掛毯 (TPR) 2005 Q3 法說會逐字稿

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

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

Thank you. 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 include 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 due to expected economic trends, or our ability to anticipate consumer preferences. Please refer to our latest annual report on Form 10(K) for a complete list of these risk factors. Also please note that the historical growth trends may not be indicative of future growth. We presently expect to update our estimates each quarter only. However, the failure to update this information should not be taken as Coach's acceptance of these estimates on a continuing basis. Coach may also choose to discontinue presenting future estimates at any time.

Finally please note that all prior year per share numbers that will be discussed have been adjusted to give effect to the Company's 2-for-1 stock split, which was effective earlier this month.

Now let me outline the order of speakers and topics for this conference call. Lew Frankfort will begin with an over overall summary of our third fiscal quarter 2005 results, as well as strategies going forward. Mike Devine will then follow with details on financial and operational highlights for the quarter, as well as our outlook for the fourth quarter, full year 2005 and initial guidance for fiscal 2006. Following Mike we will hold a question and answer session that will conclude by 9:30 a.m.

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

Thanks Andrea, and good morning everyone. I'm delighted to report that Coach courts continues to achieve excellent results. As we approach our five-year anniversary as a public company, it's important to note that we've achieved double-digit sales and earnings growth in every period. This consistency speaks to the sustainability of Coach's business model, our ability to effectively execute our strategies. And most importantly, the strength and endurance of the Coach brand which rests on three core brands equities: Product innovation, relevance, and exceptional value.

Before I go through the highlights of the quarter I want to briefly mention our acquisition of Sumitomo's interest in Coach Japan, which we are very pleased about. This acquisition will be immediately accretive to earnings when it becomes effective at the beginning of FY '06. As you know Japan is a key market, and we are very excited about embarking on a new phase of growth there, in fact while in Japan a few weeks ago we outlined an accelerated growth plan to double the business again over the next few years, through a combination of new stores, expansions and further improvements in same-store productivity.

This morning we reported excellent quarterly results ahead of our recently revised guidance and analysts estimates, as a 33% increase in sales combined with an improvement in margins continued to drive the bottom line. The highlights of our third fiscal quarter were, first, net income rose 53% to $89 million, or $0.23 per diluted share. This compared with 58 million, or $0.15 per share, in the year ago period. The recently revised consensus estimates for the quarter was $0.22 per share.

Second, net sales totaled $416 million, up 33%. Third, direct to consumer sales which consists primarily of sales at Coach stores rose 30% to $209 million during the third quarter. Fourth, comparable store sales in the U.S. rose 19.3%, with retail stores up 12.9% and factory stores up 28.5%. It's worth noting that based on our four-year comp, our full price or retail stores are twice as productive as they were in FY '01.

Finally Japan sales rose 35% in local currency driven by new stores, expansions and high single-digit retail comps.

Our strong U.S. retail comps reflect both market share gains and category growth, as our business was primarily driven by well-received monthly new product flow, and by higher average transaction size. The factory stores, we continue to experience exceptional comp store sales increases, driven mainly by a substantially improved merchandise offering with an increased level of factory exclusives tailored to the more classic factory consumer.

In addition our sales also benefited from the overall strength of the factory channel, and we would also note that we anniversaried the end of factory store in-home promotions during March. As we've mentioned before there was little cross-over between the full price on factory consumer, as they are each dedicated to their respective channels, focusing 80% of their Coach spend in their preferred environment. During the quarter, we opened a new retail store in Palm Desert, California, a new market for Coach.

Also as mentioned on our last call we began the renovation of 595 Madison Avenue in January, while opening a very successful interim space just a block away at 3 West 57th Street. We also expanded a factory store in Dillon, Colorado, and closed one in the Hamptons, in order to convert this location to a full price store. We ended the quarter with a total of 186 retail stores and 80 factory stores. Indirect sales rose 36% to $207 million, from 153 million in the same period last year.

