Tapestry Inc

NYSE:TPR

Earnings Call Transcript 2019-Q2

[Operator]

Good day and welcome to the Tapestry 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 Andrea Resnick, Global Head of Investor Relations and Corporate Communications.

[Andrea Resnick, Global Head, IR and Corporate Communications]

Good morning and thank you for joining us. With me today to discuss our quarterly results are Victor Luis, Tapestry's Chief Executive Officer; and Kevin Wills, Tapestry's Chief Financial 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, including 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 quarterly 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 important factors that could impact our future results and performance.

Non-GAAP financial measures are included in our comments today and our presentation slides. You may find the corresponding GAAP financial information as well as the related reconciliations on our website, www.tapestry.com/investors, and then viewing the earnings release posted today in the presentation slide.

Now, let me outline the speakers and topics for this conference call. Victor Luis will provide an overall summary of our second fiscal quarter 2019 results for Tapestry as well as our three brands. Kevin Wills will continue with details on financial and operational results of the quarter and our outlook for the balance of FY19. Following that, we will hold a question-and-answer session, where we will be joined by Todd Kahn, Tapestry's President and Chief Administrative Officer; and Josh Schulman, CEO & Brand President of Coach. Following Q&A, we will conclude with some brief summary remarks.

I'd now like to turn it over to Victor Luis, Tapestry's CEO.

[Victor Luis, CEO]

Good morning. Thank you, Andrea, and welcome, everyone. As noted in our press release this morning, during the second quarter, our sales and gross profit rose, successfully anniversarying the strong holiday results of the prior year. That said, this performance fell short of our expectations in the face of an increasingly volatile macroeconomic and geopolitical backdrop. Importantly and as expected, we generated significant synergies while also making material systems and strategic brand investments across our portfolio. Taken together, adjusted earnings per diluted share were even with the prior year.

Across Tapestry, we made significant progress on our strategic pillars during Q2, notably maximizing the opportunity with the Chinese consumer globally. To this end, Coach held its first-ever runway show in Shanghai, which was incredibly well-received by the editorial community and generated more than 1.1 billion impressions. At Kate Spade and Stuart Weitzman where we are focused on driving awareness in the region, we invested in key talents, infrastructure as well as marketing partnerships with Chinese brand ambassadors, while expanding our reach to the opening of new stores.

While we understand that there are some continuing concerns around Chinese luxury spending, we view China's heightened emphasis on driving domestic demand as entirely aligned with where we are making our investments across brands. Indeed, we believe further investment in domestic markets with China, the most important, is the best hedge against volatility that may at times occur in tourist spending. Further, we were very pleased by the relative outperformance of all of our brands’ China businesses this quarter.

Our teams across Tapestry remained focused on executing our four strategic priorities. First, continuing to harness the power of our multi-brand model. Our synergy capture was evidenced in part in the significant gross margin expansion we achieved in Kate Spade’s second quarter results. To that end, we remain on track to achieve run rate synergies from both COGS and SG&A of approximately $100 million to $115 million in fiscal 2019, up from $45 million in fiscal year ‘18. We've also continued to make progress on building a scalable, shared services model, including investments in systems and infrastructure to support our current and future growth opportunities. During the quarter, we deployed the first phase of our ERP implementation, SAP’s S4 HANA, successfully migrating our global finance functions for Tapestry, Coach and Stuart Weitzman. And just yesterday, we successfully transitioned Kate Spade to the S4 HANA ERP system as well. Now that our S4 implementation is well-advanced and with our experience operating as a multibrand holding company, we've identified additional opportunities to further streamline our organizational structure. We expect these incremental efficiencies along with the return on our brand investments to support our goal of double-digit operating income growth in fiscal year ‘20.

Second, fueling innovation. Across all of our brands, we are focused on delivering distinctiveness newness and compelling product across categories and channels, supported by bold marketing campaigns and unique collaborations. We understand that innovation is what drives velocity of purchase in our key categories. And having a nimble, flexible supply chain, which we leverage across brands, enables us to deliver a higher level of innovation with increased frequency. Our commitment to innovation is clearly evident across our brands in our just introduced spring collections as well as the impact for marketing campaigns launched to support them.

Third, driving global growth. We continued to integrate the recently completed buybacks of the Kate Spade operations in Singapore, Malaysia and Australia, as well as the Stuart Weitzman business in southern China in the second quarter. We also invested in key talent and infrastructure in these markets to support business development across our portfolio. These initiatives will allow us to accelerate international growth and drive brand awareness. During the second quarter, we added 40 net new stores across brands including the acquired businesses. These new locations were primarily focused in international markets and took our directly operated total store count to 1,496. Our business is now more direct than ever, allowing for a consistently high level of execution in our delivery of our brand experiences. In fact, we had over 170 million visits to our stores and sites in the second quarter alone.

And fourth, advancing our digital and data analytics capabilities. Across all brands, we are continuing to drive superior results for our online channel and remain committed to delivering a seamless, online-offline experience. Our data labs team is focused on further strengthening and integrating our customer database platform and supporting customer relationship management program in each of our brands, advancing data tools to drive aggregated business insights across the organization and innovating with advanced analytics to optimize key processes, for example, using machine learning on product allocation, pricing or promotion planning. The team is making substantial progress on these goals and helping us become even more data-driven and predictive, building on the solid foundation we have created.

Some of the key launches of this past quarter include a Tapestry real estate tool that allows our teams to analyze store density and identify white space in any geographic location as well as measure cross-channel migration of our customers, a Tapestry product portfolio tool that allows our brand management, merchandising and marketing teams to measure the performance of all our products across channels and regions against target priority segments, driving deep insights, which can inform future product launches.

