Tapestry Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
May 9, 2024

There are 10 speakers on the call.

Operator

Good day, and welcome to this Tapestry Conference Call. Today's call is being recorded. Later, you will have the opportunity to ask questions during the question and answer session. At this time, for opening remarks and introductions, I would like to turn the call over to the Global Head of Investor Relations, Christina Colon.

Speaker 1

Good morning. Thank you for joining us. With me today to discuss our Q3 results as well as our strategies and outlook are Joanne Prevoisierat, Tapestry's Chief Executive Officer and Scott Rowe, Tapestry's Chief Financial Officer and Chief Operating Officer. Before we begin, we must point out that this conference call will involve certain forward looking statements within the meaning of the Private Securities Litigation Reform Act. This includes projections actual results may differ materially from those expressed or implied in the actual results may differ materially from those expressed or implied in the forward looking statements.

Speaker 1

Please refer to our annual report on Form 10 ks, the press release we issued this morning and our other filings with the Securities and Exchange Commission for a complete list of risks and other important factors that could impact our future results and performance. Non GAAP financial measures are included in our comments today and in our presentation slides For a full reconciliation to corresponding GAAP financial information, please visit our website, www.tapestry.com

Operator

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Speaker 1

investors and then view the earnings release and the presentation posted today. Now, let me outline the speakers and topics for this conference call. Will begin with highlights for Tapestry and our brands. Scott will continue with our financial results, capital allocation priorities and our outlook going forward. Following that, we will hold a question and answer session, where we will be joined by Todd Kalm, CEO and Brand President of Coach.

Speaker 1

After Q and A, Joanne will conclude with brief closing remarks. I'd now like to turn it over to Joanne Previserat, Tapestry's CEO.

Speaker 2

Good morning. Thank you, Christina, and welcome, everyone. As noted in our press release, our 3rd quarter earnings results outperformed expectations, reflecting an unwavering commitment to disciplined brand building and operational excellence. Our talented global teams continued to advance our long term initiatives, fueling innovation and consumer connections, while successfully harnessing the power of our customer engagement platform to navigate the dynamic backdrop with focus and agility. Touching on the highlights for the quarter.

Speaker 2

1st, we delivered total revenue in line with the prior year on a constant currency basis consistent with the low end of our guidance range. These top line results were led by international growth of 3% at constant currency, which included increases of 19% in Europe, 15% in other Asia and 2% in Japan, with each region expanding versus the prior year fueled by traction with tourists. In Greater China, as anticipated, sales declined 2% against last year's strong revenge spending. We remain confident in the long term opportunity in China despite a more gradual recovery in the region than originally expected, and we continue to invest in our brands, teams and platforms to support our growth. Finally, in North America, revenue declined 3 percent compared to last year amid a challenging consumer backdrop.

Speaker 2

Importantly, we are continuing to drive a healthy business underscored by significant gross margin expansion compared to last year and our plan. 2nd, we continue to put the consumer at the center of everything we do to drive engagement and emotional connections with our brands. In the quarter, we acquired younger consumers to our brands. And we continue to see new customers transact at higher AUR than the balance of our customer base. At the same time, we improved lapsed customer reactivation in North America.

Speaker 2

3rd, we delivered unique omnichannel experiences with a focus on driving brand desire, consumer connections and cultural relevance. We launched immersive retail experiences across brands globally with highlights that include the continued rollout of the CoachPlay concept and Kate Spade's successful renovation of the Gotemba outlet in Japan. And just last month, we introduced the Stuart Weitzman Shop in Shop in Nordstrom in New York City. We believe these locations drive awareness and customer acquisition, notably with younger cohorts. Further, we maintained our strong digital positioning with sales more than 3 times above pre pandemic levels, which represented over 25 percent of revenue.

Speaker 2

Importantly, our digital business is underpinned by Tapestry's data rich platform and leading capabilities, which has enabled us to seamlessly meet consumers where and how they're shopping across their purchase journey. 4th, we fueled fashion innovation and product excellence by delivering compelling assortments to consumers with particular success at Coach, where we drove handbag AUR gains at constant currency. Importantly, this focus also continued to drive operational gross margin expansion, helping to fuel our highest Q3 gross margin in nearly 2 decades. We understand innovation wins with consumers and we are committed to bringing creativity, quality and compelling value to customers around the world. Overall, we generated 3rd quarter operating income and earnings above expectations, driven by stronger than anticipated margins, highlighting the power of brand building, consumer centricity and operational agility.

Speaker 2

We achieved these results while making Now turning to highlights across each of our brands, starting with Coach. Our team delivered another strong quarter with the power of the brand's unique expressive luxury positioning once again on display. We continued to infuse innovation across all customer touch points, driving engagement, cultural relevance and emotional connections with customers globally. Importantly, the success of our strategies, together with consistent execution is evident in our financial results with revenue growth at constant currency, significant gross margin expansion and profit gains with further runway ahead. Now touching on some details of the Q3.

Speaker 2

We continue to drive growth in our handbag offering led by our iconic platforms. The Tabby family delivered another quarter ahead of expectations and nearly doubled versus last year. The introduction of our quilted tabby was an incredible success, fueled by the top selling black tabby with brass hardware at a premium AUR of $5.50 At the same time, core tabby styles remain strong and we see further opportunity ahead across the entire family. While we continue to animate this family, we're leaning into key styles including Quilted Tabby and see further opportunity ahead. Across the balance of the assortment, our timeless Willow and Rogue families remain foundational volume drivers.

