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Coach (NYSE:COH)

Q2 2011 Earnings Call

January 25, 2011 8:30 am ET

Executives

Michael Tucci - President of Retail Division - North America

Andrea Resnick - Senior Vice President of Investor Relations & Corporate Communications

Lew Frankfort - Chairman and Chief Executive Officer

Michael Devine - Chief Financial Officer, Chief Accounting Officer and Executive Vice President

Analysts

Dana Telsey - Telsey Advisory Group

Christine Chen - Needham & Company, LLC

Robert Drbul - Barclays Capital

Brian Tunick - JP Morgan Chase & Co

Omar Saad - Crédit Suisse AG

Erika Maschmeyer - Robert W. Baird & Co. Incorporated

Jennifer Black - Jennifer Black & Associates

Neely Tamminga - Piper Jaffray Companies

Kimberly Greenberger - Morgan Stanley

Laura Champine - Cowen and Company, LLC

Lorraine Hutchinson - BofA Merrill Lynch

Operator

Good day, and welcome to the Coach Conference Call. [Operator Instructions] At this time, for opening remarks and introductions, I'd like to turn the call over to Senior Vice President of Investor Relations and Corporate Communications at Coach, Ms. Andrea Shaw Resnick. You may begin.

Andrea Resnick

Thank you Shirley. 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. Mike Tucci, President of North American Retail is also joining us to discuss our holiday performance and spring initiative.

Before we begin, we'd now 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 year. These statements are based upon a number of continuing assumptions. Future results may differ materially from our current expectations and based upon a variety of risks and uncertainties, such as 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.

Now let me outline that the speakers and topics for this conference call. Lew Frankfort will provide an overall summary of our second fiscal quarter 2011 results. He will also discuss strategies going forward. Mike Tucci will review the holiday season from the U.S. retail perspective and discuss key initiatives for the spring season ahead. Mike Devine will continue with details on financial and operational results of the quarter. Following that, we will hold a question-and-answer session that will end shortly before 9:30 a.m. We will then conclude with some brief summary comments.

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

Lew Frankfort

Thanks, Andrea, and welcome, everyone. As noted in our release this morning, we were very pleased with our holiday results, including strong sales and earnings growth and exceptional comparable store sales in our North American Retail businesses. Our performance clearly demonstrates the brands of vibrancy across channels and geographies and bodes well for future growth. Beyond the top line, we were also very pleased with our high levels of profitability and substantial cash generation.

In addition, we made continued progress against our global business initiatives, including international expansion, Men's, and digital media. We experienced strong response to our new collections, and our pricing and assortment strategy continued to resonate with consumers worldwide. We're well situated to build upon our leadership position and continue to gain market share. Further, the announcement today of the authorization of a new buyback program reflects our financial strength and our confidence in Coach's future.

While I will get into more detail about the outlook for the category and our business shortly, I did want to take the time to review our quarter first. Some key highlights of our second fiscal quarter were: First, earnings per share rose 33% to $1 compared with $0.75 in the prior year; second, quarterly net sales totaled $1.26 billion versus $1.1 billion a year ago, an increase of 19%; third, Direct-to-Consumer sales rose 17% to $1.1 billion from $934 million in the prior year on a comparable basis; fourth, North American same-store sales for the quarter accelerated, writing 12.6% from prior year, while total North American Direct-to-Consumer sales rose 17%; and fifth, sales in Japan were even to prior year in constant currency and rose 8% in dollars; and finally, we continue to generate very strong sales growth and significant double digit comps in China.

During the quarter, we opened two North American retail stores both in Canada, as well as one factory store. Thus, at the end of the period, there were 347 Full Price and 129 factory stores in operation in North America.

Moving to Japan, one Coach shop-in-shop was opened in addition to a travel retail location. At quarter end, they were 171 total locations in Japan with 20 Full Price stores, including eight flagships, 117 shop-in-shops, 27 factory stores and seven distributor-operated travel retail locations.

And in China, we added three new locations all in the mainland. At the end of the quarter, they were 52 Coach locations in China, including 10 in Hong Kong, two in Macau and 40 locations on the mainland in 16 cities. As we've discussed previously, we are building a multichannel distribution model in China, including flagships, retail stores, shop-in-shops and factory stores.

Indirect sales increased 28% to $168 million from $131 million in the same period last year. This gain reflected significant growth in shipments into international wholesale and U.S. department stores given positive POS sales trends notably in the international business. Specifically, sales for the quarter at retail and international wholesale locations were very strong driven by double-digit gains in same-store sales and new distribution, while sales at POS and U.S. department stores rose 3% for the quarter.