Moving forward, in light of our recent results and the uncertain global environment, we are revising our outlook for the balance of the fiscal year, which Kevin will touch on shortly. And while we were not satisfied with our second quarter performance, we are proud of the continued progress on our key strategic priorities and confident that the investments we are making in our brands and our Tapestry platform will drive a return to double-digit operating income and earnings per diluted share growth in fiscal 2020.

Now, returning to the second quarter results and starting with category trends. During the second quarter, we estimate that the men's and women's premium handbag and accessories market, which is now over $45 billion, grew at a high-single-digit rate globally on an organic basis, a slight deceleration from the September quarter. In U.S. dollars, the growth rate was mid to high-single-digits, given the appreciation of the dollar. We also wanted to share some highlights of our U.S. brand tracking survey fielded in November and December.

Among the broad premium market and looking at emotional attributes, Coach is a leading brand in making women feel confident, original and smart, while Kate Spade leads in making women feel feminine, beautiful and fun. It is important to note that we saw gains in the brand affinities of both Coach and Kate. Specifically, among the broad premium market, the percentage of women who agree that Coach and Kate Spade are their most loved handbag brands and are brands that they would confidently recommend, increased versus year ago.

Looking at specific brand performance and starting with Coach. Global comparable store sales rose 1% in Q2, led by outperformance in our international channels and across our e-commerce platforms and reflected our compelling offering across categories. We were especially excited by the brand’s increased traction with Chinese consumers globally, driven by domestic demand, partially offset by a decline in tourist spend. Further, we drove an increase in operating income through both gross margin expansion as well as SG&A leverage. Our goal for holiday across all channels was to continue to elevate and differentiate the brand by offering innovation and emotion through our product assortment marketing and the in-store experience with a special focus on gifting for the season.

There were many highlights of the quarter in keeping with our brand priorities. In retail, we successfully cascaded leather goods innovation from our fashion shows and global marketing campaigns with Parker, Charlie and dreamer families, all of which remain strong drivers of the business in the first holiday season. We’ve continued to animate these families with new materials and shapes during the quarter.

Likewise, we also reinforced Signature as a coveted brand icon by having the most significant presentation at retail in many years. In addition to the iconic tan coated canvas, we also introduced the metallic signature platform for a festive holiday take on logo and the new elevated jacquard print. As expected, our customers were excited to have Signature back in a meaningful way in their retail assortments.

Most broadly, during holiday, we transformed our stores into a festive gifting destination, featuring our whimsical party animals and emotional gifts across all price points. We also continued our momentum in women's ready-to-wear, with strengthened shearling outerwear globally and particularly in China.

In outlet, during the quarter we increased the level and frequency of newness and novelty in the channel. We had multiple introductions in the edit, which represents the pinnacle of our outlet assortment. The bestsellers included the new Cassidy Crossbody, the perfect day to evening bag, which was featured in many novelty iterations as well as the Abby Duffle and L Hobo, two shoulder bags in rich pebbled leather. The edit continues to achieve higher AURs globally. In addition, we pulsed multiple gifting messages during the season, including the strong component of festive glitter and metallic bags and small leather goods. We also had a disruptive Wizard of Oz collaboration, bringing the excitement of this holiday classic to a full lifestyle collection, including bags, small leather goods, ready-to-wear, and soft accessories.

Overall, Signature product continues to drive sales and our customer is responding to innovation within this assortment. We had multiple iterations of signature newness throughout the quarter, including an exclusive Black Friday capsule, juxtaposing Signature against animal prints. In Q2, logo penetration rose over the prior year. And consistent with our strategy to drive growth outside of our core women's bags and small leather goods categories, men’s continued to comp across channels and geographies, driven by lifestyle, notably outerwear and footwear, as well as small leather goods. In outerwear, shearling styles drove more than half of Q2 ready-to-wear sales. The November launch of the new Rivington family and bags also proved a great success. This family continues to be a focus as we move into spring and beyond.

We were very pleased with the performance of our women's and men's footwear assortment globally. In retail, our strong growth was led by our sport and casual offerings, notably women's boots and booties as well as on-trend sneakers across genders. In Q2, strong performance in the C143 sneaker continued across both women's and men's with an expanded offering coming for spring. In outlet, we were excited by the traction we experienced in women's boots and booties, and men's sneakers.

Our Signature platform continued to perform well in both our women's and men's offering and across channels. In addition, we have made significant progress in driving our license categories, both in stores and in the broader market. Coach fragrances gained momentum, moving up from the 27th rank to number 16th within the prestige fragrance division of the U.S. department and specialty store market based on dollar sales, according to the NPD Group's point-of-sale data in the 12 months ending December 12, 2018.

Further, last month, we announced the global multiyear licensing agreement with Incipio Group to launch mobile device accessories, a comprehensive range of Coach mobile accessories will release on Coach.com and Coach stores worldwide beginning in the fall of 2019 and will be a key part of our holiday programs.

We were also delighted with the growth we drove in e-commerce with particular strength in our full price retail dotcom business globally. Of note, Q2 ‘19 was our best dotcom holiday performance ever in North America. During the quarter, we also rolled out our new homepage design, which has seen terrific engagement results as well as enhanced personalization functionality through our product recommendations, which is driving strong conversion results.

On stores, our customization program, Coach Create, continued to drive sales in Q2 as we accelerated our offering of customization option, now including footwear and outerwear in addition to leather goods. Customization was offered in 12 countries in 110 stores during holiday, supported by over 200 onsite craftspeople. And by fiscal year-end, this service will be expanded to over 150 stores. Around 300 additional stores are serviced remotely. With the millennial focus on personalization and authenticity, this is not surprising that this program is helping to engage and recruit the younger consumer.

Our marketing, our fun and festive 360-degree holiday campaign featuring whimsical holiday party animals and key product families resonated well and drove brand buzz. We continued to drive digital engagement with Selena Gomez's video content to launch holiday. And we augmented the use of global imagery with local ambassadors with Guan Xiaotong in China and Kiko Mizuhara in Japan.

