Earnings Call Transcript - TPR Q2 2022

Operator, Operator

Good day, and welcome to this 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 the Global Head of Investor Relations, Christina Colone.

Christina Colone, Global Head of Investor Relations

Good morning. Thank you for joining us. With me today to discuss our second quarter results as well as our strategies and outlook are Joanne Crevoiserat, Tapestry's Chief Executive Officer; and Scott Roe, Tapestry's Chief Financial Officer and Head of Strategy. Before we begin, we must point out that this conference call will involve certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. This includes projections for our business in the current or future quarters or fiscal years. Forward-looking statements are not guarantees, and our actual results may differ materially from those expressed or implied in the forward-looking statements. Please refer to our annual report on Form 10-K, the press release we issued this morning and our other filings with the Securities and Exchange Commission for a complete list of risks and other important factors that could impact our future results and performance. Non-GAAP financial measures are included in our comments today and in our presentation slides. In addition, as we continue to anniversary the onset of the COVID-19 pandemic, we will again be providing financial information compared to FY '20 or pre-pandemic in FY '21, where applicable. For a full reconciliation to corresponding GAAP financial information, please visit our website www.tapestry.com/investors and then view the earnings release and the presentation posted today. Now let me outline the speakers and topics for this conference call. Joanne will begin with our second quarter highlights for Tapestry and our brand. Scott will continue with our financial results, capital allocation priorities and outlook going forward. Following that, we will hold a question-and-answer session, where we will be joined by Todd Kahn, CEO and Brand President of Coach. After Q&A, Joanne will conclude with brief closing remarks. I'd now like to turn it over to Joanne Crevoiserat, Tapestry's CEO.