All indirect businesses, including Coach Japan, U.S. department stores, international wholesale, and special markets, contributed to the significant increase. We were delighted with the continued strength in Japan, where as noted we achieved a 35% increase in constant currency, and a 39% increase in dollar terms. During the quarter we opened one new factory store in Japan, as well as a high volume wholesale tourist location in Okinawa and, as-planned, closed 3 small Mitsukoshi locations. We also expanded five locations including a major shop-in-shop in Shinjuku Mitsukoshi, Mitsukoshi in Tokyo. This brought the total number of store openings in FY '05 to 10, and the number of expansions to 12.

At the end of the third quarter, we had a total of 106 locations in Japan with 16 full price stores including 6 flagships, 76 shop-in-shops, 11 factory stores, and 3 wholesale locations. As we mentioned before since the quarter ended we opened our seventh Japanese flagship in Nagoya to an enthusiastic reception. We were also very pleased by a 30% increase in POS sales at U.S. department stores which reflected primarily further market share gains in this channel for Coach.

Throughout the quarter, consumers enthusiastically embraced our transitional and spring offerings across categories and collections. These included the novel dot group of gallery totes and accessories, which sold extremely well in January, new styles and colors in our SoHo and Hamptons leather collections, and the fun, fresh, Valentines types group of handbags and accessories. In March we launched our expanded collection of Hamptons Weekend, in which we added styles, sizes and color choices, in this lightweight collection along with a scribble fabrication, which is a playful interpretation of our signature pattern. This expanded group enhances Coach's appeal in the casual weekend market and has been remarkably well-received. We also brought back an updated SoHo twill group for its third consecutive year.

As mentioned in our press release our business has continued strong through April across all channels. As always we have a strong mix of fresh and innovative products in the pipeline. This month we launched a new group of straw boxy Totes which is an entirely new silhouette for Coach. These are available in two sizes trimmed with with metallic or buck leather and suede, and includes a wood circle Limited Edition appliqued version. Also in April, our lifestyle optic signature fabrication was introduced in yellow, pink and green in several SoHo handbag styles, as well as in footwear, scarves and hats. Optic is the feature for Mother's Day and we just added a new white-on-white variation.

Next week we will launch new summer program to replace last year's beach concept, a key driver will be a new interpretation of last year's very successful shoulder tote in scribble and signature, which will be offered in two sizes. Additional newness includes scribble boxy totes and signature scarf print in hobos and totes. Coming in June, our collection in both vintage, signature, tye dye, and patch work signature, a perennial favorite, to anniversary last summer's successful signature stripe group.

Clearly we have delivered on every key metric and while our past successes have been noteworthy, we believe that we are only just approaching the halfway mark in terms of organic growth. Whether we talk about a marathon that has become an Ultra-marathon, or a baseball game in the fourth earnings, we have substantial opportunity to leverage our successful luxury positioning, and drive growth through our multi-channeling business model while continuing to enhance our profitability.

To this point as most of you know we have been implementing four key strategies that focus on sustaining accelerated growth. First, most generally we are building market share in a growing U.S. women's accessories market, by leveraging our unique position as an accessible, luxury lifestyle brand. As part of this strategy we are emphasizing new usage occasions, such as weekend or evening and offering novelty and special Limited Edition products, to heighten our [cashay], especially with our top-tier customers.

Our second strategy to continue acceleration of growth in U.S. retail. We plan to add 100 U.S. retail stores over the next four to five years, bringing the retail store base to nearly 300 locations. During the fourth quarter of this fiscal year, we will add seven additional retail stores. This will bring our full year openings to 19, including six new full price markets for Coach, which include Des Moines, Sarasota, Tucson, Palm Desert, Syracuse and Toledo. FY '06 we plan to open 20 additional retail stores. Also in keeping with our strategy to expand our most productive locations, we will be expanding an additional retail store in the fourth quarter, Ala Moana, and beginning the expansions of our White Plains, and Scottsdale stores, taking us to 11 retail expansions undertaken during FY '05 which, when completed, will add a total of 17,000 square feet to the retail base.

Third, we are aggressively expanding market share with the Japanese consumer. From about 8% this year to a goal of 15% during the next four to five years. As I mentioned, we are obviously very pleased with the acquisition of the 50% minority interest in CJI from Sumitomo. We have completed our development plan well ahead of schedule and owing our business completely will provide an excellent opportunity for us to nimbly drive the next phase of Coach's growth in Japan. This phase will include opening new retail locations, including flagship stores, which we now believe could reach 15, double the current number of flagships.