We estimate that the addressable U.S. Handbag and Accessory category rose at a 5% to 10% rate in the holiday quarter, similar to the increase it experienced in the preceding nine months of the calendar year. At the same time, Coach's bag and accessory sales rose about 14% across all channels in North America during the most recent quarter. In our Direct businesses in North America, Handbag and Accessory sales rose 18%. Importantly, it now appears that the category will increase to $9 billion in FY '11, surpassing its previous peak achieved three years ago.

Separately, it's worth noting that we've seen continued modest improvement in our customer's outlook for the economy with over a third of those surveyed now believing that the U.S. economy is improving, the best reading in over three years. Her intention to purchase Coach over the next year is significantly higher than where it was a year ago, with over 2/3 of consumers surveyed noting they probably or definitely would purchase a Coach product in the next 12 months.

Our total revenues in North America rose 17% with our directly operated businesses up similarly, driven by 12.6% in same-store sales increases and new distribution. Fueling these overall strong comp results were significant gains in conversion from prior year and modest traffic growth, partially offset by a slight decline in average transaction size. We were particularly pleased with the improvement at conversion since it's a driver that we have the most control over through product and service. Mike Tucci will discuss our performance in more detail in just a moment.

In Full Price stores, conversion was the primary contributor to our comp growth, while average transaction size was also modestly higher compared to prior year. Traffic trends was slightly lower year-over-year. In factory, where our business remained remarkably strong, we saw increases in traffic and conversion, while transaction size declined modestly. Our factory store growth continued to be driven by increased spending of factory channel, loyal Coach shoppers and by new consumers entering the franchise.

As noted, in Japan, we posted an 8% increase in dollars on a flat performance in constant currency. Our market share further expanded against continued contraction in the category. Our growth in share reflects the relevance of our accessible luxury positioning with the Japanese consumer who is becoming more value-oriented.

Once again, I want to call out China, our fastest-growing business. During the quarter, our sales continued to rise sharply from prior year fueled by distribution growth and significant double-digit comps. Clearly, the Coach proposition is resonating with this consumer who is participating in this category and increasing numbers. While Mike Devine will get into more detail on our financials and I will discuss our outlook in some detail, I wanted to give you this recap.

Now I will turn it over to Mike Tucci to discuss our North American Retail businesses. Mike?

Michael Tucci

Thanks, Lew, and good morning. Today, I'd like to review what was an exceptional holiday season touching on the three important productivity drivers within our North American business: product performance, digital strategy and coach.com results and progress on our new Men's initiative.

During the holiday quarter, as always, we maintained a high level of product innovation and distinctive newness, ensuring that we had a steady flow of new product throughout the period. A key to this effort was that we are somewhat less front-end loaded than in previous holiday seasons. In October, we relaunched the Madison collection featuring the new Sophia satchel in core leather, gathered leather and novelty applications, along with the fresh dotted op art logo. The reception was excellent and Madison was our top collection for the quarter.

We also benefited from a first-time inclusion on Oprah's favorite things for holiday featuring our large patent Sophia in crimson and camel on network TV. During the quarter, we also updated Poppy and added new colors in our Madison and Kristin collections. In mid-December, we introduced the Alexandra tote group to capture peak sales with new products just before holiday.

Additionally, we generated excellent sales increases in women's accessories in the quarter, notably in money pieces and small bags. Our holiday product was supported with a comprehensive marketing plan, which highlighted a powerful gifting message for the shopping season. The emphasis of our marketing was item-driven across handbags, women's accessories and other gift ideas. Our campaign span coach.com, digital media and compelling print and in-store marketing to drive traffic into stores and on the Internet.

Most generally, the merchandising and pricing strategies we initiated last year to create a more balanced and productive handbag assortment have become proven sustainable growth drivers in North America. Both handbags and women's accessories achieved positive comps in the quarter with handbag penetration holding at over 53% of sales with a high single-digit increase and average unit retails. This pricing power was driven by mix as leather and novelty continued to trend very well.

Looking forward, we're excited about our spring product initiatives as well. We've been pleased with our performance of our newest collection, Colette, which launched on 12/24 featuring new tote, hobo and carryall silhouettes. And for spring, our major product launch is the new Kristin collection, which will be introduced on February 18. Kristin is the strong assortment of beautiful hobos, totes and satchels offered in a range of leathers and novelty fabrications such as embossed python, linen signature and op art, appealing to a broad range of consumers. This relaunch will be supported by a comprehensive broad-based marketing campaign, including window vinyls, special shopping bag and a focused online and print media campaign.

