掛毯 (TPR) 2006 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'd like to turn the call over to the Vice President of Investor Relations at Coach, Ms. Andrea Shaw Resnick. You may begin.

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 such as expected economic trends or our ability to anticipate consumer preferences. Please refer to our latest annual report on form 10K 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 our each quarter only. However, the failure to update this information should not be taken as Coach's acceptance of these estimates on a continuing basis. Coach may also choose to discontinue presenting future estimates at any time.

Now, let me outline the order of speakers and topics for this conference call. Lew Frankfort will begin with an overall summary of our third quarter fiscal 2006 results, as well as our 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 4th Quarter full fiscal year 2006 and our initial guidance for fiscal 2007. 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 again delighted to report that Coach continues to achieve excellent results. As we approach our 6th anniversary as a public company, it's important to note that we have achieved double-digit sales and earnings growth consistently in every quarter. This performance 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 brand equities: product innovation; relevance; and excellent value.

This morning, we reported excellent quarterly results, as a 20% increase in sales, combined with an improvement in margins, continued to drive the bottom line. The highlights of our 3rd fiscal quarter were, first: net income rose 35% to $109 million, or $0.28 per diluted share. This compared with $81 million or $0.21 per share in the year-ago period and the consensus estimate for the quarter of $0.27 per share.

Second, net sales totalled $498 million, up 20%.

Third, direct to consumer sales, which consists primarily of sales at Coach stores in U.S. and Japan, rose 22% to $374 million during the 3rd Quarter.

Fourth, comparable store sales in the U.S. rose 21.1%, with retail stores up 11.7% and Factory stores up 34%. It's worth noting that based on our 4-year comp, our retail stores are twice as productive as they were in FY '02.

And finally, Japan sales rose 23% and local currency, driven by new stores and expansions and high single-digit comps, while dollar sales in Japan impacted by the weaker yen, rose 10%.

During the quarter, we opened 3 new retail stores in the U.S., all in new markets for Coach: Naples, Florida; Albany, New York; and Reno, Nevada. We also opened one new factory store in Sawgrass Mills, Florida, and closed one in Charleston, North Carolina. Thus, we entered the quarter with a total of 206 retail stores and 84 Factory stores.

In Japan, Coach opened 3 net new retail locations and expanded 2 additional locations, as well. At quarter end, there were 115 total locations in Japan.

Indirect sales rose 14% to $124 million from $109 million in the same period last year. All indirect businesses, including international wholesale, special markets, and U.S. wholesale, contributed to this increase.

In the United States, department store sales growth at POS continued the be excellent, with comp sales running up over 20% last quarter and total sales up about 17% after accounting for the closure of locations as a result of the Federated-May merger.

As mentioned last quarter, we continue to see intensified competition in accessories, as this category remains one of the few bright spots within U.S. department stores. However, we welcome new entrants into our arena as a means to drive additional consumer interest and are confident we will continue to demonstrate our ability to outpace the competition over time.

Further, as we have often discussed, U.S. customers are extremely loyal to their handbag brands. Thus, Coach, as the U.S. market leader, with a broad and diversified consumer base, continues to be in an ideal position to take advantage of this strong category growth.

Naturally, we are very pleased by the strength demonstrated across all of our full-priced channels once again this quarter. Our excellent U.S. retail comps reflect category growth and modest market share gains, as our business was primarily driven by well-received monthly new product flow, while average transaction size, traffic, and conversion all rose in the period.

As was the case in the holiday quarter, units per transaction contributed to the gain in our average sale, reflecting the success of add-on items, such as charms, iPOD covers, and cell phone lanyards.

In Factory stores, we continue to experience exceptional comp store sales, driven by a strong merchandise offering, with an increased level of Factory exclusives tailored to the more classic Factory consumer. In addition, our sales also benefitted from the overall vibrancy of premium Factory centers. As we've mentioned before, there is limited crossover between the full-price and Factory consumer, as each is dedicated to her respective channel, focusing 80% of her Coach spend in her preferred environment.