In fact the opening of our Nagoya store earlier this month was very successful. It was part of a week long series of Coach press events culminating way charity concert by Mandy Moore, in which Coach commit to do a substantial contribution to UNICEF to be used for children who are victims of the tsunami. The concert also provided an excellent opportunity to showcase the Coach brand and strengthen our cashay with stylish Japanese consumers. We expect that we could eventually have a total of at least 140 Coach locations in Japan across the same multichannel distribution model that we have established in the U.S.

This year we plan to expands about 15 of our most productive shop-in-shops, adding nearly 14,000 square feet or 11% to our retail base. Overall, we expect sales in Japan to grow over 30% this fiscal year, in a market that continues to be sluggish.

And lastly of course we continue to have an overall focus on improving the rate of profitability, so that our bottom line results continue to outpace top line performance. The strategies and actions I just outlined build on the strength our core brand and business equities. They are designed to reinforce Coach's leadership position as an American classic lifestyle accessories brand, offering accessible luxury 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 of strategies. Let me now take you through some of the important financial details of our third quarter results. As Lew mentioned, our quarterly revenues increased by 33% with direct-to-consumer up 30%, and our indirect segment up 36%. In the third quarter our gross profit margin expanded by 220 basis points over the comparable period of the prior year from 75.9% to 78.1.

There are three primary contributors to this quarterly improvement: First, channel mix, as our highest gross margin channels grew faster than the business as a whole. Second, the positive impact of product mix, driven by increased penetration of higher margin mix material, special and Limited Edition products. And, third, our sourcing cost initiatives.

SG&A expenses as a percent of sales declined in the quarter to 43%, a 60 basis point decrease from the 43.6 reported in the year ago quarter. This reduction was primarily due to operating leverage gained due to strong top line growth with the exception of CJI, which continued to build infrastructure. Offsetting our operating leverage gains was a $3.9 million cumulative adjustment to store rent expense. This is a one time, non-cash, pretax charge, which now puts us in compliance with the SEC's current interpretation of FAS 13.

Due to the combination of sales growth and profitability improvements our operating income rose 45% to $146 million in the third quarter versus the same period last year. Operating margin in the quarter was 35.1% compared to 32.2% in the year ago quarter. Net income for the quarter increased 53% to $89 million, or $0.23 per diluted share, as compared to 58 million, or $0.15 per share in the year ago period. And was ahead of the recently revised consensus estimate of $0.22 per share.

Inventory levels at quarter end were $181 million, $27 million, were only 18% above prior year levels. We are pleased that we were able to support a 33% increase in quarterly sales, the 22 net new U.S. stores, 6 net new Japan locations, and 27 total expansions, all of which opened in the last 12 months with this modest increase in inventory. Accounts receivable balances rose approximately $5 million driven by sales gains in the indirect channel. DSO for non CJI trade receivables at quarter end, improved to 38 days versus year ago levels of 39 days.

We ended the third quarter with $694 million of cash and marketable securities. Only Coach Japan's revolver borrowings of $21 million remained on the consolidated balance sheet. The Company repurchased 6.1 million shares on a post-split basis in the third quarter at a total cost of $170 million, at an average price of $27.70 per share completing our current share buy-back authorization program.

Net cash from operating activities in the third quarter was $106 million compared to 100 million generated last year during Q3. Free cash flow in the third quarter was $89 million versus 88 million in the same period last year, mainly due to increased earnings. Both cash flow measures were offset by the timing of cash tax payments in the quarter. CapEx spending, primarily for new stores and renovations, was $17 million versus 12 million in the same quarter last same quarter a year ago.

As Lew mentioned, we are excited about buying out Sumitomo's interest in CJI, at the end of the fiscal year, well ahead of our original expectations. The purchase price will be approximately $225 million, plus undistributed profits of paid-in capital of about 75 million. The acquisition will have a positive impact on Coach as the elimination of the minority interest payment will more than offset the reduction of the interest income we otherwise would have received on the cash, being used for the purchase. In total the buy-out will be accretive immediately upon becoming effective.