On the factory side, our strong results were fueled by a powerful combination of new product introductions with key styles offered at great prices. Our inventory investment strategy enabled us to capture sales upside throughout the season. Our product assortment was also supported by our in-store and direct marketing campaigns. Importantly, while we're bold in our pricing strategies, the gains in our Factory business drove improved operating margins. As we enter the spring season, we continue to see opportunity to leverage our factory model and increase productivity within this business.

A second important growth area in the quarter was digital. As we discussed last quarter, coach.com is a key marketing tool and it's becoming a very important revenue opportunity as well. We noted that our primary objective online in North America is to build top-of-mind brand awareness and drive store traffic while also maximizing e-commerce opportunities. In our second quarter, we saw the digital initiatives we've put into place for holiday such as the virtual gift guide and e-gift card pay off in the exceptional performance of our online business. In fact, coach.com is now our fastest growing Full Price channel in North America where both traffic and sales continue to grow at a double-digit pace during the holiday quarter.

Of course, our web presence is now global with informational sites in 16 countries, three of which U.S., Canada and Japan are e-commerce platforms. More generally, we will continue to use our digital capability as an enabler and customer touch point as we expand the Coach brand globally.

Moving back to our stores, as Lew mentioned, we opened two new retail stores in Q2, Pickering in Ontario and Victoria, British Columbia, taking our first half openings to five, all of which are performing very well and ahead of plan. We also opened one new factory store, taking the first half total to eight, including our first five Men's stand-alone factory stores, which opened in Q1. These stores also opened strongly and are running above our pro formas.

In Full Price, based on the initial success of our first Men's stand-alone store in Bleecker Street and our Men's sales growth in core Coach stores, we'll be opening two additional Men's retail stores later this fiscal year, including the one at Garden State Plaza in New Jersey and one in Copley Plaza in Boston. This month, we dedicated more space and introduced a broader Men's product assortment to seven additional stores bringing our total Men's concept store count to 37 in North America, including eight flagships such as 595 Madison Avenue in New York.

On the factory side, our Men's stores, which are located next to or nearby our most productive factory locations, are performing extremely well. We believe the strong consumer response we experienced reflect the strength of the Coach brand and the factory consumers focus on value and function. It confirms our belief that there is a particularly large opportunity for Men's in our factory channel. During the remainder of that FY '11, we're planning to open at least five more Men's factory locations.

In summary, we're excited with the continued progress we've made in improving our Full Price productivity and our Men's initiative. We're feeling great about the spring season given the current sales trends in both old Full Price and factory channels.

With that, I'll turn it back to Lew for a discussion of our strategies and opportunities for growth. Lew?

Lew Frankfort

Thanks, Mike. Our strategies continue to be focused on expansion opportunities both here in North America and increasingly, in international markets. In addition, as always, we're focused on improving performance in existing stores by increasing Coach's share of our consumers' accessories wardrobe while continuing to attract new customers into the franchise. Mike just discussed our Men's initiative, which we're confident will be a significant contributor to global growth in the seasons and years ahead, both in North America and in international markets.

Moving on to distribution growth, as mentioned in prior earnings calls, we expected our square footage globally and across all channels will increase about 10% this year compared to 8% last year. Starting in North America, we will open about five stores in the back half of fiscal 2011, bringing the total to about 10 new North American retail stores for the year. In addition, we'll open about 12 new factory stores during the balance of the year primarily to support our Men's initiative. In total, we expect North American square footage growth of about 8% this year, similar to last year.

In China, as mentioned, our sales are growing rapidly as the market continues to develop swiftly. Last year, we doubled sales to over $100 million and are on track to generate sales of over $175 million this year. We are also now targeting $500 million in sales during FY '14, a 10% market share compared with 5% today. Driving this growth in addition to same-store sales, we expect to open about 25 new locations this year, increasing square footage by about 65%. Over the next few years, we're targeting to open about 30 new locations per annum. These locations will be primarily focused on the mainland and mirror our multichannel distribution model in North America and Japan.

In Japan, the overall consumer market remains very challenging, and the category continues to contract. Our goal continues to be market share gains, and we have done this quite well in our core Women's business. As elsewhere, we're now also focusing on Men's, where we've already seen early success. This year, we now expect to open about 10 net new Coach Japan locations, including five Men's stores. In total, we expect the net square footage growth in Japan will increase by about 6% this year, similar to last year.