As mentioned, a highlight of the quarter was our first ever Shanghai runway show, our first dual gender show outside of New York, which was live streamed and drew significant and positive global attention, both editorially and in media coverage overall. We will continue to leverage the halo from the show during the next few quarters, culminating with the in-store launch of the Shanghai collective, a series of collaborations with Chinese artists that was an integral part of the show.

More recently, we’ve launched our partnership with Michael B. Jordan as the first global face of Coach Men and held our first event with our philanthropic partner for the Coach Foundation, The Future Project. To celebrate the launch, Michael surprised students at Barringer High School in his hometown of Newark, New Jersey, generating national TV coverage and driving very-positive engagement across social media platforms.

Now, to get into a bit of comp detail on the quarter, the drivers of our overall second quarter performance was fairly consistent with our previous trends, with global comparable store sales in bricks and mortar driven primarily by conversion, reflecting our strong product offering. As noted, we saw continued strength in our e-commerce business globally. During the quarter, our global Coach comp remained solid, rising 1%, accelerating on a two-year stack basis, led by our international markets. Greater China comps rose and accelerated from Q1. And importantly, our business with the Chinese consumer increased globally.

Japan comp was very-strong while our other Asia businesses were also positive with Korea the only exception. Finally, Europe comp returned to positive territory. North America also accelerated on a two-year stack basis but comped slightly negatively, reflecting a difficult compare given last year's very-strong holiday quarter performance.

We understand that there's been a lot of focus on tourist flows as well as concerns related to Daigou or reseller activity. What we saw over the quarter was the anticipated and continued headwind from the tourist spending in North America.

In addition, notably in outlet, we experienced volatility in the spending patterns of some of our customers believed to be resellers in advance of changes in e-commerce laws on the Mainland, effective January 1st. We know this type of activity is prevalent globally for luxury brands, which sell at premiums outside of their home markets. Ultimately, we believe this curtailment of reseller activity will have a long-term benefit to our brand in our business. Importantly, at the same time, we’ve seen an acceleration in local customer demand in both the U.S. and Mainland China.

Moving to wholesale, as expected our North America shipments were slightly below prior year, during the quarter, due to shipment timing with the first quarter as well as the closure of certain department store accounts. On a POS basis, we comped up in the quarter, despite the lower level of promotional event days. Our international wholesale revenue rose versus the prior year in Q2, excluding Coach Australia and New Zealand as that business has transitioned to a directly operated retail model. This reflected some shipment timing shift with third quarter. At POS, sales were modestly below prior year on the same basis. Overall, we are satisfied with Coach’s performance in the quarter, in light of the tough compare, volatile tourist trends, notably in North America.

Moving forward, we remain focused on, first, delivering a heightened level of newness throughout the pyramid of fashion, price and occasion across channels and geographies; continuing to build on our established and authentic signature platform; driving growth beyond our core bags and accessories; utilizing technology and digital to enhance and modernize the customer experience, notably through customization; and lastly, amplifying our marketing message that balances unexpected brand impact and broad appeal.

In summary, we are excited about the spring season and remain confident in the brand’s opportunities for growth, go forward.

Moving to Kate Spade, we made continues progress on our integration efforts and the execution of strategic initiatives. That said, our sales fell short of our expectations with second quarter revenue totaling $428 million, down 1% versus prior year.

Top line results were driven by new stores in the consolidation of Kate Spade China offset by the deliberate pullback in disposition and the decline in comparable store sales, which fell 11% with our online business outperforming bricks and mortar stores. This comp softness reflected the lack of distinctive newness in the final season from the brand’s previous design team.

Given the lack of newness for holiday and our excitement about the new creative direction, we made a deliberate decision to shift marketing dollars from both Q2 and Q4 into the current quarter in support of the launch of Nicola Glass’s new collection. In fact, her spring collection was introduced in our full price channels just last week. And while early days, initial reads have been strong.

In handbags, the Nicola group featuring the Spade twistlock hardware, a new brand code, is resonating globally. And Margo, defined by its curved feminine silhouette and crafted from refined grain leather is also performing very well. Perhaps most exciting is the response to her ready-to-wear designs, notably online and across classifications. We believe this indicates that we’re taking the existing customer on the journey with us.

Overall, this performance underscores our confidence in achieving a significant inflection in the business with a return to positive comps.

At Kate Spade, we continue to focus on our five strategic pillars. First, global expansion, we added 31 net new locations in Q2, including 15 acquired in Singapore and Malaysia and are on track to add 60 to 70 stores globally, including distributor buybacks. To-date, our new doors are meeting or exceeding our expectations at high levels of productivity.

Second, branding, we evolved our messaging to play to the brand’s core attributes of fashionable and feminine while addressing fun in a more universal way. In support of Nicola’s debut collection, we cast actress Julia Garner, Sadie Sink and KiKi Layne to star in our new Kate Spade New York campaigns for 2019. The three new faces personify the brand’s promise of optimistic femininity. The campaign was shot by famed photographer and long time brand collaborator Tim Walker, and has launched globally to very positive reviews and engagement.

Third, as we’ve discussed, we’re introducing exceptional and aspirational products, upgrading quality through elevated materials and construction while maintaining price, providing excellent value to our customers. And we've begun to create compelling and covetable brand icons and codes such as the Spade turnlock to make our product both instantly recognizable and more distinctive.

Fourth, we’re creating immersive channel experiences and have started to roll out new retail and outlet concepts. In fact, of all the openings thus far in fiscal year ‘19, all have reflected the new color palette, enhanced visual merchandising elements, and merchandising by category of our evolved store model. In addition, we’ve made some lifetouch renovations in key existing full price location, approximately 50 in total as of the end of January with a goal of touching approximately 90 locations globally by the end of this quarter. These front room wraps leverage the brand’s new iconography in our specialty stores to appropriately showcase the new product in a cost-effective yet brand-enhancing manner.

