Coach F4Q07 (Qtr End 6/30/07) Earnings Call Transcript

Jul.31.07 | About: Coach, Inc. (COH)
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Coach Inc. (NYSE:COH)

F4Q07 Earnings Call

July 31, 2007 8:30 am ET


Andrea Shaw Resnick - IR

Lew Frankfort - Chairman, CEO

Mike Devine - CFO


Bob Drbul - Lehman Brothers

Margaret Mager - Goldman Sachs

Jeff Edelman - UBS

Kimberly Greenberger - Citigroup

Liz Dunn - Thomas Weisel

Analyst for Randy Konik - Bear Stearns

Christine Chen - Needham



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 for Coach, Ms. Andrea Shaw Resnick.

Andrea Shaw Resnick

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

Before we begin, we must point out that this conference call will involve certain forward-looking statements, including projections for our business in the current or future quarters or fiscal years. These statements are based upon a number of continuing assumptions. Future results may differ materially from our current expectations based upon risks and uncertainties, 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. A

also, please note that historical growth trends may not be indicative of future growth. We presently expect to update our estimates each quarter only. However, the failure to update this information should not be taken as Coach's acceptance of 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 fourth quarter and fiscal 2007 results as well as our plans for the new fiscal year. Mike Devine will then follow with details on financial and operational highlights for the quarter and year, as well as our outlook for the first quarter and full year fiscal 2008. Following Mike, we will hold a question-and-answer session that will conclude by 9:30 a.m.

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

Lew Frankfort

Thanks, Andrea and good morning, everyone. As we announce our fourth quarter results and the end of our fiscal year, we are very pleased with our excellent performance and are equally enthusiastic about our prospects. We're confident that FY08 will be another great year for Coach with sales planned to rise to about $3.16 billion, 21% ahead of last year.

We are seeing a continuation of about 20% growth in the premium handbag and accessory category in North America, and heightened interest in the category globally, as it takes hold in emerging markets for luxury goods, such as greater China. Given the strength of the Coach brands and the resonance of the Coach proposition internationally, we are in position to capitalize on these opportunities both at home and abroad in the years ahead.

Our performance in FY07 was highlighted by a 28% increase in revenues, a 37% increase in net income, and a 41% increase in EPS. It was a year of many accomplishments, including:

First, the opening of 48 total net new stores in North America; 41 new retail stores, and seven net new factory stores.

Second, a 16% increase in North American full price comparable store sales for the year driven primarily by increases in conversion and traffic with smaller gains in transaction size, while our U.S. factory business posted a remarkable 30% comp gain for the year. At the same time, our Internet business experienced meteoric growth with sales up 51%. We had 50 million unique visits with an average of 6 minutes spent on the site per visit.

Third, we achieved over 30% gains in U.S. department and specialty stores at POS.

Fourth, we also had an excellent year for Coach Japan. Retail sales rose 19% in constant currency and 16% in dollars to over $483 million, despite flat category sales of imported bags and accessories in Japan. Coach strengthened its number two position in this market, achieving a 10% share this year, up from 9% last year.

Finally with our distributors, we successfully opened eight net stores in Mainland China as we strengthened our international leadership team.

Our strong annual performance was capped off by an excellent fourth quarter as we announced a sales increase of 30% and a 43% increase in earnings per share for the quarter just completed. I'm pleased to report that this was the 22nd consecutive quarter that Coach achieved sales growth of at least 20%.

Some highlights of our fourth fiscal quarter were:

First, net income rose 41% to $159 million or $0.42 per share compared with $113 million or $0.29 per share in the prior year.

Second, net sales totaled $652 million versus $502 million a year ago, a gain of 30%.

Third, direct to consumer sales rose 29% to $541 million from $419 million in the prior year.

Fourth, North American same-store sales for the quarter rose 20.2% with retail stores up 11.6% and factory stores up 31.2%. In addition, sales on the Coach Internet site rose 44%.

Finally, sales in Japan rose 23% in constant currency, driven by distribution growth and high single-digit overall comps.

During the quarter, Coach opened 15 North American retail stores, including three new markets for Coach, including: Columbia, South Carolina and Buffalo, New York. In addition, we expanded six locations. Also, three new factory stores were opened. At the end of the period, there were 259 full price and 93 factory stores in operation in North America.