Speaker 2

And we augmented our offering to build relevance with younger consumers, including the Coach Original Swing Zip, which has gone viral on social media, as well as the Ace Tote, both of which over index with Gen Z customers. Overall, our creative and innovative products supported an increase in global handbag AUR at constant currency, including growth in North America. Looking forward, we see continued runway longer term given our innovation pipeline and brand heat. At the same time, we advanced our focus on building out the lifestyle assortment to expand the brand's reach with consumers with the goal of powering customer recruitment, purchase frequency and ultimately customer lifetime value. In footwear, sales rose against last year reflecting success in our core styles, notably the low line sneaker as well as strength and newness, including our brand sandal.

Speaker 2

In men's, the Gotham, Charter and recently launched Hall families led in the quarter. And in ready to wear, we debuted classic denim styles contributing to the strong success of denim across all categories in keeping with market trends. Next, we created purpose led storytelling, building meaningful emotional connections with the brand. We again blended purpose and product with our spring Find Your Courage campaign, inspiring consumers to embrace confident self expression. The campaign takes place between the physical and virtual worlds, brought to life with the help of members of the Coach family, including Little Nas X, Camilla Mendez, Youngjie Lee and Woo Jin Yang, as well as our newest member, EMA, a virtual model and digital creator.

Speaker 2

Further, we launched deeply unique and immersive retail experiences across the globe, engaging the consumer across all 5 senses. We took Coach Play to Tokyo, opening our largest concept store yet on Cat Street, which celebrates the brand's heritage, self expression and local Japanese culture. Importantly, the store resonates with younger consumers and has outperformed expectations. In March, we launched the brand's first full service restaurant at the Grand Indonesia Mall in Jakarta, highlighting Coach's expanding presence in Southeast Asia and our strategy to connect with consumers through experiences beyond product. Overall, the brand's marketing and focus on omni channel experiences help to drive new customer acquisition, including nearly 800,000 new customers in North America, of which nearly 60% were Gen Z and Millennials.

Speaker 2

And we've seen gains in unaided brand awareness in the U. S. Per our brand tracking work, underscoring that our investments in brand building are working. Finally, we continued to build our sub brand Coachtopia, our reimagination of the product creation process to evolve our vision of circularity, has driven incremental brand relevancy and desire. During the quarter, we launched The Road to Circularity, a Coachtopia docuseries that explores how we're reimagining waste as a valuable raw material.

Speaker 2

And in April, we unveiled Coachtopia's inaugural store in Hainan, an initiative that combines our mission of sustainability and our commitment with investing in brand building in China and with Chinese consumers. While Coachtopia remains a small portion of the assortment, we're excited by the momentum we're building specifically with younger audiences. In closing, Coach is fueling consumer desire, bringing expressive luxury to life, while driving sustainable healthy profit growth that funds investments in brand building. We are confident in the future and the tremendous potential for this iconic brand. Now moving to Kate Spade.

Speaker 2

During the quarter, while top line results were challenged as anticipated, profit exceeded expectations in prior year, led by continued gross margin expansion and disciplined expense management. Importantly, we advanced our strategic agenda, sharpening our execution to bring enhanced innovation to consumers. And where we've offered newness, we've seen our customer respond. This progress reinforces our path forward as we build a more profitable business, while remaining focused on driving the top line growth required to realize the long term potential of the brand. Now touching on our strategic priorities and results in more detail.

Speaker 2

1st, we remain focused on strengthening the brand's core handbag foundation, a requirement to win in today's dynamic consumer backdrop. During the quarter, we broadened the core assortment across channels through new introductions, including the Sweet Work Tote, Phoebe and Spadeflower Signature programs. Importantly, newness drove higher customer recruitment, AUR and gross margin versus the balance of the offering. At the same time, the performance of newness also reinforces our sense of urgency to refresh our carryover families, which remain pressured. To this end, the pipeline of handbag newness will continue to increase into fiscal year 2025, building on the progress we're seeing today and supporting the brand's runway for enhanced revenue and profitability.

Speaker 2

And as we innovate our core handbag offering, we will also continue to deliver emotional lifestyle assortments, a differentiator for the brand. During the quarter, we delivered growth in jewelry, which is a key recruitment vehicle and profit driver for the brand. Now turning to our 2nd strategic focus area, powering the omnichannel experience to drive customer engagement. As you know, we recently launched a dedicated katespadeoutlet.com site replacing the brand surprise site and providing a more seamless way for outlet consumers to discover and shop the brand online. As a result of this effort, our outlet omnichannel customer penetration increased in the quarter and remains an opportunity to drive customer lifetime value over time.

Speaker 2

Further, by bringing a more unified experience to consumers across all brand touch points, we can continue to more efficiently scale our marketing and merchandising efforts, supporting our goal of driving sustainable direct to consumer growth. 3rd, we are focused on creating emotional marketing that fuels brand relevance and heat. During the quarter, we launched a new global campaign Time to Spring, anchored in the brand codes of Joy, Color and New York City, which garnered significant media impressions and strong engagement on social platforms. Our marketing investments supported the acquisition of approximately 400,000 new customers to the brand in North America. Moving forward, we will continue to distort our marketing efforts to top and mid funnel activations that support brand building and growth.

Speaker 2

And finally, we will maintain a commitment to operational excellence, positioning the brand for long term success. This focus has underpinned the brand's meaningful gross margin and profit expansion this year and is embedded in our strategies and ways of working for the future. Overall, we continue to advance our long term strategies with the relentless focus on accelerating our progress. Our path forward is clear and our vision for the brand and its potential is unchanged. Turning to Stuart Weitzman.