And fifth, we are leveraging the Tapestry platform and capturing synergies for Kate Spade through COGS and indirect savings as we optimize our supply chain, notably for bags and small leather goods from raw materials buying and manufacturing to transportation and logistics.

The Kate Spade team is also tapping into Tapestry’s resources and expertise such as global business development and store construction to accelerate growth and improve profitability over time.

As we look ahead for Kate Spade, we continue to expect that it will be a year of solid revenue growth, driven by new distribution, acquisitions and consolidations of distributor businesses and a return to positive comps during the second half and notably in the fourth quarter when all specialty products will evolve to new designs.

And while we remain confident that Nicola’s product will drive an inflection in the business, we have now built in a slightly more muted top line assumption for the balance of the year, given the weaker than expected performance of the carryover product, which we’ll be transferring to outlet. Importantly, as previously noted, over our three-year planning horizon, we continue to believe that Kate Spade can approach $2 billion in sales at significantly higher operating margins.

Turning to Stuart Weitzman, we were pleased to meet our objective of returning the brand to topline growth in the holiday quarter. This reflects the progress the SW team has made in executing our FY19 strategic priorities.

First, we continue to evolve and refine our product development processes and supply chain, addressing the challenges that arose last spring. Importantly, production levels and shipments have stabilized, reflecting the investment in talent and processes as well as the added manufacturing capacity. Of course, we recognize that there is still work ahead to optimize our production and delivery schedules, especially for the global wholesale market to allow us to capture the in-season replenishment orders. With the rollout of our world-class Tapestry IS platform in the months ahead, the team is excited by the prospects of capturing this opportunity.

Second, we’re expanding our footwear offering in new classifications while maintaining our authority in iconic Stuart Weitzman style. During the quarter, we experienced growth in booties, loafers, sneakers and pumps where we have notable product newness.

Third, we are expanding globally with the focus on the Chinese consumer. We are encouraged by the brand’s performance in China where we’ve acquired our business from our distributor partner and are focused on driving awareness and increasing market share. This spring, we’re particularly excited to launch a capsule collection in collaboration with Yang Mi, a leading celebrity and influencer in China. In fact, her first post for the brand on her own feed drove 48 million views and was reposted 700,000 times in the week after launch. In addition, in January, prior to lunar New Year, we opened an additional seven locations on the Mainland in our new modern and elegant store concept.

Fourth, we’re driving growth beyond footwear, gaining credibility in handbags and leather goods. This quarter, we introduced the brand’s new spring collection of handbags which generated exceptional growth. We continue to see significant opportunity to grow the brand’s handbag offering, given the complementary nature of the footwear and bag categories.

And fifth, we are creating brand desire through bold and modern marketing. We’re thrilled to have just launched our new marketing campaign, introducing Kendall Jenner, Yang Mi, Willow Smith and Jean Campbell as the season’s diverse cast of #SWWomen. This campaign with its global relevance highlights the brand’s core attributes and values of using fashion, function and fits.

In summary, we’ve made significant progress in addressing the challenges in our supply chain, while at the same time evolving the brand's creative direction through product and marketing. Overall, we would expect improvement in the second half versus the prior year with the third quarter still pressured by investments and the fourth quarter approaching breakeven levels of profitability, on strong sales growth. We remain excited about the opportunities for the brand across geographies, classifications, and categories and are confident in our long-term vision.

Before handing the call over to Kevin for details on our financial results and guidance for fiscal 2019, I would like to touch on our CFO transition. As we announced in November, tomorrow will be Kevin's last day with Tapestry. He has been a key member of our leadership team, and I speak for the entire organization in wishing him success as he embarks on his next chapter in Tennessee. Until a new CFO is named, I am extremely excited to share that Andrea Resnick will serve as our interim CFO. All of you know Andrea, and her exceptional knowledge of the business and leadership will ensure that we do not miss a beat. Importantly, our strategic priorities remain unchanged with our experienced and proven teams across Tapestry focused on their execution.

With that, I will turn it over to Kevin for the financial review of the quarter and our outlook. Kevin?

[Kevin Wills, CFO]

Thanks, Victor, for your warm wishes. I have truly enjoyed my time at Tapestry and leading exceptional finance team. Good morning, everyone.

Victor has just taken you through our quarterly results and strategies. Let me now take you through some of the important financial details of the quarter as well as our outlook for fiscal year ‘19.

Before I begin, please keep in mind that the comments I’m about to make are based on non-GAAP results. Corresponding GAAP results as well as the related reconciliation can be found in the earnings release posted on our website today.

Now, turning to the financial results for Tapestry.

Total sales for the quarter rose 1% on a reported basis and 2% in constant currency to $1.8 billion. While we delivered growth over our solid prior year results, our performance felt short of our internal expectations due primarily to softness at Kate Spade while comparable store sales were impacted by the lack of newness in the last season under the previous design team. That said, we were pleased to generate growth at Couch, reflecting positive comparable store sales led by international outperformance as well as strong growth in our digital platforms. And at Stuart Weitzman, we achieved our objective of returning the brand to sales growth in the holiday quarter.

Turning to gross margin. Our gross margin for the quarter rose 10 basis points to 67% on higher level of sales. The expansion in our margin was driven by Kate Spade, which rose 120 basis points, fueled by the realization of COGS synergies as well as a 10 basis-point increase in gross margin in Coach, which included 45 basis-point of currency benefit. These increases were partially offset by decline in gross margins at Stuart Weitzman of 380 basis points, which included 200 basis points of pressure from currency.

SG&A expenses totaled $805 million and represented 44.7% of sales as compared to $783 million and 43.9% respectively in the prior year. The increase in SG&A expenses was driven, as projected, by cost associated with regional buybacks and JV consolidation, new store distribution at Kate Spade as well as a higher level of marketing at Coach.