And, of course, we were delighted with the strength in Japan, where we continue to grow our footprint significantly. As some of you know, I had a chance to visit Japan during this quarter, and now believe that our opportunity there, notably in markets with limited outright luxury brand development, may well be larger than we originally envisioned.

Throughout the quarter, consumers enthusiastically embraced our transitional and spring offering across categories and collections, as the look of our assortment continues to evolve to reflect changing consumer preferences. These included Gallery satchels and updated Hamptons collection, including signature stripe carryalls and the novel Poppy group of totes, demis, and accessories.

In February, our fresh interpretation of Soho sold exceptionally well, as did a new group of shoulder totes, an important key item silhouette throughout spring. Our Valentine's Day selling period results were very strong, anchored by a studded Soho signature group accented with red and pink suedes, including an assortment of add-on items, such as wallets, scarves, charms, and key fobs.

After Valentine's day, we introduced a new Hamptons weekend collection, including a distinctive patchwork design, which became an instant success. During the quarter, our limited edition offerings performed very well, including the Hamptons vintage carry-all at $598, and the new Legacy Leather shoulder tote at $798.

As mentioned in our press release, our business in April has continued strong. As always, we have a strong mix of fresh and innovative products in the pipeline. In April, our Soho optic signature fabrication was introduced in a seasonal pallet and several strong-selling handbag styles, as well as in footwear, scarves, and hats. In addition, straw totes and hobos in our important Legacy silhouettes were also introduced.

For May, we're now launching a new summer program, including soft totes in Classic Signature and new seasonal gradient Signature as well as Optic Signature shoulder totes, and coming in June will be a new Signature Patchwork and tie dye groups, both perennial favorites.

Clearly, we have delivered on every key metric, and while our past successes have been noteworthy, we believe that we're only just approaching the halfway mark in terms of organic growth, as a monogram focussed on delivering accessible luxury accessories to a broad and loyal consumer base.

While we have often discussed our four key growth strategies, they can be summarized into two primary drivers of top line growth which are focussed on achieving continued rapid growth during the years ahead. Namely, distribution growth and improved productivity.

First, on distribution, the opportunities for Coach are abundant, both in our core North American and Japanese markets and in the emerging markets, as well, notably in the rest of Asia. We have begun to see widespread recognition of the Coach brand by Asian consumers. Today we have about 75 locations through distributors in markets such as Hong Kong, Korea, Taiwan, and Thailand, to name a few.

By the end of this fiscal year, we will have added a net total of about 55 new Coach locations globally. This includes nearly 30 in the U.S., consisting of 25 full-priced stores and a net of 3 factory stores, 14 in Japan, and 12 through international wholesale, bringing our global total to about 525 locations, excluding U.S. department stores. In addition, we will have expanded over 20 U.S. and Japanese Coach-operated locations and 15 international wholesale locations.

For FY '07, we plan to open about 85 net new locations globally, increasing our U.S. full-price openings to at least 30, along with about 5 U.S. factory stores, 15 to 20 locations in Japan, and an additional 30 locations through our international distributors, primarily in Asia. This will be augmented by our plans to expand about 30 to 35 Coach-operated locations in the U.S. and Japan and about 12 international locations. Thus, by the end of next fiscal year, we expect to stand at about 610 Coach locations globally, excluding U.S. department store doors. Our square footage is expected to grow about 20% next year to nearly 1.4 million square feet as a result of these new openings and expansions.

Beyond FY '07, the potential for distribution growth remains significant. As you know, we believe it can bring our number of North American full-price stores from about 200 today to more than 350 over the next several years, at an accelerated pace of at least 30 locations annually.

In terms of factory stores in the U.S., our plans are to open 3 to 5 net new stores annually, getting to about 105 locations from the current 84.

In Japan, we have about 110 locations to date, and now believe that our potential is well over the 150 locations that we have cited in the past, if we can realize the regional potential. We are currently assessing this opportunity, given the success of our new stores and these very underdeveloped markets, where, during the first few months of operation, half of shoppers note that they are new to the Coach brand. It's worth mentioning that included in our Japanese openings planned for this year, 10 are in new markets for Coach, and 6 of these are in what we consider regional markets, with most having no luxury brand presence.