Speaker 2

Results in the quarter were pressured, reflecting headwinds in the brand's 2 key markets of North America and Greater China. Despite the challenged financial performance, we remain focused on supporting brand health by investing in product and marketing to drive growth and profitability long term. Touching briefly on these focus areas. During the quarter, we expanded our assortment of casual styles in keeping with market trends. This included new block heels, wedges, ballet flats and loafers, which are performing particularly well across key full price wholesale accounts, supporting strong sales gains at POS in North America.

Speaker 2

Further, our fall and pre spring wholesale bookings are up meaningfully, reflecting our progress in delivering product innovation and relevancy. Further, we continued to build out new categories with the launch of the brand's men's collection and an expanded sneaker assortment. At the same time, our handbag collection, while still a small portion of the assortment, drove growth at high AUR. Now turning to marketing. During the quarter, we drove relevance by tapping into cultural moments to amplify our key product strategies.

Speaker 2

For example, we launched our pre spring collection with the backdrop of Palm Beach and leveraged a multifaceted influencer approach to reinforce our recently launched sneaker offering with Sofia Richie Grange, Suki Waterhouse and Jenna Dewan showcasing Stuart Weitzman trainers. As a result of these efforts, U. S. Google search queries for the brand increased, while consideration also rose in the U. S.

Speaker 2

Per YouGov. Overall, the Stuart Weitzman team is leaning in to accelerate progress and enhance profitability longer term through relevant differentiated product and emotional marketing to fuel brand desire. In closing, Tapestry delivered 3rd quarter earnings ahead of expectations, successfully advancing our strategic agenda to power our iconic brands to move at the speed of the consumer in an ever changing environment, while investing in our future. We remain confident in our vision and the significant long term opportunity to drive sustainable organic top and bottom line gains and meaningful shareholder value. Before turning the call over to Scott to discuss our financial performance and outlook in more detail, I'd like to provide an update on our pending acquisition of Capri.

Speaker 2

1st and foremost, we remain excited by the opportunity to expand our house of powerful brands, positioning Tapestry as a leader in innovation. The combined company will bring significant benefits to customers, employees, partners and shareholders around the world. By investing in and growing Capri's brands, we will bring more innovation to more consumers globally, positioning us to better compete within the growing over $200,000,000,000 global luxury market for handbags, accessories, footwear and apparel. Further, through this combination, we will be a home and incubator for talent, driving our purpose led and people centered mission and continuing to elevate employee and consumer experiences. With regard to the transaction timeline, following unconditional approval from the European Commission and regulatory approvals in China and Japan, the FTC filed a suit on April 22 to block the proposed acquisition.

Speaker 2

We remain confident in the merits and pro competitive, pro consumer nature of this transaction and look forward to presenting our strong legal arguments in court. Our timeline always contemplated the potential for litigation and we continue to expeditiously work to close the transaction in calendar year 2024. In the meantime, and as always, we remain focused on continuing to execute on our current business and strategic growth agenda. I'll now turn it over to Scott.

Speaker 3

Thanks, Joanne, and good morning, everyone. As Joanne mentioned, our fiscal Q3 operating income and EPS exceeded expectations, demonstrating our disciplined execution and agility. Importantly, we significantly expanded gross margin and generated strong free cash flow while investing in future growth drivers for our brands and business. Now moving to the details of the quarter, beginning with revenue trends on a constant currency basis. Sales were in line with the prior year and at the low end of our guided range.

Speaker 3

These results were led by 3% growth internationally driven by gains in Japan, other Asia and Europe even as we anniversaried growth from the prior year. In Japan, sales grew 2% and in other Asia, revenue rose 15% with growth in each country in the region, notably Korea and Malaysia. In Europe, growth continued with revenues 19% above last year. And in Greater China, as expected, revenue declined 2% as we lapped last year's resurgence in traffic and spend following the end of COVID related restrictions in the region. In North America, sales declined 3% compared to the prior year amid a challenging consumer backdrop, though gross margin rose significantly and outperformed plan as we supported brand health.

Speaker 3

Now touching on revenue by channel for the quarter, our direct to consumer business declined 4% due to declines in North America and Greater China. And in wholesale, revenue grew over 20% led by strength in international supported by our strategic growth initiatives on digital platforms. Moving down the P and L, we delivered the strongest third quarter gross margin in nearly 2 decades, which was ahead of our expectations and 190 basis points above last year. This year over year expansion was driven by the benefit of 100 basis points from lower freight expense, FX tailwinds as well as operational outperformance. SG and A was relatively flat with last year and favorable to our forecast on both a dollar and rate basis, reflecting operational savings as we continue to tightly control costs while making ongoing strategic investments in our brands, people and business platforms.

Speaker 3

In addition, SG and A benefited from an expense timing shift of approximately $20,000,000 into the 4th quarter, primarily relating to marketing. So taken together, operating margin And 3rd quarter EPS of $0.81 beat our expectations by approximately $0.15 fueled by an operational beat as well as the previously mentioned favorable expense timing shift worth roughly 0 point 0 $6 Now turning to our balance sheet and cash flows. We ended the quarter with $7,400,000,000 in cash and investments and total borrowings of $7,700,000,000 which reflects the bond financing related to the planned acquisition of CapRe. Free cash flow for the quarter was an inflow of $79,000,000 CapEx and implementation costs related to cloud computing were $29,000,000 Inventory levels at quarter end were 12% below the prior year, underscoring our focus on disciplined inventory management and driving inventory turn. Looking forward, our inventory is well controlled and current and we continue to leverage the benefits of our supply chain navigating the Red Sea disruption with only modest impact, which has been incorporated into our outlook.