Our operating income totaled $402 million in the quarter as compared to $411 million in the prior year, while operating margin was 22.3% as compared to 23%, reflecting the higher level of investment versus prior year. As projected, net interest expense was $13 million for the quarter as compared to $22 million in the prior year. Our effective tax rate was 20.3% as compared to 21% in the prior year's Q2. Taken together, our EPS was a $1.07 in the quarter, even with prior year.

Now, moving to global distribution by brand. For Coach, we opened a net two locations in the quarter. We opened 16 net new Kate Spade locations while acquiring 15 stores in Singapore and Malaysia. And for Stuart Weitzman, we opened seven new locations in Q2.

Turning to our balance sheet and cash flows. At the end of second quarter, our cash and short-term investments were approximately $1.5 billion while our borrowings outstanding were $1.6 billion, consisting primarily of senior notes. As previously discussed the reduction in our deposition as compared to the prior year as the Q2 reflects, the repayment of $1.1 billion in term loans in January of 2018.

Inventory levels at quarter end were $732 million as compared to ending inventory of $666 million in the year-ago period. The increase in the prior year was primarily driven regional buyback activity over the past 12 months. Net cash from operating activities was an inflow $618 million as compared to an inflow of $535 million a year ago. Our CapEx spending was $61 million versus $78 million a year ago. Free cash flow was an inflow of $557 million versus $457 million in the same period last year.

Now, turning to our capital allocation policy. Our long-term priorities remain unchanged. First, we will continue to invest in our brands in order to drive sustainable growth and value creation; secondly, we will seek strategic acquisitions, looking for great brands with opportunities for expansion; and finally, returning capital to shareholders with the focus on dividends. Overall, our strong balance sheet will support our growth initiatives while allowing us to maintain strategic flexibility.

Now, moving to our 2019 outlook. As noted in our press release, in light of our second quarter results and the uncertain global environment, we are revising our outlook for FY19. Consistent with our prior practice, the following guidance is presented on a non-GAAP basis and replaces all previous guidance.

Starting with sales. We expect total revenues for Tapestry in fiscal 2019 to increase at a low to mid-single-digit rate from fiscal 2018. This includes the expectation for low-single-digit growth at Coach, driven by continued positive low-single-digit comps. In addition, we continue to project an increase in Tapestry’s gross margin for the year, although to a lesser degree than originally anticipated. That said, on a lower level of sales, we expect this improvement to be offset by SG&A deleverage, given the impact of regional distributor buyback activity and systems investments.

Net interest expense is expected to be in the area of $50 million for the year. The full-year fiscal 2019 tax rate is projected at about 18% to 19%. The increase over prior year is due primarily to the introduction of a new tax regime, requiring a current inclusion in U.S. federal taxable income of certain earnings that control foreign corporations known as GILTI. We expect our weighted average diluted shares outstanding for the year to be approximately $293 million. Overall, we are projecting earnings per diluted share for the year in the range of $2.55 to $2.60.

It is important to note that we continue to expect meaningful variability by quarter in the back half of the year. We’re planning a higher level of SG&A growth in the third quarter, based upon the timing of a regional buyback activity, new store opening plans and our investments in systems as well as the shift in Kate Spade marketing spend Victor mentioned. While in Q4 we expect revenue growth to accelerate, as we gain traction at Kate Spade and Stuart Weitzman, enable us to drive leverage. Therefore, taken together, we would expect operating income and EPS to decline in the third quarter, while increasing in Q4. We still expect CapEx to be in a range of $300 million to $325 million in FY19, which we would anticipate to be the peak level spend over our planning horizon.

We expect to incur nonrecurring pretax charges of approximate $35 million attributable to the Company's ERP implementation efforts. We also expect to incur pretax integration and acquisition charges of approximate $80 million to $90 million. The increase versus our prior estimate includes additional expenses associated with organizational streamlining Victor mentioned, which will result in cost savings in FY20 and beyond. It also reflects the higher cost of purchase accounting related to distributor buybacks.

Finally, turning to our fiscal year ‘19 directly operated distribution plans by brand which are unchanged. For Coach, we continue to expect a modest net decrease in our store count in FY19 due primarily to net closures in North America and Japan. For Kate Spade, we remain on track to grow the brand’s directly operated store base by 60 to 70 net new locations in FY19. Specifically, we continue to project 40 to 50 net new door openings, notably in international markets where we see significant opportunity for growth. We've also added 21 locations to the acquisition of brand’s operations for Singapore, Malaysia and Australia. And for Stuart Weitzman, we expect to open approximately 30 net new locations this fiscal year, primarily in China.

In addition, as previously announced, following the successful buyback of the brand’s business in northern China in FY18, we acquired the brand’s operations in southern China where there are total of six locations. Beyond this fiscal year, we’re also pleased to have entered an agreement to buy back the Stuart Weitzman business in Australia, which is expected to close by this summer.

In closing, we are focused on balancing near-term transitional challenges with our longer term goals. We remain confident in the power of our brands and multi-brand operating platform and are targeting double-digit operating income and EPS growth outlook for FY20. Importantly, we have a healthy balance sheet to support our strategic priorities and a strong team to drive results.

I would now like to open it up to Q&A.

[Operator]

[Operator Instructions] And your first question is coming from Bob Drbul of Guggenheim.

[Bob Drbul, Guggenheim]

Hi. Good morning. I actually have two questions this morning. I think the first one, given these results and the updated outlook for 2019, what gives you the confidence in double-digit operating income and EPS growth in 2020 and your ability to operate this multibranded model? And my second question is, when you think about the Kate Spade positioning right now, what gives you the confidence in Kate’s inflection, what are you seeing quarter-to-date? Can you give us a little bit more detail around that piece? Thanks.

