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Edited Transcript of TPR earnings conference call or presentation 5-Nov-19 1:30pm GMT

Q1 2020 Tapestry Inc Earnings Call

NEW YORK Nov 7, 2019 (Thomson StreetEvents) -- Edited Transcript of Tapestry Inc earnings conference call or presentation Tuesday, November 5, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrea Shaw Resnick

Tapestry, Inc. - Global Head of IR & Corporate Communications

* Jide J. Zeitlin

Tapestry, Inc. - CEO & Chairman of the Board

* Joanne C. Crevoiserat

Tapestry, Inc. - CFO

* Joshua G. Schulman

Tapestry, Inc. - CEO & Brand President of Coach

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Conference Call Participants

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* Alexandra E. Walvis

Goldman Sachs Group Inc., Research Division - Research Analyst

* Brian William Nagel

Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst

* Erinn Elisabeth Murphy

Piper Jaffray Companies, Research Division - MD & Senior Research Analyst

* Irwin Bernard Boruchow

Wells Fargo Securities, LLC, Research Division - MD and Senior Specialty Retail Analyst

* Mark R. Altschwager

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Michael Charles Binetti

Crédit Suisse AG, Research Division - Research Analyst

* Oliver Chen

Cowen and Company, LLC, Research Division - MD & Senior Equity Research Analyst

* Omar Regis Saad

Evercore ISI Institutional Equities, Research Division - Senior MD and Head of Softlines, Luxury & Department Stores Team

* Paul Trussell

Deutsche Bank AG, Research Division - Research Analyst

* Paul Lawrence Lejuez

Citigroup Inc, Research Division - MD and Senior Analyst

* Rakesh Babarbhai Patel

Needham & Company, LLC, Research Division - Senior Analyst

* Robert Scott Drbul

Guggenheim Securities, LLC, Research Division - Senior MD

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Presentation

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Operator [1]

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Good day, and welcome to this Tapestry conference call. Today's call is being recorded. (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 and Corporate Communications, Tapestry, Andrea Shaw Resnick.

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Andrea Shaw Resnick, Tapestry, Inc. - Global Head of IR & Corporate Communications [2]

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Good morning, and thank you for joining us. With me today to discuss our quarterly results are Jide Zeitlin, Tapestry's Chairman and Chief Executive Officer; and Joanne Crevoiserat, 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 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 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. 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 and the presentation slides posted today.

Now let me outline the speakers and topics for this conference call. Jide will provide an overall summary of our fiscal first quarter 2020 results for Tapestry as well as our 3 brands. Joanne will continue with details on financial and operational results of the quarter and our outlook for FY '20. 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 Chief Legal Officer; and Josh Schulman, CEO and Brand President of Coach. Following Q&A, we will conclude with some brief summary remarks.

I'd now like to turn it over to Jide Zeitlin, Tapestry's Chairman and CEO.

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Jide J. Zeitlin, Tapestry, Inc. - CEO & Chairman of the Board [3]

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Good morning. Thank you, Andrea, and thank you to each of you for joining our earnings call. Although this is my first as CEO, this is Tapestry's 77th call since Coach's IPO in 2000. I still remember how exciting it was to listen to that first call 19 years ago, when I joined the call as an adviser to the company. Having seen this journey progress over the years, my principal takeaway relates to the resilience of this remarkable organization. The combination of a powerful brand with exceptional people and culture has enabled this company to reinvent itself, to fix historical mistakes and to address new competitors and evolving consumer desires.

I've approached my first 2 months as CEO with an optimism borne of our history and an appreciation that this history has been defined by innovation and change. I've immersed myself in day-to-day operations and key decision-making. My experience during this period of time has deepened my conviction that our 3 brands have powerful equities that connect meaningfully with significant and distinct consumer segments globally. I believe that each brand benefits from our shared set of resources that drive [affinities] and allow for sharing best practices across divisions.

I'm excited by the work ahead of us to reignite growth by bringing a more consumer-centric focus to our investment decisions and by improving our execution. While our first quarter EPS was better than the forecast we shared with you in August, embedded in our results are external and internal challenges, ranging from the situation in Hong Kong to competitive pressures to self-induced mistakes. We will touch on a number of these headwinds throughout the course of this call.

Now let me turn to results by brand. We achieved solid and consistent performance at Coach. This was our eighth consecutive quarter of positive comps, which speaks to how our product resonated with consumers globally, driven by brand interest and vibrancy. Coach's digital and international channels again led growth this quarter. In fact, I recently returned from China, where all of Coach's international store managers gathered, including those from London to Tokyo to Sydney and many points in between. This group and the store associates they work with are exceptional. Although I am admittedly biased, I believe that they are the best store team at scale in all of retail.

Turning to Kate Spade. Revenue performed in line with expectations. The business realized a mid-teens decline in comparable store sales, which reflected the product and merchandising challenges we've previously identified and are actively working to address. Kate Spade's geographic mix is also more skewed to North America than Coach, thus leaving the brand more exposed to a domestic market that is facing greater traffic and promotional challenges than many of our key international markets. At Stuart Weitzman, sales were negatively impacted by softer wholesale demand, which offset growth in the brand's direct business. That said, gross margin expansion resulted in an operating loss equal to plan and to the prior year quarter.

As we look ahead, we are maintaining our total Tapestry outlook for fiscal year '20. We understand that to meet this guidance, we need to continue to drive growth at Coach while simultaneously improving trends from current levels at Kate Spade and Stuart Weitzman. Our imperative is to fuel desire for our brands and make investment decisions through a consumer-centric lens. We are focused on becoming more agile, continuously leveraging data and technology to increase our productivity and speed to market. These improvements will enable us to fund additional brand-building initiatives and to return capital to shareholders. To this end, we have commenced an in-depth, comprehensive and efficient review of our business to address both near-term and long-term opportunities.