In addition to our two core markets, the U.S. and Japan, we know that mainland China will become an important market for luxury brands during the next several years, as the income and consumer spending levels catch up to the retail development that already exists in this market.

For now, we're focusing our development in Hong Kong, which, as you know, is the gateway to greater China. During early July, we'll be opening a major retail store on Canton Road, our 13th location in Hong Kong. Over the next two fiscal years, we're planning to open four net additional locations there. That said, we are intensifying our development efforts in mainland China, where we have 2 small stores to date, focused on the domestic consumer. It's our intention to open at least 10 locations in major cities during the next 2 to 3 years.

The other important sales driver will continue to be improving the productivity of our existing locations. We believe all 3 components of comp growth are still available to us. First, transaction increases through a tiered merchandise offering, including higher limited edition penetration along with driving units per transaction with a broader assortment of add-on items and potentially new flanker categories.

Second, conversion through enhanced service and ensuring that we are meeting a broader array of our consumers' accessory needs. Whether she is coming into Coach for an evening bag, a weekend carry-all, a business tote, a satchel, a key fob, we will continue to offer her relevance and fashion innovation at an excellent value.

And finally, driving traffic. Compelling presentations, excellent service, laser marketing techniques, sophisticated advertising campaigns, a dynamic website, and preferred customer events such as trunk shows and pre-selling opportunities, all will continue to entice her into visiting our stores.

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 lifestyles 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 was just taking you through the highlights and 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 20%, with direct-to-consumer up 22% and indirect up 14. Adjusting for the impact of the weaker yen, total sales rose 23% for the period.

Net income for the quarter increased 35% to $109 million or $0.28 per share, as compared to $81 million or $0.21 per share in the year-ago period. This included option expense of about $19.1 million pretax or $11.4 million after tax this year, and $13.5 million pretax or $8.4 million after tax last year.

Our operating income rose 25% to $165 million in the 3rd Quarter, versus $132 million in Q3 last year.

Operating margin in the quarter was 33.2%, compared to 31.8% in the year-ago quarter, a 140-basis point improvement.

In the 3rd Quarter, our gross profit margin expanded by 20 basis points over the comparable period of the prior year from 78.1% to 78.3% of sales, as gains from product mix and supply chain initiatives more than offset the impact of channel mix.

The selling, general, and administrative expense ratio declined 110 basis points in the quarter and represented 45.1% of sales versus 46.2% for the year earlier period. The decline in the quarterly rate was the result of achieving leverage throughout our business. All selling units taken together saw our year-over-year spending rates decline, and we also continued to leverage the top line volume in all of our centralized functions.

It should also be mentioned that the strength of U.S. factory stores helped reduce the expense ratio during the quarter. Given the exceptional leverage of this channel and its low relative SG&A level in comparison to our full-price retail channels, in fact, the strength of factory had a net impact of 50 basis points on our operating margin during the 3rd Quarter.

Inventory levels at quarter end were $210 million, $30 million -- or only 16% -- above prior-year levels. We are pleased that we were able to support the 20% increase in quarterly sales, the 24 net new U.S. stores, 9 net new Japan locations, and 13 total expansions, all of which opened in the last 12 months, with this modest increase in inventory.

Accounts receivable balances rose approximately $27 million, driven by sales gains in all channels. Day sales outstanding at quarter end actually improved by a day from 36 days last year to a day sales of 35 during Q3 of this year.

We ended the 3rd Quarter with $838 million of cash and marketable securities, up from $694 million a year ago, and of course, essentially, no debt.

The Company repurchased 499,500 shares of common stock at an average cost of $36.64 during the third fiscal quarter, bringing our year-to-date total to 3,463,700 shares repurchased at an average cost of $32.85. As of the end of Q3, approximately $136 million remained available for future repurchases under the existing program, which expires in May of 2007.

Net cash from operating activities in the 3rd Quarter was $98 million compared to $101 million generated last year during Q3. Down slightly year over year due to unusual interquarter timing of working capital, on a year to date basis, cash from operating activities was actually up nearly $60 million to $402 million.