Beyond our directly owned businesses in China and Japan, we have a significant international wholesale business, generating over $400 million in sales at retail. Most of these sales come from other markets in Asia where the Coach brand resonates well and includes a sizable travel retail business catering to the growing population of Asian travelers. Given our focus in this area, we're also opening about 25 new distributor-operated locations in the Asian region during this fiscal year.

Moving to Europe, it is a new region of expansion for Coach. To date, we've opened six boutiques in Printemps Department stores in France and expect to open one additional location within Printemps during the balance of the fiscal year. And through our joint venture with Hackett, we've launched the brand with four shop-in-shops in Spain and one in Lisbon with one more to go before year end, all within El Corte Inglés.

Last quarter, we also announced plans for our initial stores in London, a stand-alone store in the Westfield White City Mall, which is on plan to open in late February and a 5,100 square foot flagship on New Bond Street, our first global flagship store in the region coming this summer. We've been pleased with our initial results in Europe as our brand gains recognition with the domestic consumer and benefits from our popularity among tourists notably those who are Asian based.

Beyond the opportunities in the Coach concept and brand, as you know, we launched Reed Krakoff in September and a few boutiques in the U.S. and Japan, as well as two prestigious international specialty retailers such as Lane Crawford in Hong Kong and Colette in Paris. While it's still very early days, we are pleased that the product is appealing to the targeted pinnacle luxury consumer.

In summary, we are excited about the global opportunity for Coach especially the emerging market potential given the rapid growth of the category and the foundation, which we have begun to build in the important Asian region.

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

Michael Devine

Thank you, Lew. Lew and Mike have just taken you through the highlights and strategies. Let me now take you through some of the important financial details of our second quarter results. As mentioned, our quarterly revenues rose 19% with Direct-to-Consumer, which represents over three quarters of our business, up 17% and Indirect up 28% due to higher shipments into international wholesale accounts and the U.S. department stores.

Earnings per share for the quarter increased 33% to $1 even as compared to $0.75 in the year ago period as net income rose to $303 million from $241 million. Our operating income totaled $453 million in the second quarter, up 19% from $381 million in the same period last year. Operating margin in the quarter was 35.9% compared to 35.8% in the year-ago period.

In the second quarter, gross profit rose 19% to $915 million from $771 million a year ago, and gross margin rate remained strong at 72.4% even with the prior year. Gross margin reflected the impact of channel mix and continued high levels of promotional activity in our factory channels, offset by sourcing cost improvements.

Moving to expenses. We were pleased that we were able to gain modest leverage in the holiday quarter, which is our toughest quarter to do so. Specifically, SG&A expenses as a percentage of sales improved from prior year levels in the second quarter and represented 36.5% of sales versus 36.6% last year. Once again, our two primary direct businesses here in North America and in Japan both provided leverage not only to their own P&Ls but to the corporate P&L as well, more than offsetting the impact of our investment spending. We believe we're striking the right balance between driving future growth opportunities and operating efficiently.

Inventories at quarter end were $367 million, up 36% from the end of last year's Q2 but down 4% on a two-year basis. Clearly, these inventory levels were key to delivering the exceptional holiday quarter. Our current inventories support the strong underlying business trends and will allow us to maximize sales this spring. Generally, it's worth noting that we've been rightsizing our inventories this year, bringing them up to more appropriate levels to support our growing businesses, including new growth initiatives such as Men's, global expansion and our new distribution center in Asia.

Cash and short-term investments stood at $940 million as compared with $1.1 billion a year ago, despite repurchases of nearly $1.4 billion worth of Coach common stock in the interim 12 months. During the second quarter, we repurchased and retired nearly 7 million shares of our common stock at an average cost of $55.72, spending a total of $388 million.

Net cash from operating activities in the second quarter was $408 million compared to $364 million last year during Q2. Free cash flow in the second quarter was an inflow of $382 million versus $347 million in the same period last year, due to higher net income offset by working capital items; our CapEx spending was $26 million versus $17 million in the same quarter a year ago. As we stated on our last two earnings calls, based on our plans for the year, we expect the CapEx will be about $150 million in FY '11, primarily for the opening of new stores across all geographies.