In Japan, we opened six new locations, including one standalone retail store, three shop-in-shops, and one factory store while a DFS location was opened at Narita Airport. At quarter end, there were 142 total locations in Japan. This was a net increase of 20 locations from the 122 at year end 2006. In addition, Coach expanded two locations during the fourth quarter, bringing the year-end total to nine expansions in Japan.

Indirect sales on a continuing basis increased 34% to $111 million from $83 million in the same period last year. POS sales at U.S. department stores sustained the torrid pace posted in recent quarters of over 30% growth, while we also realized significant gains in international POS sales.

The continued momentum of Coach in North American retail stores enabled us to achieve an excellent quarter in this channel, driven primarily by conversion with more modest gains in traffic and average transaction size. Results in our full-priced businesses, both Coach retail stores and U.S. department stores, continued to be driven by the monthly flow of distinctive and relevant new product, especially new Lifestyle collections, such as Ergo.

Our U.S. factory store business also continued to be exceptional this quarter, driven by double-digit conversion and traffic gains with a small contribution from higher transaction size. Our strength in the factory channel reflects [break in audio] centers. Most importantly, our sustained full-price and factory store sales growth reflects our ability to successfully operate two distinct store concepts attracting two distinctive consumer groups.

I also want to highlight another spectacular season and year for Coach women's footwear for both our licensed business in the U.S. wholesale channel and in the Coach stores where it is sold. First our business in department stores, where we are sold through nearly 700 locations, rose 90% at POS for the February through June season to-date period. For the full year, women's footwear in department stores also increased by about 90% to $145 million in sales. In the 55 Coach comp retail stores where footwear was sold, it represented 11% of sales last quarter, up 21% from the prior year. We also introduced a few key items to an all-store distribution with great success.

Moving on to Coach Japan, we were extremely pleased with its performance this quarter where sales rose 23% in yen and 17% in dollars. Growth in Japan was fueled primarily by distribution through both new stores and expansions, augmented by high single-digit comparable location sales as our market share continued to expand against a weak category backdrop. The acceleration in Japan was attributable in large part to the phenomenal success of Ergo, which appealed to the consumers' interest in lightweight, close to the body shapes and minimal hardware.

Finally, as always, we were pleased with a significant improvement in operating margins. While Mike Devine will get into more detail on our financials, I wanted to give you a recap of Coach's excellent performance and touch on some of the product highlights of the fourth quarter. Across all businesses, handbags and women's accessories continue to propel our sales, as the look of our product continues to evolve and reflect changing consumer preferences.

Earlier in the quarter, we saw excellent response to Ergo, our third new Lifestyle platform for the year. For May, we launched a new summer program featuring Legacy Cotton Signature, which was built on the success of last year's small capsule group. In June, Patchwork, a perennial favorite, returned across a variety of Ergo silhouettes along with new styles and fabrications in Signature Stripe. Our over $400 handbag offering continued to perform quite strongly during the fourth quarter and comped at over 75% in Coach retail stores, representing over 17% of handbag sales in the period.

Our business in July remains strong as we successfully introduced an expanded collection of Chelsea handbags, including novelty and limited edition styles. Our August floor set installed last week features Hampton’s, anchored by our best-selling carryall, updated with an outside pocket and turn lock in lightweight leathers and Signature. It also includes Legacy in new shapes and colors.

In September, we will be introducing a belted version of Ergo with hardware and a range of fabrications, including several sophisticated Patchwork styles inspired by early 20th century art. We're also excited to be launching an expanded jewelry offering with an all-store distribution in early September.

During fiscal 2008, we will be introducing three major Lifestyle platforms. The first, Bleeker, arrives in October and will offer consumers a fresh interpretation of bags and accessories inspired by our best-selling icons and anchored by our original double set first introduced in 1973. It's crafted from hand burnished leather and features our archival heritage logo, proprietary Coach hardware and a new capsule lining. Bleeker is lighter weight than our very successful Legacy line, with sharper price points at about a 25% premium to our core handbag offering.