Free cash flow in the 3rd Quarter was $49 million versus $84 million in the same period last year, primarily due to increased CapEx spending. However, it also was up on a year to date basis.

CapEx spending, primarily investments in corporate facilities and for new stores and renovations, was $49 million versus $17 million in the same quarter a year ago.

We now believe our CapEx for FY '06 will rise to about $140 million, as we lay the ground work and build the infrastructure to accommodate accelerated distribution growth in the years ahead. As you know, the majority of the increase from last year's $95 million is due to our capitalizing on some outstanding real estate opportunities, both here and in Japan.

We are also investing in our corporate facilities here in New York, including expanding our space for the QA lab, sample-making unit, and product archives, as well as in our distribution center in Jacksonville.

As Lew noted, for the full fiscal year, we'll be opening approximately 30 new U.S. retail and factory stores and continuing our North American expansion programs. In Japan, we'll be opening 14 net new locations, including a flagship location in Kobe.

Now, I'd like to provide you with our goals for the 4th fiscal quarter and full fiscal year as well as our initial guidance for FY '07. For the full quarter ending July 1, 2006, we are targeting sales growth of at least 20% to over $500 million, with U.S. comparable store sales gains of at least 10% in each channel and mid single-digit comps in Japan. And operating margins for the quarter, which will be about 300 basis points above the year-ago level, with gross margin increasing modestly, and as expected, most of the operating margin expansion resulting from a substantially lower SG&A expense ratio versus last year's 4th Quarter. These factors, taken together, should result in earnings per share of $0.28 versus $0.23 a year ago, an increase of 22%. Excluding the $7 million fiscal year '05 Q4 tax benefit, which impacted last year's quarter by nearly $0.02, this would equate to a gain of 32%, all of which translates for the full fiscal year to net sales growth of about 23% to about $2.1 billion; a gross margin north of 77% versus 76.6 reported in FY '05; a significant improvement of over 100 basis points in SG&A expenses as a percentage of sales on a year-over-year basis, resulting in an over 200-basis-point improvement on our operating margin to about 36%. Therefore, in FY '06, operating income is expected to grow by about 30% over FY05, resulting in earnings per share of $1.25, a gain of 36% from the $0.92 reported in FY '05 and compared with the consensus estimate of $1.24.

Our preliminary goals for the full fiscal year 2007 are: Net sales growth of about 19% to $2.5 billion, with at least high single-digit comparable store sales gains in both the U.S. retail and factory channels and mid-single-digit comp location sales in Japan; and with our continued focus on profitability, pretax income dollar growth of nearly 23% over FY '06.

Two factors will somewhat moderate that growth on the EPS line in 2007. First, a higher share count, brought about by option exercises; and secondly, a higher tax rate, rising to about 38.5% due to the fact that incremental taxable income is being taxed at higher rates. All of this taken together will produce net income growth of over 21% and earnings per share of $1.50, up 20% from the $1.25 targeted for FY '06 and $0.02 above the current consensus of $1.48.

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

In summary, we're confident that our growth strategies will enable us to continue to gain share in the large and growing global market for fine accessories and gifts. Thank you for your attention, and now Lew, Andrea, and I will be happy to take some questions.

Please note that to accommodate the most number of analysts during our Q and A session, we ask that you to keep it to one question and one directly related follow-up per analyst. Thank you.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Bob Drbul from Lehman Brothers. Sir, your line is open.

Hi, good morning.

Good morning, Bob.

Lew, can you talk a little bit more about your willingness to step up and accelerate the global distribution and sort of what that implies for the growth rate over the next few years at the top line, and your expectations?

Sure. As you know, during the last several years we've planned a top line growth at about 20% and the wind's been at our back, and we realized more than that in each of our prior years. As we look at the strength of the Coach brand, it's obvious to us that we have the opportunity today to accelerate development, both in North America as well as Japan and in emerging markets for a whole series of reasons. This year, for example, we're opening about 25 Coach stores, full price, in the U.S.. Approximately 12 are in new markets and they're performing extremely well, and we believe that the opportunity for us to open stores just continues to grow in the United States, both in new and existing markets.