Naturally, we were very pleased to report these strong financial results and as Lew and Mike have said, we're well positioned for the back half of our fiscal year. While we do not give specific guidance, as you know, I always think it's helpful for you modelers out there to keep a few things in mind when looking at the year. First, and most generally, we continue to target double-digit sales increases globally with double-digit earnings growth. And given the ongoing strength in our business, we now believe that we'll achieve high single-digit same-store sales growth in North America for the balance of the fiscal year, even in the face of more difficult spring compares. This is up from last quarter when we projected mid-single-digit growth. Additionally, we expect the continuation of our positive POS trends in our Indirect businesses. However, our second-half comparisons will be impacted by the timing of shipments in those Indirect businesses and the extra week in the prior year's fourth quarter. As you may recall, that extra week contributed $70 million of sales and $0.08 of EPS.

Second, we were excited that our top line sales growth drove higher levels of profitability in the first half, and while our previous comments regarding second-half gross margins still stand, our sales growth, coupled with controlled spending, will help offset both product cost and channel mix pressures. Therefore, we are reiterating our previous guidance of a full year FY '11 operating margin at about last year's level of about 31.5% on a 52-week basis.

Third, our tax rate is likely to stay in the area achieved in the first six months for the balance of the year as we continue to refine our international tax strategies.

Fourth, I wanted to briefly touch on share count. We would expect second-half share count to be similar to where we ended second quarter.

Before we open it up for Q&A, I wanted to echo Lew's earlier words. This was an exceptional quarter for Coach. Clearly, our holiday results bode well for the future, and we're confident that we'll continue to deliver very strong sales and earnings gains over the balance of the fiscal year and beyond.

Thank you all for joining us on our call today, and now Lew, Mike, Andrea, and I would be happy to take questions, which will be followed by brief closing remarks from Lew.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Bob Drbul with Barclays Capital.

Robert Drbul - Barclays Capital

Lew, I guess the first question that I have is can you talk about what contributed to the upside in the comp versus the mid single-digit guidance, and sort of what impact it had through the P&L as you look at it? And the second question I have is for Mike is so where, if you could, put any buckets on the inventory increases with the various initiatives in terms of quantifying any of the specific buckets on each category?

Lew Frankfort

Sure, Bob. I'll actually ask Mike Tucci to answer your first question regarding comps.

Michael Tucci

Sure, good morning, Bob. We had strong performance across-the-board from a comp standpoint. When I look at the business by channel, the Full Price channel performed very well, balanced throughout the quarter, a really strong online quarter, which was very nice for us. We continue to see that channel grow from an interaction standpoint, as well as being able to drive revenue there. So that was very pleasing to us, and that did provide some upside. On the factory side, the quarter was extremely strong. And we felt like from a positioning standpoint, while we were able to drive the value in terms of our proposition, we did see some upside there based on ownership of product, the very strong handbag assortment, which drove sales as we went right into peak through Christmas and the week after. So I would say across-the-board, we had strength. We are pleased with the pricing power in handbags, which drove comp in both Full Price and factory. And we had a very strong accessories quarter and it feels like the cycle, from an accessories standpoint, was a driver of comp within the quarter as well.

Michael Devine

Bob, let me jump in on inventory levels. We've never answered inventory levels with that degree of specificity, but let me just say a couple of things about it. Our inventory investments are nicely aligned with our growth opportunities, and I think so that would spend a number of our initiatives. I would firstly say that our investment in factory inventories allowed us to capture the outperform during the holiday quarter that Mike just spoke to, that we wouldn't have been able to get to this time last year or so that investment was well placed. Also, investment in our Men's initiative is a part of the inventory driver. And then lastly, feeding inventory into the Asia region through the ABC is also a subset of where the inventory growth came from. But the thought I want to leave with in addition to enabling the growth is that our inventories are exceptionally clean and current and really position us well now that maximize sales as we move into the spring quarter, I'm sorry, the spring half of the year.

Operator

Our next question comes from Kimberly Greenberger with Morgan Stanley.

Kimberly Greenberger - Morgan Stanley

I was hoping you could talk to us about your gross margin outlook. And in particular, in light of sourcing cost inflation, are you considering any very slight increases in pricing? Or are you simply redesigning into the, I guess, higher cost of goods? How are you thinking about gross margin progress throughout the calendar year of 2011 and with sourcing cost inflation coming? How does that impact your thinking?