The second platform for FY08 is the Heritage Stripe collection, an assortment of durable coated cotton canvas totes, bags, and accessories, which we expect to fully launch during early spring. Next April, we will relaunch Soho, a perennial favorite. It will return in new fabrications and silhouettes with reinterpreted proprietary detailing.

Technologically, we will also continue to innovate to improve efficiency in our stores and enhance the level of service we provide to our customers. In North America first, we just introduced store pickup giving our consumers the option to buy online and pick up their merchandise at a Coach store two hours later. This service will support last-minute purchasing and drive many additional Internet visitors into our stores.

Second, after a successful pilot in 19 stores last holiday, at the end of September, we will be rolling out E-Runner to nearly 100 stores. As you may know, this is a handheld device, which our sales associates on the floor use to capture the customers' order and transmit it electronically to the stock room, making the transaction at the cash more efficient by reducing wait time and allowing the customer to continue to browse.

Third, we will be piloting a real-time in-store inventory system in select factory stores with the intention of improving inventory accuracy and operational efficiency.

In Japan, we have just launched a non-commerce informational website, which we expect will drive Internet visitors into our stores. In addition, we completed the rollout of a POS system to Coach Japan this spring where we are now planning to introduce many of the same improvements that are part of our North American store environments.

Along with these investments in technology, we are, of course, also investing in further developing our greatest asset, which is the talented team who work in our stores. I just attended our annual North American store managers conference which took place in Boca Raton. The theme of the conference was leadership, and it focused on building the skills of our leadership team through customized training programs. As always, I was struck by the passion and commitment of the Coach retail team.

As you may know, we have low turnover for our industry and promote two-thirds of our store managers from within. I had the chance to talk with many of the attendees who were blown away by our performance, especially in single-store and secondary markets; markets like Milwaukee, Tucson, and Portland. In fact, it is these markets and success stories that make us confident in our ability to successfully double our North American retail store count to about 500 over the next several years.

Our new stores fall into three categories. First, existing markets. These are markets where we have several stores, but our current store trends show that we are still underdeveloped. Houston, Texas, a $33 million market for Coach last year, is a perfect example. Our newest stores in this market Baybrook and La Cantera, generated first year sales well ahead of pro formas and posted huge first-year comps. Our newest entrant in the market is First Colony, which just opened in March and is running at a $2.5 million annual clip, nearly 60% ahead of our expectations. It's particularly noteworthy that our Houston comp was 49% in FY '07, which represented an acceleration from the prior two years.

Developing markets is a second category for us. These are markets such as Milwaukee, Tucson, or Portland that have opened in the last few years that we had previously considered a single-store market, but early successes warranted the opening of second and third stores. Portland, Oregon is an example of a market where we have three stores today, which together generated $8.5 million in sales last year and comped at 30%. The newest, Bridgeport Village, opened in September 2005 and generated sales of $1.4 million in its first 12 months and is now comping at 37%.

Lastly, new markets. These are markets where we did not consider opening stores just a few years ago. However, given the much higher than expected new store productivity levels we're achieving and our deals with mall developers, we are opening them today with great success. They include such markets as El Paso, Texas which generated first-year sales of $3 million, well ahead of its pro forma.

Similar to the way we have looked at our store fleet with an eye toward evolving them from core to fashion to flagship, we are looking at cities and markets as potential candidates for upgrading. Clearly, our franchise is building as the consumer trades up into Coach and we also capture a larger share of our existing consumers growing accessories wardrobe. With the accessories market rapidly expanding and the Coach brand so vibrant, the potential for Coach and its current concept is far greater than we ever thought possible.

As most of you know, we have two primary sales growth drivers, each planned to achieve about 10 points of growth. First is distribution, as we expand our global network of store locations with an emphasis on North America. Second is productivity, which we drive globally through the introduction of innovative, relevant product, offering excellent value. We have been implementing five key strategies that focus on sustaining growth within our global framework. Clearly our largest opportunity continues to be in North America.

First, most generally, we're building market share in the rapidly growing North American women's accessories market by leveraging our leadership position as a top of mind and preferred brand for self-purchase and gifts. As part of this strategy, we've been emphasizing new usage occasions within our handbag offering and developing new flanker categories such as jewelry and fragrance. There is also a continuing opportunity to elevate our handbag offering, given the strength of our $400 plus segment, although we expect to see this AUR increase to be partially offset by the growth of categories, which have lower overall price points.