In Japan, as I mentioned, we have been exploring regional department store opportunities and the numbers that we're generating from these stores are extremely strong and in many of these instances, there is no other luxury brand presence, and when we open, we find long queues of consumers thanking us for coming to their markets. And that gives us great opportunities well beyond the 150 locations we have identified as a potential in Japan.

Moving to the rest of Asia, as our brand continues to develop among domestic consumers, we see the opportunities as being very rich and it's our intention to seize them.

Okay. Great.

And then just one follow-up. On the quarter, the gross margin was up year over year, but it was a little lower than the expectation. I was wondering if you might be able to elaborate a little bit more on that.

Bob, I'll take that one. I guess I would start by saying that we were very, very happy with our profit rates in Q3. The 33.2% op income was a record op income for non-holiday. We beat last year's rate by 140 basis points. We beat our guidance by 100 basis points. We've just projected Q4 up nearly 300 basis points and guided to higher rates of profitability for FY '07. So we really feel pretty good about our rate of profitability and improvement.

You know, as we've said before, with gross margin rates now approaching 80%, as we look at opportunities for future profit improvement, most of that improvement is going to come from the SG&A line. So we're feeling pretty good where we sit today.

Great, thank you.

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

Thank you, good morning.

Good morning, Jeff.

Lew, would you discuss the distributorships you have internationally? Are these largely airport locations or free standing? And what are the dynamics of ultimately acquiring those?

Sure. First, most of our international locations are located within strong urban areas. We do have a small number within airport locations. They're a combination of free-standing stores and Coach shops within department stores. We have a time-limited performance-based arrangement with our distributors, where we control the store design as well as approve a location selection and play a strong role in visual merchandising, training, and support. And our intention is to utilize the expertise of local distributors as we learn a particular market.

Okay. So there's no intention to ultimately buy these distributors and bring some of the growth internally?

I didn't say that.

Okay. [Laughter]. Thank you.

You're welcome.

Thank you. Your next question comes from Margaret Mager with Goldman Sachs. Your line is open.

Hi, it's Margaret.

Hi, Margaret.

Congratulations on 16 consecutive terrific quarters.

Thank you.

I would like to ask about the sales growth in the full price stores, if there's any callouts on regional differences or flagships versus fashion stores versus core stores. Any more color on the performance of the full price stores would be appreciated.

Sure.

And then related to that, Lew, your customer relationship marketing programs, if you could talk about what you're doing on that front as far as, you know, engaging your best customers in a more profound way and how you're doing -- what your plan is for Mother's Day.

Absolutely.

First, in terms of regional differences, as is always the case, certain regions perform better than others, and what we've seen over the last 18 to 24 months is that the underdeveloped regions are in the South -- Southeast. Atlanta, Florida, and Texas are continuing to outpace the rest of the country. We continue at the same time across the entire Midwest to enjoy excellent sales results.

The only notable soft spot in our performance is in Hawaii, where the weaker yen and a lower inbound travel is affecting our Japanese sales within this particular market.

As far as preferred customers are concerned, we, as you know, have an incredibly loyal consumer base and it sometimes startles even us who are very familiar with the brand every day. What we're learning more and more is that our best customers do want to learn about when we're going to introduce new products. They welcome previews and in fact very frequently we have queues outside of our stores the first day of a new floor set and preferred customers, with their local store managers, often can get a peak a few days before we actually put the product out, by going into the back room with our store staff. So preview events are very important for us.

We do continue to acknowledge appreciation to our consumers in the form of thank-yous. We are successfully piloting what we call preferred customer events to select targeted narrow ranges of consumers. All of these activities strengthen the bond between Coach and our consumers, and even today, 90% of our consumers expect to repurchase Coach and 50% of active users cite Coach as the bag they use most often.

Okay. Mother's Day?

