Earnings Call Transcript - TPR Q3 2020

Operator, 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 of Investor Relations & Corporate Communications

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 performance and results. 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 a recap of our fiscal third quarter results for Tapestry, as well as the current update on our global business in light of the COVID-19 pandemic. Joanne will continue with high-level financial and operational results for the quarter in addition to the mitigating actions we are taking and our priorities going forward. 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, who is serving in an Interim Role as Chief Commercial Officer of the Coach brand while the search for permanent CEO is underway. 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.

Jide Zeitlin, Chairman and Chief Executive Officer

Good morning. Thank you, Andrea, and everyone for joining our call. I hope this is the first and last earnings call I’ll be taking from my home office in Brooklyn. We are all experiencing a 100-year storm due to COVID-19, and no one is unaffected by its daily realities. We extend our thanks to the brave individuals on the front lines fighting this pandemic, and our hearts go out to those impacted by it. This crisis has significantly changed how we live and manage our business. This morning, we reported our fiscal third-quarter results, marking our first adjusted quarterly earnings loss in nearly 20 years as a public company. We entered the year with strong momentum, especially with the Coach brand, but as the coronavirus spread, our results weakened significantly. Initially, we hoped the pandemic would affect only certain regions, particularly as Mainland China and South Korea began to recover. However, by mid-March, results declined in North America, Europe, and across Asia Pacific. We’ve never faced a situation where 90% of our stores were closed or had limited hours. It's evident that this crisis will have long-lasting effects. We’re taking steps to mitigate the impact on our business, which relies on sales growth to cover brick-and-mortar costs. Looking ahead, we’re concentrating on four main areas: protecting the health and well-being of our employees, consumers, and communities; driving digital revenue along with revenue in China and South Korea as we prepare for store reopenings; accelerating elements of our multi-year growth plan; and preserving liquidity, which Joanne will address shortly. Guided by our values, we have prioritized our community, employees, their families, and our customers. Nearly three months ago, we quickly closed stores in Mainland China and reopened them wherever safe. We maintained pay and benefits for our retail staff while moving corporate employees to remote work. Though our distribution centers remained operational, we implemented enhanced health and safety measures and supported local communities through donations and initiatives. I am incredibly proud of our teams worldwide and grateful for their dedication. Second, we’ve taken steps to drive revenue and reopen stores. We’re optimistic that we will weather this storm and emerge stronger. During our last call, I mentioned that most of our Mainland China stores were closed. By mid-March, 95% were open, although foot traffic was below last year’s levels. Recently, we have fully opened all remaining stores and have seen an increase in sales, particularly in retail. We’ve noticed significant differences within the country, partly due to domestic travel restrictions. Unlike some European counterparts, most of our sales to Chinese consumers have always occurred in China. While sales are improving, we haven’t seen significant domestic growth from the return of tourist spending. In South Korea, revenues are also recovering, and all our stores there are operating normally. We’ve learned valuable lessons from China that guide our global actions as we begin reopening in Europe, North America, and elsewhere. Store reopenings are based on local government regulations and are decided carefully on a case-by-case basis. Our reopening strategy prioritizes the health and safety of customers and employees, including thorough cleaning protocols, social distancing signage, enforced customer limits, and the use of masks and sanitizers. Tomorrow, we plan to reopen around 40 stores in North America, offering only contactless curbside or pickup services. Customers will be able to place orders over the phone or online, depending on the store layout. We also reopened five locations in Germany and Austria, and a dozen in Australia. Shifting to digital, e-commerce has been a bright spot this quarter, and we have focused on enhancing our online presence. With most of our physical stores closed, it’s crucial to respond digitally. Prior to COVID-19, about 10% of Tapestry’s sales came from online. Embracing digital during this trend is a significant opportunity for our customer-focused growth strategy. Our distribution centers are operating well, essential for meeting rising e-commerce demand, with minimal disruptions from China. We manufacture a limited range of products in China and have a diverse manufacturing network. After quarter-end, we faced more disruptions in Asia and Europe, but we worked closely with our suppliers to adapt to changing supply and demand levels. Most of our partners in Europe have reopened, including tanneries in Italy and footwear producers in Spain. Our logistics operations are functioning smoothly. Importantly, we are acting quickly to accelerate work that was already planned before COVID-19, focusing on driving growth in digital and creating a more efficient organization. While we are uncertain about how long this pandemic will last, it's evident that the world will change. Consumer behaviors are evolving, and trends toward digital shopping are accelerating. We are improving our understanding of digital consumer experiences to better meet their needs. Recognizing the shift from physical to digital shopping is vital. Physical stores will remain essential, but we expect their share compared to digital shopping to balance out. Growth in digital reflects consumer preferences, which we must embrace. This includes extending our partnership with Tmall in China and examining our distribution network as stores reopen and traffic levels stabilize, which may be lower post-COVID-19. Successful future business models will require significant investments in technology. We are also rethinking our operating model and culture, emphasizing data-driven decision-making and listening to consumers. Before handing it over to Joanne, I'll briefly outline strategies for each of our brands. For Coach, our focus is on three areas: enhancing digital engagement, promoting growth in China, and achieving operational excellence by refining our cost structure. Digital is not merely a shopping platform; it’s about engaging with consumers and connecting with their values. China is our biggest growth opportunity, with resilient demand for fashion among Chinese consumers. Our brand’s momentum will help us take advantage of the growing middle class. Chinese customers are increasingly engaged online with Coach through social media. We have conducted numerous successful live-stream sessions to boost business. We are also pursuing operational efficiencies in both the short and long term. We are reviewing our global store network and holding individual locations to higher productivity standards, significantly reducing our SKU assortment to improve supply chain efficiency and inventory turnover, and cutting our corporate payroll while maintaining high customer service standards. At Kate Spade, the team is reengaging with the brand’s core culture and values, focusing on brand strategy and customer experience. The significance of color and novelty is central, while teamwork balances playfulness with pragmatism. The team emphasizes community and consumer understanding. This has led to increased effectiveness in digital marketing and social media engagement, as stores remained closed. Some retail customers have connected personally, leading to successful Zoom shopping parties. Regarding Stuart Weitzman, while we are disappointed with recent performance, we are optimistic about the brand’s long-term potential and our commitment to achieving sustainable growth. The team is implementing initiatives focused on a curated assortment that reflects the brand's fashion sensibilities, strategic growth in China, and enhancing digital capabilities, including buy online and pick-up in-store functions and improved segmentation for personalization. In summary, no one is exempt from the effects of this unprecedented storm. We are taking decisive actions to ensure Tapestry emerges as a robust company once conditions normalize. We have a solid balance sheet, a multichannel international distribution model, modest exposure to wholesale, and a diversified supply chain. Most importantly, we possess strong brands with deep consumer connections and a history of successfully navigating global challenges. Now, let's turn it over to Joanne for a brief financial review of the quarter and our actions taken to address the COVID-19 crisis.