Joanne Crevoiserat, CEO

Good morning. Thank you, Christina, and welcome, everyone. We delivered record sales and adjusted earnings in the holiday quarter, highlighted by an inflection at Kate Spade, ongoing momentum at Coach, and a return to pre-pandemic revenue levels at Stuart Weitzman. Importantly, we realized a significant acceleration in sales trends, driving strong double-digit growth over pre-pandemic levels and well outpacing our expectations across brands. We took bold and deliberate actions to deliver for our customers and effectively navigated industry-wide challenges to meet increasing demand for our brands. These results are a testament to the significant transformation of our business, the strong consumer backdrop and engagement with our categories, and the ingenuity and agility of our teams across the globe. We are a different company than we were just 18 months ago, backed by the strength of our unique brands and the benefits of our multi-brand platform. Now turning to the highlights from the second quarter. We continue to make meaningful progress against the acceleration program by sharpening our focus on the consumer, leveraging data to lead with a digital-first mindset, and working with speed and agility. First, we maintained a consumer-centric lens by utilizing our customer data and analytics capabilities to enhance engagement, resulting in improvements to key customer metrics. We acquired nearly 3 million new customers who transacted with our brands across channels in North America, a low double-digit increase compared to the prior year with growth in both stores and online. This brings total new customer acquisition to over 11 million over the past 18 months. Importantly, in each brand, we're increasing retention rates and reactivating lapsed customers effectively as we continue to prioritize driving customer lifetime value to fuel sustained growth. Second, we advanced our digital capabilities through significant investments in the channel to improve the customer experience and drive conversion. We realized another quarter of outperformance with sales up approximately 30% versus last year, nearly three times pre-pandemic levels. Digital sales represented one-third of our total business as customers continued to shop online even as in-store traffic trends improved. Given strong consumer engagement in this channel and the power of our platform, we expect digital to reach $2 billion in revenue in this fiscal year with further runway ahead. Third, we again increased global AUR at each of our brands, reflecting the power of our brands, the traction of our compelling product assortments, and our innovative marketing. In addition, we've benefited from the infusion of data into our decision-making to streamline our offering and tailor messaging to consumers. This has resulted in lower promotions and higher SKU productivity, while also helping to identify opportunities to strategically raise prices to offset inflation. And fourth, we invested further in our China platform to foster distinctive connections and engagement with Chinese consumers. In the quarter, revenue on the Mainland rose mid-single digits, representing an increase of over 35% compared to fiscal year '20, despite disruption associated with COVID, including travel restrictions, traffic pressure, and lockdowns in certain cities. Greater China revenue rose high single digits in the quarter. Importantly, we continue to resonate with the Chinese consumer globally as sales for this cohort rose low single digits against pre-pandemic levels. In the quarter, sales growth in China was fueled by digital as we continue to innovate and meet consumers where they want to shop. As such, we've expanded our presence on social media platforms while maintaining leadership positions on Tmall and TikTok even as new brands have launched on the platform, highlighting our prominence in the market and strong brand engagement, specifically with younger consumers. In fact, we achieved record sales during 11/11 on Tmall's Luxury Pavilion with Coach as the number one ranked brand in the handbags, luggage and leather goods category and Stuart Weitzman as the number one ranked footwear brand. Looking forward, while we anticipate volatility in the near term due to the pandemic, we remain confident that China represents a meaningful long-term opportunity across our brands. This was reinforced by our recent China brand tracking survey results, which showed handbags and small leather goods as a category where consumers intend to spend more over the next 12 months. I will now touch on second quarter highlights for each of our brands, starting with Coach. We again outperformed expectations, delivering 24% sales growth compared to last year. Revenue trends accelerated on a two-year basis, increasing 20% above pre-pandemic levels. This strong growth was enabled by the foundational changes we've made to ensure the consumer remains at the forefront of our strategy. As a result, Coach achieved its highest quarter revenue and profitability in nearly 10 years. The brand continues to gain traction with consumers globally across categories and genders, further increasing our confidence in the runway ahead. During the quarter, Coach made progress against its strategic initiatives. First, we remain focused on building iconic families to create a foundation for our product pipeline in future seasons. Our core assortment, notably the Taavi, Willow, and Fields continue to drive our performance. At the same time, newly launched styles, including the studio bag and reinvigorated icons, such as the Rogue resonated with our customer base. Second, we further infused data into our decision-making to more effectively address the functional and emotional needs of our clients. This enabled a significant pullback in promotions and drove full-price selling, resulting in an increase in global handbag AUR. In North America, handbag AUR rose low double digits, marking the region's 11th consecutive quarter of gains. Our momentum and the customers' response to the style and craftsmanship of our product reinforce Coach's pricing power and the further opportunity to increase prices to offset inflationary cost pressures. Third, we emphasized the brand's values through approachable messaging, highlighted by our inclusive holiday campaign. In addition, we connected with all audiences through the authentic recreation of Jennifer Lopez's iconic 'All I Have' music video, which resulted in strong social engagement. Our marketing initiatives were rounded out by the unique storytelling moments created by our successful Ski capsule including pop-up cabins at Rockefeller Center, a custom-branded virtual game and our first foray into the NFT world featuring characters from the collection, which were claimed in the second. Overall, these actions helped to drive strong customer metrics, including the acquisition of over 1.5 million new customers transacting in North America. At the same time, purchase frequency again rose, and we reactivated lapsed customers at an increasing rate. Fourth, we again drove strong revenue growth in the digital channel, which rose over 30% compared to last year and has nearly quadrupled since fiscal year '20. We maintained this momentum even as store trends improved, underscoring the long-term opportunity for our online business. Fifth, we delivered mid-single-digit sales growth in China or an increase of nearly 45% against pre-pandemic level. This improvement was led by outperformance in digital. At the same time, we continued to invest in our physical presence. In keeping with our focus on growing the brand with the emerging middle class, we're adding approximately 10 new Coach stores in the region this year on a net basis, primarily in Tier 3 and 4 cities. We're also renovating key storefronts and expanding our footprint in nontraditional locations to build awareness particularly with younger consumers. Sixth and finally, we drove double-digit growth in our men's business with notable success in our horse and carriage pattern. We believe men have runway in bags and small leather goods as well as in broader lifestyle categories, increasing our conviction in reaching $1 billion in revenue at high margins over the planning horizon. In summary, we're combining