Let us now turn -- now discuss results by brand in greater detail, starting with Coach. Global comparable store sales rose 1% in the first quarter, led by outperformance in our international channels and across our e-commerce platforms. Excluding the pressures from Hong Kong, which intensified over the period, comps were up roughly 2%. The drivers of our global bricks-and-mortar comparable store sales were conversion, reflecting our strong product offering, as well as traffic.

Coach delivered overall positive comps across most international regions, including Europe and Asia. As anticipated, results in Japan were strong, benefiting from a pull-forward of demand in advance of the consumption tax increase, which was affected on October 1. Our Greater China business was constrained by the situation in Hong Kong. However, we continued to drive positive same-store sales on the mainland as well as in Taiwan. Our international wholesale business also rose on a POS basis in the quarter.

Comps in North America were flat to prior year despite the negative impact of lower tourist spend. In addition, while our North America wholesale shipments were below prior year in part due to timing, our business at POS increased despite fewer promotional event days. We were particularly proud of the brand's performance in North America in light of the weaker mall traffic trends in both outlet and full-price retail.

Looking at our first quarter progress against Coach's brand strategies for fiscal year '20. First, we accelerated product innovation and disruption across our good, better, best price architecture in retail with the introductions of Tabby, Troupe and Hadley and an outlet with the Disney collaboration, along with several new styles, both sporty and functional. We comped the comp in Signature in both channels. Particularly exciting was an increase in global and North America outlet handbag AUR against a highly promotional backdrop. In addition, we drove outsized growth beyond bags in our less-developed women's and men's footwear and ready-to-wear categories.

Second, we drove fashion authority through cultural relevance. Examples this quarter include our September New York Fashion Week runway show on the High Line, attended by global influencers and a number of celebrities, including actor, producer and face of Coach Men's, Michael B. Jordan. In addition, we released a new Dream It Real campaign, which featured a global cast, including MBJ, Yara Shahidi and Kiko Mizuhara. More recently, since quarter end, we launched a collaboration with MBJ featuring the anime franchise, Naruto, which generated strong excitement and sell-throughs in the men's category.

Third, we injected excitement into the store experience. One of the highlights of this quarter was an Art of Signature pop-up next to The Vessel at Hudson Yards. We also had a Coach original store takeover in New York during Fashion Week set to coincide with our spring 2020 show on the High Line. Coach original celebrated the heritage of the brand in a modern way with distinct product stories, including restored vintage bags, remade updates of archival styles and remixed bags, which are individually handcrafted combinations of vintage Coach bags. These activations not only drove strong sales in their respective locations, but just as importantly, drove significant digital engagement. Based on the positive reaction to Coach originals and its link to the spring collection, we will roll out Coach originals pop-ups in high-profile locations globally.

We're looking forward to holiday, where we will continue to innovate in our core families while disrupting with new drops that include the Tabby shop. The Tabby shop drops show the full breadth of this best-selling style across new novelty iterations as well as a new take on our original icon, the horse and carriage logo. In outlet, we will be launching a Star Wars collaboration. And in both channels, we're excited about our robust gifting assortments. In summary, we're optimistic about the holiday season and the balance of fiscal year '20 for our largest brand. We remain confident about the opportunity for continued growth as we look to accelerate innovation and relevance globally.

Moving to Kate Spade. Total sales declined 6% on both a reported basis and in constant currency with a mid-teens comp decline, offset by -- in part by new store distribution as well as the acquisition of the brand's operations in Singapore, Malaysia and Australia, which we have not yet anniversary-ed. Comparable store sales matched our expectations, declining 16% on an aggregate basis, impacted by the brand's exposure to the difficult North America market as well as the product voids and merchandising challenges discussed on our August call.

In our bricks-and-mortar business average ticket was positive for the quarter, which together with the brand's relatively stable gross margin, speaks to our deliberate management of in-store promotions. Traffic comp remained under significant pressure and was the primary cause of the decrease in comp store sales. On the other hand, international markets continue to outpace our domestic business with positive comps in mainland China and Japan.

Turning to product and brand strategy at Kate Spade. The team has begun to address initial learnings, including broadening the product assortment in retail through increased breadth of key silhouettes and a diversity of materials in order to more fully satisfy consumer use educations. We're also bringing in more color and novelty for holiday and beyond. These are playful elements that are the hallmark of the brand's unique personality and that we believe drive direct and indirect demand.

In addition, we're evolving our marketing with a nod to the past, which we saw in the first quarter with our campaign that featured Anna Kendrick, our beloved brand ambassador. Further, our spring runway show at New York Fashion Week featured a diverse cast of women. This show, and notably the product, was well received as feminine, optimistic, democratic, relatable. In outlet, as we've discussed, we are heightening the overall level of innovation, including our first-ever collaboration designed for the channel. We expect that these actions -- we expect these actions to support sequential progress in comps as we move through the year.

As mentioned, we are currently in the process of an intensive review of our business. A key focus is the Kate Spade brand. Our intent is to reengage our core consumer and attract new customers. We need to find the right balance between sophistication, witty novelty and color across all aspects of the brand. Our internal research has shown that the consumer continues to have an admiration and affection for the brand. But we must ensure that we have a product that is compelling and relevant to her lifestyle, supported by marketing that more effectively connects her emotionally with the brand.