Joanne Crevoiserat, Chief Financial Officer

Thanks Jide and good morning everyone. I hope this finds you all safe and well. 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. Turning to our third quarter financial results, which reflect a significant negative impact of the coronavirus. Total sales declined 19% on both a reported and constant currency basis for the quarter. We entered the quarter with strong momentum; however, as we moved into February, trends in greater China deteriorated sharply due to the coronavirus outbreak, declining over 80% versus the prior year for the month, while top-line trends elsewhere remained positive. To this end, on a quarter-to-date basis through February, total sales increased double digits in Europe, mid-single digits in North America, and low single digits in Japan. In March, although revenue trends began to gradually and steadily improve in certain areas first impacted, notably in China, we experienced widespread global disruption. Accordingly, Tapestry's global sales fell over 40% in March from the prior reflecting the added pressure from store closures in North America and Europe, which began mid-month. Importantly, throughout the quarter, we experienced strong double-digit growth in our global e-commerce business. However, this was not enough to offset the loss of business due to our store closures. Gross margin decreased 210 basis points, compared to the prior year in the third quarter, primarily due to the lower penetration of higher margin international businesses. SG&A declined 3% year-over-year driven by variable savings on a lower revenue base, as well as the realization of fixed cost savings in light of the current environment. I will touch on some of these actions momentarily. The operating loss for the quarter totaled $32 million and earnings per diluted share was a loss of $0.27. The EPS result included a negative impact of approximately $0.10 from an unfavorable tax rate as compared to our original projections. Due to the lack of visibility and potential variability in results through the end of our fiscal year, the Q3 tax rate was determined based on year-to-date actual results only, which included geographic mix headwinds in the quarter. This is in contrast to our historical method of calculation based on full annual forecasted results. On the balance sheet, we ended the quarter on a strong liquidity position with just under $900 million in cash and cash equivalents and $900 million available on our revolver. Total borrowings outstanding at the end of the quarter were $1.6 billion. Total inventory ended the quarter up 5%, reflecting actions taken in the quarter and the recognition of incremental obsolescence reserves in light of the current environment. As you saw today in our press release, we took a number of charges in the quarter in part related to the COVID-19 crisis. First, we recorded $478 million in brand intangible and goodwill impairment charges associated with Stuart Weitzman. These charges were a result of the decline in both current and future expected cash flows, which was exacerbated by the COVID-19 pandemic. Clearly, we’ve been disappointed with the brand's performance and recognize the need to get back to its core proposition as Jide mentioned. We have done a substantial amount of work to understand the consumer and believe there is a significant opportunity given its unique fusion of fashion and fit. We’re also committed to improving profitability at Stuart Weitzman, which will be an element of Tapestry’s multi-year growth agenda. In addition, as mentioned we recorded $104 million in charges related to an increase in inventory reserves, and we incurred $66 million in store impairment charges due to COVID-19. Now, moving to mitigating actions that we have and will be taking to effectively navigate the COVID-19 pandemic and reinforce our financial flexibility while positioning the company for long-term growth. We’ve identified or implemented over $1.3 billion in cash preservation actions. First, we are tightly managing inventories by reflowing late spring and early summer product introductions. These are goods that were in production at the start of the coronavirus outbreak. We are also cancelling deliveries scheduled for late summer and early fall 2020. Taken together, these actions are expected to result in over $500 million of working capital savings beginning in Q4 and continuing through the first half of fiscal year 2021. We are also targeting a CapEx reduction of at least $100 million in fiscal 2021, as compared to our run rate spend of approximately $275 million as we delay or cancel new store openings while prioritizing investment in high-return projects, notably in digital. In addition, we have cancelled or deferred projects previously scheduled for our fiscal fourth quarter and now expect CapEx of approximately $225 million for fiscal year 2020, $75 million lower than our original plan for the year. Subsequent to quarter-end, we drew down $700 million of our $900 million revolving credit facility to enhance our cash balances, bringing our total borrowings outstanding to $2.3 billion. In addition to these measures, we are also aggressively controlling our SG&A expense. We are rightsizing marketing expenses, reducing fixed costs such as rent and driving procurement savings, including reducing external third-party services. We’ve also announced steps to minimize corporate costs, including temporary compensation reductions for our board, management team, and employees. And while we are pleased that we were in a position to extend salary and benefits to the vast majority of our North America retail team through May 30, despite store closures, we will furlough most assistants from managers and sales associates should stores not reopen at that time. Beyond these near-term defensive actions, we’ve also accelerated part of our multi-year growth agenda to create a more streamlined organization as Jide previously mentioned. We began these actions in Q4 and expect to complete them by the end of fiscal year 2021. We believe these steps will allow Tapestry to emerge as a global consumer-centric company with a more agile organizational structure that will be more responsive to the rapidly changing retail environment. And finally, we made the decision to suspend our quarterly cash dividend and share repurchase programs saving approximately $700 million on an annualized basis compared to fiscal 2020. In the near term, our priority is to preserve our cash on hand in light of the environment. Longer term, our strategic intent is to return to sustainable top and bottom-line growth and strong free cash flow generation, which we intend to utilize for debt pay down, as well as capital return to shareholders through dividends and share repurchases. In closing, as noted in our release, while we are not providing guidance at this time due to the lack of visibility, we do still intend to hold an Analyst and Investor Day this summer to discuss our long-term strategies. We believe in the benefits of Tapestry's multi-brand model and the power of each of our brands. This is particularly true during challenging times when the advantages of scale, as well as shared best practices and systems come to bear. Our objective is to successfully navigate this crisis through the identification and execution of mitigating actions and ensure we emerge a stronger, more agile company. This will require us to make both bold and difficult decisions. It has also created the opportunity and the need to accelerate key elements of our multi-year growth agenda. Importantly, our view of the long-term opportunities for our brands is unchanged and our strategic intent to drive organic growth and profitability is unwavering. And now, I’d like to open it up to Q&A.