[Victor Luis, CEO]

First, I think, to your first question in terms of guidance for FY20. There are two important themes as we target mid-single-digit topline growth with the double-digit operating income and EPS growth. The first theme is lapping key investments that we've made and the second theme is traction from the brand investment that we’ve made, specifically around Stuart Weitzman, and of course Kate. So, more specifically, as we enter Q4 of this fiscal year, we will have lapped all of the strategic brand investments, especially in Asia where we bought back, as all of you are aware, distribution for Kate Spade and Stuart Weitzman. And by the end of Q3, that will mostly be behind us. And I can share with you all that I’ve spent some time with those teams on the ground in December. And we have really talented and very-focused teams there and we’re getting [Technical Difficulty]

[Operator]

Ladies and gentlemen, we apologize. But, there will be a slight delay in today’s conference. Please hold and the conference will resume momentarily.

[Victor Luis, CEO]

Hello. Operator, can you hear us?

[Operator]

Yes. We can hear you now.

[Victor Luis, CEO]

Okay, great. Thank you. Sorry about that everyone. We lost one of our mics there for some reason. I’m just going to start at the beginning, Bob, with your question because I’m not sure when we lost the line and that first mic. But, as I was suggesting, two very important themes, one is lapping the key investments that we’ve made and two is the traction that we are getting from key brand investments that we are making, specifically around Stuart and Kate. And more specifically around those two themes, as we enter the fourth quarter, we will have comped all of the investments and the distribution, buy backs in Asia, especially in the key China market for both Stuart Weitzman and Kate Spade. And as I was sharing, I’m not sure if you guys heard during the call, but I visited those teams in December and can share my excitement, not only by the strength of the talent that we have on the ground and the investment that we’ve made in structure but the performance that they are already driving for us, which of course we start comping from the fourth quarter.

Also, as you heard in our speakers’ notes, we are really pleased with the successful implementation of the SAP S4 HANA platform. We were the first and are the first company globally to be on this new version of SAP. It started with the implementation and finance for Tapestry, Coach and Stuart Weitzman early last quarter and just this week in fact where on day two, we have implemented the entire foundation of this platform in Kate Spade including supply chain, logistics and the systems and cost savings that we expect from that and system efficiencies, have given us the confidence, along with the continued experience that we have in operating as a multibrand model to look for more efficiencies in the organization, which we discussed as well and Kevin touched up, as we move forward.

As a result, by I would say Q4, we will be closer to the growth rates that we actually expect in FY20, having comped both the strategic investments and benefiting from the brand inflections that we expect in Stuart Weitzman as we comp last year's issues that we experienced, and you saw some of that already in the last quarter, as well as Kate Spade. And what I can share with you in regards to Kate Spade, obviously we normally don’t talk about comp within the quarter and I won’t talk holistically, but I can definitely share with you that in Kate Spade, we’re really pleased with the lunch, we’re entering the second week here and we have seen a definite inflection. By the end of third quarter we will have 50% of the product in the full price channel will be complete newness, and by the end of the fourth quarter 100% of the product will be complete newness, and that’s what we experienced here in Kate Spade with the lack of newness, the teams were focused on driving just that and driving innovation.

We made a decision, as you heard in the speakers; notes, a shipped investment, both from the second quarter, as well as from the fourth quarter toward this launch. Hopefully some of you have followed the launch, whether it’d be on social media and look at the very positive engagement that we’re seeing, overwhelmingly positive. I encourage you to go, it be Facebook, whether it be Instagram, and see the reaction that we’re getting.

And there is few things that I would share so far as early highlight. First and foremost, handbags incredibly well received, especially pleased by the fact that the iconography has been especially pleased. We have discussed over and over the need for platforms that can drive sustainable long-term growth. And the new branding on Kate Spade is exactly that, and we’re seeing the consumer react to that very, very positively; we’re seeing that across ready-to-wear, we’re seeing that across hand bags, we’re seeing that across jewelry as well, which excites us.

Secondly, ready-to-wear. Ready-to-wear is a very important part of the Kate Spade business, much more sold than our other businesses. And in the case of the new launch, we’re really excited that that’s resonating well. And that is the most important point that we can make in terms in taking the current consumer along with us on the Kate Spade journey, under Nicola’s direction, so that as well excites me. And what we saw in the second quarter and actually beginning from September was that the product and the lack of newness, especially in our full price channel and our full price -- meaning full price brick and mortar and full price dotcom, and that’s what really led to the drop in comp. And we have a newness that’s coming in that’s truly global and truly a reflection of the product. So, hope that gives you some color, Bob and to the others on the call as well.

[Operator]

[Operator Instructions] Your next question comes from Irwin Boruchow of Wells Fargo.

[Irwin Boruchow, Wells Fargo]

So, I guess, I have my question on the gross margin line. Kate Spade, you guys talked about, carryover inventory, given the sales performance at holiday into the third quarter. What kind of a gross margin impact should we be thinking about for Kate Spade in the third quarter, could Kate gross margins be down? And then, also, you would talk about the Coach gross margin being a little less optimistic on that for the fiscal year. Just kind of can you talk about that, the promotional environment, what exactly the puts and takes are there.

[Kevin Wills, CFO]

On the Kate Spade carryover, we did come out with in the speakers’ note and we expect that to put some incremental pressure on the third quarter results. We’re not giving specific margin guidance by quarter. And on Coach, again, due to the promotional nature of the North American business, we have expected some pressure there as well. So, taken together, that was one of the reasons that we were looking to reduce the guidance in the back half.

[Victor Luis, CEO]

Yes. And I would just add something. Obviously, with the lack of performance of the product that was in stores, we could have easily been much more promotional, gotten rid of that inventory. We made a very clear decision not to be more aggressive in the full price channel, not only to create of course an overhang with consumers as we launch new product, but more specifically because we have tremendous confidence in the new products coming in, and we have a lot of confidence that that product can and will work effectively well in the outlook channel as we exit this quarter and beyond. And relative to the total business, we think that impact will be minimal.