Our second strategy is the continued rapid growth in North American retail. We plan to add about 40 retail stores in North America in each of the next several years. Based on the continued rapid growth of the market, the performance of our new stores, and the greater numbers of new consumers we're attracting, we believe that North America in total can easily support about 500 retail stores, including up to 20 in Canada. This road map for expansion is based upon a buildup of individual malls and locations to meet our demographic requirements and economic hurdles.

During FY08, we expect to open about 40 new North American retail stores, including 15 from the first quarter. These new openings will include 11 completely new markets, such as Augusta, Georgia and Nashua, New Hampshire which opened last month. We expect to open at least six new factory locations with three opening in the current quarter. In addition, we will be expanding at least ten retail stores and several factory stores. Taken together, we would expect total square footage to grow by about 18% in FY '08, similar to last year.

Third, outside the U.S., we're continuing to increase market share with the Japanese consumer, driving growth in Japan primarily by opening new retail locations and by expanding existing ones. For FY08 we plan to open about ten to 15 net new retail locations, as well as a few factory outlets as this channel becomes more important to Japanese consumers. We will also continue to expand key locations.

Overall, we expect to increase our square footage in Japan at a slightly lower rate in FY08 than we did last year.

Also, we're continuing to target overall constant currency sales growth of 10% to15% for both the first quarter and full year in Japan driven primarily by distribution growth and low, single-digit comps.

Our fourth strategy is to raise brand awareness in emerging markets to build the foundation for substantial sales in the future. Greater China, Korea, and other such geographies are increasing in importance as the category is growing rapidly and Coach is taking hold. During the fourth quarter, 15 new Coach locations opened internationally, excluding Japan. Most of them were in Asia, including four in mainland China. In FY08, we will open through distributors, about 30 net new locations focused on greater China, Southeast Asia, and the Middle East. We also plan to open at least five more locations in major cities in Mainland China this year, bringing our total to 16.

In addition, underscoring our commitment to the region, we recently announced a new president for Greater China, Thibault Villet, who will be establishing our on the ground presence. He's responsible for the strategic leadership and operating results of Coach Greater China, including Mainland China, Hong Kong/Macau and Taiwan. Thibault will be partnering with Coach's regional distributors to develop, implement and execute the company's greater China strategy, focused on rapidly growing distribution, raising brand awareness, and building consumer loyalty.

Lastly, of course, we continued to have an overall focus on improving the rate of profitability so that our bottom line results continue to outpace top line performance.

At Coach, our formula for success has remained constant despite a changing environment. Our distinctive brand, our leadership position, our loyal consumer base, our multi-channel, international distribution and our focus on innovation and the consumer never vary and set us apart from the competition. The engine that drives these elements is our strong and seasoned management team, fueled by innovative, compelling product and supported by an adaptive, dynamic , global sourcing and supply chain. Our brand has never been stronger nor has our proposition ever been more vibrant. We are well-positioned to continue to capitalize on the abundant opportunities available to us and have the vision, strategies, and tactics in place to realize our long-term growth plans.

I will now turn it over to Mike Devine, our CFO, for further details on our financials.

Mike Devine

Thank you, Lew and good morning, everyone. Lew has just taken you through the highlights and strategies. Let me now take you through some of the important financial details of our fourth quarter and year end results.

As Lew mentioned, our quarterly revenues increased 30%, with sales of our direct businesses up 29% and the indirect business up 34%. For the year, total revenues rose 28% with sales generated by our direct channel rising 30% while our indirect revenues were up 20%. Net income for the quarter increased 41% to $159 million, and EPS rose 43% to $0.42 per share, as compared to $113 million or $0.29 per share in the year ago period.

Net income rose to $637 million in FY07, up 37% from the $464 million earned in the prior year. Diluted earnings per share rose 41% to $1.69 versus $1.19 a year ago. Our operating income rose 43% to $245 million in the fourth quarter versus $172 million in the same period last year. Operating margin in the quarter was 37.6% compared to 34.3% in the year ago quarter, a 330 basis point improvement. For the fiscal year, operating income rose to $993 million, a 39% increase, and operating margin for the year rose to 38% from 35.1% a year ago, up 290 basis points.