Operator, Operator

Thank you. Your first question comes from Bob Drbul of Guggenheim Securities.

Bob Drbul, Analyst

Hi, good morning.

Jide Zeitlin, Chairman and Chief Executive Officer

Good morning, Bob.

Bob Drbul, Analyst

I guess, two questions. I think the first one is just more category. Do you think the market for handbags and accessories, you know will be disproportionately impacted in the economic downturn, do you think consumers are going to be shopping for handbags? Can you talk about that maybe generally, and then I think the second part of it would be, can you just talk about your confidence level in maybe Kate Spade and Stuart Weitzman, can these brands weather this storm that we’re in right now? Thanks very much.

Jide Zeitlin, Chairman and Chief Executive Officer

Absolutely. Thank you, Bob, and I hope you are well also. With respect to the category, we’re confident in terms of our ability to both weather the storm, but as importantly to come out the other end strong. If you look at kind of previous downturns, whether those are macroeconomic or whether those are natural disasters around the world and our experience coming out of those periods, we’ve seen continued strong demand for our product and have no reason to believe that this will be any different, particularly when we look at the real-world experience we are getting in parallel today. We clearly have seen what is happening to our business in China and in South Korea, and we – on an everyday basis globally are seeing the demand for our product digitally. And so, there’s nothing we’ve seen that would suggest to us that we’re not going to come out of this period with genuine, authentic real demand for our products. With respect to your question on Kate Spade and Stuart Weitzman, I guess the way I think about it is that it is actually one in times such as this that the power of a well-capitalized portfolio company is most evident. Smaller brands in our world, like Kate Spade and Stuart Weitzman, benefit from having greater leverage with landlords and supply chain partners and from having a stronger balance sheet. At the same time, larger brands, in our case, Coach, benefit from the innovation that we see at Kate and at Stuart that migrates across the brands, and there are a couple of great examples of that which perhaps we'll get into later in the call. But, fundamentally to come back to each of Kate Spade and Stuart Weitzman, they have unique brand propositions that have deep emotional connections to their customers, and one of the benefits of a lot of the work that we've done over the last eight or so months is that our brand work has shown significant opportunities for both these brands, particularly at Kate Spade, where if there's ever a moment in terms of consumer behavior is evolving and where we believe it's going to evolve coming through this COVID-19 period, the Kate Spade core culture and unique spirit is tailor-made for that. And then particularly as we continue to reposition the important role of color and novelty in that brand, we think that there is real upside there. So we believe it's deeply in Kate Spade and Kate Spade coming through in this period as ever. And Stuart Weitzman, differently but similarly, is clearly a unique brand. It's got that balance, as we've talked about between fashion sensibility and remarkable fit. We're taking, as I mentioned or alluded to in my opening comments, very disciplined steps to narrow its assortment to focus much more clearly on boots, espadrilles, and sandals and to focus geographically very much on China, North America, and digitally from a channel perspective. Stuart Weitzman is going to be a survivor, particularly in a category that's quite fragmented where others who are smaller and who don't have the benefit of being on a broader platform are not going to survive. So, we think that there’s going to be a real market share opportunity for Stuart Weitzman. And then, I guess, lastly, I’d just say that I couldn't be more pleased, and our executive committee couldn't be more pleased with Liz and Giorgio, who have hit the ground running and are having a huge impact in each of their businesses. It's, as odd as it may sound to say, this moment has really proven catalytic for them and for their leadership and parenthetically, as well as for the broader leadership team across Tapestry. So, long way to say that, you know, we don’t want to go through a period such as this, but having gone through it, as we all continue to go through it, we feel very confident about both Kate Spade and Stuart Weitzman. So, thank you again, Bob.