Coach's iconic history of quality and craftsmanship with new and innovative initiatives to engage with consumers. The continued outperformance of the brand is a direct reflection of the advantages of the Tapestry platform, the benefits of the strategic investments we're making in marketing, and our ability to meet the consumer where they want to shop. We're driving sustainable growth with Coach approaching $5 billion in sales in fiscal year '22, while maintaining exceptional margins. Now moving to Kate Spade. Before I turn to the details of the second quarter, I'd like to take a step back to acknowledge the significant transformation and tangible improvements the team has made through the acceleration program. Over the last 18 months, we've returned Kate Spade to the brand our customers know and love. We've rebuilt our product foundation through the introduction and amplification of brand codes, which will serve as the platform for future icons. At the same time, we're maintaining a consumer-centric lens and infusing data into assortment planning and marketing. In North America, we acquired nearly 5 million new customers and have improved brand awareness. We've also reactivated over 2 million customers during this timeframe. In addition, we increased overall digital sales penetration to over 35% as of the most recent quarter as we focus on meeting the customer where they want to shop. And in keeping with the progress we've made to deliver great products, we've grown the brand's global handbag AUR highlighting pricing power for the future. Our work has fueled increasing momentum, giving us further confidence in the long-term opportunity for meaningful sales and market share growth. Moving to our second quarter. Kate Spade sales grew 33% compared to last year. Importantly, we drove a significant inflection against pre-pandemic levels and realized an 18-point sequential acceleration. At the same time, the brand delivered operating margin expansion ahead of both prior year and pre-pandemic levels. These results were fueled by the successful execution of our strategic priorities. First, we maintained a consumer-centric approach, resulting in approximately 1.3 million new customers purchasing with the brand across North America direct channel. At the same time, we continue to drive strong double-digit growth in both existing and reactivated customers by utilizing data to gain a deeper understanding of customer preferences and purchase drivers. Second, we amplified key platforms as we continue to build and innovate our core product offering, notably our Knott and spade flower jacquard again outperformed expectations. In addition, newly introduced core styles resonated with the consumer, including our Carlyle family pattern, which brought in a new and younger customer. Importantly, the strong performance of the core offering as well as deliberate actions to decrease promotional activity resulted in low double-digit global handbag AUR growth. Third, we drove brand heat through activity centered around increasing engagement with the consumer, while reinforcing our brand values to surprise and delight customers. This included new and exciting experiential initiatives such as opening a Disco truck in downtown Manhattan, offering an exclusive jacquard handbag at a pop-up in Tokyo and wrapping some of our bags in our signature spade flower. Further, in keeping with the brand heritage, we continue to invest in novelty platforms to maximize our emotional connection with shoppers. The Sequin embellished Slice Pizza bag at an AUR of over $300 was a top novelty performer and it hit across our social media accounts. Overall, these activities to increase brand heat are paying off with growing brand awareness per our most recent U.S. brand tracking survey. Fourth, we maximized our lifestyle positioning through a focused assortment, including occasion options across ready-to-wear footwear and jewelry that were embellished with emotional details. Overall, these categories outperformed expectations and helped to boost customer acquisition and engagement as lifestyle remains an important driver of purchase frequency. Finally, we're building on the brand's already strong digital presence. We've continued to test and learn new ways to foster consumer engagement, such as the infusion of shoppable content through key social media platforms. Our innovative online approach backed by the passionate Kate Spade community helped to drive approximately 30% revenue growth in the channel compared to last year or double pre-pandemic level. Over the past year, we've rebuilt the brand foundation. These fundamental adjustments are taking hold and unlocking the next phase of growth for Kate Spade. We're continuing to lean into our iconic roots infusing our recently introduced brand codes and delivering strong marketing aligned with our product and values. We are incredibly excited for the opportunity ahead and remain confident in our ability to achieve $2 billion in revenue and high-teens operating margins over the planning horizon. Turning to Stuart Weitzman. The brand drove significant trend improvements in the holiday quarter, highlighted by 37% revenue growth compared to last year and a return to pre-pandemic sales level. In addition, we delivered improving operating profit with operating margin expanding over 250 basis points. We continue to advance our overall growth strategies in the second quarter. First and importantly, the Stuart Weitzman team delivered the brand's highest quarter of operating income since fiscal year '18. This progress was fueled by the strategic actions we've taken through the acceleration program, notably optimizing our fleet globally, improving our digital foundation, and reestablishing our presence with wholesale partners. Second, we remain focused on digital in China, areas that represent significant long-term growth opportunities. In the quarter, digital sales rose over 35%, representing an increase of approximately 70% compared to two years ago at attractive margins. For Mainland China, we delivered growth on both a one- and two-year basis. Third, we maintained a consumer-centric strategy by infusing data analytics into assortment planning and capitalizing on market shifts to 'buy now, wear now' styles and dress and occasion wear. This drove the recruitment of new customers at an increasing rate, while continuing to reengage and reactivate clients. Fourth, we drove brand heat by sparking desire through our product assortment backed by engaging marketing, which featured Kate Hudson for the holiday campaign. We built upon our authority in boots and booties with outperformance in the Nora and Stuart. We also infused newness into our icons, including updated constructions of the lift and the introduction of our Nudistcurve. Our compelling assortment, coupled with higher full price sell-throughs and a reduction in promotional activity drove our second consecutive quarter of AUR growth. Going forward, we see continued opportunity to increase prices while maintaining our positioning within the overall market. And fifth, the brand continued to regain momentum in the wholesale channel, notably with key domestic full-price partners. Overall, we're making continued progress at Stuart Weitzman and remain on track to drive strong revenue growth with a return to profitability this fiscal year. In closing, our strong holiday results across each of our brands support the higher revenue and earnings outlook provided today. Importantly, the outperformance we've delivered is a direct reflection of our consumer-centric strategy as we continue to grow our data and consumer insights capabilities to enable increasingly powerful customer engagement. Our momentum also highlights the incredible execution of our team and the agility of our platform as we've successfully navigated the volatile backdrop. We're continuing to offer compelling and innovative products, underscored by the increased traction and pricing power of each of our brands. I'm confident in the long-term potential of our multi-brand portfolio and look forward to sharing our continued progress as we move forward. With that, I'll turn it over to Scott, who will discuss our financial results, capital deployment priorities, and fiscal '22 outlook.