In the fourth quarter, gross profit rose 29% to $509 million from $394 million a year ago. Gross margin continued at its exceptionally high levels, finishing at 78.1% versus 78.5% in the prior year. During the year, gross profit rose 28% to $2.02 billion as compared to $1.58 billion a year ago, while gross margin was 77.4% versus 77.7% last year.

As expected, SG&A expenses as a percentage of net sales were substantially below prior year levels in the fourth quarter, and represented 40.5% of sales versus 44.1% a year ago; a 360 basis point decline. For the full year, SG&A expenses as a percentage of net sales declined 320 basis points, 39.4% from 42.6% last year. All selling businesses saw their year-over-year spending rates decline and we also continued to leverage top line volume across all of our centralized functions.

At year end, cash and short-term investments stood at about $1.2 billion as compared with $538 million a year ago. Inventory levels were $291 million, up about 25% above prior year levels, below our 30% sales growth as our supply chain improvements and inventory management programs allowed us to support 48 net new U.S. stores, 20 net new locations in Japan and substantially increased sales levels with moderate additional inventory investment. Accounts receivable balances rose $23 million or about 28%.

Net cash from operating activities in the fourth quarter was $257 million compared to $195 million last year during Q4. Free cash flow in the fourth quarter was an inflow of $214 million versus $161 million in the same period last year, mainly due to higher net income.

Our CapEx spending, primarily for new stores and renovations, was $43 million versus $34 million in the same quarter a year ago. For all of fiscal year 2007, net cash from operating activities was $779 million compared to $597 million last year. Free cash flow in fiscal year '07 was an inflow of $638 million versus $463 million in fiscal year '06, while CapEx spending totaled $141 million, again primarily for new stores and expansions, as well as investments in corporate infrastructure.

Now I'd like to provide you with some of our updated goals for fiscal 2008. We are looking for net sales growth of about 21% to at least $3.16 billion, driven by distribution growth and productivity gains. We expect to open at least 46 new stores in North America, 15 to 20 new locations in Japan, and about 30 new international locations, while we continue to expand select, highly productive locations globally. We expect to achieve at least 10% comparable store sales gains in both the North American retail and factory channels, and low single-digit comp location sales gains in Japan.

With our continued focus on profitability, pretax income dollar growth of about 26% above FY '07 levels. Two factors will somewhat moderate that growth on the EPS line in 2008. First, the higher share count, brought about by option exercises. Secondly, a higher tax rate, rising to about 39% due to the fact that incremental taxable income is being taxed at our maximum rates. This taken together would produce net income growth of about 25%, and earnings per share of at least $2.06, up over 22% from the $1.69 we just reported for FY07.

Moving to the first fiscal quarter of 2008, we are targeting net sales of about $655 million, representing a year-on-year increase of over 23%. For the quarter, we expect to open about 18 stores in North America, five in Japan, and five international wholesale locations with several expansions across these geographies, all augmented by U.S. comparable store gains of at least 10% in the retail channel and mid-teens in the factory channel with low single-digit comp location increases for Japan. We're looking for operating income to be up at least 25% year over year and earnings per share of at least $0.39 , an increase of more than 25%.

For FY08, we expect CapEx to rise to about $200 million, primarily for new stores and expansions both here and in Japan as discussed. In addition, we will be expanding our distribution center in Jacksonville by about 50% or 280,000 square feet to support Coach's projected sales growth over the next five years. While we upgraded the technology at this facility a year ago, we've now decided that a physical expansion is necessary to accommodate the faster than expected growth of our business. This will require CapEx of about $12 million to $15 million in FY08.

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'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 everyone for your attention. Now Lew, Andrea and I will be happy to take some questions.

Question-and-Answer Session


Our first question comes from Bob Drbul - Lehman Brothers.

Bob Drbul - Lehman Brothers

Lew, the question that I have regarding Japan, when you look at the high single-digit comp in Japan, do you think that marks a significant improvement or change in the environment? How about maybe just Coach's success in Japan? Do you think this is an inflection point?