Bob Drbul, Analyst

Thank you. Good luck.

Operator, Operator

Thank you. Your next question comes from the line of Ike Boruchow of Wells Fargo.

Ike Boruchow, Analyst

Hi.

Jide Zeitlin, Chairman and Chief Executive Officer

Hello, Ike. How are you?

Ike Boruchow, Analyst

Hi, Jide. I hope everyone is doing well. I actually have two quick questions. First, Joanne mentioned that global sales were down 40% in March. I know visibility is very low right now, but could you provide some insight into how global sales have trended in April? Secondly, regarding expenses, I understand that the pandemic had an abrupt impact late in the quarter, making it challenging to adjust the cost structure for the third quarter. However, could you share some expectations for operating expenses in the fourth quarter? This would really help us understand the implications of the cost initiatives you're discussing on the P&L as we consider flow-through rates. Thank you.

Joanne Crevoiserat, Chief Financial Officer

Yes, thanks for your question. As we progressed through March, we observed more widespread store closures due to the global pandemic, which affected our results for the month. With limited visibility regarding store reopenings, traffic trends, and consumer behavior moving forward, it's genuinely challenging to provide guidance or present a precise forecast. However, we've noted that with stores reopening in China, there has been consistent progress in traffic trends and consumer demand returning to the market. Although we are not providing guidance for Q4, I can share some data points that might help you understand how Q4 could unfold. In Q3, our sales declined by approximately $260 million compared to last year, with only 2.5 weeks of store closures in North America and Europe during that quarter. Based on that data point, and considering the extensive global closures and anticipated slower recovery, we project that the impact in Q4 could be three to four times greater. Regarding gross margin, as seen in Q3, it was lower due to mix, particularly because of the reduced share of our high-margin international businesses, especially in China. Moving into Q4, a lower share of North American sales might positively influence gross margin. Concerning SG&A, while we've implemented significant measures to cut spending, the impact was not fully realized in Q3 due to timing. We expect those efforts to have a greater effect in Q4, although they won't be enough to completely mitigate the declines in sales, leading to substantial deleverage due to lower sales in Q4. Overall, we are planning cautiously and taking decisive actions to navigate these challenges and emerge stronger in the end.

Ike Boruchow, Analyst

Thanks Joanne. It’s very helpful.

Operator, Operator

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

Erinn Murphy, Analyst

Great, thanks. Good morning, and I hope you all are well. My question is about inventory. Could you discuss where you anticipate inventory might peak over the next four quarters? Additionally, regarding your planned promotional activity, can you share some strategies for liquidating products, especially through outlets? I'm curious if you're reconsidering how to approach made-for products versus using them primarily to liquidate full-price items. Thank you.

Joanne Crevoiserat, Chief Financial Officer

Yes, we have taken significant actions regarding inventory as we navigated through the crisis. We are adjusting supply to match the evolving demand trends. We made strong moves to reorder production from late spring and early summer while canceling deliveries scheduled for late summer and early fall. This strategy allows us to manage our inventory in a less seasonal manner and offers us great flexibility to adapt our product flow as demand evolves over the coming quarters. By adjusting our product flow and canceling orders on the backend, we’ve saved over $500 million in working capital. Our products can be shipped globally, which enables us to shift inventory to areas experiencing increased demand, specifically in China and digital platforms. We are confident in our inventory management, and our teams are swiftly working to match supply with demand throughout our network. Currently, we do not anticipate major changes in product availability across channels. With our adjustments, we expect to introduce new products gradually over the next few quarters. As of the end of Q3, our inventory increased by 5%. We project that as we conclude Q4, our inventories will remain within the mid-single-digit growth range due to the actions we've implemented. Looking forward into fiscal year 2021, we are committed to effective inventory management and expect to finish that year with a decrease in inventory compared to the previous year. This is a key priority for our organization, and our teams are intensely focused on monitoring and addressing shifts in demand trends.

Erinn Murphy, Analyst

That's helpful. And then anything on the thoughts around outlet, are you changing kind of how you're thinking about the near term there in terms of liquidation strategies?

Joanne Crevoiserat, Chief Financial Officer

No. You know I would say, you know, we're leaning into the areas where we see demand, but don't expect a significant need to liquidate full-price product through outlet to a much larger degree than we have in the past. One thing we are monitoring is the promotional activity and the outlook across the industry. We have seen an intensification in the promo environment in North America and Europe, particularly as retailers are moving through excess inventory, but again, we remain focused on the controllables and the aggressive actions that we've taken to manage our inventory put us in a better position in the months ahead, so we expect that we'll be able to continue to drive – meet demand with the right supply by channel between outlet and retail, and also to manage through the promotional environment with a healthy inventory position.

Erinn Murphy, Analyst

Very helpful. Thank you all.

Jide Zeitlin, Chairman and Chief Executive Officer

Thank you.