Turning to Stuart Weitzman. While top line sales results were weak, we did make progress on a number of key strategic initiatives in the quarter. In product, we broadened our footwear offering beyond boots and sandals, notably with growth in sneakers in keeping with market trends. We continue to build our awareness globally. Our fall campaign that featured Kendall Jenner and Yang Mi garnered over 1 billion impressions. We also drove local buzz and editorial coverage in China following the Plaza 66 pop-up launch in Shanghai and landing the cover of Vogue China.

As we look forward, we're working to improve our execution from concept to market. Simply put, this means offering fashion innovation while ensuring that we meet our high-quality expectations and delivery commitments. Stuart Weitzman has always represented a fusion of fashion and fit, a key differentiator for the brand, one that is highly valued by our customers. Therefore, we're addressing our challenges through investment in talent, operational process improvements and a focus on the fashion sensibility of the core design aesthetic. I'm confident we can leverage the brand's core equities to drive revenue growth and improved profitability.

To recap, we delivered first quarter results that were in line with our plan, and our teams are now focused on the holiday season. These are exciting times at Tapestry, and there's continued opportunity to better connect consumers with our brands. Each of our brands have powerful equities that resonate meaningfully with distinct consumer segments, bringing diversification to our portfolio. Each brand leverages Tapestry's infrastructure and core capabilities, including local market knowledge and a wealth of talent to drive significant benefits.

With that, let's turn to Joanne for the financial review of the quarter and our outlook. Joanne?

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Joanne C. Crevoiserat, Tapestry, Inc. - CFO [4]

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Thanks, Jide, and good morning, everyone. As Jide has just taken you through the highlights and strategies, I will cover some of the important financial details of the quarter as well as our outlook for fiscal year '20.

Before I begin, please keep in mind that my comments are based on non-GAAP results. Corresponding GAAP results and the related reconciliation can be found in the earnings release posted on our website today. In addition, as noted in our press release, beginning in fiscal year '20, we're presenting the impact of foreign currency gains and losses within other expense and income. Accordingly, our Q1 results are presented on this basis and our prior year results have been recast for comparability.

Turning to our first quarter financial results. Total sales were in line with our expectations with revenue declining 2% on a reported basis and 1% in constant currency. As Jide mentioned, Coach showed continued momentum with global comps increasing 1%. Kate Spade revenue declined by 6% with comps decreasing 16%, in line with our projection, while Stuart Weitzman sales decreased 9%, reflecting softer wholesale demand.

Gross margin was down 20 basis points in the quarter, primarily due to FX headwinds at Coach. In addition, gross margin results reflected incremental pressure related to tariffs, principally at Kate Spade, given the brand's higher penetration of ready-to-wear and jewelry, which are primarily manufactured in China. At Stuart Weitzman, gross margin expanded significantly, driven by channel mix with the growth in direct sales.

SG&A for the quarter was even with prior year and better than forecast as we tightly controlled costs in the context of a challenging environment. We also benefited from favorable expense timing with some costs originally planned for Q1 now shifting into the second quarter. Favorability in SG&A was partially offset by an FX loss in the quarter, primarily related to the devaluation of the RMB.

Earnings per share of $0.40 was ahead of our guidance of $0.35 to $0.37. During the quarter, as highlighted in our press release, across Tapestry, we added a net of 4 locations, driven by international expansion at Kate Spade and Stuart Weitzman. We ended the quarter with 1,544 directly operated stores globally.

Turning to our balance sheet and cash flows. At the end of the quarter, cash and short-term investments were approximately $788 million while borrowings outstanding were $1.6 billion, consisting primarily of senior notes. As noted in our press release, during the quarter, we recorded impairment charges of $76 million related to store assets, including the lease assets recorded in connection with the adoption of the new lease accounting standard. Inventory ended the quarter at $880 million, up 7% versus last year, consistent with our expectations for sequential improvement during the quarter. We expect inventories to remain elevated in the second quarter but end the fiscal year approximately even with last year.

For the first quarter, net cash from operating activities was an inflow of $6 million versus an outflow of $19 million a year ago. CapEx spending was $72 million versus $55 million a year ago and reflected the shift in spend from the fourth quarter, as mentioned on our August call. We continue to expect CapEx to be approximately $300 million for the year. Free cash flow for the quarter was an outflow of $66 million versus an outflow of $75 million last year.

Now turning to capital allocation. In this fiscal year, we are dedicating our resources to driving organic growth rather than pursuing strategic acquisitions while returning capital to shareholders through dividends and share repurchases. To that end and consistent with our expectations for the fiscal year, we bought back $300 million of common stock in the first quarter. Together with our current annual dividend payout, we are on track to return approximately $700 million to shareholders this fiscal year.

Moving to our 2020 outlook. Consistent with our prior practice, the following guidance is presented on a non-GAAP basis and replaces all previous guidance. Starting with the second quarter, we are projecting revenue to be similar to prior year. This guidance incorporates continued low single-digit comp growth at Coach. At Kate Spade, we expect comps to decline at a high single-digit rate while revenue at Stuart Weitzman is expected to be approximately even with last year. Operating income is expected to decline in the quarter due to a contraction in gross margin as well as mid-single-digit increase in SG&A growth, including the shift in timing of expenses from the first quarter. We expect earnings per share to be $0.95 to $1 in Q2.

Now turning to our full year outlook, where we are reaffirming key elements of our guidance. We continue to expect total revenues for Tapestry to increase at a low single-digit rate from fiscal 2019. This includes the expectation for low single-digit growth at Coach, driven by continued positive low single-digit comps. We expect Kate Spade to deliver low to mid-single-digit sales growth, driven by distribution. At Stuart Weitzman, we now project slight growth, reflecting weaker-than-expected performance in Q1 as well as continued soft wholesale demand.