Lew Frankfort

Good question, Bob. We actually believe that it has a lot to do with the strength of the collections we introduced last spring. Ergo was a phenomenal success. It actually generated 30% of sales during its launch month, much higher than we thought. As a result, we benefited particularly and we're taking those learnings forward as we introduce new Ergo groups, both in September and next June. Overall, we believe that the improvement is really within the range of variability. So, we're still forecasting 10% to 15% overall growth.


Our next question comes from Margaret Mager - Goldman Sachs.

Margaret Mager - Goldman Sachs

Congratulations on 22 excellent quarters. Could you just talk about why the factory outlet channel is performing at double the pace of the full price channel? I know you said conversion and traffic were up double digit in factory outlet, but could you give us more color as to why that is occurring? Is it marketing that you're doing?

Lew Frankfort

I'm with you.

Margaret Mager - Goldman Sachs

That's one question. On CapEx, even if we take out the distribution expansion, it's still up 31% year over year. Why is that? If you could elaborate.

Lastly, going forward, your points of leverage in your business model, what can we expect or how should we think about how you'll create further leverage and push your operating margins up even further above already truly excellent levels?

Andrea Shaw Resnick

Thanks for keeping it to one question, Margaret.

Margaret Mager - Goldman Sachs

If you want to answer one that's fine.

Lew Frankfort

Mike, why don't you take the CapEx and the margin expansion questions first?

Mike Devine

Margaret, you may recall that we guided to FY07 CapEx spending earlier in the year, I think on the last call, to about $160 million and we came in at about $140 million. That's purely timing of projects and settling up of invoices, if you will. So the way I think about it, if you look across the two years and you move the $20 million of timing out of '07 and into '08 and layer on the spend at Jacksonville, you're roughly, from our '07 guidance of $160 million, you get in the neighborhood of the $200 million. So it really does not represent any significant change in strategy from our thinking for '07. We feel it's relatively consistent, it's more about timing other than the Jacksonville issue.

So in talking about operating margins, obviously we saw another great quarter of SG&A leverage where, overall, we drove total increase in our operating rate improvement by 330 driven by SG&A leverage of 360, another great year where we got the operating margin up to 38%, 290 basis points above where it was for the full year. All of this happened, we think consistent with our guidance for the year on flattish gross margin rate, down slightly from last year, largely driven by channel mix and incredible SG&A leverage.

As we said many times, we believe that there is much leverage behind that for '08 and beyond. If we can continue to grow our top line in the neighborhood of 20%, you'll see us create great leverage in our centralized functions whether it's the Jacksonville distribution center or advertising or design and finance teams, everything that we have here in New York.

If we can continue to comp at 5% to 7% in the North American retail business, that business will continue to deliver leverage, as well. We're now seeing leverage coming out of Coach Japan. So, much leverage to come and we're optimistic that we'll continue to see operating margins grow into the future.

Lew Frankfort

With regard to our factory store outlet performance, there's a lot I can say about the channel. I'll just provide some headlines in relationship to Coach. First for Coach, our factory store channels is equivalent to our diffusion brands. We never go on sale in our full price and our accessories concept. If someone wants to buy Coach on sale, they need to go to a factory store outlet. In fact, about 80% of sales in North America we estimate are purchased on discount. In Coach, we have an extremely loyal factory store customer who wants the Coach brand, but only wants to buy it at a discount. We do no external marketing whatsoever. It's entirely a pull strategy, which means that consumers are just are coming in increasing numbers because they're satisfied with what they realize.

What we have done, as you know, is improve the merchandise offering, and I do think that's attracting consumers, as well. So despite the higher gasoline price and concerns that some people have about consumer confidence, we're not seeing it at all in our factory store business or in our other channels.

Margaret Mager - Goldman Sachs

Is there any risk you're pulling traffic away from full price into factory outlet?

Lew Frankfort

We measure it consistently, and the answer is no.


Your next question comes from Jeff Edelman - UBS.

Jeff Edelman - UBS

Lew, a very insightful discussion earlier. My question relates to price points in the U.S. stores. Given the 17% increase in the handbags over $400, are we seeing a shift in mix as you're pulling more customers up into the lower end price points? Just a follow-up on that: given the new product flow, what can we look at for average selling price in the first and second quarters? Thank you.

