Tapestry, Inc. (NYSE:TPR) Q3 2024 Earnings Call Transcript May 9, 2024
Tapestry, Inc. misses on earnings expectations. Reported EPS is $0.595 EPS, expectations were $0.67. Tapestry, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
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. [Operator Instructions] At this time, for opening remarks and introductions, I would like to turn the call over to the Global Head of Investor Relations, Christina Colone.
Christina Colone: Good morning. Thank you for joining us. With me today to discuss our third quarter results as well as our strategies and outlook are Joanne Crevoiserat, Tapestry’s Chief Executive Officer; and Scott Roe, 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 for our business in the current or future quarters or fiscal years. Forward-looking statements are not guarantees and our actual results may differ materially from those expressed or implied in the forward-looking statements. Please refer to our Annual Report on Form 10-K, 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/investors and then view the earnings release and the presentation posted today. Now, let me outline the speakers and topics for this conference call. Joanne will begin with highlights for Tapestry in each of 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 Kahn, CEO and Brand President of Coach. After Q&A, Joanne will conclude with brief closing remarks. I’d now like to turn it over to Joanne Crevoiserat, Tapestry’s CEO.
Joanne Crevoiserat: Good morning. Thank you, Christina and welcome, everyone. As noted in our press release, our third 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. First, 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% compared to last year, amid a challenging consumer backdrop. Importantly, we are continuing to drive a healthy business, underscored by significant gross margin expansion compared to last year and our plan. Second, 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 approximately 1.2 million new customers in North America alone, of which over half were Gen Z and millennials, consistent with our strategy to recruit 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. Third, we delivered unique omni-channel 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 Coach play 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 three times above pre-pandemic levels, which represented over 25% of revenue.
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. Fourth, 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 third quarter gross margin in nearly two 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 third quarter operating income and earnings above expectations, driven by stronger-than-anticipated margins, highlighting the power of brand building, consumer centricity and operational agility.
We achieved these results while making strategic investments in our brands to support healthy, sustainable growth into the future. 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 continue 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 third quarter.
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 $550. 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. 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-indexed 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 in newness, including our BRENT sandal. In men’s, the Gotham, Charter and recently launched Coach Family led in the quarter. And in ready-to-wear, we debut 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 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 Lil Nas X, Camila Mendes, Youngji Lee, Kōki, and Wu Jinyan as well as our newest member, imam, a virtual model and digital creator. Further, we launched deeply unique and immersive retail experiences across the globe, engaging the consumer across all five 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 omnichannel experiences helped to drive new customer acquisition, including nearly 800,000 new customers in North America, of which nearly 60% were Gen Z and Millennials. And we’ve seen gains in brand awareness in the US per our brand tracking work, underscoring that our investments in brand building are working. Finally, we continue to build our sub-brand, Coachtopia, our reimagination of the product creation process to evolve our vision of circularity, which has driven incremental brand relevancy and desire.
During the quarter, we launched the road to circularity, a Coachtopia docu series that explores how we’re reimagining waste as a valuable raw material. 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. 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. First, 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 Suite Work Tote, Seabee and Spade Flower 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. 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 second 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’s 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. 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.
Third, 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 in 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. 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 a 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. Results in the quarter were pressured, reflecting headwinds in the brand’s two 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, bale flats and loafers, which are performing particularly well across key full-price wholesale accounts, supporting strong sales gains at POS in North America.
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, 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 Grainge, 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. 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 third 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.
First 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 billion 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 22nd to block the proposed acquisition.
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.
Scott Roe: 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. 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 revenue 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. 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&L. We delivered the strongest third quarter gross margin in nearly two 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&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. In addition, SG&A benefited from an expense timing shift of approximately $20 million into the fourth quarter, primarily relating to marketing. So taken together, operating margin expanded 110 basis points, and operating income rose 6% compared to the prior year, well ahead of plan and third 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 $0.06.
Now, turning to our balance sheet and cash flows. We ended the quarter with $7.4 billion in cash and investments and total borrowings of $7.7 billion which reflects the bond financing related to the planned acquisition of Capri. Free cash flow for the quarter was an inflow of $79 million. CapEx and implementation costs related to cloud computing were $29 million. 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. 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 million in dividend payments for the quarter. For the fiscal year, we continue to expect to return approximately $325 million 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 Capri. We are maintaining our fiscal year 2024 EPS outlook supported by the third quarter’s outperformance while taking a prudent approach to the fourth quarter planning. For the year, we’re modifying our top line outlook to incorporate more moderate 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 $6.6 billion, 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 currency. In North America, we expect revenue to decline slightly versus last year. In Greater China, we anticipate low single-digit sales growth. 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&A expenses, we expect deleverage of roughly 120 basis points, reflecting reinvestments in our brands, people and business in supportive growth initiatives. Moving to below-the-line expectations for the year. Net interest expense is expected to be approximately $12 million, 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 233 million 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 $1.1 billion, and we expect CapEx and cloud computing costs to be in the area of $140 million. 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 fourth quarter 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. 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&A in part due to the negative impact of the expense timing shift from the third quarter.
Taken together, EPS for the fourth 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. Second, we will utilize our strong free cash flow for rapid debt repayment. We’re committed to maintaining a solid investment-grade rating. To this end, we initiated a long-term leverage target of less than 2.5 times on a gross debt to adjusted EBITDA basis and expect to achieve that within two 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 Capri and reiterate our confidence in the excellent strategic fit and value creation opportunity it presents. 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 million 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 built on our track record of operational excellence, driving margin and EPS outperformance against a 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. I’d like to now open it up for your questions.
Operator: [Operator Instructions] We’ll take our first question from Bob Drbul of Guggenheim.
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