Scott Roe, CFO and Head of Strategy

Thanks, Joanne, and good morning, everyone. We delivered another quarter of high-quality results, including sales outpacing last year, pre-pandemic levels and expectations despite a difficult backdrop. At the same time, we utilized our strong free cash flow to return over $550 million to shareholders in the quarter through a combination of share repurchases and dividends. Through the acceleration program, we're a fundamentally different company as evidenced by our better use of data, higher digital penetration and stronger margins compared to pre-pandemic levels. We're increasingly building momentum across our portfolio of brands. Turning now to the details of the second quarter. Revenue increased 27% compared to prior year, outpacing expectations of each brand. Against pre-pandemic levels, sales rose 18%, a 9-point sequential acceleration driven by better trends in stores, along with continued strength in the digital channel. By region, North America delivered over 35% revenue growth compared to last year. And the region accelerated to 25% growth on a two-year basis amid a strong consumer backdrop with increasing demand for all of our brands. Sales in Greater China rose high single digits, including a mid-single-digit increase in Mainland China. Compared to two years ago, the region grew nearly 35%. Trends in both Europe and the balance of Asia improved versus the prior quarter on a one-year basis, though remain below pre-pandemic levels, largely due to the lack of tourist inflows and COVID resurgences. Moving down the P&L. As anticipated, gross margin contracted in the quarter, reflecting our early and deliberate actions to invest in incremental freight to maintain product flow. In spite of a 320 basis point headwind from these freight investments, the gross margin was still nearly 150 basis points ahead of where we were just two years ago. This is a testament to the better use of data analytics to improve assortment planning and marketing messaging, driving lower promotional activity, increased SKU productivity and higher full-price sell-through. SG&A growth slightly outpaced the sales increase as anticipated given last year's unusual compares associated with the pandemic, including wage subsidies and rent concessions as well as a gain from the deferred purchase price of the Kate Spade China joint venture. Excluding these nonrecurring items in the prior year, we drove leverage in the business while making continued investments in digital, marketing and talent. So taken together, operating income grew double digits in each brand. And while operating margin was impacted by freight, the quarter was still nearly 2 points ahead of where we were just two years ago. Earnings per diluted share for the quarter was $1.33, an increase of 15% compared to the prior year and over 20% versus FY '20. Now turning to our balance sheet and cash flows. We ended the quarter in a strong position with $1.65 billion in cash and investments and total borrowings of $1.6 billion. Inventory at quarter end was 19% above prior year, including a significant increase in in-transit. While our actions to aggressively secure goods positioned us well for the holiday period, top line sales in excess of our expectations, notably at Kate Spade, resulted in lower than projected inventory balances. Touching on capital allocation and cash management. Based on the strong results of our second quarter, significant free cash flow generation, robust balance sheet, and our outlook for growth, we now expect to return over $1.5 billion to shareholders in fiscal '22, an increase from the prior outlook of $1.25 billion. We now anticipate the repurchase of $1.25 billion in common stock, which includes $750 million bought back through Q2. In addition, our shareholder return plans continue to assume approximately $270 million through our dividend program. Our capital deployment plans underscore our commitment to our shareholders and our confidence in the momentum of our business. Overall, our capital allocation priorities remain unchanged. First, we're investing in the business to drive long-term profitable growth; and second, we're returning capital to shareholders through dividends and share repurchases. Separately, during the quarter, we completed a $500 million tender offer on our notes due in 2025 and 2027, funded by a $500 million 2032 bond offering, a leverage-neutral transaction that allowed for effective debt maturity management and a modest benefit to our interest expense. In addition, we still intend to repay our July 2022 bonds totaling $400 million by the end of this fiscal year. Now turning to our fiscal '22 outlook. Before we move into the details of our guidance, I'll touch on the current external environment. Across the world, the backdrop continues to be volatile. Consumer demand in the United States remains high, while near-term headwinds associated with the pandemic exist in China, which I'll expand upon shortly. Further, supply chain constraints persist throughout the industry. We're continuing to act boldly to mitigate these headwinds and deliver for our customers. Please note that all growth rates compared to prior year are on a comparable 52-week basis excluding the impact of our 53rd week last year. We now expect revenue to be approximately $6.75 billion, which would mark a record for the company. This represents an increase of nearly 20% compared to fiscal '21 with strong double-digit growth at each brand. Our guidance contemplates ongoing strong momentum in North America in the second half which is helping to offset the expected near-term COVID-related disruptions in China. This is proof of the benefits of our globally diversified platform. Our guidance also incorporates lower-than-expected on-hand inventory due to the revenue outperformance in the first half as well as higher levels of in-transit. These longer lead times from ongoing supply chain disruptions are expected to limit our ability to change stronger underlying demand in the second half of the year, specifically in Q3. We continue to expect modest operating margin expansion for the fiscal year, maintaining our gross margin and SG&A rate expectations. As previously shared, we expect gross margin to contract modestly due to incremental cost pressures associated with freight. The pressure is now expected to be approximately $170 million in the fiscal year. Excluding this impact of 250 basis points, underlying gross margin continues to expand through lower discounting and improved SKU productivity. In addition, we're capitalizing on the pricing power exhibited by each of our brands by increasing prices selectively going forward. In addition, modest SG&A leverage is anticipated for the fiscal year. We continue to expect about $300 million in structural gross run rate expense savings as a result of the acceleration program. We're committed to reinvesting in the business to fuel long-term growth. Net interest expense for the year is now anticipated to be between $60 million and $65 million. In addition, our guidance contemplates a fiscal year tax rate of 18.5%, assuming a continuation of current tax laws. We are now expecting a weighted average diluted share count to be in the area of 274 million shares. This lower guide largely reflects our more aggressive posture in the second quarter along with the previously mentioned $250 million increase to the buyback expectation for the year. So taken together, we now expect EPS to be $3.60 to $3.65 above our prior guidance of $3.45 to $3.50. Finally, we now anticipate CapEx to be about $200 million for the year. Turning to the second half, we continue to contemplate double-digit revenue, operating income, and EPS growth with particular strength in the fourth quarter. So to provide some more guardrails on Q3 specifically, revenue is expected to increase low double digits, which contemplates the inventory constraints previously mentioned. While these pressures are being realized across the portfolio, we anticipate an outsized financial impact on our smaller brands, given their relative size. Looking at the bottom line, third quarter operating margin is expected to contract largely due to incremental freight expense in the area of $55 million as well as increases in SG&A primarily due to marketing investments. In addition, while we're continuing to incorporate a 50 basis point benefit to gross margin from the reinstatement of GSP for the fiscal year, we're now reflecting the positive impact in the fourth quarter. Overall, EPS is expected to decline approximately 20% in the third quarter, an increase over 60% in the fourth quarter, which has been contemplated in today's higher outlook for the year. So in closing, we're further leveraging the benefits of the acceleration program and our transformed business model, evidenced by increasing momentum at each of our brands. Our strong holiday results underscore our confidence in the benefits of our multi-brand platform and direct-to-consumer business model, which supported the increase in the fiscal year outlook. In addition, we're generating significant free cash flow and now plan to return over $1.5 billion to shareholders in this fiscal year alone. Overall, we remain confident in our long-term ability to drive continued revenue and operating income gains. I'd now like to open it up for your questions.

Operator, Operator

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

Robert Drbul, Analyst

I guess, Joanne, can you elaborate a little bit more on the inflection that you're seeing at Kate Spade? And I guess maybe if you could just give us an update in terms of like where you think this brand can go over the longer term, either both on top line but also operating margin profitability?

Joanne Crevoiserat, CEO

Certainly, Bob. We achieved impressive results and a notable turnaround at Kate Spade during the second quarter, driven by our products, our team, and a strong focus on consumers. The second quarter has increased our confidence in the long-term potential to grow Kate Spade into a $2 billion brand. I want to commend the team for their efforts over the past 18 months, as they have utilized our Tapestry platform and the acceleration program to rebuild the brand's foundation and restore Kate Spade to its status as a customer favorite. Here are some highlights from the second quarter: we experienced a 33% increase in sales, which is 16% above pre-pandemic levels, representing an 18-point sequential improvement. We also achieved stronger operating margins compared to both last year and pre-pandemic figures. Our digital presence continues to grow, with a 30% increase, nearly doubling pre-pandemic levels. We welcomed 1.3 million new customers this quarter and successfully reactivated many lapsed customers. Additionally, we saw a low double-digit increase in global handbag average unit retail, showcasing the strength of our product offerings. The team has concentrated on developing and enhancing key platforms. The Knott and spade flower styles continue to perform well, alongside new styles like the Carlyle, which are attracting new customers. These offerings are resonating with consumers, resulting in higher full-price sales across our collections. Importantly, we are also observing an increase in brand awareness in our consumer research. There's much to be enthusiastic about regarding Kate Spade. The brand holds a unique position in the market, and we are confident in our ability to achieve $2 billion in revenue with high-teens margins in the future.