Operator, Operator

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

Alexandra Walvis, Analyst

Good morning. Thanks so much for taking the question here. Firstly, a quick follow-up to Erinn’s question, you know, how are you guys thinking about balancing the need for cash preservation as a result of these order cancellations with also the considerations around relationships with your manufacturers, and you know, making sure that those are preserved for the long term? And then, I had a second question on rent, you mentioned that you were looking at rent reductions. I wonder if you could comment more broadly on how you're thinking about how the fleet might emerge from this versus where it was before. Thank you.

Jide Zeitlin, Chairman and Chief Executive Officer

Absolutely. So perhaps, Todd, you may want to start on the rent and on the fleet, and then I'll pick up on that piece.

Todd Kahn, President and Chief Administrative Officer

Thank you and good morning. As we evaluate our fleet, we are increasingly aware of the omni-channel behavior of our consumers. They shop online, in our stores, and across both platforms. In the coming year and throughout our strategic planning period, we intend to hold ourselves to a significantly higher standard of profitability for the fleet. This means that our criteria for renewing leases or building new stores will be stringent. If a location does not meet our standards, we will choose to exit. Recently, we've observed that when a store closes in a local area, around 20% of its sales volume shifts to a nearby store, which is a positive trend. Regarding our rent discussions, we are currently engaged in productive conversations with our major landlords in the U.S. We have successfully navigated similar situations in Asia during the pandemic, resulting in favorable rent accommodations, and we expect to secure some rent reductions in North America during this timeframe. Great. And Alex, with respect to the SPs, you know, I would – I know you know, we began as a manufacturer, right, with a factory on 34th Street, and I think that gives us a real sensibility in terms of understanding the SPs on top of what is a really strong supply chain team that we have that engages with them every day. And so, you know, we have tried to be very thoughtful in our engagement with them as we cut them for deliveries in finding that right balance between clearly protecting our balance sheet, managing our inventory and cash levels and making sure that we did it in a way that our SPs can manage. And so, you know, Joanne has talked about the financing facility that we put into place for the benefit of our SPs. And so, we tried to take steps such as that and others to make sure that they're able to weather this storm so that we have a robust ecosystem of suppliers coming out the other end, but at the same time, recognizing clearly, we’ve got to be strong to be in a position to benefit from that on the other end.

Operator, Operator

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

Mark Altschwager, Analyst

Good morning. Thank you. A question on the stores, just with respect to reopening plans, can you talk about any notable differences between retail and outlet? And as curbside pickup becomes a bigger picture in retail models, I’m wondering that changes the way you think about digital within the outlet business? And then broadly on the stores, with respect to the changes in the retail workforce, beyond the near-term furloughs and actions related to COVID, how do you envision the store operating model changing? Thanks.

Jide Zeitlin, Chairman and Chief Executive Officer

Thanks. That's quite a mouthful. Do you want to – why don't you opt in and then I'll add.

Todd Kahn, President and Chief Administrative Officer

Thank you. In terms of the curbside concept, we are actually testing starting tomorrow in about 40 locations in North America, both across full price and outlet stores and looking at how the consumer responds to that. We're optimistic, but again, it still won't fully replicate the experience that particularly the Coach, Kate Spade, and all of our brands give in terms of the service level. So, it will be hard to fully mitigate the sales through a curbside experience. In terms of outlet, we are putting in and we have significant and well-detailed protocols in opening all of our stores. We’ll obviously be following the regional state government guidelines on safety, but in addition to that, we’re going to be doing things in North America like temperature checks for all our employees when they start their workday. There will be significant protocols on cleaning. There’ll be enforcement of social distancing. So, there will be for some period of time, a new normal in that, and our workforce is typically, particularly in our larger stores, flexible. So, it will respond to the needs of the customer and if the volume isn't there, we’ll obviously pivot to a smaller workforce in those stores.

Jide Zeitlin, Chairman and Chief Executive Officer

And the one thing I would add just on the broader theme of reopening is, you know, clearly as we reopen, location-by-location, we do so into a world where the shift from brick-and-mortar to digital shopping is clearly accelerating. It’s been, you know, accelerated. It's a secular trend, but, you know, COVID-19 has clearly accelerated that trend. And as such, the line between physical and digital worlds is increasingly and will increasingly be blurred. That's that stores will always play a vital role for us and our consumers' experience with our brand. And so, even though we think that the world will move to a place where there's greater parity between brick-and-mortar and digital, and you know, this is not a short-term phenomenon, we continue clearly to be very, very invested in our brick-and-mortar stores.

Mark Altschwager, Analyst

Thank you.

Jide Zeitlin, Chairman and Chief Executive Officer

Thank you.

Operator, Operator

The next question comes from the line of Jamie Merriman of Bernstein.

Jamie Merriman, Analyst

Thanks very much. Just a quick one on China, Joanne, I think you mentioned that China was down about 80% in February and then it’s picked up since then. I was wondering if you could give us a sense of what you've seen from traffic levels maybe in March just so that we can understand what that progression has looked like as things have started to reopen? And then, just on the supply chain disruptions, it sounds like those were maybe primarily in Europe, but I was wondering if you could give a little bit more detail? And then, you know, was that disruption isolated in a particular brand like Stuart Weitzman? Or was it more widespread? Thanks.