Lew Frankfort

So I'll take the cost part of the gross margin equation, and then I'll ask Mike to speak to the pricing power. But Kimberly, we really are where we've been for about a year now in terms of talking about our gross margin rates. We did have called out inflationary pressures would have a dampening impact on our gross margin rates in the back half of our FY '11, and so that is still going to hold. The way we wanted to ask everyone to think about it, however, is also the guidance that we've given previously, the gross margin rates coming in for the year in the 72% to 73% range are still valid. That guidance that we give a couple of quarters ago, we still feel very good about. And of course, we could go on and list. In addition to the inflationary pressures, all the positive things that we're doing to move gross margin and help to offset those pressures, things like counter-sourcing materials, looking to migrate a substantial amount of our production into lower-cost countries out of China into countries like Vietnam and India as an example. And ultimately with the top line growth in the Asian region, most notably China. We'll start to get some help from channel mix as well. So there are a number of positives going on in the gross margin line that will help mitigate on the inflationary pressures.

Michael Tucci

On the Retail side and Full Price, there's absolutely a focus on finding pricing opportunity within handbags in particular using Q2 as a foundation where we took handbag average unit retails to $2.95. Again, we're targeting that $300 sweet spot, that was about a 9% improvement. We will continue to focus on that area in the back half, and there are a couple of things going our way. One is a shift towards leather, which helps us from a pricing standpoint on the retail side, so we do see an opportunity to impact average unit retail in the second half, on the Full Price side of the business that will carry through to factory. And I really want to be clear on the factory side. We do have pricing power. We were aggressive in the quarter. However, we were able to protect margins from a gross margin standpoint in factory and we drove tremendous operating margins. That effort positions us very well on the back half to continue to focus on unit retail gains and the factory channel productivity gains in the factory channel and drive operating margin.

Operator

Our next question comes from Brian Tunick with JPMorgan.

Brian Tunick - JP Morgan Chase & Co

I guess one clarification first on this channel mix that impacted the gross margin here. Was it deeper promos at factory or was it selling less made-for-factory products?

Michael Tucci

It was actually neither one. It was not deeper promos or discount rate, and factory was virtually the same. Our margin rate in factory was actually a touch higher. It's purely a function of volume. When we put that volume increase into the quarter, it moves a bigger percentage of our overall pie into the factory channel, which has an impact on gross margin, also has a very positive impact on operating income. Hence, you see the EPS impact that we were able to deliver. So that's the story on channel mix there.

Brian Tunick - JP Morgan Chase & Co

And then on China, you guys talked about this $500 million goal by FY '14. Can you maybe give us a sense about how you think about profitability expectations in this channel, clearly, I guess higher gross margins. But how would you expect China by '14 to rank in terms of profitability versus your other channels?

Lew Frankfort

Mike D?

Michael Devine

Yes, Brian, I'll jump in on that one. We're very excited about it. We already are achieving four-wall store operating margins in China that begin with the four. And so as we gained same-store sales, those four walls will only drive higher. And as we grow the top line, open additional stores, realize same-store sales year-over-year, will more than cover the infrastructure investment that we have on the ground there today. And so we will have a positive as we talked about, of course, one of our highest gross margin channels that it will also help gross margin from a channel mix perspective, but ultimately be a strong driver of operating income as we grow the top line and leverage the infrastructure there with these exceptionally strong four-wall operating margins from of the China stores.

Operator

[Operator Instructions] Our next question comes from Omar Saad with Credit Suisse.

Omar Saad - Crédit Suisse AG

I wanted to ask about the SG&A flow-through in the quarter. I know you've got a lot of investments going on. Can you help us understand how you think about managing SG&A, the duration of some of these investments? I know you got a lot of growth, as you've just talked about in China and other markets. How should we be thinking about modeling SG&A on those lines?

Michael Devine

Omar, I'll take that one as well. I was really pleased with that flow-through during Q2 and we really leverage the top line growth. If you go back actually as I did in preparation for this call and looked at the Q1 transcript, I actually called out that I didn't see us having SG&A leverage in the December quarter. And the reason there is, if you look across the four quarters of the year, you'll see that Q2 last year was in the mid-30s where at the balance of the quarter for the year are in the 43%, 44% range in terms of SG&A as a percentage of sales. Point being that we already have so much leverage in this holiday quarter because of the top line growth. So the fact that we outperformed in our North American business, that Japan did as well as it did with a tough market backdrop, really allowed those mature businesses to pull our leverage to the P&L that help us offset our investment spending in Europe, in other parts of Asia, in the new RK brand, et cetera. So I was very pleased that the flow-through was as strong as it was in Q2, and that really bodes well, for the flow-through coming our way in the back half of the year.

Operator

Our next question comes from Kristin Chen with Needham.