In addition, we are still projecting a modest decline in gross margin for the year, including the negative impacts associated with bringing the Kate Spade footwear business in-house in the second half of the fiscal year, along with pressures from currency, primarily at Coach. The gross margin projection now also incorporates the impact of known U.S. tariffs on imports from China, including the 30% tariff on handbags and small leather goods enacted on October 1 as well as the 15% tariff for categories such as footwear, ready-to-wear and jewelry.

For context, we have a diversified manufacturing base and our exposure to China is relatively limited for handbags and small leather goods, where we've migrated our production. However, in footwear, ready-to-wear and jewelry, which are smaller but fast-growing categories for Tapestry, we currently have more exposure to China.

We continue to expect SG&A growth to be approximately in line with top line growth, reflecting the important investments we have made in the long-term health of our business, including systems, new stores and regional buybacks. Net interest expense is now expected to be approximately $50 million for the year, reflecting lower interest income related to the recent federal rate cuts. The full year tax rate is still projected to be approximately 17.5%. Overall, we continue to project earnings per diluted share to be roughly even with last year.

Touching on distribution. Across Tapestry, our distribution expansion efforts will focus on international markets. By brand, we expect little change in our Coach directly operated store count with closures in North America, offset by modest net openings in international markets. At Stuart Weitzman, we expect to open a net of 15 to 20 locations globally. And at Kate Spade, we're projecting 30 to 40 net openings in this fiscal year.

In closing, we're focused on sharpening our execution and delivering our financial plan with the important holiday season underway. As Jide discussed, we're working to address both near-term and long-term opportunities with a consumer-centric mindset. We're also looking to be more agile and invest in areas that maximize returns. Overall, our strategic initiatives are intended to drive sustainable growth and productivity across our brands and unlock the inherent value in our multi-brand model. At the same time, we're committed to returning meaningful capital to shareholders, supported by our strong balance sheet and cash flows.

I'd now like to open it up to Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Bob Drbul of Guggenheim.

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Robert Scott Drbul, Guggenheim Securities, LLC, Research Division - Senior MD [2]

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I guess my first question, Jide, I know it's early days, but can you just give us your assessment of the business from where we are and why you are still a proponent of the multi-brand strategy, assuming that you are?

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Jide J. Zeitlin, Tapestry, Inc. - CEO & Chairman of the Board [3]

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Terrific. Thank you for your question. Let me address it perhaps both through a rearview mirror perspective as well as one that's forward-looking. And so as noted, I'm 60 days in. And my perspective, I believe, is balanced somewhere between realism and optimism. If we take a look backwards for just a moment, we did what we told you we would do, right? We delivered an in-line quarter and the start to the year was as expected. We repurchased $300 million in stock. We're on track to return a total of $700 million to our shareholders this fiscal year, inclusive clearly of our dividend. And this represents an increase of 40% year-on-year and underscores our commitment to return capital to our owners. And then lastly, backwards-looking, we've maintained our outlook for fiscal year '20 even in the face of internal and external headwinds, such as Hong Kong.

That said, looking forward, we need to sharpen our focus on execution. And as such, we're asking a lot of hard questions here internally. First principles for us are to focus on driving organic growth. And you heard me say a number of times in my prepared comments and you heard Joanne also reiterate it, we're very focused on being consumer-centric. And what do we mean by that? We really mean that we need to ensure that our core consumer is at the heart of everything we do, from product to marketing to store design. And this is a key element of the work that we've launched here in recent weeks. We need to make sure that we're really in a position to tell relevant brand stories that really connect our consumers with the values of our brands.

The second real area of focus is on -- as you drive growth, how do you really ensure that you've got operating leverage in the business? So how is it that we can become more agile, more efficient? And really do believe that there's an opportunity to better leverage the data and technology to increase our speed to market. We also need to be more efficient frankly and productive across many different areas from market strategies -- in terms of concept to market strategies, in terms of product assortment, in terms of our stores and also the ways that we work. And I think if we're able to do this, it will allow us to ultimately unlock resources and then -- that we can distort in terms of investing more in brand-building, at the same time as returning capital to our shareholders.

More specifically to your -- to the part of your question on our multi-brand strategy. One of the things that clearly we're very focused on is how to unlock even further the benefits of our multi-brand model. And I very much believe that our brands are stronger together as a result of our shared platform. This said, let's acknowledge it. Tapestry is a relatively young multi-brand company. And we're doing a lot of work to better define that balance between corporate and brand functions and do so in a way that's appropriate to our brands and to our culture.

So the diagnostic work has just begun. But it's one that we're moving forward with quite rapidly. And we want to include it relatively soon so that we're in a position to address both near-term and long-term opportunities. We're clear that we face a number of challenges, and we're clear about those challenges. At the same time frankly, we're confident that these challenges are fixable and the solutions are largely within our control. So as we go forward, we're committed to being transparent in our communications, and we will openly acknowledge where we see issues. And at the same time, we're going to move very swiftly to apply the learnings from the work we've done and the learnings from just the deep experience in this organization. So thank you, Bob.

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Robert Scott Drbul, Guggenheim Securities, LLC, Research Division - Senior MD [4]

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Got it. And if I could just ask a second question, I think the guidance is for sequential Kate Spade improvement in comps in the second quarter. I was just wondering if you could just give us a read in terms of your confidence in there. What are the key drivers that you're seeing within that business on the sequential improvement expected?