Speaker 3

Importantly, we expect to end Q4 with inventory in line with the prior year well positioned into fiscal year 2025. Turning to our dividend program, our Board of Directors declared a quarterly cash dividend of $0.35 per common share representing $80,000,000 in dividend payments for the quarter. For the fiscal year, we continue to expect to return approximately $325,000,000 to shareholders through the dividend at an annual rate of $1.40 per share, a 17% increase compared to last year. Now moving to our guidance for fiscal year 2024, which is provided on a non GAAP basis and does not include any potential impact from the planned acquisition of CapRe. We are maintaining our fiscal year 2024 EPS outlook supported by the 3rd quarter's outperformance, while taking a prudent approach to the 4th quarter planning.

Speaker 3

For the year, we're modifying our top line outlook to incorporate trends in both North America and Greater China across brands. That said, our EPS outlook is unchanged, supported by stronger margin results and a commitment to being disciplined stewards of our brands. Moving to the fiscal year in further detail, we expect revenue of over $6,600,000,000 approximately in line with the prior year on a reported basis and representing growth of about 1% on a constant currency basis. Moving to sales details by region at constant In North America, we expect revenue to decline slightly versus last year. In Greater China, we anticipate low single digit sales growth.

Speaker 3

In Japan, revenue is forecasted to grow mid single digits, while other Asia is expected to increase at a low double digit rate. And in Europe, we anticipate low double digit growth. In addition, our outlook assumes operating margin expansion of 110 basis points. We anticipate gross margin to expand approximately 230 basis points, which includes a benefit from moderating freight costs of roughly 130 basis points. On SG and A expenses, we expect deleverage of roughly 120 basis points, reflecting reinvestments in our brands, people and business in support of growth initiatives.

Speaker 3

Moving to below the line expectations for the year, net interest expense is expected to be approximately $12,000,000 which incorporates higher yield on cash and investments compared to the previous outlook. The tax rate is expected to be approximately 20% and our weighted average diluted share count is forecasted to be in the area of 2 33,000,000 shares. So taken together, we continue to expect EPS of $4.20 to $4.25 representing 8% to 9% growth versus last year. Finally, before contemplating any deal related costs, we still anticipate free cash flow of approximately $1,100,000,000 And we expect CapEx and cloud computing costs to be in the area of $140,000,000 this forecast includes nearly half of the spend to be related to store openings, renovations and relocations, mostly in Asia, with the balance primarily related to ongoing digital and IT investments. Quickly touching on our outlook for the Q4 specifically, our guidance implies an expected sales decline in the area of 1% at constant currency or roughly 3% below the prior year on a reported basis, including an FX headwind of approximately 150 basis points.

Speaker 3

Further, we anticipate an operating margin decline in the area of 50 basis points, which incorporates the expectation for continued strong gross margin gains offset by higher SG and A in part due to the negative impact of the expense timing shift from the 3rd quarter. Taken together, EPS for the 4th quarter is forecasted to be in the area of $0.85 Now to outline our capital allocation priorities looking forward, which are unchanged. First, we will invest in our brands and businesses to support sustainable growth. 2nd, we will utilize our strong free cash flow rapid debt repayment. We're committed to maintaining a solid investment grade rating.

Speaker 3

To this end, we initiated a long term leverage target less than 2.5 times on a gross debt to adjusted EBITDA basis and expect to achieve that within 2 years of the Capri transaction close. Finally, we will return capital to shareholders through our dividend. Importantly, we believe our strong cash flow profile provides us with further opportunity for investment and capital return. Following the achievement of our leverage target, over time, we expect to increase our dividend with the goal of achieving our stated target payout ratio of 35% to 40% and see the opportunity to resume share repurchases in the future. Before closing, I'd like to touch on the acquisition of CapRe and reiterate our confidence in the excellent strategic fit and value creation opportunity it presents.

Speaker 3

We believe the transaction will enhance our strong organic growth and TSR potential supported by double digit EPS accretion on an adjusted basis, enhanced cash flow more than $200,000,000 of cost synergies and compelling ROIC, accelerating benefits for our consumers, employees, partners and shareholders for years to come. In closing, for the quarter, we build on our track record of operational excellence, driving margin and EPS outperformance against the challenging demand backdrop, advancing our long term growth initiatives and controlling the controllables. In addition, we generated strong free cash flow, while continuing to invest for the future. Our consistent earnings delivery demonstrates the power of our operating model and talented global teams. Looking forward, we remain confident in our vision and in our ability to realize it with a steadfast commitment to drive sustainable profitable growth and shareholder returns.

Speaker 3

I'd like to now open it up for your questions.

Operator

We'll take our first question from Bob Drbul of Guggenheim.

Speaker 4

Hi, good morning. I was wondering Good

Speaker 2

morning, Bob.

Speaker 4

Hi, Duane. Can you talk a little bit more just about your the confidence that you have in your ability to maybe hit the FY 'twenty five Investor Day EPS target of $5 given, against the environment, the backdrop in the second half performance?