Christine Chen - Needham & Company, LLC

I wanted to ask, so your opportunities to increase AUR at the Full Price stores, wondering if you could share with us on the really high-end bags, bags over $400, what was that penetration in the holiday quarter versus last year? And then on another note, as far as factory, what was the percentage of factory-exclusive product in the holiday quarter versus last year? I think last quarter you had mentioned that it had ticked up pretty substantially from the year before.

Michael Tucci

Sure. There is absolute opportunity by price bucket in Full Price. We had a very good quarter. Average with handbag over $400, and that's just the benchmark, penetrations were double-digit, north of 10%, which is very good. We will focus on that opportunity, particularly given the fashion cycle that we're in around manipulated leathers, gathered leathers, treated leathers, some of the burnishing that we're doing on bags. So that offers us a pricing opportunity on the Full Price side as we move forward as we develop our assortments into spring and next fall. On the factory side, our product mix in factory was very much driven by made-for-factory product. Again, I think we were north of 80% in made-for-factory. In fact, it was 89% for the quarter, probably an all-time high, very little clearance, very little Full Price delete activity in the quarter in the factory channel, and that trend will continue. One of the things that we did this quarter, which helped us on the factory side, is that we corrected a flow imbalance that we had last year where we were chasing inventory in factory and doing a lot of pull-forward on spring goods to sell in the holiday quarter. We corrected that this year, and we are able to maximize the quarter with products that was actually planned within the quarter, and that also positions us very well as we entered into January.

Christine Chen - Needham & Company, LLC

And what were the penetrations last year?

Michael Tucci

About 85%, in fact, made-for-factory.

Unidentified Analyst

And then the $400 bags in Full Price last year?

Michael Tucci

About the same.

Operator

Our next question comes from Lorraine Hutchinson with Bank of America.

Lorraine Hutchinson - BofA Merrill Lynch

I wanted to follow up on the Men's business, both in Full Price and factory. Could you just give us a little bit more details about your plans for size of stores, expected productivity versus Women's and then what your expectations are for margins over the long term for Men's?

Michael Tucci

I'm sorry?

Lew Frankfort

The question focuses on Men's, Mike, what type of size of store we're contemplating, what kind of productivity are we achieving or anticipating relative to our Women's stores.

Michael Tucci

Sure, Okay. The Men's stores actually are being targeted smaller, probably less than 1,000 square feet of selling space, about 1,500 square feet overall. You can assume that productivity on those stores will be extremely high given our sales thresholds, so it's a very intimate environment. On the factory side, store size will be about 2,500 square feet. We're still working the model. We're also trying something or we're exploring something on the Full Price side where we'll have a dual-gender stores side by side with a separate Men's environment and Women's environment, and that may give us some productivity opportunity. So we actually see this from a margin standpoint in terms of store contribution, as well as gross margins, these stores are very attractive.

Operator

Our next question comes from Neely Tamminga with Piper Jaffray.

Neely Tamminga - Piper Jaffray Companies

Lew, can you talk a little more about the Chinese consumer as you're learning more and more about this customer in terms of their preferences? Or is there any price resistance, some of the price points that have out there? Just a little bit more on the qualitative side about those consumers will be helpful.

Lew Frankfort

Sure. What we're finding is that she wants to participate in the accessory category as she does in other modern fashion areas. And she's looking for authenticity, quality, value. She's discerning. She's thoughtful. We see her as embracing Coach. The purchase reintent is approaching 90%, which is remarkable, a level we have not seen in any other market, at any other state, at any early stage of our business. And we have the emerging Chinese middle-class consumer growing at a 30% rate. And she sees Coach as an expression of authentic New York fashion. She likes the spirit. She likes our heritage, and she sees us as offering exceptional value, and she's willing to pay two to three weeks of her annual income to purchase a Coach bag.

Operator

Our next question comes from Jennifer Black from Jennifer Black & Associates.

Jennifer Black - Jennifer Black & Associates

You've expanded your price points as well as the appeal in your Poppy collection with your most recent floor set. And I wondered if you plan to do the same with your other collections? And I also wondered if you already seen an impact on your blended AURs on Poppy?

Michael Tucci

I think as we get more time with each major collection, we're constantly moving and refining it. What's happening within Poppy, specifically, is that we're trying to capture the opportunity around trend in some novelty applications and leathers and mix materials. And that actually will have a positive impact on pricing within Poppy, which really flows through the balance of our collections as well.