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Jide J. Zeitlin, Tapestry, Inc. - CEO & Chairman of the Board [5]

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Absolutely, Bob. And hopefully, nothing, if not consistent, on that front in terms of being very focused on our product architecture in terms of broadening that, being very focused on our merchandising, so introducing more color, for example, in outlet, really working to find that right balance between sophistication and playful witty elements in our product and in our marketing and in our store environment that are consistent with the brand. So it's a lot of kind of very fundamental steps in terms of just broadening the reach of the brand and of the product and of the business.

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Operator [6]

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(Operator Instructions) Your next question comes from the line of Irwin Boruchow of Wells Fargo.

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Irwin Bernard Boruchow, Wells Fargo Securities, LLC, Research Division - MD and Senior Specialty Retail Analyst [7]

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So my one question will be regarding the progress at Kate Spade. So I guess just curious, within your guidance for the fiscal year, is there a plan to see a positive comp in any quarter for the remainder of the fiscal year? And then just when we're trying to think about the inflection in the business that is going to loom at some point, Jide, would you expect to see comps inflect a positive before we're able to see Kate's margins stabilize? Or could EBIT margin actually begin to improve ahead of comp growth? Just trying to understand the cost side and the pricing side, just basically what's going on at the brand overall.

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Jide J. Zeitlin, Tapestry, Inc. - CEO & Chairman of the Board [8]

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Ike, you cut out just a moment. Do you mind repeating the second half of your question? I got the first half in terms of -- would you mind repeating the second half?

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Irwin Bernard Boruchow, Wells Fargo Securities, LLC, Research Division - MD and Senior Specialty Retail Analyst [9]

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Yes. I was just basically asking, is it possible that we could see the Kate Spade EBIT margins stabilize ahead of comp growth? Just trying to understand on the cost side and pricing, like how do we think about EBIT margin inflection in relation to comp inflection?

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Jide J. Zeitlin, Tapestry, Inc. - CEO & Chairman of the Board [10]

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Understood. So a couple of things. First of all, we are calling for a sequential improvement as the year unfolds and particularly in the second half of the year. Footwear will be additive to the business as we have brought in that license in the second half of the year. And in terms of calling specifically positive comp or calling margin enhancement, that's not something that I'm prepared to do at this moment.

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Joanne C. Crevoiserat, Tapestry, Inc. - CFO [11]

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Yes, Ike, I can jump in. Our guidance does reflect sequential improvement in the Kate business as we see those merchandising actions really gain traction as we move through the year. Near term, we expect some gross margin challenges related to both tariff pressure, which is more exacerbated at the Kate Spade brand based on the penetration of ready-to-wear and footwear and jewelry, which are manufactured in China. Although we are working on diversifying our sourcing in that brand, there are near-term pressures related to tariffs as well as bringing footwear in-house. Although it will have a top line benefit, it will have a -- versus a license agreement, it will weigh on margins a bit in the back half. And then we expect some heightened promotional activity as we clear through some inventory levels at Kate. So that's the near-term story of gross margin for the brand.

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Operator [12]

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Your next question comes from the line of Erinn Murphy of Piper Jaffray.

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Erinn Elisabeth Murphy, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [13]

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I guess my question today is on the Coach brand and the consistency there. You referenced the North American business was flat. Could you share kind of what you saw between full price and outlet during the quarter? And then what did tourism into the North American market look like this quarter in context relative to the prior view?

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Jide J. Zeitlin, Tapestry, Inc. - CEO & Chairman of the Board [14]

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Thank you. Josh?

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Joshua G. Schulman, Tapestry, Inc. - CEO & Brand President of Coach [15]

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Yes, I'll take that one. As we said, the North America market was flat this quarter. And given the tough trends in both retail and outlet mall traffic, we were pleased with our ability to outperform the mall traffic in both of those relevant sectors. And we did that through a variety of methods. You can see the -- there was an acceleration in our strategy around collaborations. And we saw that when we do those, those tend to drive big inflections in traffic, particularly in the outlet malls.

So we saw that with Disney in July. We had a graffiti artist [capsule] in August. And so we've been getting better at executing those and we see the traffic comp in outlet. Jide also mentioned something on the horizon. Our big Star Wars collaboration, which will be hitting in advance of Black Friday this year. So that's something to look forward to on that front. Your question about tourism, tourism has been tough for all of fiscal '19. And that trend continued into Q1. So the traction that we've seen in North America retail and outlet has been primarily through the domestic customer.

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Operator [16]

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Your next question comes from the line of Alex Walvis of Goldman Sachs.

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Alexandra E. Walvis, Goldman Sachs Group Inc., Research Division - Research Analyst [17]

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A little bit of a follow-up to the previous question. Can you talk a little bit about -- the Coach brand continues to deliver solid results in North America despite challenges seen elsewhere. Can you comment on the backdrop for consumer spending and overall retail traffic? Where are we versus where we are 3 months ago? How are you expecting those trends to progress?

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Joshua G. Schulman, Tapestry, Inc. - CEO & Brand President of Coach [18]

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It's been very consistent. The data that we see about the consumer, is that the consumer is in a good place. However, the traffic has been challenging, consistently through fiscal '19 and into Q1. And whether that's retail malls or the outlet malls, the traffic has been tough. And so that really speaks to the execution of the teams in how they're driving excitement so that we get an outsized share of the traffic that is coming to the malls. And increasingly, the customer is shopping in an omni-channel ecosystem and engaging with us online, where we're seeing very robust growth. And when we talk about the digital growth and international growth outpacing, a lot of that digital growth is happening in North America, obviously.