That said I would now like to provide you with our goals for the fourth fiscal quarter and full fiscal year. For the fourth quarter ending July 2, 2005, we are targeting sales growth of over 23% to at least $415 million with U.S. comparable store sales gains of at least 10% in each channel, and mid-single-digit comps in Japan. As you know last years fourth quarter included a 14th week. So on an apples-to-apples basis this would actually represent a sales gain of 30%.

Operating margin for the quarter which will be about 100 basis points above prior year levels with gross margins increasing significantly, and as expected, SG&A as a percent of sales actually rising slightly, entirely due to increased marketing spend in Japan related to the media events that Lew mentioned earlier. These factors taken together should earnings of at least $0.23, an increase of at least 35%, again on an apples-to-apples comparing fourth quarter '05 to comparable thirteen-week period in FY '04, this would equate to a gain of at least 44%. This compares with analysts revised consensus estimate of $0.22 per share.

All of this translates for the full fiscal year, to net sales growth of about 30% to over 1.7 billion, a gross margin of nearly 77% versus 74.9% reported in FY '04, a significant improvement of about 100 basis point in SG&A expenses, as a percentage of sales on a year-over-year basis; resulting in a nearly 300 basis point improvement in our operating margin to about 36.4%; thereby accomplishing in one year, our three-year operating margin targets. In FY '04 operating income is expected to grow by about 40% over FY '04, resulting in EPS of at least $0.97, a gain of at least 43% from the $0.68 reported in FY '04, and compared with analyst recently revised consensus estimate of $0.95.

Our preliminary goals for full year 2006 are net sales growth of at least 19% to at least $2 billion, with at least high single-digit U.S. comparable store sales gains, and mid single-digit comp locations sales gains in Japan. And with our continued focus on profitability, net income growth well ahead of sales growth driven by continued overall operating leverage and the buy-out of Sumitomo's interest in CJI. This will produce EPS of at least $1.18 up from the $0.97 targeted for FY '05, compared with analyst current consensus of $1.13.

As mentioned in our press release our guidance excludes the earnings impact from the implementation of accounting for share base payments, which is currently expected to be required in the first quarter of FY 2006. While these are our current goals, our actual results may vary from these targets based upon a number of factors including those discussed under the business of Coach Inc. and risk factors in our annual report on Form 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 all for your attention and now Lew, Andrea and I will be happy to take some questions.

[OPERATOR INSTRUCTIONS] Our first question is from Bob Drbul. You may ask your question.

Good morning, congratulations. A couple of questions, Lew. I would like to talk about the acquisition on the CJI buyout if we could. The first one would be, could you elaborate a little bit on the rationale and the timing of it, why you are doing it right now, why it happened at this point in time versus the expected period?

And the second one is for Mike, is essentially can you talk a little bit in terms of the valuation what have you are paying and where we come out, we would estimate around 7.5 times EBITDA, does that make sense with the numbers you guys have?

Mike, why don't you take the second part first?

Sure. I think based on the EBITDA that the Company is expecting to record in the minority interest guidance of about 16 million, a number of 7.5, somewhere between 7.5 is the right number to think about for the EBITDA multiple for the purchase price. We are thrilled with the economics of that happening earlier, and I'm sure Lew will speak to that in a moment.

Bob, simply said we wanted control of our destiny so that we can move more nimbly and efficiently in Japan, and clearly our business is running ahead of our plan and we approached Sumitomo, and asked if we could find a way to purchase on their full 50% share. And I think you know, are we are about 2.5 years ahead of schedule.

And even after the acquisition you guys will still have a significant amount of cash on the balance sheet. Can you maybe talk a little bit about your priorities for the use of that as you look forward now?

First and foremost our priorities are to maintain growth strategies of opening new stores in new markets. We are obviously well capitalized and continue to open stores and expand them both in the U.S. and Japan. And work with our partners and international strategies. So, I'm sorry, in international markets. So that's first and foremost. We saw all, we talked about earlier.