Operator, Operator

The next question comes from Ike Boruchow with Wells Fargo.

Irwin Boruchow, Analyst

Scott, can you provide more detail on the inventory shortfall we experienced this quarter? What impact does this have on overall revenue and specifically on Kate Spade in the third quarter? It's crucial for us to understand the direction of that brand, especially since it seems there are significant improvements being made. Additionally, in your forecast, do you anticipate these challenges extending into the fourth quarter?

Joanne Crevoiserat, CEO

Scott, I think you're on mute. Do you have it now?

Scott Roe, CFO and Head of Strategy

I'm not on mute. Can you hear me?

Joanne Crevoiserat, CEO

Yes, we can hear you now.

Scott Roe, CFO and Head of Strategy

I'm sure that was my error. Sorry. Yes, this is a good story. We took decisive and early actions regarding inventory to position ourselves well for the holiday season. As evident from our strong quarter, those actions worked particularly well for Kate Spade. The key point is that we sold through a significant amount of inventory, and we wish we had a bit more because the demand continues to be very strong as we move into the third quarter. This situation will create some short-term challenges in meeting that demand. However, our production levels are getting back to normal, which we mentioned last quarter. There are still some logistics challenges, including longer lead times. The main message is that demand remains strong, and although we had an excellent quarter, our limited inventory, especially for Kate Spade, may hinder our ability to fulfill that demand. Yet, we expect to be in a better position by the end of the year, and this should not be a long-term issue for us. Additionally, as we managed our inventory and incurred costs, we previously discussed that these costs are reflected in our short-term gross margin. Importantly, since our inventory flow is returning to near-normal levels, we have significantly reduced our use of air and expedited freight moving forward. That challenge is mostly behind us now. It may take some time for these changes to fully reflect in our financial results, and we will experience some of the effects in the third quarter. However, we have substantially limited the excess freight costs to get our inventory levels back into shape.

Irwin Boruchow, Analyst

Scott, are you able to quantify the headwinds at Kate Spade specifically in the third quarter?

Scott Roe, CFO and Head of Strategy

Yes. We haven't put a number on that. Just know that the demand is stronger than our ability to supply it in the short term, and we will see some moderation in the third quarter and in the growth rate at Kate. That is not a reflection of the underlying demand or the strength of the brand. It's more of a supply-demand match in the short term.

Joanne Crevoiserat, CEO

Yes. And I'll add to that, Ike, that our outlook raised our sales expectations for the year. We still expect double-digit increases in the back half of the year and strong double digits across the board across brands for the year in '22, delivering record sales levels at $6.75 billion. So continue to expect top line to perform.

Operator, Operator

We'll go now to Erinn Murphy with Piper Sandler.

Erinn Murphy, Analyst

My question is about digital. It has remained a strong focus. There are two parts to my inquiry. First, regarding the $2 billion target for digital this year, how is that divided across different concepts? Secondly, looking ahead, as digital expands, has that prompted you to reassess your fleet strategy, whether that means considering outlet locations or maintaining full-price offerings?

Joanne Crevoiserat, CEO

Yes. We have fundamentally transformed our business to strengthen our engagement with the consumer in this channel, and you can see that in our results. We are meeting our customers where they choose to engage and shop. And that's really been delivering results. We've invested in capabilities, including in talent to power the work here and drive better consumer experiences across our digital platforms. As you mentioned, we're approaching $2 billion in business. We reached one-third of our business in the holiday quarter, which is triple pre-pandemic level. So seeing a lot of traction here, and we continue to see new customer growth in these channels. So we feel great about the growth both from the revenue standpoint, but also from the customer profile, the new customers, the younger customers that we're increasingly attracting to our brands. And we're also seeing this digital business as accretive to our margins as digital margins are higher than the respective brick-and-mortar. So that $2 billion represents a margin benefit to us, but also represents an opportunity because at $2 billion, it's less than one-third of our business on an annualized basis, and we think it can go higher from here. So we feel very optimistic about our digital business and continue to invest in those capabilities. And then to your question about stores, we also believe that stores represent an important touch point for our brands. And consumers are shopping across channels. We did see improvement in store trends this quarter. At the same time, we continued to deliver strong growth in digital. So as customer shopping behaviors are changing, we're investing behind those experiences and those omnichannel experiences that make that a great touch point for our customers, and it's an important touch point for our brand. We have been focused on driving higher productivity and profitability across our store fleet. And even though our traffic levels in store business overall haven't exceeded pre-pandemic levels, our margins in our store fleet have exceeded pre-pandemic levels. So we've done the work to ensure we're driving more profitability and more productivity out of our store fleet, and we continue to invest in great experiences for our consumers across all channels.

Operator, Operator

The next question comes from Lorraine Hutchinson with Bank of America.

Lorraine Hutchinson, Analyst

Can you talk to the current environment in China? And then from a longer-term perspective, how big of a driver is China and Kate achieving its $2 billion revenue goal?