Joanne Crevoiserat, Chief Financial Officer

Yes, I’ll – on the China business, it's – you know we've been pleased that all of our stores on Mainland China are now open. And to your point, we have seen very nice and very steady improvement in the business through March and also through April. So, the business is responding. In fact, in some locations, we have seen positive comps, you know, more in locations that are not impacted by domestic tourists' business where those have been lagging a little bit more based on just travel restrictions within the country, but overall, I’m pleased with the progress we are seeing in China and the steady improvement. Your question, I apologize, I lost the second part of your question.

Jamie Merriman, Analyst

It was about supply chain disruptions that you talked about, were they specific to a particular brand? Or...

Joanne Crevoiserat, Chief Financial Officer

So – yes, thank you. The supply chain disruptions that we saw were very minimal and not material, particularly in China as we've migrated most of our finished goods production away from China for many years. So, as disruptions were progressing through the country, we were much less impacted. So from a supply chain standpoint, you know, our business was less effective. As the pandemic spread through Europe and other parts of the globe, we were impacted with raw material suppliers in Italy and some finished goods production in Spain, particularly with Stuart Weitzman. However, those facilities are back online. So again, overall, from a supply chain perspective, our diversified sourcing base has worked well for us and we have been much less impacted from a supply standpoint.

Operator, Operator

Your next question comes from the line of Lorraine Hutchinson of Bank of America.

Lorraine Hutchinson, Analyst

Thank you. Good morning. Just wanted to follow-up on some of the questions around the outlet business, is there a plan to develop more of a presence online to address the post-COVID shift toward e-commerce?

Jide Zeitlin, Chairman and Chief Executive Officer

Short answer is yes. Todd, do you want to add a little more?

Todd Kahn, President and Chief Administrative Officer

Yes, that is definitely the short answer. The more fulsome answer is that we recognize that just like our retail customer, the outlet customer is an omni-channel customer and I'll speak specifically to coachoutlet.com. It is a robust channel that we are using, we're learning and that customer, particularly a millennial younger customer is going to embrace and is shopping.

Lorraine Hutchinson, Analyst

Thank you.

Todd Kahn, President and Chief Administrative Officer

You're welcome.

Operator, Operator

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

Oliver Chen, Analyst

Hi, good morning.

Todd Kahn, President and Chief Administrative Officer

Hello, Oliver. How are you?

Oliver Chen, Analyst

Very good. Thank you, thank you. The China momentum has been encouraging, but that market has had a coordinated shut down as well as reopening. What are your thoughts on the key lessons there in terms of what may be applicable to the U.S. and some of the difficulty in the U.S. as different areas are opening at different times? I would love your thoughts on what that may mean and what you're considering, as well as some things you mentioned on the call including live streaming and using Zoom, how you see retail evolving with new opportunities to pursue at-home engagement? And then, Joanne, on the debt covenant, was just curious about how we should think about that four times covenant as we approach next quarter and what's on your mind for managing that? Thank you.

Todd Kahn, President and Chief Administrative Officer

Thank you, Oliver. I’ll start and then Joanne can continue. Regarding China, I often reflect on the advantages of being a global direct-to-consumer company. Each day feels like Groundhog Day for us, as we observe developments in China, learn from them, and consider their implications for our global operations. While some aspects of China are unique to its context, we pay close attention and strive to understand these nuances. However, we believe there are many relevant insights from the Chinese experience that apply to other regions of our business. For instance, South Korea, with its different policy framework, has experienced a curve that is surprisingly similar to China's. This gives us confidence as we contemplate reopening in the West. When we analyze our digital business in the West and examine consumer behaviors, it suggests there is genuine demand during this time, which isn’t confined to a single region or political system. Additionally, regarding WeChat, live streaming, and at-home engagement, this ties back to my earlier point about the merging of physical and digital experiences. We see significant opportunities in creating a true omni-channel environment. I was particularly impressed by what occurred within our portfolio; the concept of live streaming originated at Stuart Weitzman in China. The Coach team there recognized its potential and the real business impact it had. They adapted it successfully for Coach. Simultaneously, teams across the Pacific, including in California and North Carolina at Kate Spade, leveraged Zoom to connect store associates with customers in a personal way. This approach not only generated brand enthusiasm and connectivity but also resulted in strong digital outcomes for Kate Spade. We believe these trends are part of a broader shift, and we are committed to learning as much as possible from them.

Joanne Crevoiserat, Chief Financial Officer

And Oliver, I'll jump in on the other questions regarding our credit facility, and I'll start by saying, you know, our priority right now is to protect our liquidity through this crisis and we entered the crisis really at the beginning of the calendar year in a very strong liquidity position and we ended the third quarter with just under $900 million in cash and cash equivalents on hand. As we entered the fourth quarter, we did draw $700 million of our $900 million revolver really to further bolster our cash balances and have the flexibility and liquidity. You know our covenant is an adjusted debt-to-EBITDA covenant and we are closely monitoring our leverage and in close communications with our credit facility banks on any adjustments we need as we move forward for a short period of time to see it through the crisis.

Oliver Chen, Analyst

That's great. Thank you. Best regards. Thank you both.

Todd Kahn, President and Chief Administrative Officer

Thank you, Oliver.

Operator, Operator

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

Paul Trussell, Analyst

Good morning and thank you for taking my question. Earlier, you mentioned some of the dynamics that we should keep in mind on gross margin, especially with some of the geographic mix changes going on, was hoping you could dig into a little bit more detail on other puts and takes around gross margin as we think about not just geographic mix, but, you know, the channel mix and just what's transpiring in terms of the rate of recovery, how you’re managing inventory and anything else to note? Thank you.

