach brand has the imagery and equity which enables us to sell price points at any level -- sell products at any level. We have sold exotic handbags and do today at several thousand dollars a bag. We notice, though, (indiscernible) distance when it comes to Coach products. For us, the challenge is making sure that we offer the right price value relationship and make sure that we sort our stores based on the consumers who shop there. So, you will see, increasingly, a layer of product that we're going to add to -- those stores where the consumer demographics can really support luxury product. Those are what we refer to as our flagship and fashion stores.

At the same time, it's important to note that we do have a very diversified and broad franchise, and that is a key to our strength. So attractive price points will always be a part of our equation.

Over time, we do believe our average retail will grow faster than certainly CPI will grow.

So you think that you can add more -- layer in more of the higher priced product while not alienating the core loyal, more moderate customer?

The short answer is yes. We have been doing it for three years now and our franchise is as strong in classic bastions as it was three years ago.

Thank you, Lew. Then another question on the conversion rates dipping down a bit -- I was in many of your stores over the holidays and I will be honest with you, sometimes the lines were just impossible. I just wonder if, during thee peak periods, if you have thought about that and how you might manage that logistically, going forward.

We're going to do that a few different ways. It's obvious that it's very hard to service everybody during the busiest weeks of the year -- (multiple speakers).

Particularly when you're doing the gift wrapping, when you are doing the gift boxing at the same time, yes.

We actually have a series of initiatives underway. Mike will touch on our POS system that we're putting into place now.

Yes, we had -- during the holiday season, Janet, we had six stores piloting our new POS system, which, by the way, we will have rolled out across the whole chain by the end of our fiscal year.

Just one data point -- one of the stores that we have it in was Riverhead, our Riverhead store, which operates with four registers. Last holiday season, lines at the door, constrained, at our peak doing about $15,000 an hour through those four registers.

With the new POS system, we increased that by roughly 50 percent to up to $22,000 an hour through the register at peak, so an improvement of roughly 50 percent. So, we're very excited about the throughput we think we can gain from POS, and it will help us get through holiday next year at Riverhead, compared to last year, when the lines were out the door; they were virtually nonexistent this holiday.

In addition, clienteling is going to play a much stronger role in early December. What we're going to do nationally next year is have special shopping nights in the first two weeks of December for our best customers, where we will give them an opportunity to preview Resort product, as well as to get our special service. We think that combination of client, improved clienteling and system enhancements, as well as our strength and service capabilities in the store, will help us a great deal next holiday.

Then I was just wondering if you could just talk about sourcing issues -- -- any changes, pro or con -- the dollar or perhaps the quotas disappearing in the year, etc., that may help you or hurt you.

It's business as usual on the sourcing side -- no problems, no issues.

In other words, you don't see any (indiscernible) price increases, going forward?

None that we have not budgeted in our plans.

Liz Dunn.

Thank you, Prudential Securities. Just a few questions -- obviously, the higher priced product performed better than your expectations. I think you were looking for a five point increase in average unit retail this year, and it looks like you got about 10 points. How much of the price increase have you been able to keep in gross margin? How much has really gone into making the product more special?

Also, could you share the merchandise margin differential between regular product, pinnacle and flag and what percent of your handbags sales are in each piece? Thank you.

Sure, I will take that one. The answer is that the gross margin rates are very, very similar across all of our handbag and accessory product categories. So the short answer is, where we have priced up, it is priced up because there's additional make billed into the bag and the cost is up proportionally.

The gross margin rate improvement, the 200 points roughly that we attributed to product mix -- very little of it came from price increase; it was all predominantly the increase in mix material, collection share of total sales. So the gross margin rates are consistent across the categories is the short answer.

Pinnacle and special edition product worldwide represented somewhere between 5 and 8 percent of sales, most of it being special edition -- much more so in Japan than in the U.S.

We're going to conclude our conference call. As always, feel free to reach out to me or to Mike with any follow-up questions. Thank you all for joining us this morning. Have a great day.