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Operator [19]

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Your next question comes from the line of Oliver Chen of Cowen & Company.

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Oliver Chen, Cowen and Company, LLC, Research Division - MD & Senior Equity Research Analyst [20]

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Jide, regarding the brand architecture at Kate Spade, what's your hypothesis regarding balance and thinking about product versus femininity versus novelty? And as we seek to understand the opportunity ahead at Kate Spade, would love your thoughts on sequencing the change because there's different things that are happening, whether it be silhouette options and thinking about the speed of execution. Would love your thoughts on how this will unfold and how you're thinking about timing and what should come earlier versus later as you also test read and react in the marketplace.

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Jide J. Zeitlin, Tapestry, Inc. - CEO & Chairman of the Board [21]

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Thank you. So let me just make an overall comment about Kate because the question's come up a number of times. And we talk a lot about, and you've heard us in both Joanne and me talk in our opening comments and Josh in his last response, about kind of brand equities and connecting consumers emotionally with these values. And as you know, that's a process that is part science and part art, but it's also 100% experience. And it's one where when you look at a premium fashion brand, you do not turn it on a dime. And so if you go back 6 or 7 years when we had overextended the Coach brand, the process of rebuilding the health of that critical brand did not happen overnight. And I still personally remember how there was a period of time after we had taken some dramatic steps to reconnect the brand with its core consumer, when we did not immediately see green shoots. So we had to, at that time, have confidence in the relevance of our brand values and in the experience of brand-building.

And in many ways, Oliver, this is where we are met today with Kate Spade, right? Since acquiring the brand, we've changed both the creative and commercial leadership of the brand. We understand what the process is for building brand health and growing the business. And we also -- as part of that, we understand that it's not a straight line, but it's one that we believe we will get right because it's just part of our DNA. And I've got to tell you, we really believe we're not telling ourselves stories, we're not telling you stories. When we look at the core pillars of this brand and we see a lot of white space, a lot of alignment with the values, the desires of a large group of consumers globally. So the brand work we've done and more recently done with the help of some outside consultants since I became CEO has only confirmed and deepened our internal analysis in terms of just the size of the potential market that really has an alignment with the Kate Spade brand pillars.

So as I said earlier, when working with premium fashion brands, positioning yourself for sustained growth does not happen in a straight line. It's a process. It's a process that we know well. And it's a process that we're confident that we will get right. There are a number of near-term tactical steps that we're taking, including adding more novelty to the product line, broadening the assortment in specialty, particularly around satchels, more innovation in outlet. But all of those are steps or durations along the way towards a process that we've been through before and that we're confident that we will ultimately get right.

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Operator [22]

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Your next question comes from the line of Mark Altschwager of Baird.

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Mark R. Altschwager, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [23]

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Wanted to ask a question on Coach. So recently, the Coach comp has been led by international. Just given the pull-forward in Japan that benefited Q1 and some of the intensifying pressure in Hong Kong, does the performance in North America need to accelerate in order for the brand to maintain its positive comps? I guess overall, I'm just trying to better understand your level of confidence in the sustainability of the positive comp at Coach, given some of those intensifying macro pressures internationally?

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Joshua G. Schulman, Tapestry, Inc. - CEO & Brand President of Coach [24]

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We continue to be confident in our ability to drive low single-digit comps for the remainder of the year in each quarter. And we understand that there will be puts and takes, given some of the macro trends. But we are confident in our guidance.

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Operator [25]

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Your next question comes from the line of Paul Trussell of Deutsche Bank.

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Paul Trussell, Deutsche Bank AG, Research Division - Research Analyst [26]

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I wanted to ask about gross margins. Perhaps, first, starting with the just reported quarter, maybe break down for us some of the puts and takes across FX, product sourcing costs, mix and days of promotion in terms of the overall company's and specifically the Coach banner's GPM? And how should we think about those same puts and takes looking forward?

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Joanne C. Crevoiserat, Tapestry, Inc. - CFO [27]

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Yes. This is Joanne, Paul. I'll jump on that. The gross margin, it makes sense, I think, to disaggregate by brand to talk about what happened in Q1. In the Coach brand, the gross margin performance was primarily driven by FX, so the decrease in gross margin. Promo activity was up a little bit but much less than what we saw in Q4. In Kate Spade, the gross margin performance was fairly stable year-over-year and far less promotional than we had been in Q4. We were very focused on carefully balancing promotional activity and brand health in the Kate Spade brand. And that continues to be a focus as we move forward. And with Stuart Weitzman, we saw a significant increase in gross margin, primarily due to channel mix with the increase in direct business [due to] the impact of the distributor buybacks that we've invested in and new store openings that we've seen there. So that was the story for the first quarter.

As we look to gross margin for the year, the modest decline in gross margin, really the mix out of Hong Kong impacting Coach. In Kate Spade -- along with, I should say, along with FX pressures in the Coach brand. In Kate Spade, we continue to see pressures as we rightsize inventory. So there will be some promotional pressures -- some pressures related to tariffs, as I mentioned before, and related to bringing footwear in-house, which again as -- the change from being a licensed business to bringing it in-house weighs a little bit on our gross margins there. So those are the primary contributors to the gross margin outlook for the year.

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Operator [28]

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Your next question comes from the line of Omar Saad of ISI.