[Operator]

Thank you. Our next question is from David Schick of Consumer Edge Research.

[David Schick, Consumer Edge Research]

You called out Parker and some of the other platforms that were working. Is anything changing with cycle time in the industry, and how long one of these platforms matters and iterates? And sorry to follow on to these Kate questions. Does the repositioning, as you do that and you have more data, do you think about the real estate portfolio any differently there?

[Victor Luis, CEO]

I’ll ask Josh to first talk a little bit about the Coach specifically and life cycles. And then, I'll touch on Kate.

[Josh Schulman, CEO and Brand President, Coach]

Good morning. So, I think it’s an interesting question about cycle times and how the customer is responding to fashion. On the one hand, the customer is wanting more and more newness. I think that you can see that in how we’re dropping products more frequently in different ways, surprising and delighting the customers. At the same time, when you have an important platform like Signature, that is part of something that is not a seasonal trend, that is something that you can really build over the course of many years. And I would say, that’s one of the things that we’re most proud of in our product performance right now. It has been very deliberate way that we launched Signature over the past year, which is now in the high teens globally, in our retail channel. And we’re continuing to sustain higher AURs in signature, and the customer is really responding. So, the answer to your question is both. She wants fashion, she wants newness. But, for the brands where she has a very close affinity and a deep love, she wants to wear that icon proudly. And so, we’re seeing both impacts on our business.

[Victor Luis, CEO]

And David, relative to Kate and the evolution of that brand and its impact on the real estate, I think we’re all aware of the key investments of course that we talked about over the past year, first and foremost, reducing both the flash model as well as the urban disposition channel to the of $100 million, which is a key investment that we should think about in terms of long-term brand health; secondly, in terms of physical and other channels go forward. Kate footprint is much higher, I think relatively clean. We’re incredibly pleased with the new store format that we launched and the performance that we’re seeing. So, we’re being very thoughtful about how we leverage that go forward and the tremendous amount of attention right now in terms of wardrobe [ph] is on of course Asia with a specific focus on China where we’re seeing very solid performance. Again, couldn’t be happy with that team and the work that they are doing. And we start comping that business of course in the months ahead.

[Operator]

Your next question is from Erinn Murphy of Piper Jaffray.

[Erinn Murphy, Piper Jaffray]

My question is around -- to see overall category and Couch’s position in it. I think, you said that category grew high single digits and Couch was up 1.5%. I’m curious to see where from a global prospective you’re seeing some of the share loss relative to where the growth is in the category? And what are the levers that you think are most actionable to kind of reaccelerate the Coach brand relatively to where the market is growing today. Thank you.

[Victor Luis, CEO]

Overall, we have not seen a change in theme, Erinn, from the last few quarters. I would say that globally this past quarter, most of the growth is coming -- or outsized growth coming especially from Asia, China domestically being and continuing to lead. And I would say that a lot of the growth is coming from a couple of the traditional European brands that are driving outsized dollar performance with the U.S. this past quarter having grown closer to a low single to mid single digit rate relative to the high single digit rate that we saw globally with a slight deceleration from the September quarter.

In terms of what drives this at the end of the day, Erinn, it is the same things we’ve discussed; it has a lot to do obviously with brand’s connection and the motion, innovation and consumers and driving desirability with consumers. So, everything that we’ve been doing for the past several years, obviously we’re in a very different situation, very different distribution than the traditional European luxury brands, has been focused just on that. We have worked still ahead of us but continue to be incredibly satisfied with the progress made and of course never fully satisfied with the realization that it never ends and there is lot ahead of us. And I’m really excited by what Josh and the team have planned for the next 12 months in terms of both products and marketing, and of course couldn’t be happier with the work that Nicola and Anna are doing on Kate. Again, I highly encourage you guys to go and experience that over this quarter and next as everything rolls out. And of course, Eraldo and the team at Stuart Weitzman, when we think about the progress in just 12 months getting back first to deliveries and then kicking off this quarter with a really innovative marketing campaign, encourage you guys to stay tune for that one because there is more coming. And the Yang Mi collaboration for China, very exciting where that’s getting again tremendous buzz. So, very excited by the brand work being done and us getting a return on those investments.

[Operator]

Thank you. Next question is coming from Oliver Chen of Cowen and Company.

[Oliver Chen, Cowen and Company]

Thank you. Regarding the Coach brand and the go forward for merchandise margin, what are your thoughts on merchandise margin with respect to what you're seeing with tourism spending and balancing, making sure you’re offering a great value to the customers? And at the Kate Spade brand, with distinctive newness and the rebalancing that's happening with new product, could just give us some color on what happened with the product mix and the average unit retail and number of transactions, or thoughts around what the new product is versus what wasn't enough newness within those activities? Thank you.

[Victor Luis, CEO]

Sure. Let me start first with Kate. There is not a tremendous shift, Oliver. So, this was not about a price repositioning by any means. There were two very important themes here. Newness in terms of really innovative and I would say emotional products for the consumer, creation of brand recognizable platforms that allow us to then bring those across different categories and create sustainable long-term growth platforms within branding is absolutely vital to that and we’re on our way, and nothing but two weeks of course. But, I think you all go online and you see the reaction and you see how consumers are responding to the Spade logo and how we are beginning to play with that in print and hardware and in other branding applications, could not be happier by that. And very pleased that the consumers is seeing the Kate Spade’s emotional attributes and I talked about that on our speakers note as remaining consistent. And of course, we will test those every six months go forward but very excited by the initial results there. So, really, no mix I would say. The key drivers for us have been of course the synergies that we’ve been able to drive. So, the theme and the strategy has been very consistent, new product, more emotional products, greater perception of value at greater perceived quality at similar price points and mix to where we had been in the past.

I’ll let Josh touch a little bit on Couch merchandise or gross margin in terms of any impact going forward. Josh?