We are a big buyer of the stock during the third quarter. And we would see that as a potential use of our cash going forward as well. But we are, the business is running well, we are in a cash build mode, and we are very pleased about that.

Thank you very much.

Our next question is from Jeff Edelman of UBS. You may ask your question.

Thank you. Good morning. Lew, the first question is what was the increase in the average selling price here in this quarter, and given the merchandising changes you are setting up for the fall, what could we look at for the fall and holiday season?

Okay. Well, first, the average transaction in our retail stores increased by about 10%. And that was in part driven by a much larger role that handbags played in the mix, I think about 40% of that is due to that, with the other 60% coming from products that had more make and detail than like product the prior year.

In terms of this fall we are thinking that we can look forward to perhaps a high single-digit increase in average transaction size, as we introduce a larger range of accessories compared to last year, including the ID charms which we had discussed during our last conference call, I believe.

Okay. Secondly you've been doing extraordinarily well with your Limited Edition. Is this going to grow, and have you thought about having a separate collection in a separate free-standing store at some point in time?

I will answer the second part first. We don't contemplate a separate store. We think the Coach umbrella is strong enough, and strong enough so that we cannot carry everything within one environment, and it's a lot more efficient in terms of returns.

In terms of our Special Edition product we are looking for it to continue to grow. We don't know how high is up, we think in the second half of the fiscal year, it will be somewhere between 10 and 12%. I'm sorry, in the -- yes, that's correct, in, that it's averaging, I'm sorry, it's averaging 10 to 12% today. Next year in the first half of the new fiscal year, we are looking for it to increase to north of 15%. Eventually it could be as high as 20% or so.

Great. Thank you. Nice job.

Dana Telsey of Bear Stearns.

Good morning and congratulations. Can you talk a little bit about the infrastructure in Japan? You've added some people recently. Are there any other additions that you need to make? And now under complete ownership by Coach do you expect any difference in operating procedures and processes than what you had before? And lastly on factory outlook comps which are so good how is it going, obviously it's working well with the new design team, how much differentiation will we see between the products and price points between full price and factory stores? Thank you.

Let me take the last question first. In terms of our factory stores, today the product line is sharply differentiated. We do not put in today's products from full price until the following year or longer, and I think what we can all look forward to, is continued efforts on the part of our design team to focus its efforts on the product that we think will drive this much more classic older value-oriented consumer, and more generally we believe the factory channel, the resurgence is something that's going to continue for the next few years. Traffic is up in better malls. Sales are up in better malls and clearly the drive for value, whether it's at the discount level or at the accessible luxury level, is something that is going to be maintained.

In terms of, in terms of Coach Japan first with regard to the organization, earlier today in Tokyo we announced the name of our new COO, Jonathan Huet, who will be be coming to us from Adidas where he was responsible for operations pan Asia. He has a very strong logistics, finance and IT background. We think he's going to be a very strong addition to our team as the business approaches half a billion dollars we need a lot more specialization.

We did announce a few weeks ago the appointment of Norito Ebata to the head of retail and consumer service. He is going to actually be starting in a few days. He comes to us from Starbucks. And we envision Ian working with his senior team, the existing senior team plus Norito and Jonathan to help layout our organizational requirements over the next few years.

In terms of our business processes we are in an SAP platform. We are already integrated globally and we are extremely efficient in that regard. When we talk about operating independent of a partner we are talking really about decision-making, whether it's around organization, new stores. It's going to eliminate a process, and allow us to be able to move more fluidly.

Thank you.

Margaret Mager of Goldman Sachs.

It's actually Jennifer [Tong] for Margaret Mager. One question on the factory outlets. Could you elaborate on your expansion strategy in terms of new openings, expansions or renovations?

Sure. Well, first, we are looking to open, I believe, three to five factory stores during the course of the next year. What we are looking to do is focus on those opportunities that are sizeable and, for example, next year we are looking to open one store in the northern California in the Napa Valley, which we think can generate north of $5 million, a second store in Raleigh, a third store in Minneapolis and in addition we are looking to open in Sawgrass Mills in Southern Florida. Our intention is to focus on openings that can be very substantial.