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Omar Regis Saad, Evercore ISI Institutional Equities, Research Division - Senior MD and Head of Softlines, Luxury & Department Stores Team [29]

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Jide, as a follow-up to the multi-brand question, maybe you could talk about your assessment of some of the kind of core competencies and capabilities, especially in the digital arena that Tapestry, the operating group, has that it can really bring to bear unique capabilities and technologies it can bring to bear across multiple brands. Where do you think some of those competencies are that we can watch unfold across all 3 brands over the coming years?

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Jide J. Zeitlin, Tapestry, Inc. - CEO & Chairman of the Board [30]

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Thank you, Omar. A couple of comments there. First, in terms of broadly some of the benefits of the multi-brand and then we'll talk to more specifically to digitally. But as you've likely heard us talk about before, first is just the diversified earnings stream reduces the pressure on us to be overly reliant on any one brand. Two, stronger -- we're stronger when dealing with landlords, whether buying, marketing, advertising and as well as creating a more robust platform for top-tier talent to want to be on. And so that is -- those are some of the benefits. As you've heard us talk about in earlier calls, we've also talked extensively about our Data Labs capability that we've built now over time that allows us to both take a very deep database and leverage the insights from that database everywhere from marketing to promotional cadence to really thinking through our brand alignment in terms of product as well as store environment.

Our new Chief Digital Officer, Noam, has really brought a lot of capacity to bear in terms of thinking through an enterprise plan that allows us to drive kind of efficiency across the platform. So we're actually -- one of the key aspects of the work we're doing right now in terms of a diagnostic work is very focused on how to better leverage our digital capability. And that's literally everything from thinking about strategic partners with people such -- with entities such as Tmall and how do we deepen that to thinking about other ways of, in an omni-channel world, meeting our customer where she or he most looks to engage with the product.

And there's some -- I think one of the benefits of this combination that we talked about of experienced management with new leaders coming in is that there have been certain aspects of digital that have perhaps been a little bit more out of -- one that the organization was less willing to engage with that we're very much open to thinking about how -- whether or not it makes sense for us to engage with and to leverage as part of driving the top line growth of this business.

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Joshua G. Schulman, Tapestry, Inc. - CEO & Brand President of Coach [31]

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Just building on what Jide mentioned, I think a great example of this is our work with Tmall. As we've mentioned, we recently launched Coach on Tmall with a soft launch in September. And we've seen terrific results with 90% of the customers being new customers to the brand. And with Noam's partnership, we're going to be able to more quickly leverage those learnings across not just Coach but the other brands. So there's a lot of work here on how we can leverage insights from each other's digital activities for the greater good.

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Operator [32]

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Your next question comes from the line of Michael Binetti of Crédit Suisse.

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Michael Charles Binetti, Crédit Suisse AG, Research Division - Research Analyst [33]

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Let me just ask you on -- Jide, I'd love to know if you'd be willing to share whether the brands are trending today in line with your outlook for the quarter. I know they're low single-digit for Coach and high singles for Kate, and whether that includes the negative snapback in Japan that you guys have seen in the past after some of the change -- the spike and the change in the tax rate. But I guess bigger-picture point though on Coach, on the Coach brand and the leverage point there, I have to say with that brand, it's been remarkably consistent through good times and bad. And where is the leverage point on that brand now? You've done a nice job growing same-store sales for the past few years in that low single-digit rate. But the margins have been up every year. How do you think about the sustainability of that dynamic, given some of the natural inflation in that business?

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Jide J. Zeitlin, Tapestry, Inc. - CEO & Chairman of the Board [34]

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Absolutely. So why don't I start and then, Josh, you may want to jump in. First, it's early days in the quarter. And our guidance that we've given in terms of full year guidance is predicated on our current view in terms of outlook for the quarter and beyond. So I wouldn't say a lot more than that. But one comment I'll make in terms of just Coach and the opportunity there, very much believe and a lot of the initial work that we're doing is that there is actually substantial opportunity over the intermediate to long term to actually -- to drive organic growth there to even more closely align the core brand values with where we believe consumers are today and where consumers are going. So if anything, some of the early days of the work that we're doing would suggest that there is a greater growth opportunity there as opposed to what I think was implicit in your question in terms of the opposite of that.

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Joshua G. Schulman, Tapestry, Inc. - CEO & Brand President of Coach [35]

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So I'll comment actually on both aspects of the question. Just a few things to watch out for in the upcoming holiday season with Coach. I mentioned the Star Wars collaboration in outlet. And we are also super excited about Coach's appearance as the first fashion or luxury brand in the Macy's Thanksgiving Day Parade. And all of us will be watching on Thanksgiving morning as our mascot, Rexy, floats down Broadway. And I think that's an example of the power of Coach. Coach is a powerful brand that has always stood for inclusivity and how we can even more fully own that in a culturally relevant way. We're pleased with Coach in that the base we start with is a well-run machine with a 27% operating margin today.

And as we think about product opportunities for us. Our strategy is really focused on innovation in our core. We've talked out the need to innovate in the good, better and best price buckets. This quarter, we specifically called out our handbag AUR in the outlet channel. We know a lot of you have been on the journey with us here, particularly in North America. And we're so pleased with the progress that our teams are making on introducing new, differentiated product but also leveraging some of the insights from our Data Labs in terms of finessing their promotional strategies to drive better AUR. So innovation in core is key because leather goods are today and will always be the core of Coach.

Secondly, collaboration and co-creation, whether that is a big traffic-driving collaboration that we've done. We've mentioned Star Wars, which is coming up in the future. We've mentioned Disney, which drives a lot of traffic and sales. Or Jide mentioned in his prepared remarks, a collaboration with Michael B. Jordan and Naruto, much smaller in scale, actually driving scarcity and brand heat. Both of those are super important. And then the third category of our focus here in products are acceleration categories. And we've said that there are opportunities for us in footwear, in men's and, to a lesser extent, in ready-to-wear, all of which are important focuses for us. And you'll be hearing more about our important footwear launch of the [City Sole] family, which we'll launch in spring. City Sole is a new -- a sneaker and a hybrid category, to be clear.