Speaker 2

Sure. Maybe Bob starting with this year, fiscal 2024, I want to acknowledge that we just delivered a strong earnings beat in our Q3 and we reiterated our outlook for fiscal 2024. That's an important step in getting to our fiscal 2025 targets. And I would say despite the dynamic environment that we've operated in since sharing those targets 3 years ago, we remain confident in our ability to deliver the earnings target we set. That really reflects our commitment to brand building and our track record of disciplined execution, both of which are driving our results.

Speaker 2

And hats off to our teams around the world who are maniacally focused on serving our customers with the agility required in this environment. And what gives us confidence, I would say Coach, our largest brand, is in a position of strength. Expressive luxury is driving new customer acquisition, new and younger customer acquisition and strong engagement globally. We have brand heat and a pipeline of innovation to come. And I am pleased with the execution and the discipline that allowed us to grow profit even in a challenged environment.

Speaker 2

So we do have a sense of urgency to drive stronger top line growth across our portfolio. We remain focused on those initiatives and investments that will fuel that long term growth and we see tremendous runway ahead. But maybe I'll turn it over to Scott to share a little more detail.

Speaker 3

Sure. Joanne and hey Bob, good morning. I'll just start with reiterating what Joanne said. We are on track to deliver the Investor Day EPS targets even despite a more modest top line. And how are we doing that through consistently driving gross margin outperformance coupled with disciplined expense control.

Speaker 3

And just remember that $5 is impacted by the pause in share repurchases, which we quantified about $0.35 impact and now, FX is working against this a bit. But the best evidence that we can achieve this $5 as adjusted going forward is to look at what we're doing right now. We've already done it. Our performance over the last 3 years, we delivered double digit EPS CAGR even in a challenged market. And look at this year, we're on track to deliver high single digits earnings growth even on flat sales in fiscal 2024.

Speaker 3

And so as you look forward, I'm not providing explicit guidance here, but just to give you some idea of our expectations, we'll continue to focus on the factors in our control. Operational gross margin drivers remain intact. Inventories are well controlled and current. And we're continuing to focus on tightly managing our SG and A, investing in growth drivers, finding leverage throughout the P and L. And I think one of the things you see on display is really we've remade this P and L to a more variable model since 2019 pre pandemic.

Speaker 3

And that allows us to invest, but also to flex and react when we see challenging market conditions such as what we're experiencing right now. So when I put that together, these factors all reinforce our confidence in our ability to achieve that $5 as adjusted that we laid out as a commitment in our Investor Day.

Speaker 4

Great. Thank you very much.

Operator

We'll move next to Ike Boruchow of Wells Fargo. Your line is open.

Speaker 3

Hi. Good morning, everyone. Congrats the quarter and a tough day. I guess a question and a clarification. I guess maybe Scott, just you can give us a little unpack Q4 a little bit more, specifically Coach North America and China expectations that are embedded in that quarterly guide?

Speaker 3

And then I just wanted to make sure I understand. So when you've said, the double digit accretion on the deal for some time, I guess what I'm trying to understand is, is that a year one number? I mean, I think we all know that, since the deal went through, I think that company's EBITDA, at least on the Street estimates, have been cut 30%, 40%. So is that more of a multiyear accretion expectation? Or is that still is that a year 1 double digit accretion number that you guys are kind of talking to?

Speaker 3

Just trying to understand more. Thank you. Yes, sure Ike. Maybe I'll start with the second just to knock that one out. It obviously depends on the timing of when we close, but we're talking about a 1st year accretion.

Speaker 3

There's seasonality in the business and there's some variability there. But yes, on a full year basis, we expect that double digit EPS if you look at the calendar year. What gets a little tricky is when you close and where we're at in our year, but if you look at a 12 month period, that duration, that's what we're speaking to. And as it relates to what's in the guide, I think you asked about China and Coach. And so first of all, remember in the second half, this has been a strange quarter by quarter if you think about China.

Speaker 3

So in Q2, we were up against the COVID compares. We had really high growth. In the back half, we're up against revenge spending, which puts pressure on the China business. So if you look at Q4, it's in the area down double digits from a China standpoint year on year. But let me remind you, for the full year, we're growing at a low single digit rate, even with all that noise in China for the full year.

Speaker 3

And as it relates to Coach, maybe I'll throw it over to Todd to comment on Coach.

Speaker 5

Good morning. Thanks, Scott. Again, we feel very good about where we're at at Coach. As you saw in this quarter, we delivered our highest gross margin in almost 20 years. And we see continued growth.

Speaker 5

We're not chasing the last dollar. We're being very disciplined and prudent, but we're growing with the people we want to grow with. In North America, Joanne mentioned, we grew 800,000 new consumers, 60% are young, Gen Z and millennials. And what's exciting about that is that is the future fuel for sustainable long term growth. So I'm pleased where we're at.

Speaker 5

I'm pleased with what we're going to deliver in the year in total and how and what it means for our future. Great. Thank you.

Operator

We'll take our next question from Matthew Boss of JPMorgan.

Speaker 6

Great. Thanks. So Joanne, could you elaborate on the progression of North America demand for the Coach brand maybe as the Q3 progressed and more recent trends that you've seen in Q4 to date? And then Scott, to your bottom line confidence, could you speak to the drivers of the roughly 200 basis points gross margin expansion in the 4th quarter and just runway for operational gross margin multiyear?

Speaker 2

Sure. I'll kick it off with an overview of North America and it's really a continuation of what we've been seeing in the market. The consumer is being more choiceful despite some positive factors in the market. Certainly, the labor market is a positive. In the market, we do see consumer confidence is low in North America, likely impacted by sticky inflation.