Jennifer if you've been up to the expanded Coach store in Woodbury Commons, you would see that we've taken our #1 factory store in the United States and added about 35% onto it's square footage, so we are looking at expanding our most productive stores in place, and I think you can see, you will see a number of expansions next year.

Also could you please update us on conversion versus traffic growth in your full price stores?

What we said earlier is that our traffic this year was consistent with last year's level as expected. Last year we experienced a real surge in traffic which was up 30%, and we experienced also as expected a reduction in conversion. This year we are pleased that we were able to sustain the same level of very high traffic that we experienced last year, and achieve conversion equal to last year. So it's been a period where we have been able to sustain the gains that we enjoyed last year.

Thanks very much.

Christine Chen of Pacific Growth Equities, you may ask your question.

Thank you, congratulations on another great quarter. Can you just remind me if there is any margin difference between factory and retail stores?

The answer is, yes and no. There's a difference in the gross margin. Obviously we sell the goods at a discount, but the operating expenses are much lower in the factor stores, so that the four wall contribution in factory stores is roughly equal to the contribution of full price stores.

And at the department store level are there plans to continue increasing the number of doors, or are you currently happy with what you have in the pipeline right now?

Well?

At the U.S. level.

We were very pleased with our department store business. Our POS sales grew 30% last quarter. In fact, our sales have more than doubled in a lesser amount of square footage over the last three years, than we enjoyed three years ago.

And what they are finding is that Coach is the brand of choice. We have about 20% plus market share in U.S. department stores. Our growth of this Spring was fueled by Macy's East, Macy's West, Nordstroms, and Dillards, just to name a few chains, and what we are doing is selectively expanding the best locations, and raising up the performance bar in smaller doors to ensure that we can really show the full breadth of Coach.

So overall while we do expect square footage to grow a bit it will largely be through expansions and not new door openings. Thank you very much. You're welcome.

Mark Friedman of Merrill Lynch. You may ask your question.

Thank you. Good morning, everybody, great job in the quarter.

Thank you, Mark.

Lew, I was wondering if you could talk about the men's collection that we've noticed in the flagship that's been expanded. Is that something that's registering enough that it's worth reinvestigating in other stores, or is it going to be kept Limited Edition? And anything else as far as new initiatives for fiscal '06 besides the bigger accessory business you've answered before.

Sure. Well, first, it's taken us a while to define the role that men is going to play in the Coach franchise and, Mark, we've decided that we couldn't have it both ways, and that we are a women's brand, and that we are focusing our energies really on great product for women, on a feminine retail environment.

Having said that we do have a focused men's collection in 35 stores, and it is doing well. It's running about 10% in those locations. We do believe that there's an important place for men, but it's subordinated to women and we are looking for men's products to stay within the same area where it's offered today.

In terms of next year, to be more specific around some of the initiatives, first in the area of accessories we are very pleased that we will be introducing a group of technology cases largely to hold I-Pods, Blackberries, and the like, and we are introducing them in styles and materials that complement the products that we are introducing for that season. And the product looks great and we think we are going to do really well with them.

Secondly and I just touched on I.D. charms before, one of the ways in which we are going to enable our consumers to have individualized bags without customizing them is to provide them an opportunity to buy any type of alphabet letters that they wish, which are proprietary to Coach, and the early reaction among our consumers, not in pilots but in surveys has been spectacular, and we are excited about that opportunity. We are also introducing a group of cosmetic cases that will also add to the accessories opportunity.

And lastly one other opportunity for us is in the whole area of baby. We used to -- we had an initiative around Coach Kids, and this time it will be around Coach Babies. We already have two silhouettes in our stores on baby bags, and we are going to be introducing two additional styles, and some accessories to go with those items. The team is really enthusiastic about the fall and holiday product, and I invite you, Mark, to come up here and visit.

Joe Teklits of Wachovia.

Two very different questions, one for Mike and one for Lew. First Mike in your explanation of your gross margin increase for the quarter to clarify, you mentioned one of the reasons the increase was channel mix. But I think you also said that your indirect business was up slightly more than your direct business. So maybe just an explanation of that for me, and also in your outlook for the future, for the bottom line exceeding the top line is there anything built into that for any merchandise margin improvement, or are you fully maxed out there?