Joanne Crevoiserat, Chief Financial Officer

Yes, I can take that. In terms of gross margin, I would say that generally speaking, the margin performance within each brand is shaping up the way we had expected. However, the impact of the disruption in our business with stores closed has had a significant and material impact on the outcome on overall margins. So, the real driver is – has been the geographic mix, most prominently, and that, as I mentioned, worked against us in Q3 with the international business and namely China, having a much lower penetration to our average and that business is a high-margin business. As we move into Q4 and as we've seen more stores closed more broadly across the business, we see that impact actually reversing a bit with the North America business underpenetrated as we move into Q4, relatively underpenetrated I should say. You know by channel, I would say that we feel really good about our ability to drive the digital business globally and have seen a really nice response from our customers in terms of demand trends there, but have not seen a material impact on margin. As we think about managing margins through the rest of this fiscal year and into fiscal year 2021, one of the biggest controllable items is how we manage our inventory. And as I mentioned earlier, we've taken aggressive actions to align our inventory with how we see the demand trends unfolding and that includes the over $500 million of adjustments that we have taken. Not only does that preserve cash flow, but it also puts us in a better position as we move through the year to manage the promotional activity. So, the other factor in gross margin that we're monitoring is really that promotional activity. You know, we expect that the environment and the promotional environment will intensify as we move through and we're very focused on making sure that we're controlling the elements that we can control, again, with aggressive inventory actions. A few data points give us confidence in our ability to positively manage margins in AUR, and to-date, we've seen success in driving higher margins on digital as we've managed through this part of the crisis, particularly in North America. As China has reopened, we've been generating higher margins versus last year across channels. You know, we have stated increasing AUR and driving margins, healthy margins as a priority in the past and our focus continues to be there. Longer-term, we expect to continue to drive higher AURs based on being closer to the customer and driving innovation in our product. I think short-to-medium term, it's really about managing our inventories and responding appropriately to the environment.

Paul Trussell, Analyst

Thank you for the color.

Joanne Crevoiserat, Chief Financial Officer

Thank you.

Todd Kahn, President and Chief Administrative Officer

Thank you.

Operator, Operator

Your next question comes from the line of Simeon Siegel of BMO Capital.

Simeon Siegel, Analyst

Thanks. Good morning, guys. And I hope everyone's doing okay through all this. Just given the economic landscape, can you remind us what percent of domestic store sales and locations are within maybe enclosed malls versus off-mall? And then, Jide, this might just be the wrong time for this question, but you did mention the benefits of being a well-capitalized brand throughout all of this. Can you just talk about recognizing defense is important, talk about the offense, the opportunity you mentioned to grab share whether it's the existing brands or maybe any other color you see if you're looking at other brands within that are not as well capitalized? Thank you.

Jide Zeitlin, Chairman and Chief Executive Officer

Thank you. Todd, do you know the response on the malls?

Todd Kahn, President and Chief Administrative Officer

Yes, directionally, you can think about half the malls being outdoor malls and about half the malls being enclosed malls when you look at the total North America fleet.

Jide Zeitlin, Chairman and Chief Executive Officer

Great. Thanks, Todd. So, I'll take a slightly more expansive kind of response to your question about where we find ourselves and how we take advantage of being in a relatively strong position, and I'll go back to some comments that Joanne made earlier, but, you know, there really are three phases to both weathering the storm and then emerging strong. And clearly, the first is to – you know there's an expression that they use in India that I'm fond of, it’s do the needful, right. So to right size our costs and make sure that our costs are really in line with the current scale of our business, and you know, we're clearly doing that, have been doing that for some time. We'll continue to stay focused on that. Second is to rebuild, rethink core aspects of our operating model. And so, we have the benefit, you know, we didn't know it at the time of having begun rethinking our growth model, you know, six to eight months before COVID-19 hit. And so, our ability to really be very thoughtful and deliberate about increasing our focus on the consumer, investing in systems to better connect with that consumer to understand where she is traveling to, really – as we've talked a lot about on this call about, you know, the digital and being on the front end of that, using data to proactively drive decisions and having an organization that's much more agile in terms of how it makes decisions and in terms of the culture, and our sense is that, you know, our relative strength allows us to hold two thoughts in our minds at the same time. One is to take the immediate, really firm steps that need to get taken on the cost side in terms of our business, but two is to really be thinking going forward and to be making very surgical investments in areas going forward. And that then allows you to get into a third phase, which ultimately is what I’ll call the flywheel, right, where you really have this exceptional business model. And, you know, as we've sat internally and really looked at where we're likely to go, you know, our sense is that coming out of this extraordinary period, you know, and having taken the steps that we've already taken and positioning ourselves to continue to work forward, particularly on our growth agenda. You know, we'll be in a position where we've got really healthy margins and margins in many ways, frankly, that look more like the historical Coach business did in its best years and real operating leverage in the business going forward. That's part of the luxury that our position affords us as opposed to some of our peers who may only be able to focus on the first part of that, on just right sizing their costs and not thinking as much forward, both because they may not have had the benefit of beginning to think through some of those issues six, eight months ago, but also because they may not have the wherewithal to make those investments going forward in a very surgical way.

Simeon Siegel, Analyst

Great. Thanks a lot. Good luck for the rest of the year and best wishes to everyone.