Joanne Crevoiserat, CEO

Let me start by discussing China and the opportunity for Kate. We saw growth in China during the second quarter, both year-over-year and compared to two years ago. We are optimistic about the long-term potential of that market. In Q2, we experienced growth that was 35% above pre-pandemic levels, driven by global engagement with Chinese consumers. This growth has been supported by digital innovations on existing and new platforms. We enjoy strong engagement, especially with younger consumers. Innovation and a solid business model have continued to drive our growth in the region. We do anticipate some near-term challenges due to COVID, as we're currently observing some effects and expect restrictions and lockdowns in specific cities. Nonetheless, we firmly believe that China represents a compelling long-term growth opportunity for Tapestry across all our brands. The data shows that Chinese consumers have remained resilient throughout the pandemic, and our research indicates strong brand loyalty. We've achieved record sales and ranked number one on Tmall for both Coach and Stuart Weitzman in their categories. Looking ahead, we see strong purchasing intentions in our category for the next year, and our brands are well-positioned to capitalize on this. We're targeting the rapidly growing middle class and implementing strategies to foster sustainable growth across all brands. Currently, Kate Spade has a limited presence in China, with our focus on North America and Japan—the core markets for the brand. As we develop Kate Spade, we foresee future growth opportunities in China. To provide further insight, I'll hand it over to Todd to share more about the success we're experiencing with the Coach brand in China.

Todd Kahn, CEO and Brand President of Coach

Thanks, Joanne. As most of you know, the Coach brand has been in China for over 20 years. We have deep, deep roots in the country. And in our recent brand perception study, two things were very noteworthy. One, the majority of the Coach customers in China have a positive economic outlook for the next 12 months. And that gives us a lot of energy around our clients and our customers there. Two, the Coach brand is a beloved brand that successfully competes with traditional European luxury brands. And we love that positioning. And we're going to continue to invest and grow in China. For example, last summer, we held a major fashion show in Shanghai showcasing our winter collection. That showcase led to the sales of the Ski capsule that we showed and sold in our stores in the second quarter. We will return this summer with another winter show in China, continuing to build on the momentum and really focusing on both the emotional and functional needs of our Chinese clients. So again, both our mid- and long-term expectations and growth in China are very robust, and we're really excited about what the Coach brand is going to deliver under the Tapestry platform in that area.

Operator, Operator

We'll go now to Oliver Chen with Cowen.

Oliver Chen, Analyst

The average unit retail increases of the Coach brand have been really impressive. But what's ahead with maintaining that and anniversarying that in terms of sustaining that momentum? And as a follow up, NFTs and the Metaverse have been increasingly embraced by luxury brands. What are your thoughts on the strategy there and how that may be executed as well as this is a different question, ESG and supply chain, just key priorities that you have for ESG and supply chain as well.

Joanne Crevoiserat, CEO

Thanks, Oliver. There's a lot there. I'll start with pricing and move to the Metaverse and then the ESG. So on pricing, across brands, we represent compelling value in the market. We deliver beautiful quality product at great prices. We do see the market moving higher, and we've had success in driving AUR. We see AUR as an opportunity across our brands. We saw that in the second quarter where we drove AUR higher across all of our brands. And we've had sustainable growth at Coach, which is notable. And we're driving AUR increases through product innovation with this disciplined promotional activity and really through our transformation efforts that I've called out. And consumers continue to recognize the value we're delivering. We do see further runway. We think it's sustainable. We see runway to leverage price increases to offset inflation, while maintaining our market positioning and delivering compelling value for our customers, which is our overarching goal. And we talked about the transformation efforts and the sustainability of these results, but we are using data to improve our assortment planning. We're seeing increased SKU productivity, lower discounting. We're not relying on promotions. We're seeing the pricing power happen across brands. Maybe I'll pass it to Todd to talk a little bit about what you're seeing at Coach, where we've had an amazing track record of success, but continue to see runway and then I'll pick up the ESG and Metaverse question.

Todd Kahn, CEO and Brand President of Coach

Great. Thank you, Joanne. Oliver, you know Coach at its best balances logic and magic. And the Tapestry platform has enhanced the logic side, particularly with our digital center of excellence and our consumer insight work. On the magic side, over the last two years, we have created an environment where our creative team, led by Stuart Vevers can thrive. This combination has resulted in 11 quarters of increased handbag AUR in North America, a second quarter resulting in the highest revenue and profitability in 10 years, a sustainable top line approaching $5 billion in this fiscal year, substantially greater SKU productivity, over 1.5 million new customers transacting with the brand in North America just this last quarter, meaningful growth in men's ready-to-wear and footwear and all men's categories. Finally, our inclusive, authentic and fun storytelling in our marketing. These are foundational changes for our brand. And what this allows us to do is to continue to push and get priced in our product. And when I've been asked over and over again in many quarters now about how much more room is there in AUR. I look at where the Coach brand sits today relative to traditional European luxury. And the white space between where we transact and where traditional European luxury transacts is at the greatest delta in 20 years. That gives us a lot of confidence and a lot of room to grow our price positioning. So I'm very optimistic about our future. I know Joanne will talk about sustainability. On the NFT, we dipped our toes in the water last quarter. We are going to look at it. I think I'd like selling physical real products, and our consumers like to touch and feel, but I do think that's an opportunity to explore as we really get closer, particularly to a younger consumer. So you'll see more of that over time. And then I'll kick it back to Joanne to talk about sustainability.

Joanne Crevoiserat, CEO

Yes, the work we're currently doing with NFTs is a testament to our innovative approach. We are continually exploring new ways to connect with consumers, including understanding their interactions with NFTs and how it influences consumer loyalty. We are engaging in experiments to see how customers respond as we gather more insights into NFTs. Regarding ESG, it plays a crucial role in our company and all our brands. Our program, Our Social Fabric, has been integral to our operations, focusing on three main areas: our people, our planet, and our communities. We're committed to making progress in these areas, with clearly defined goals. I’m pleased to announce that we have just published our corporate responsibility report, which details the advancements we've made across all three pillars. For instance, we've committed to linking 10% of our leadership incentive compensation to our progress on EIND. We are dedicated to these objectives and are already seeing results. We established a $50 million Tapestry foundation to support various initiatives and recently partnered with FIT in their social justice center to enhance EIND in our industry. On environmental efforts, we’ve formed a partnership with Savory Institute for regenerative leather, which aligns with our biodiversity goals. Additionally, we are committed to achieving net zero emissions by 2050 at the latest and are making strides towards our renewable energy goals, as well as improving sourcing and traceability. Community engagement is another area where I'm proud of our efforts. Our associates are highly involved, and we've provided them with a paid volunteer day to encourage participation in their communities. We aim to reach 100,000 volunteer service hours, and we are well on our way, which is fostering a sense of pride among our teams. They value the support for their community involvement and are proud to contribute to something larger than just our business. ESG is a vital focus for our company, and we are making measurable progress.