Mother's Day, we're expecting to increase UPTs. That's one of the thoughts that we expressed to you before the holiday season. And we're doing that through a sharp range of gift items which we're introducing into our stores now, ranging from Legacy to shoulder totes, and in smaller pieces, a range of scarves, key fobs, iPods, sunwear, seasonal footwear, and if I could just add, we had an incredibly strong footwear season this spring and our actual comps were up over 40% in footwear, where shoes represented over 10% of our sales and in U.S. department stores, shoes actually comped over 40%. So we now see shoes as a 10% year-round business for us in stores that carry footwear, and we are planning, starting this fall, to introduce key items on a 12-month basis in all of our stores. And last quarter, a key item, sneaker and flip-flop, represented 2% of our sales in all stores. So we are looking at footwear as an additional way to drive Mother's Day sales.

Okay. That's very helpful. Thanks, Lew. And good luck in the next quarter.

Thank you.

Thank you. Your next question comes from Dana Telsey with Telsey Advisory Group. Your line is open.

Good morning, everyone, and congratulations.

Can you talk a little bit about pricing trends and what you expect going forward and for next year? And also, the Special Edition and Limited Edition product, which has been so successful: what are you seeing there as that as a percentage of the business? Thank you.

Sure. Well first, Dana, Limited Edition products, last quarter, was over 7% of sales compared with only 4% the year before, and what we're most excited about, as we indicated earlier, is the performance in all of our stores with regard to two styles that we had introduced: the Legacy shoulder tote, excuse me, as well as the Daphne satchel. The Hamptons Vintage carry-all also did extremely well. So what we're finding is that there's an appetite in all of our stores for a higher-end product.

With regard to average ticket, which was up on the high single digits this last quarter, almost a third of that was due to increased units per transaction, and we expect that trend to continue in FY '07, where we expect our average ticket to be up mid-single digits.

Thank you.

Your next question comes from Dana Cohen from Banc of America. Your line is open.

Hey, good morning, guys. Just following up. I guess, can you explain a little bit more the desire to accelerate the square footage growth? I mean, I guess you're trading magnitude for duration, and I just want to understand that tradeoff.

I'm sorry, magnitude for duration?

Correct.

I'm not sure if I know what you mean.

Well, I mean, you can only have X-number of stores over time, so if you're going to accelerate now, trading years of growth, and I'm just trying to understand why you want to accelerate the growth now.

The reality is that our potential has expanded dramatically. That's really the bottom line. And, indeed, we believe ultimately, in North America, Japan, and east Asia, excluding U.S. department store locations, we can drive our store count to well north of 800.

So, first, the category has grown dramatically, which qualifies many more locations for growth. Second, our productivity within existing stores and new stores in new markets have demonstrated the capacity for Coach well beyond what we ever dreamt could be the case, and these are structural changes and we expect that the appetite for accessories is going to continue unabated during the future.

And then, I guess my second question would be, if -- I think I just want to clarify: you said the operating margin of Factory was a positive 50 basis points. That was to operating margin, not SG&A?

Correct. That's through to the op income line, Dana. As you would expect, it had a dampening impact on the gross margin rate, itself. But because of the leverage that you get from that channel, it more than offset that and drove 50 BPs to op income.

Great. Thanks so much.

You're welcome.

Thank you. And our next question comes from David Schick of Stifel Nicolaus. Your line is open.

Hey, good morning.

Good morning, David.

I was hoping you could talk more -- you're talking about the Japan business being a little bigger than you had previously expected potentially. Maybe from Mike Devine's standpoint, how should we expect the operating margin of Japan to play out over multiple years as we up the size of how big that might get.

Yes, David, it's all good news, let me tell you, because as you, I'm sure, are well aware, it's our highest margin channel because of the premium we're that able to get in Japan. And we get good economics, particularly in these regional stores that we're opening. These are going to largely be in department stores, where we're very much welcomed by the department store partners and the economics that we're receiving in these regional marketplaces are very, very good. So it will help us to drive SG&A leverage through the centralized functions that occur in Japan and produce great overall contributions on their own right. So over time, it's going to be a nice contributor to that continued op income expansion that I talked about earlier on the call.

Okay. With the mix shift affecting the gross margin rate of change here in the States, is there a point where we should see that inflection in Japan take over to a greater degree on the gross margin line in aggregate?