And I was just curious about Lew's comments in the press release about Coach becoming a resource for the newest styles similar to the way consumers seek out the latest innovations and technologies is pretty interesting. I'm assuming you are not going to broaden out beyond accessories, handbags, into other areas of fashion, if you will, but are you seeing like accessories leading trends, or dictating or setting trends, versus being the follower and accessorizer of trends in the past? I'm just curious.

Let me take the second, first in terms of consumer electronics and other technology trends. Our only intention is to accessorize those trends. So when someone buys an iPod and I think there will be over 20 million sold in this country, we want to give them the opportunity to have a well-made functional, fun, stylish case. So we won't be expanding into consumer electronics, again, we are just going to be accessorizing them.

However, in terms of fashion innovation, we do see consumers coming to us monthly to see what's new from Coach, whether it's color or style. We do believe in the world of accessories. We are not only an innovator but we find that our consumers do follow us as well.

The answer to your margin question is a simple one. Coach Japan which carries our highest gross margin is in the indirect segment and is what's driving the growth, and is one of the primary contributors to the channel mix.

Okay.

In terms of a longer look around margin we do we do seek additional upside to our gross margin rate, although at rates approaching 75, 76%, we are not going to see the same year-over-year growth as in the past. But channel mix will continue to drive margin expansion. And also product mix. Lew talked earlier about we are going to see increased penetration for our Limited Edition and special products, and those collections carry with them a marginally higher margin rate than the core product offering. So we do expect to continue to see gross margin expand modestly in the future.

Brian Tunick of JP Morgan, you may ask your question.

Just following up on Joe's question, I guess, on the input side, Mike, are you seeing any trends in the raw materials, becoming more challenging or easing?

No, nothing significant there at all in any of our raw materials markets. We continue to drive sourcing improvements and counter-sourcing, which if anything will help us modestly in the margin rate.

And then on the EBIT margin side, since you recognized I guess your three-year goals in one year, are you able to talk about another three-year goal out there, is there more opportunity on the SG&A side obviously?

We haven't given specific guidance that far out about where operating margins can go, but I think you hit on a good point. We will as I just talked about see gross margins expand modestly, but looking out going forward, I think we will begin to see more of the improvement in operating margin come from the SG&A line, as we continue to leverage our expenses through top line growth and through process improvements.

What kind of comp do you need in the U.S. to get leverage on SG&A?

Well, within the channel itself our retail business, we need a comp in the high, mid to high single digits. But, of course, with the growth in all of the other channels contributing to get overall leverage to the consolidated financials, we will produce leverage with a much lower, could produce leverage with a much lower comp in the retail business.

I guess the final question for Lew, as you walk the malls, and the POS channels do you see anyone out there that you think is starting to actually recognize the opportunity in the affordable luxury segment, or do you still think we've got several more quarters or years at least, before the market catches up to you?

Well, we are hoping that some accessible luxury propositions take hold, because we do believe that the entire category would grow as it began to grow in the second half of calendar '03. But I'm not sure anyone is too far along yet.

Thank you.

Jennifer Black of Jennifer Black and Associates.

Good morning and let me add my congratulations, Lew.

Thank you Jennifer.

I have a couple of questions. I wondered if you could talk about the number of handbags per woman, what they are purchasing, and what are you would foresee over this next year? Two, if you could talk a little bit about special occasion, satins and what you plan for holiday versus a year ago. It seems like there is an opportunity. And, three, do you have any plans for your most loyal customers? Is there anything new that you are doing? And then lastly are you happy with your shoe offerings? It seems like there's an opportunity to improve it.

Okay. In terms of the number of handbags, women are now buying on average somewhere between 3 and 4 handbags a year, which is up from about 2 handbags just a few years ago. With see that level being maintained as in the case of best Coach consumers probably are increasing.

In terms of special occasion, we are excited by a few initiatives of this holiday. First we are going to, we are building on the success of our Madison evening or special occasion group, that we launched last November 1st. With a broader range of styles across multiple materials from [Lurex] to satin to chenille, fur, and mosaic.