Operator, Operator

We'll go next to Mark Altschwager with Baird.

Mark Altschwager, Analyst

I wanted to follow up on the digital front. You've been accelerating your investments there, and I was hoping you could just unpack it a little bit. I guess, first, I think part of that is marketing, which clearly appears to be contributing to the momentum today. And I think you're also investing in teams and capabilities, which might still be in the earlier innings. So I guess I'm curious, one, what were the learnings from the investments over the holiday quarter? I guess which channels are you seeing the greatest success? And two, just kind of medium term here, how should we think about the leverage point on SG&A as you continue leaning into digital?

Joanne Crevoiserat, CEO

Thank you, Mark. We've achieved significant success in digital, yielding strong returns on our investments. A key aspect of this is technology, integrating our digital as well as data and analytics capabilities. Our solid technology foundation enables us to quickly adopt new technologies and innovations. By embedding data and analytics more thoroughly into our processes, we're enhancing conversion rates and improving our marketing efforts. The platform and infrastructure we're investing in are boosting our performance, and we've noticed improvements. During this holiday quarter, our digital business grew by 30%, which I consider strength on strength. We also provided a much better experience for our consumers, reflected in a significant increase in customer satisfaction scores during the holiday season due to our ongoing changes. This is positively affecting the experience, results, and conversions. Additionally, we're heavily investing in building talent, as these teams are essential in driving our innovation, which is flourishing. Innovation remains crucial to our business, and we are focused on acting swiftly to align with our customers' needs. Our innovation is evident in our quick advancements on new platforms. For instance, in China, we were the first fashion brand to run a commercial site on TikTok, where we remain the top brand, as well as on Tmall. We offer shoppable content across various social media platforms, and our NFT initiative exemplifies our approach to innovation, embracing experimentation and agility to stay connected with our customers. This is the guiding focus of our investments, and we are reaping strong returns.

Scott Roe, CFO and Head of Strategy

Yes, Mark, maybe I'll just build too, and part of your question was around leverage and how we see that. I just, first of all, say the power of these platforms is really impressive, and you heard Todd mention how the logic side of the business is really powering all of our brands, and I think it's obvious in the results that you're seeing and I can tell you as someone who is relatively new to the story, seeing this company go from a technology deficit to technology really driving the business in a really short period of time through the acceleration program. It is really, really impressive and encouraging. And I'll just remind you, in the prepared remarks, I talked about $300 million of structural run rate savings that came through the acceleration program over the last couple of years. That's not really about saving money to save money. That's reallocating money into our digital and consumer data experience and again, building those platforms which have leverage. So that's how we can have significant investments in some of the, what I would argue, the points of difference that are really driving our business. And at the same time, having leverage in other parts of the SG&A structure allow us to continue to grow our operating margins over time. So that's kind of the flywheel or the secret sauce here, I think as you look at this transformed business model that unlocks future growth.

Operator, Operator

Our next question comes from Michael Binetti with Credit Suisse.

Michael Binetti, Analyst

Congratulations, there's a lot of positive developments to discuss this quarter. Can we focus for a moment on the Coach gross margin? The two-year trend appears to have slowed slightly from the first quarter. I'm interested in understanding the different components, particularly how freight affects that brand compared to the impact of the AUR initiatives you’re implementing. This will help us better identify what influences are lasting versus temporary as we move through the upcoming quarters. And Scott, our conversation wouldn’t be complete without addressing the SG&A for the company. I hope you’re managing well with that.

Scott Roe, CFO and Head of Strategy

You're consistent, my friend.

Michael Binetti, Analyst

Yes. To follow up on Mark's question, as we analyze the revenue increase this quarter compared to the plan, the significant revenue growth, the flow-through rate for SG&A appears to align more with what we observed last fiscal year rather than last fiscal quarter. Could you provide some insight into how we should consider the flow-through on SG&A if we see further revenue increases in the upcoming quarters?

Scott Roe, CFO and Head of Strategy

Yes. I'll begin, and then Todd can add his thoughts on margins and AUR. Regarding your question about freight and its impact on margins for Coach, there really isn't a significant difference overall. The guidance I've provided isn't much different across brands in terms of allocations. When considering our ongoing margin structure, I wouldn't highlight anything particularly unique among the brands. We took decisive actions across the board because many of the challenges we faced were consistent within our supply chain. You can see the results from these actions in Q2. It's important to remember that we expedited freight and utilized air freight for specific reasons. At that time, about 40% of our production in Vietnam was halted, creating a supply gap that we addressed with expedited airfreight. Fortunately, we now observe that flow is becoming more normal, and the issues are largely behind us. However, it will take some time for this to reflect in our P&L since it relates to the inventory. As that inventory sells, you will begin to see changes, particularly in the third quarter. While we do see higher ocean rates, much of the expedited freight is returning to normal levels, and that process is already underway—albeit it takes some time to impact the P&L. We are also continuing with pricing actions. Todd, do you want to add anything about what you're seeing with the Coach brand?