Speaker 2

And so we are seeing an overall more cautious consumer. But in that context, we're seeing innovation continue to win and Coach has been doing a phenomenal job at delivering innovation. And we're being quite disciplined in terms of how we manage our business for the long term. And our expectations for the business reflect that. We're meeting the high bar, we're winning, we're driving higher gross margins.

Speaker 2

And Todd just mentioned highest gross margin in nearly 2 decades. We're driving higher AUR, we're delivering the innovation and we're acquiring more new consumers to brands. And those new consumers are transacting at higher AUR and higher gross margin. As we see the business unfold, we're planning prudently to continue to build our brands for the long term. And then maybe for the second part of your question, Scott, toss it to you.

Speaker 5

Todd, I've got you're on mute, I think.

Speaker 3

Thank you, Todd. Sorry about that. Yes. So in the Q4, we're going to grow almost 200 basis points. In terms of gross margin, I'd say for the full year or 2, if you just think about the overall performance, 230 basis points for the full year, which includes about 130 basis points of freight.

Speaker 3

So that freight benefit we said starts to wane as you move through the year, but it's still a contributor in Q4. As you think about going forward, as I said in an earlier comment, the gross margin drivers are still intact, right? We are investing in our businesses. We are increasing our marketing investment consistently over time. It's about triple where it was several years ago.

Speaker 3

And that engagement with the consumer gives us confidence in our ability to continue to get them to vote. The consumers in charge, they decide that they continue to vote in terms of our products and the AUR that comes with that as well as opportunities on the cost side. We see that we have AUC benefits that were achieving this year and we see that continuing on a go forward basis.

Speaker 6

Great. Best of luck.

Speaker 3

Thanks, Matt.

Operator

We'll take our next question from Lorraine Hutchinson of Bank of America.

Speaker 2

Thanks. Good morning. Joanne, you just discussed the challenging macro environment in North America. Are conditions deteriorating enough to cause you to change your strategy? Would you give up some of this gross margin strength to give some of the value back to consumers and drive sales growth?

Speaker 2

Absolutely not. We are and have been really focused on brand building and building our brands and creating emotional connections with consumers. First, we know that the category we play in is both durable and resilient and powers the category powers through downturns historically because the consumer has an emotional connection with it. And we see strong growth in the category going forward. And we want to be sure that our brands are well positioned, regardless of the macro environment as strong brands.

Speaker 2

And that's been our work for the last 4 years, and we're gaining traction. We offer incredible value in the marketplace to consumers, and that won't change. Where we represent and how connected consumers are to our brands continues to grow. Their affinity for our brands continue to grow. And that's where we're investing.

Speaker 2

That's been it's not just about gross margin and the product and the innovation that we're delivering, but it's also about the marketing investments we're making to reach consumers, the investments in digital to reach consumers where we are. And that's the virtuous flywheel that we've been developing and it's working. So we'll remain committed to it.

Speaker 1

Thank you.

Operator

We'll take our next question from Brooke Roach of Goldman Sachs.

Speaker 7

Good morning and thank you for taking our question. As you think about the opportunity for Tapestry to gain share in North America against this challenged macro. Can you talk a little bit more about the innovation pipeline you have on the horizon and how you're thinking about engaging customers between the outlet and the value focused channels relative to the full price channels and what you're seeing there currently? Thank you.

Speaker 2

Yes. Innovation is winning. That's what I will say and we're very focused on delivering the innovation that consumers respond to and recognize. It starts with knowing the customer. And again, our direct to consumer platform, our data and analytics capabilities and our consumer insights capabilities are what help fuel this innovation, right?

Speaker 2

We're staying close to consumers and their behaviors and their preferences change rapidly. They have changed over the last 4 years and I expect they'll continue to change. And so we're connecting with consumers, understanding consumers at a deeper level and then building product and experiences that speak to consumers. That's the innovation that wins. And we're doing that exceptionally well at Coach and maybe I'll pass it to Todd to share some of his insights on innovation.

Speaker 5

Thank you, Joanne. I couldn't be more excited with what I see, what we're seeing now both in our stores, but I have the benefit and the privilege of walking through our showrooms and seeing what we're going to deliver 9 months from now. And what we're seeing is innovation across all price points. We're not just innovating at the top. We're innovating at our value channel and at our retail channel.

Speaker 5

And we're doing some really interesting things. We talk a lot about the strength of Tabby. One of the things you're going to see when you visit stores in June, we're going to take Tabby at full price to 100 outlet stores in North America. Because what we've recognized is we're spending quite a bit on marketing our image, leaning in on Tabbie. Consumers don't always see the difference like we see between an outlet store and a retail store.

Speaker 5

And with taking those tabbies, they will be sold at full price in outlet because the consumers coming in with their iPhones and saying, I want this back. And we want to make sure we deliver what our customers want wherever they shop. And that's what's so exciting. And ultimately, yes, we talk a little bit about the overall backdrop, but we're in an emotional category. And what we've seen, we haven't seen any degradation in consumers at our economic level.

Speaker 5

So again, we win when we deliver newness, when we deliver emotion, when we have purpose led campaigns. You're seeing that with Coach. This year, we will end over $5,000,000,000 It's the first time in over a decade where Coach has done that. But we're ending at $5,000,000,000 in a very healthy sustainable way. And that's what I feel so good about our future.

Operator

Our next question is from Michael Binetti of Evercore ISI.