In addition we are introducing a group of beaded totes which are basically gallery totes, which are going to have, which are going to be embellished with beads, jewelry. And the reaction has been great, and we are very enthusiastic about the opportunity.

Lastly we are introducing what we are going to call capsule ski group. It's going to be a lifestyle group of products that will be offered in quilted fabrics, ranging from hobos to pocket first, pocket flaps. Not only will it be quilted, but certain styles will be fur-trimmed as well.

Moving to our most loyal consumers, our client telling initiatives are really focused on the individual consumer at the store level, and we have been developing client telling programs which we have discussed before, whether it's thank you notes to consumers who make a substantial purchase with us that's handwritten, or whether it's informing consumers of new styles that we think they may have a proclivity for. We think in the area of Coach service we will continue to focus on strengthening the experience both in the store, as well as the post-store service aspects. With regard to shoes we are pleased with our footwear performance. We do think there's an opportunity and we have strengthened our entire leadership team, and believe that we are going to continue to see growth in our footwear business up.

You should know, Jennifer, that our footwear business is extremely successful, also, in U.S. department stores, where we share or are already the #1 brand within the Bridge designer group.

That doesn't surprise me. You blew out if the scribble tennis shoes in about a day. Thank you very much and good luck.

Neely Tamminga, Piper Jaffray.

Thank you and let me add my congratulations to Lew and team. Lew, in Japan with respect to those expansions, obviously the flagships are exactly the way you guys need to go. You've seen positive results from that, but these expansions within your existing department store locations, the 15 that yo've identified can you give a sense again of the timing of that, and will there be more beyond that, and I guess the real question is can you accelerate that, now that you have the joint venture in-house at the end of this year?

First, unlike in the U.S., our space in Japan is much smaller, and we have not been able to merchandise Coach as a lifestyle brand in most of our locations, and because of the very strong successes that we've enjoyed over the last few years, there is an opportunity for us within place to double, triple and in some cases grow seven to ten-fold, the square footage and we are focused on the best performing locations.

In terms of acceleration we already have a very accelerated program and are very pleased with the 15 expected expansions that we are going to realize this year, and looking forward, I'm thumbing through a page here, I'm sorry -- this year it's about 15 renovations, and next year we are looking for a similar number. And all of the locations have been identified virtually approved with our targeted dates.

So expansions are going to play a very major role in Japan, much more important than in the United States. And a very good opportunity for us. I had just cite one store. I was in Shinjuku, Mitsukoshi about three weeks ago, and we expanded our space within the store, relocated and expanded to include some frontage on the side street and some windows on a main street, and the store is trending over 100% higher than it was before we expanded. We expect to do north of $10 million in that location. So it's a very efficient way to grow our business.

Sounds wonderful. Congratulations, Lew. Best of luck.

Our last question is from David Schick of Legg Mason.

Hi, good morning. I just wanted to follow up on something that Mike Tucci had actually talked to us about, which is the test of some new POS in the stores that allows, I guess, more customer data and transaction history, and how it's going to help lever or to devote more selling time. Can you talk to us about that test, how it's progressing and where you think that would go during the year?

Sure. Well, first, in terms of throughput, we are able to move people through our stores more rapidly, and the biggest gains we are experiencing are in factory stores which are extremely challenging during the very busiest periods. So the biggest gains first are in factory stores. Where we are able to dramatically increase our sales just by providing much improved service.

In terms of a database, database management clearly on having information available to us at the store level as to most recent purchases, as well as cumulative histories will help us in our client telling initiatives, and we have a variety of programs that we are piloting there.

Are you ready to talk about what the pilot stores have been able to do that nonpilots, or is it not at that point yet?

Much of the -- much of the work is granular, David, and it's subtle. And the short answer is, that we are able to, we are able to register improvement in a variety of metrics, but we are not prepared to be more specific in terms of identifying them yet.

Great. Thank you.

Thank you everyone for joining us. It is now 9:34 and we are going to conclude this conference call. As always, Mike and I will be available for additional questions after the call concludes. Thank you.

Thank you. This concludes the conference, you may disconnect your lines. Thank you for your participation.