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Operator [36]

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Your next question comes from the line of Rick Patel of Needham.

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Rakesh Babarbhai Patel, Needham & Company, LLC, Research Division - Senior Analyst [37]

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My question is on Kate Spade. So given what you're seeing with traffic, can you provide some additional color on the outlook for marketing? I'm curious if you'll invest more in performance-based marketing or higher up the funnel, what you can do differently there. And as we think about financials, any context on how much marketing investment may change relative to last year?

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Jide J. Zeitlin, Tapestry, Inc. - CEO & Chairman of the Board [38]

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Yes. I'll say this. We don't anticipate any significant shifts in our marketing spend as we go forward. And although we are -- one of the conversations that we have had a lot of discussion on internally is the mix of performance versus brand-building. And if you take a look at last year second quarter, we didn't spend effectively anything on marketing. This year, we will spend on marketing.

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Operator [39]

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Your next question comes from the line of Brian Nagel of Oppenheimer.

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Brian William Nagel, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [40]

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So my one question, bigger picture, today and for the last few quarters, we've been discussing the kind of the weakness. And you've done a really nice job of outlining the initiatives you're taking -- you're undertaking to drive better results at Kate and even Coach. But the question I have is if we step back, how much of the weakness in the bags, and again this is mostly Kate but even to a certain extent, Coach, do you think is a function of internal missteps versus some shifts in the competitive landscape? And then the other question on top of that is, is there still -- within the context of your multi-brand strategy, is there still enough differentiation between Coach and Kate that they're not cannibalizing one another?

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Jide J. Zeitlin, Tapestry, Inc. - CEO & Chairman of the Board [41]

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Thank you. And in many ways, both questions are, I think, asking the same question in 2 different ways. But the work that we are doing is really intended to make sure -- first, part of it is to really make sure we get underneath the brand equities and that we have real clarity as to the distinct consumer basis for each of the brands. And the work we've done so far, built on top of internal work that's been done, does underscore that they are distinct consumer bases. And as such, we think as we execute against those consumer bases that you will see even probably greater distinction between the positioning of the products and the brands between each of the brands.

That said, inherent in that is a view that the Kate Spade brand -- and sorry to repeat myself, but the Kate Spade brand does speak very clearly to a substantial core consumer, somebody who is looking for fashion, who's looking for fun, who's looking for a feminine product. And we think that there's a reasonable amount of white space around that positioning that creates real opportunity for that brand. So we're optimistic but also mindful of the real work ahead of us to more fully achieve that potential.

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Operator [42]

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We have time for one more question. Your final question will come from the line of Paul Lejuez of Citi.

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Paul Lawrence Lejuez, Citigroup Inc, Research Division - MD and Senior Analyst [43]

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You guys have talked about some industry headwinds facing the business. I'm curious what you consider to be the greatest pressure points in that North America business. And maybe talk about it by brand, if any of those headwinds are actually showing some signs of improvement. Or are they working against you even further?

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Jide J. Zeitlin, Tapestry, Inc. - CEO & Chairman of the Board [44]

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Right. So why don't we -- I mean the big headwind that we've talked about is traffic here domestically and largely driven by a falloff in tourism. But why don't we perhaps start with Coach and then we can talk as appropriate about the other brands?

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Joshua G. Schulman, Tapestry, Inc. - CEO & Brand President of Coach [45]

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Yes, I think we touched on it earlier. We are -- overall, we're geographically agnostic in terms of where we're recognizing the revenue. So traffic -- tourist traffic trends ebb and flow over time. But clearly, they have impacted North America now for an ongoing period. And that really just forces us to be sharper on our focus for the domestic customer and how do we get better at serving the domestic customer. I think, historically, we may have had stores that were more tourist-centric. And those ones are being challenged the most.

But even in those locations, how do we focus most on the domestic customer? And what we find is that her shopping habits are changing. So when it's a domestic customer, she is more often to start her shopping journey online and want to continue that in the store channel. So how do we become more symbiotic between those channels in catering to the evolving needs of the domestic customer really is one of our biggest focuses.

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Jide J. Zeitlin, Tapestry, Inc. - CEO & Chairman of the Board [46]

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And just very briefly in terms of Kate Spade, the traffic trends are consistent there. So nothing really different to say there. And on Stuart Weitzman, the challenge is the historical one coming out of our supply chain challenges, which had an impact on our order book with -- at wholesale, which we're very, very much focused on addressing. So thank you for the question.

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Andrea Shaw Resnick, Tapestry, Inc. - Global Head of IR & Corporate Communications [47]

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That will conclude our Q&A. Jide, I'll turn it over to you for some brief closing comments.

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Jide J. Zeitlin, Tapestry, Inc. - CEO & Chairman of the Board [48]

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Terrific. Thank you, Andrea. I want to just take a moment to thank our shareholders. We are mindful that it is your capital that enables us to come to work every day, seeking to connect consumers emotionally with our powerful brands. We take our responsibility as stewards of your capital very seriously. To my fellow employees, thank you for everything you do for our customers, and thank you for your contributions to the culture of this house of remarkable brands. I'm grateful for the opportunity to work with each of you. Thank you.

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Operator [49]

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Thank you for participating in this Tapestry conference call. You may now disconnect your lines, and have a wonderful day.