You know, again, as I talked about in this rarefied air of gross margin rate approaching 80%, it's really hard to call, and quarter to quarter channel mix may push it one way or the other.

But it's really all, for us, about the operating income line, which is what's most important to drive overall profitability, and the growth in Japan and in Factory channels will both contribute to operating margin leverages. Good news.

Fair enough. Thanks.

Thank you. And our next question comes from Neely Tamminga from Piper Jaffray. Your line is open.

Great. Thanks, and congratulations on 21 conservative quarters of double-digit growth.

Thank you.

Lew and Mike, can you talk a little bit about the Japan locations? Kind of dovetailing right here into Dave's question. Can you talk about the composition of where you are from department store to flagship, and kind of what the opportunities are in some of your expansions over those department store locations?

Sure. First, roughly speaking, about 35% of our sales in Japan come from free-standing retail stores and flagship stores, and expect that composition to largely remain the same over the next year or two, that is, 65% will come from major shops within department stores, particularly in the regional markets where we can achieve a center court location on the first floor by the main entrance in many of these markets who are extremely pleased to have Coach join their ranks of brands. So we expect the mix to remain roughly the same.

With regard to expansions, that's a very key component of our strategy, because our productivity has grown so dramatically over the last 5 years in Japan that many of our installations are substantially too small to carry the broad array of Coach, and we are systematically identifying those locations that offer the greatest upside potential and are sequencing them in our expansion plans. I believe next year we're planning to expand roughly 10 or 12 locations.

Thanks, Lew. Good luck.

Thank you.

Thank you. And our next question comes from [inaudible] HSBC. Your line is open.

Yes, hi, good morning. [Anwan Hombor] from HSBC. Congratulations. I had just a question on market shares today, where they stand in the U.S. and Japan, and given the good news on Japan, have you updated your targets in terms of market shares for the years to come?

Sure. Well, first, in the United States we have about 24 to 25% market share among our target consumers, and this market share is negligibly up over the last few years because of the very strong category growth that we experienced in the United States. Last year, in calendar 2005, we estimate that category growth approached 20%, and in 2004 it approached 30%. So our market share hasn't grown very dramatically in the United States. Rather, our opportunity has instead.

With regard to Japan, our outlook continues to be to double our business in Japan over the next 4 to 5 years, and we expect market share, as a target which we've cited in the past, to reach about 15% at that point. Today our market share's somewhere between 8 and 9%.

Okay. Thank you. Just on the U.S., the difference between the comp growth at full price retail and Factory. When do you expect actually the trends to reverse, i.e., full price retail having comps above the Factory comps?

It's a good question. To some extent, it's marketplace-driven. To some extent, it's something we can easily control. And we expect comps to level off, between Factory and full price, sometime in the second half of calendar 2007 or the beginning of 2008. What we're experiencing is catchup in the Factory channel. We're a few years behind where we are in the full price channel in that we enjoyed incredible growth for a number of years in the full price channel, while we were only experiencing single-digit growth in Factory. Now that we put some focus against the Factory channel, in terms of merchandising, offering improved planning, and greater focus overall, we're now enjoying the benefits of that growth that we had enjoyed a few years ago in full price. So we expect it to level off, probably in about 18 months.

Okay, thank you very much.

Thank you. And our next question comes from Christine Chen from Pacific Growth Equities. Your line is open.

Hi. Thank you. Congratulations on another fabulous quarter.

Thank you.

I wanted to ask about the jewelry business that you've had in stores for a little while now. How is it doing? And is there a plan to grow that as a percent of the product mix?

Well, first, we don't really have a jewelry business. We sell some signature cuffs right now, which a lot of our consumers do appreciate. But we do intend to develop a capsule jewelry group and we're actively developing that group today and are looking to introduce jewelry into our full price business and on the internet sometime in Q3. Perhaps we'll introduce some items, if we're ready, by the holiday season. We think it's going to be -- it's going to have an impact on UPTs, great add-on capabilities, and these are proprietary jewelry items which we're developing both in the area of charms as well as bracelets, earrings, necklaces.