Lew Frankfort

Just a clarification, Jeff. Handbags over $400 actually increased 75% to 17% of handbag sales in our own stores and in department stores it increased from 2% to 9% during the same period. So what we're finding is that consumers are attracted to the bags that have greater make. At the same time having a very broad and diversified consumer base, we are mindful of maintaining sharp price points. We have also seen an increase in sales of our smallest across the body bags, as well. So we're finding that there's growth on both ends and we do have a good assortment in the middle, as well.

Our overall handbag price during the fourth quarter in Coach stores actually only increased about 4% to about $280 from slightly under $270. The average handbag price actually only went up about 4%.

Jeff Edelman - UBS

And the new product mix as it relates to the first half of the year?

Lew Frankfort

I believe the average handbag price to be up in mid to high single-digits. However, it will be offset somewhat by increased penetration of lower-priced categories such as jewelry and fragrance, which will be growing rapidly.

Mike Devine

Just to build off of what Lew said, we're looking for jewelry and fragrance to be about 4.5% of sales in '08 versus less than a 1.5% in '07. That's going to pull down average ticket.


Your next question comes from Kimberly Greenberger - Citigroup.

Kimberly Greenberger - Citigroup

I just had a quick question to follow-up on Bob's question. You had indicated that Ergo was 30% of sales in its launch month.

Lew Frankfort

In Japan.

Kimberly Greenberger - Citigroup

That was in Japan?

Lew Frankfort

Only Japan. That was a significant driver to the incredible 23% increase in the total quarter sales.

Kimberly Greenberger - Citigroup

Terrific. Thanks for that clarification. Mike, could you just comment on the merchandise margin or gross margin trend within each channel? That would be helpful. Lew, if you could just give us a quick comment on your outlook for the next two quarters in your indirect sales. I know you've seen 34% and 36% growth in the last couple of quarters. It looks like in the first and second quarter you're up again 10% to 11% increases last year. Would you expect this trend rate to change? If you could just comment there, that would be great, thanks.

Lew Frankfort

I think I'm going to answer the second question first. I think what you're actually referring to when you say 10% to 11% is actually our shipments, not our POS sales. The way we really look at our business is our POS sales. Let me answer it from a POS sales perspective.

Our business out of the box in July in North American department stores has continued extremely strong both in our accessories world as well as footwear. We have every reason to believe we will continue in the indirect businesses in North America to experience very strong POS increases year-on-year.

At the same time, our international wholesale business, especially our locations focused on the domestic consumer, is doing extremely well. Year-on-year, we expect to see extremely strong results. Last year in the first half, I know we did some inventory balancing and our shipments did not keep pace intentionally with our POS sales. I think we're in the better inventory position. So it's likely that we will see our shipments more closely reflect our POS sales in the first half.

Mike Devine

Kimberly, let me talk to gross margin a little bit. I can't do it though, without first starting and saying that we believe the most important operative metric, of course, is to look at consolidated operating margins and we're thrilled with the expansion we had in the quarter and the year.

But moving back to gross margin rate, for the quarter we continue to have excellent trends in our business unit, gross margins while on consolidated we were off; channel mix, the fact the factory grew more quickly than the business as a whole and CJI, our highest gross margin channel grew more slowly, hurt us almost 60 basis points. So, if you adjust out for channel mix, we actually saw organic gross margin rate improvement.

If I could just elevate the story to look at the full year, for that time period, our gross margin year over year was down about 28 basis points. If you look there, channel mix and also the currency, the FX impact, those two things were a drag of 82 basis points. So our organic margin actually was up more than 50 basis points year over year, adjusting for those two factors with virtually every channel up year over year dramatically.

In fact, ironically, the biggest improvement came from our factory store year-over-year gross margin rate improvement. We're very happy with the underlying trends in our gross margin rate and particularly seeing that it's being driven, the improvement year-over-year and factory, is also very helpful.


Your next question comes from Liz Dunn - Thomas Weisel.

Liz Dunn - Thomas Weisel

Let me add my congratulations. My question relates to your mounting cash balance. Can you weigh in on what your plans are? To what point you are comfortable buying back stock? Is there any potential that you would consider an acquisition of another luxury brand with complementary categories? What are you just going to do with all this cash?