[Josh Schulman, CEO and Brand President, Coach]

Yes. So, for the full-year, we continue to anticipate gross margin expansion for Coach. And in the second half, it should be fairly flat as we’re anniversarying some of the key cost benefits we got from GSP last year. Speaking more specifically about the product strategy that drives the gross margin, as we talked about on several of these calls, we really have the line architecture around good, better, best, both for retail and for outlet. And I think in our retail channel, you’ve seen the work that we’ve done this past year in the 300 to 400 price segment, particularly around Parker and Charlie and some of those lines that have become quite significant. And now, we’re starting to see the impact of Dreamer and some of the latest introductions. We’re very excited about Harmony coming online at somewhat higher price points as well. And it’s really the same for us in outlet too. And so, you can see the price architecture there. We have focused on marketing, the added marketing, our pinnacle line. And we’re really learning a lot about what the outlet customer will pay from that exercise, and how we can influence future collections, updates on that.

When we think about that on a global basis, often it is our international customers, our Chinese tourist customers and our Chinese customer at home that is most willing to pay for the top of the pyramid product with the highest AURs, whether that’s in handbags or in ready-to-wear and so forth. So, we’re feeling good about the work we’re doing. And we always want to keep the balance. So, there is always some things to be done. There are always product holes to fill in when you’re dealing with such a broad consumer.

[Operator]

Thank you. Your next question is from Mark Altschwager of Baird.

[Mark Altschwager, Baird]

Just a follow-up on Coach for Josh or Victor. So, you mentioned pressure from reduced sales to resellers at Coach outlet; furthermore, Coach marketing and distribution strategy is really aimed at capturing sales in Mainland China. So, I'm wondering to the extent of the changes in tourist shopping patterns have a structural component, what if anything needs to be done to right size the North American outlet footprint.

[Victor Luis, CEO]

I would say, first and foremost, on the resellers and the Daigou mark. We all know of course that this is something that exists across all brands relative to the price difference with their home markets. I’ve been experiencing this since I entered the luxury goods business in 1994 in Japan, so absolutely nothing new; it’s driven by economics, driven by arbitrage and very, very difficult to control. Most brands, subs included have limits in place. We try to manage these things. But, quite often, there are organized groups who come in and by very small quantities, one at a time and leveraging of course the arbitrage and pricing.

The key for us is that, given the change -- and for us, the entire industry has the change and we don’t know how well it’s going to be enforced. But, given the changes in laws in China, specifically the Chinese government is trying of course to drive domestic consumption. They’ve made a few changes, the most important change of which is requiring all of these Daigous to register as businesses domestically as well as in the country where they are purchasing products. That is leading to a lot of changes from what we are learning; there is still very much in learning stages to some extent. But, overall, what we’ve seen is that the law will now make the digital platforms liable for this, which is driving some change in the flows, whether it’s movements from some digital platforms in China to the more social platforms where they sell or in some cases, some individuals getting out of the business completely.

And for us, the key there is first and foremost long-term we think it’s absolutely amazing, obviously it will help our brand as the Chinese government mostly protects our IP and they’ve been great partners overall over the years to us when we’ve looked to protect IP, specifically as it relates to of course, online and safe products. And secondly, of course, for us, the key has been to leverage the investments that we’re making in Mainland China. We’ve talked about that I think throughout the whole morning and of course for the past year, whether it would be the investments we made in Coach and continue to make including the significant fashion show as well as buying back our businesses at Kate and Stuart Weitzman. We’re very committed to it. We think that that’s the long-term path.

We don’t see a change as a result of any of that to our North American outlet footprint, where these folks are active happen to be the most important markets where we’re in. And so, we don’t see any impact at all to the real estate footprint.

[Operator]

Today’s final question is coming from Simeon Siegel of Nomura Instinet.

[Simeon Siegel, Nomura Instinet]

Any color on where you expect inventory over the rest the year? And then, just there were some comments on watches. I believe it is relatively small part of your business; any way to quantify how big that business is for Coach and Kate? Thanks.

[Victor Luis, CEO]

Yes. In terms of the watch business, as you suggest, it’s very small. We are I think really pleased with the work that both Movado and Fossil are doing and trying to bring new technology into it. It has never been significant for us in our own stores and remains a pretty small business. On the license front, what we’re now really excited by from a bigger presence perspective and category of course are sunwear both in stores and globally with Luxottica as well as of course our fragrance businesses. And of course we have Sofio of course for Kate in sun wear but really pleased with the fragrance business and the work that Interparfums is doing there for the Coach brand. In terms of new licenses, we did touch on the fact that we’ve signed with Incipio, really pleased with the work they’ve done for Kate. And we know that they are going to be a great partner for the Coach brand overall.

[Kevin Wills, CFO]

As it relates to the inventory, as noted in our prepared remarks, we ended the quarter with inventory up about 10% year-over-year. However, if you remove the inventory associated with the regional buyback activity, the inventories were up approximately 3% for the year. So, we feel good about inventory as we head into the second half.

[Operator]

Thank you. That will conclude Q&A. I will now turn it over to Victor Luis for some concluding remarks. Victor?

[Victor Luis, CEO]

Thank you, Andrea. Thank you, everyone. Let me first thank Kevin again for all of his wonderful work over the past almost two year with us as we laid down the foundation for Tapestry. And I want to thank and congratulate Andrew as she steps in for this interim role and we have a tremendous amount of confidence in her and of course the team supporting us. Thank you all for joining us. And as is our custom, I want to thank the 20,000 strong Tapestry team members across of the world for the wonderful job that they are doing and all of the hard work that they are putting in. While it continues to be early days in our multi-brand journey, could not be prouder of the solid foundation that they continue to lay and the hard work they are putting in. Thank you.

[Operator]

Thank you. This does conclude the Tapestry earnings conference call. We thank you for your participation. You may now disconnect.