Todd Kahn, CEO and Brand President of Coach

Sure, Scott. Thank you. As you've seen, our AUR have grown each and every quarter. And part of what allows us to do that is the focus on our iconic product and really elongating the families of product in our offering. And that has provided us the ability to discount less to raise prices. So I believe, over the next year, you'll continue to see us do more of that. You'll continue to see us absorb any inflation through pricing. Obviously, you can't do that in one quarter when you're hit with freight. And I think the reason Coach is in perhaps maybe a slightly better inventory position than our sister company is not that our merchants don't want the newest greatest product as well, it's just we've been on the journey a little longer on developing iconic product that allows us to stay in a slightly better inventory position. So I feel very good about our pricing power. I feel very good about our ability to absorb the input costs, and I would enjoy not airing goods in the future to the same level obviously.

Scott Roe, CFO and Head of Strategy

And Michael, let me just take your SG&A question real quick, too. I would say, listen, there's some timing quarter-by-quarter as we think about different marketing actions, top of the funnel actions. I would just point you to the big picture here, right? We have taken up our top and bottom line guidance for the year. We have maintained our gross margin and SG&A shaping, and we still intend to increase our operating margin for the full year. So is there some timing quarter-by-quarter? Yes. I think the bigger picture here is we had a strong quarter, and we've taken up our guidance and we still maintain the fundamental metrics that we talked about even despite a volatile backdrop, as I mentioned before. So I think that, from my standpoint, it's the big picture here.

Operator, Operator

We'll go now to Brooke Roach with Goldman Sachs.

Brooke Roach, Analyst

Joanne, I would like to dive a little bit deeper into the 3 million new customers across channels that you acquired in North America this quarter, which is a strong result against a tougher year-on-year compare. Can you talk a little bit more about what specifically you're seeing that are driving those new customer acquisitions and the sequential improvement you saw in this quarter? And then on the forward, I would love to hear a little bit more about the specific marketing efforts you have planned to keep that momentum going into the back half of this fiscal year.

Joanne Crevoiserat, CEO

Thanks, Brooke. We're seeing robust customer acquisition across all of our brands, with 3 million new customers added, totaling 11 million over the past 18 months. Our focus has been on acquiring customers as part of our brand-building initiatives, which has fundamentally changed our business approach to enhance consumer engagement. This strategy is yielding positive results. We're utilizing innovative marketing and ensuring that we're present on the platforms where our customers engage. This involves understanding and connecting with our target audience, ensuring we communicate effectively with them. These customers are not just aware of our marketing and products; they're actively purchasing from us. Our success stems from understanding our consumers and delivering products that meet their emotional and functional needs. We're effectively integrating data into this process. Our marketing efforts have also become more innovative, employing a test-and-learn strategy with cross-functional teams consistently ideating and testing against hypotheses. Successful strategies are being scaled, which is fueling our customer acquisition efforts. Additionally, we're applying the same principles to retention and repeat purchases. As a data-driven company, with over 90% of our sales direct-to-consumer, we're making the most of our data through new tools and technologies we've invested in. We continue to hire talent that enhances both the creative and technical aspects of our approach, allowing us to reach our customers where they are and resonate with their values, influencing their purchasing decisions. The new customers we're attracting tend to be younger across our brands, laying a solid foundation for future growth.

Todd Kahn, CEO and Brand President of Coach

On the Coach side, we are noticing that new customers are exhibiting higher average unit sales. We are particularly proud of the Coach Insider program, which we believe offers significant potential for customer retention. Our insiders shop 20% more often than nonmembers, and their purchase amounts are higher. This trend is evident in both our retail and value channels, and we are excited about it. What sets the Coach Insider program apart is that it isn't a discount program; instead, it offers early access and the experience of being an insider, which has greatly engaged our customers. We have received feedback from clients expressing how much they enjoy being featured in the insider program. We will continue to enhance these programs and the benefits of being a Coach Insider to foster a deeper connection with our customers beyond mere transactions.

Operator, Operator

The next question comes from Paul Lejuez with Citi.

Tracy Kogan, Analyst

It's Tracy Kogan filling in for Paul. I was wondering if you could talk about your factory outlet strategy for Kate. How many stores do you guys have there currently? And what's your ultimate target? And I'm wondering if you have the same AUR strategy at the factory outlet channel for Kate as you do with Coach.

Joanne Crevoiserat, CEO

At Kate, we've experienced significant growth and have both specialty and outlet stores performing well. The increase we're observing has been largely fueled by our full-price sales, which we're very optimistic about. We're anticipating an increase in average unit retail and have noted growth in this area across all channels, along with a strong digital presence. Overall, the Kate Spade brand offers strong value in the market with appealing products and unique positioning, and customers are engaging with us across various platforms. Our growth is notably robust in the specialty retail channel, and we are also observing meaningful engagement on social media, which enhances our connection with Kate Spade consumers. This indicates a bright future for growth in the Kate Spade brand, especially in the specialty channel, and we are confident in the opportunities that lie ahead, both in overall growth and in average unit retail.

Operator, Operator

Thank you. That concludes our Q&A. I would now like to turn the program back to Joanne Crevoiserat for any additional or closing remarks.

Joanne Crevoiserat, CEO

Well, I would thank you all for joining us this morning. Through our acceleration program, we've radically transformed our business model and it's delivering. We drove record sales and adjusted earnings during the holiday quarter with outperformance across each brand. We've increased our outlook for the year, which includes raising fiscal '22 or '22 revenue outlook to a record at $6.75 billion, with Coach approaching $5 billion and inflection at Kate Spade, digital revenue reaching $2 billion and our fiscal '22 outlook that is 40% above pre-pandemic levels. These results also support our strong returns. We expect to return over $1.5 billion to shareholders this year. And our teams are powering these results. They are our competitive advantage, and I want to recognize and thank them for the standout performance. Their relentless drive and unwavering focus on the consumer will build on our strong foundation and deliver sustainable growth into the future. Thank you.

Operator, Operator

This does conclude today's program. Thank you for your participation. You may disconnect at any time.