Todd Kahn, President and Chief Administrative Officer

Thank you.

Jide Zeitlin, Chairman and Chief Executive Officer

Thank you very much. You too.

Operator, Operator

Our final question today comes from the line of Michael Binetti of Credit Suisse.

Michael Binetti, Analyst

Hi, guys, good morning. Thanks for taking our questions in here and I’ll add my hope that everybody is doing well. Joanne, just a couple of modeling questions real quickly, you know, the gross margin, overall, was fairly stable in the quarter, just some mix that you pointed to. I'm wondering if you think it's bottomed in the third quarter given the abrupt nature of the start of the shutdown. You said in the fourth quarter, the mix shifts back in your favor from North America being lower, maybe some thoughts on how markdowns will start to phase in and I'm guessing that's a bigger drag in 4Q, so I don't know if that’s bottomed? And then, same question on the SG&A you mentioned, you know, I'm wondering if the deleverage gets worse before it gets better or not because you have more ability to proactively manage costs in the fourth quarter?

Joanne Crevoiserat, Chief Financial Officer

Yes, thanks, Michael. So from a modeling perspective, as I mentioned, the most significant impact to the gross margin rate is the store closures and the relative penetration of our geographic regions to our total. And as I mentioned in the third quarter, that worked against us with the international business and namely China, having a much lower penetration to our average and that business is a high-margin business. As we move into Q4 and as we've seen more stores closed more broadly across the business, we see that impact actually reversing a bit with the North America business underpenetrated as we move into Q4, relatively underpenetrated I should say. You know by channel, I would say that we feel really good about our ability to drive the digital business globally and have seen a really nice response from our customers in terms of demand trends there, but have not seen a material impact on margin. As we think about managing margins through the rest of this fiscal year and into fiscal year 2021, one of the biggest controllable items is how we manage our inventory. And as I mentioned earlier, we've taken aggressive actions to align our inventory with how we see the demand trends unfolding and that includes the over $500 million of adjustments that we have taken. Not only does that preserve cash flow, but it also puts us in a better position as we move through the year to manage the promotional activity. So, the other factor in gross margin that we're monitoring is really the promotional activity. You know, we expect the environment and the promotional environment to intensify as we move through, but we're very focused on making sure that we're controlling the elements that we can control with aggressive inventory actions. Few data points give us confidence in our ability to positively manage margins in AUR, and to-date, we've seen success in driving higher margins on digital as we've managed through this part of the crisis, particularly in North America. As China has reopened, we've been generating higher margins versus last year across channels. You know, we have stated increasing AUR and driving margins, healthy margins as a priority in the past and our focus continues to be there. Longer-term, we expect to continue to drive higher AURs based on being closer to the customer and driving innovation with our product. I think short-to-medium term, it's really about managing our inventories and responding appropriately to the environment.

Michael Binetti, Analyst

Okay. And I know you guys have been generous with the time here, Jide, if I ask you one higher level question, I guess as we all take a breath and be thankful that we see a path to the stores reopening at this point, I do want to ask you and others will be reopening back into a recession, a lot of the economists suggesting unemployment will be well into the double digits, you know, can you talk to anything specifically that you’re going to do to prepare to sell into the environment and into that consumer mindset related to the budget as we do get reopened here?

Jide Zeitlin, Chairman and Chief Executive Officer

Sure. You know one is to acknowledge that clearly. And so, as we think about the return, you know, it's a slower rebound and perhaps, you know, one wants to see post other downturns, but that said, clearly a rebound and in part of what we’ve seen – and sorry to mention it yet again, but what we’ve seen through our digital channels in, you know, recent weeks and months is that there does continue despite what is clearly a severe economic downturn in the west, you know, what we see as continued demand and continued desire for our product. And so – and really it’s a little bit of a repeat of some of what Joanne has said, you know, we’ve planned accordingly, so we’re not planning for a quick rebound both in terms of how we think about our long-term cost structure and how we think about where we make our investments, but let's also recognize two things: our experience in prior downturns is that our accessible luxury positioning positions us extraordinarily well relative to the traditional European luxury players. So, we think there is a market share opportunity for us in the type of environment that you just talked to. And then we also believe, you know, when you think about the balance in our business between retail and outlet, the outlet business, we think we provide extraordinary value across both of our businesses. However, that outlet business is particularly, you know, a value business, and so we think in many ways. Yes, it will be a subdued environment in all likelihood, but if there is a business, a set of brands that are well-positioned for that, we believe that, you know, our brands are exactly that.

Michael Binetti, Analyst

Thank you so much.

Jide Zeitlin, Chairman and Chief Executive Officer

Thank you.

Operator, Operator

Thank you. That was our final question. I’ll now turn the call to management for any additional or closing comments.

Jide Zeitlin, Chairman and Chief Executive Officer

Absolutely. So, I'll close this call by remembering a colleague that we at Tapestry lost this month to COVID-19. He was a true craftsman who created beautiful products in our Coach Leather goods workshop here in New York City. He was described to me by one of his fellow craftsmen as a hard-working humble man. He was our edge paint expert and very good at his job, always smiling and never causing any drama. And so for me, that description is as honorable a way to live one's life as one could live, hard-working, humble, expert. I'm proud to have been his colleague. And so I thank each of you, our fellow stockholders for entrusting us with your company during these extraordinary and uncertain times. Thank you very much. Stay well, stay safe.

Operator, Operator

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