Okay. Yes, that's what I was referring to: The cuff bracelets, which I think of as jewelry. Thank you.

You're welcome.

Thank you, and our next question comes from John Rouleau from Wachovia Securities. Your line is open.

Hey, guys. Nice quarter.

My question is similar to the one that was just asked. Given your success in shoes and some other categories, it does sound like you're expanding your product offering. Outside of jewelry, I guess there's one other big category that you're absent from at this point. I just wanted you to comment on your ability to perhaps continue to expand and get into some of these newer categories.

Would you give us a glimpse? What is that big category that we're not yet it?

Well, the fragrance category.

Ah. I thought you might have had that in mind. We're working on that. It's a little early for us to announce anything. But I think you can expect that we will be in the fragrance business within the foreseeable future.

Okay. So kind of looking at shoes, fragrance, jewelry, does that keep you busy for a little while, or can we expect other things over the next year or couple of years to kind of start to hit the stores, as well?

Well, first we're very busy innovating our handbags and accessories. Key to our success continues to be our ability to anticipate consumer preferences and to evolve our product offering, and we think we've been pretty successful there as measured by any metric that one might look at. So our focus, long-term, will continue to be primarily on accessories, but I would be remiss if I didn't mention that we have a great sunwear business, and you might want to stop by one of our stores and look for a pair for yourself or a friend.

Okay, very good. Thank you.

You're welcome.

We have time for one more question.

Thank you. And the last question comes from Brian Tunick with JP Morgan. Your line is open.

Thank you. It's [Evryn Copleman] for Brian.

Could you talk about in the Asia markets, outside of Japan, where you're planning to grow square footage. What are you marketing plans and what kind of product mix do you plan to put in these locations? And also what kind of operating margin do you expect. And also, if I can add one more, what are you plans for intermediate to longer term for your over $800 million in cash? Thank you.

Well, let me ask Mike to take the cash question first.

Sure. As we talked about earlier on the call, we are using the cash to reinvest in the business in a number of different ways. Most importantly, I think, it's in stepping up our distribution growth by taking up the new stores for next year and into the foreseeable future, continuing to invest in expansions here and in Japan, and also partnering with our wholesale partners, where appropriate, to invest capital to open new Coach locations globally.

Of course, we're investing also in our infrastructure, both here in New York and in Jacksonville, and investing in our computer systems to improve our profitability by operating more efficiently.

But the other thing that, of course, we have out for our cash spend is our share buyback program. As I mentioned we have $136 million available to us under the current program, and as opportunistic buyers, you will see us in the markets again, and that's another significant way we envision giving cash back to our shareholders.

With regard to other markets, both in Asia and elsewhere, our focus in the greater China area beyond Hong Kong and, as I indicated, opening at least 10 locations on mainland China during the next 2 to 3 years, we're also focusing on Taiwan, where we have a growing domestic business with their emerging middle class population. Korea is an important market for us, where we're focussed both on the travel consumer and on the the local consumer.

In other parts of Southeast Asia, markets such as Singapore and Malaysia and Thailand offer small to medium-sized opportunities. We're also going to be developing our presence in the Middle East, where we expect to increase our locations from 2 to 10 next year, by opening 8 additional locations. We do have 2 very successful locations in Saudi Arabia today.

Thank you. If you can comment a little bit on your marketing plans in these markets, that could be helpful. Thank you.

Just in closing, outside the United States we're going to be focusing on our 65th anniversary as a company, this fall season and next spring. Our heritage and authenticity as an American and New York brand plays really well in these markets and consistent to that, we're going to be introducing some updated heritage products in the Legacy arena. We've introduced some Precursor silhouettes, which are doing extremely well, and you'll be seeing in these markets, including Japan, campaigns that are going to be focussed on reminding people both of our heritage and our relevance for a brand for tomorrow.

Thank you, everyone for joining us. As the market is now open, we're going to conclude the conference call. Of course, Mike and I will be available all day today for Q&A. Thanks.

Thank you.

Thank you for calling in. You may all disconnect at this time. Thank you.