Mike Devine

Let me first start, maybe hold the question about the acquisition for Lew at the end, but let me lead off by saying that first and foremost, our primary use of our cash is to reinvest in our core business. This is driven largely by investment in new stores and expansions globally. We're also looking at infrastructure improvements. Lew mentioned some in the prepared remarks, technology to further lower our SG&A rate, both in the in-store environments and in our centralized functions. I mentioned we're also going to invest and increase the size of Jacksonville to handle the continued accelerated growth of the business.

As you mentioned, historically we've used our cash as part of a share buyback program. In fact, last year in about a three-and-a-half month period, we spent more than $650 million on buyback. I think as most of you know, we have an authorization out there today that will allow us to go to the market and make a purchase of $500 million. The board has always supported us when appropriate to take that number higher. We've not publicly said at what point we'll get into the market, but we've been opportunistic buyers and we would look to continue to execute that strategy.

As I also look out further for other uses of the cash, I could see at some point in the not too distant future using that cash to buy out one of our international wholesale distributors, in effect looking to replicate the CJI model that we have used so effectively to drive shareholder value. Then at the end of the day, we are in a position where we're building cash and we're comfortable building that cash balance.

As Keith Monda, our Chief Operating Officer likes to talk about, to have powder dry money so we can further extend the growth of the story beyond our LRP period. Lew, do you want to talk to the acquisition?

Lew Frankfort

Sure. First, we're not terribly enthusiastic about an acquisition in the foreseeable future, primarily because our opportunities as a mono brand continue to be boundless. We do have an articulated road map to double our business to $5 billion over the next four or five years and we feel very confident that we can do that staying focused on the opportunities with Coach. So we're not looking at anything at the moment. We'd be very cautious in this arena.

Liz Dunn - Thomas Weisel

Any chance of any dividend?

Lew Frankfort

There's always a chance of a dividend. We talk about it probably every three months. We come up on balance saying, not for now.


Your next question comes from Randy Konik - Bear Stearns.

Analyst for Randy Konik - Bear Stearns

Just a quick question regarding your product mix. With the upcoming Heritage Stripe line planned for '08, how should we think about your mix of leather versus mixed material handbags? Specifically, with this line being coated canvas, could we expect to see a cyclical return to more non-leather bags in the next year or two? Thank you.

Lew Frankfort

The short answer is that we're actually expecting, on the contrary, to see an increase in the role that leather plays within our handbag assortment in FY08 driven in large part by Ergo as well as Bleeker. Looking in its entirety, we think there'll be a modest increase in the role that leather plays compared to prior year.


Your next question comes from Christine Chen – Needham.

Christine Chen - Needham

Thank you. Congrats on another amazing quarter. I wanted to talk a little bit about international. You had mentioned that international wholesale was up. I was wondering if that was consistent across the different geographies or in one area versus the other? I also wanted to ask about the jewelry and the beauty business if you have any product introductions coming in, what we might see there?

Lew Frankfort

As Mike Devine indicated, we do expect jewelry and fragrance to account for --

Mike Devine

About 4.5 points of penetration in our full price channel.

Lew Frankfort

So less than 1%?

Mike Devine

Just under 1.5%.

Lew Frankfort

1.5% this year. So we do expect these new flanker categories to be important on the margins.

Christine Chen - Needham

For international across the geographies, is the performance pretty consistent or are certain areas performing better than others?

Lew Frankfort

Excellent question. First, what we're finding is that the locations that are focused on domestic consumers, major markets like Korea, Greater China or Taiwan are performing remarkably well as our brand takes hold with local consumers. We're experiencing great growth also in the Middle East and other Southeast Asian countries. Markets that are focused on the Japanese tourists have been suffering. Japanese tourist levels of travel did not increase in '07 compared to last year, and actually the Japanese consumers are spending less on gifting when she travels than she did prior year. So we are seeing a much greater increase in domestic locations. Our focus, of course, is in developing the indigenous populations in these developing countries.

Andrea Shaw Resnick

At this point it's 9:35, and we're going to close the floor to questions. Please feel free to call me or Mike later on today if you have any follow-up questions to the call. Thank you for joining us. Have a terrific day.

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