Speaker 8

Hey guys, thanks for taking our questions here. Congrats on a nice quarter. I have 2. I guess if we think about what's baked into the guidance you just gave us for Q4 and some of the dynamics and what it could mean as we look to the second half of the calendar year, Scott, would you mind helping us think through maybe upside and downside scenarios after your 4th quarter or maybe the puts and takes around the multi year revenue CAGRs you spoke to at the 2022 Analyst Day in regards to fiscal 2025? And then on the AUR comments that you guys made earlier, I know you mentioned some confidence in the ability to keep driving AUR AUR handbag AURs.

Speaker 8

Maybe walk us through some of the drivers that you look at to build to that. We've heard, I guess, as earning season starts, some retailers may be pointing to some concerns that the luxury brands have taken too much pricing on handbags and they need to start moderating a bit. Have you seen anything in the marketplace yet? What levers do you think about in your business if you need to kind of defend pricing if you do see that spread to luxury brands has provided a nice umbrella and you've spoken to over the last few years starts to reverse a little?

Speaker 2

Yes. Let me speak to the second part of that first, maybe then Scott, top it to you. As it relates to AUR and margin growth, you've seen us consistently deliver. We've been on this path even we started even before the pandemic and it really starts with understanding customers and what customers value. I mean AUR at the end of the day is a function of what's sold, not what's offered.

Speaker 2

So we're ultimately it's the consumer's decision. You mentioned the top of the market. The top of the market has moved price considerably higher. And in that context, the value that we deliver to consumers is incredibly stronger. And so as we play within the dynamics of this very fragmented market where the consumer has a lot of choice, we have an opportunity to know the consumer better, understand what they value and deliver that value in the form of innovation.

Speaker 2

And that's what's been driving AUR and our gross margin growth, over the last few years. And those are deeply embedded capabilities So that's why we expect to be able to continue to do this. The value that we deliver in the marketplace is incredibly strong. We know our consumers and we can then take those insights and deliver innovation behind it. And then maybe Scott, over to you.

Speaker 3

Yes, sure. Michael, you're probably not surprised. We're not giving any guidance on 25, right? So I would just repeat a couple of things that I said earlier. First of all, there's agility in the model on display.

Speaker 3

It has been since the Investor Day and our ability to deliver earnings on a lot of different conditions and difficult backdrop. The other thing I'd say is, we continue to invest in the brands, continue to invest in marketing, but we're also reading and reacting, right? And so, I'll give you an example. We talked about in this last quarter, we have made a decision within our brands to spend more on the top of the funnel and less on the bottom of the funnel. That can hurt sales in the short term.

Speaker 3

You get bottom of the funnel sales, but from the quality of sales and the acquisition of new customers, which you saw 1.2 $1,000,000 in the quarter, about half of which are millennial and Gen Z. That really speaks to confidence in the future. And these are some proof points that help us or give us confidence that we can grow both top line and bottom line in the future.

Operator

Our next question is from Oliver Chen of TD Cowen.

Speaker 9

Hi, thanks so much. The Coach gross margin continues to really impress. What are your thoughts longer term? Should you invest more just to make sure you're being proactive about how well you're doing there? And as you think about pricing, it continues to impress as well.

Speaker 9

What are you seeing with elasticity? And how are you thinking about like for like relative to mix? The tabby momentum is really impressive. Lastly, about the geographies, would love your thoughts on the China customer relative to U. S.

Speaker 9

China has been fairly mixed with some of the macros and housing and traffic being general concerns. Meanwhile, we've seen a linear U. S. Customer. Just would love thoughts on that.

Speaker 9

Thank you.

Speaker 2

Todd, do you want to kick us off with Coach gross margin and your long term outlook and then I'll follow-up with on the China piece.

Speaker 5

China, perfect. Thanks. Yes, we feel good, Oliver, about our gross margin and the sustainability of our gross margin. Now obviously, this is a standout quarter. I want to make sure no one expects every quarter to be 77%, but we like the neighborhood.

Speaker 5

We're delivering on an annual basis and we are investing. I mean, again, when we talk about investing, we're investing in the quality of our product. We're investing in marketing. If you think about it, historically Coach has been 3% on marketing. We're spending almost over 8% on marketing today.

Speaker 5

And as Scott indicated in the last question, we've shifted even more recently how we're spending that mark. Getting. We're spending more and more on top of funnel marketing to tell story, to create more connection with our consumers. We're doing that because we believe in the long term sustainability and the customer acquisition that that brings to the brand. In terms of pricing, I mean, we touched on this a little bit, but I feel and Joanne touched on this, but I think in terms of AUR, at Coach Brands specifically, we feel very good about sustaining AUR growth for four reasons.

Speaker 5

Again, it goes back to innovation and storytelling, something I've talked about over and over again, emotion always trumps price. Consumers have hundreds of choices. Every day we win because we connect with them emotionally. 3rd, traditional European luxury dominate the category. And when we compare our product with that traditional European luxury, the consumer is seeing the value and that's very important.

Speaker 5

And lastly, something that Scott always touches on, we're so disciplined in our inventory. We are our whole structure, if you think about the last 4 years, Joanne led this, We reduced our SKU count dramatically and we leaned in on important families. And that takes a lot of the pressure off that constant churn on fashion. That's what you're seeing with Tabby. That's what you're seeing with Willow, Rose.

Speaker 5

We have families that are sustainable, that are emotional, that the consumer connects with. Thank you.

Speaker 2

And Oliver, related to the consumer in China, like many others, we're seeing macro headwinds. There are there is lots of noise in the numbers. Last year, we're lapping shifts in the New Year holiday during the quarter, but also importantly that post COVID revenge spending. I do think it is important to note that our outlook for the year continues to expect low single digit growth for the year in China. So the quarterly flow of that has been quite dynamic.