Operator

Our next question comes from Laura Champine with Cowen and Company.

Laura Champine - Cowen and Company, LLC

In Japan, even though you mentioned that you're still gaining share, sales weren't quite as strong as what we were looking for. Maybe you could comment on the pace of share gain or more importantly, what your long-term views are of the health of that market and how that'll color your investments there.

Lew Frankfort

Well, first, our business was even with last year, which is running about 10% ahead of the category during the corresponding period. We were very pleased with our results. We were able to maintain very strong profitability in that business. Ramp up, Men's, which offers a future opportunity. And I believe our share today is in the neighborhood of about 17% or 18%. We believe this opportunity starts to gain additional share in the years ahead because the Japanese consumer is extremely value-oriented. In terms of the future of the category, unfortunately, the category has been on a 10-year decline. And while we expect it to slow in the rate of decline, we're not optimistic considering the aging of the Japanese population and the absolute decline in population that the category will resume growth. So our focus is to be efficient, develop our Men's business, leverage our team in Japan to assist us in growing our Southeast Asian region, and we're doing all of those things.

Operator

Our next question comes from Erika Maschmeyer with Robert W. Baird.

Erika Maschmeyer - Robert W. Baird & Co. Incorporated

I remember when you first started talking about lowering your handbag AUR, you would talk to more of a $200 to $300 sweet spot, and today, I think you mentioned $300, is that a subtle change in your philosophy?

Michael Tucci

No, our $300 target, and again, it's a benchmark. It's really where we built the assortment strategy going back almost two years now. What's happening as we anniversary that strategy and we continue to fine-tune the assortment and the cycles evolves, we will constantly look at ways to impact that from a growth and productivity standpoint, price being one of them.

Operator

Our next question comes from the Dana Telsey with Telsey Advisory Group.

Dana Telsey - Telsey Advisory Group

As you talked about new sourcing opportunities and shifting production out of China into maybe India and Vietnam, what categories are moving? How do you see the percentages shifting on the impact on margin? And then just lastly, department store and wholesale business has done well. Are you gaining further selling space and what's changing there?

Lew Frankfort

I'll take the second part first, Dana. We do have a healthy department store business. We're pleased with its performance and our accounts there as well. We do have a very strong presence today, and situationally, we do gain real estate in some locations, but in general, we're very comfortable with the nature of our distribution and the size of the space we have. And we are looking forward to a good and strong spring season. Mike D, with regard to production?

Michael Devine

Sure, Dana, in terms of moving production out of China, we have a lot of opportunities available to us. We actually have implemented or started, effective January 1, under Jerry Stritzke's leadership enact a four-year plan and measure progress and look to drive that growth by measuring and revisiting it frequently. Our big opportunities, firstly, will be to move factory store production out of China and into these new markets. And we're also going to target small leather goods, which as you can imagine are more labor-intense than bigger bags. And we had a lot of success there in India already, and we'll continue to build on that success. And we believe we can get to somewhere in the neighborhood of 40% to 50% of unit production sourced out outside of China by the end of our four-year plan. So it's an important meaningful initiative that we're putting a lot of energy against.

Lew Frankfort

In terms of gross margin impact, obviously, labor costs are increasing in a variety of markets and so does a whole set of assumptions that we've made that we believe this migration in four years will benefit us by at least 150 basis points from what it would have been had we remained in China.

Andrea Resnick

Thank you for joining us today for our second quarter conference call. I will now turn it back over to Lew for some closing remarks. Lew?

Lew Frankfort

We've had a lot of attention on individual metrics, and I think that's appropriate, and it's probably also appropriate for me to bring us back to our overall performance. Not only were we pleased with the exceptional top line growth but we were also equally pleased with the exceptional bottom line growth. And importantly, I think you need to appreciate that our organic strength has not been as strong as it had been for several years, and we are leaving this recession with all guns blazing and feeling very confident that we will continue to be able to drive top line, double-digit sales growth and double-digit earnings growth, and we're committed to that. The individual metrics will move around a bit. We measure ourselves primarily via on operating income and return to shareholders, EPS. And we will manage our balance sheet tightly.

I just want to also comment very briefly on inventory. About 2/3 of the inventory growth that we have year-over-year is to actually support new locations in terms of model stocks, as well as a new Asia distribution center. So it's only about our inventory like-for-like is up about, we believe -- our estimate about 15%. So thank you, and have a good day, everybody.

Operator

Thank you. This does conclude Coach's earnings call. We thank you for your participation.

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