Speaker 2

But we still expect growth for the year and our view on the long term opportunity in China has not changed. And our teams, we have tremendous teams on the ground. We've been in the market, as you know, for 2 decades, over 2 decades. And our teams are doing an excellent job building our brands and connecting with consumers in this dynamic environment. I was just in the market 2 weeks ago.

Speaker 2

I was meeting with teams and our partners in the region. The teams are showing agility and moving with the consumer as their shopping behaviors and preferences shift. And you saw some of our wholesale outperformance in international was related to how our teams are reading, where the consumers moving and making sure we're showing up and our brands are connecting with consumers where they are. We are seeing consumer desire for our brands continue to be strong and purchase intent in our category is still high with consumers. So we continue to invest in the market and in brand building activities to support that long term potential that we see.

Speaker 9

Very encouraging. Thanks. Best regards.

Operator

Our next question is from Mark Altschwager of Baird.

Speaker 9

Good morning. Thanks for taking the question. So Coach continues to demonstrate its ability to drive stable results despite the choppier macro. So the tools and playbook really seem to be working. So what do you think is holding back Kate at this stage?

Speaker 9

Is there a wholesale story going on there? And do you think that the success at Coach the success you're having with younger customers is having an impact on Kate at this point? Thank you.

Speaker 2

No, our opportunities with Kate, and I appreciate the question, Mark. At Kate, we are focused on building a stronger brand and a bigger brand. We see tremendous potential in the future for Kate. And we're doing both building the profitability of the brand as well as establishing a stronger brand with our consumers. So in the quarter, you saw expand gross margin, operating margin and profit versus last year.

Speaker 2

It exceeded our expectations. So the disciplined management of the business remains intact. We're executing with discipline and also an opportunity to grow the top line. And in that we see an opportunity to increase the or improve the execution in 3 areas, and we've talked about this. 1 is strengthening the core handbag foundation.

Speaker 2

Coach has 80 years of archives that we're pulling from and really driving. Kate is building those core handbag ideas. And the delivering of innovation, you've heard that as a theme at Tapestry, where we're really winning and where we see the customer respond is when we're delivering newness and innovation, in our assortments. And that's what we're focused on delivering and we're increasing that newness and innovation at Kate. Where we're delivering that, it's working.

Speaker 2

And that newness and innovation will grow, as we've mentioned, into fiscal 2025. We're also focused on the omnichannel experience. We've launched outletdot com. We have more omni channel customers, but that seamless experience and driving more emotional marketing. We're talking about shifting our investments into top of funnel.

Speaker 2

So all the things that Todd just talked about at Coach are things we're applying to Kate. Kate is in earlier innings and we continue to have confidence in the runway that we see ahead for the brand. We're being disciplined about our execution and building the profitability while we continue to execute on the things that will drive and help achieve that long term brand ambition.

Speaker 9

Thank you. And maybe one more quick one for Scott on fiscal 2025. The agility in the model came up a couple of times today. Is sales growth needed to hit the earnings goals? Trying to better understand the range of scenarios you're contemplating there.

Speaker 9

Thanks again.

Speaker 3

Yes. So again, I'm not going to get into that level of specificity, but let me be clear, we expect to grow, right? We've got the building blocks in place. We're acquiring consumers that we believe have a strong lifetime value. We're putting the investments in marketing and behind the business and we've got an innovation pipeline.

Speaker 3

So we'll come back and give you more soon, but we do expect to grow. That said, we've demonstrated this year that even on no growth essentially flat business, we can and have the levers to deliver profitability. So combination of both those things that give me a lot of confidence. Think about what this model does as it's been remade and the efficiency that we've been talking about as we achieve the growth that we expect to in the future. And this becomes a profit and a cash machine on an even higher level than the commitments that we've made publicly.

Operator

In the interest of time, please limit yourselves to one question. Thank you. We'll move next to Rick Patel of Raymond James.

Speaker 9

Thank you. Good morning. Really good control of SG and A. Can you talk about which levers you pulled in the quarter to pare back the growth there and touch on how we should think about OpEx going forward in terms of areas where you see opportunity for better control versus areas you need to make more investments in?

Speaker 3

Yes, maybe I'll start. Listen, we continue the model really hasn't changed. We continue to invest in our people's capability and in marketing. And those are the areas that you see that we invested in the quarter. And we're finding leverage really throughout the rest of the P and L.

Speaker 3

I'd remind you about 2 thirds of our rents now have a variable component. And again, we're spending about 9% in terms of marketing. So that's that really isn't a change and we've been pretty consistent in the way we're looking at that from a go forward standpoint.

Speaker 5

Thanks very much. Thank you.

Operator

This does conclude our question and answer session. I'd be happy to return the call to Joanne for concluding remarks.

Speaker 2

Well, thank you. And thank you for joining us and for your interest in our story. And thank you to our incredible teams around the world who continue to drive our results against the dynamic backdrop. Our disciplined approach to brand building and our commitment to operational excellence were once again on display in the Q3. We're delivering innovation for consumers and driving profit and earnings growth.

Speaker 2

I'm confident in our future and the significant opportunity to drive sustainable growth and shareholder returns. Thanks again and have a great day.

Operator

This concludes Tapestry's earnings conference call. We thank you for your participation.

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Earnings Conference Call
Tapestry Q3 2024
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