Business context and reporting period
Michael Kors Holdings Limited (the company now identified with Capri Holdings) filed this unaudited Form 10-Q for the 13-week second quarter and six months ended September 29, 2018. Its four reporting segments were Michael Kors Retail, Wholesale and Licensing, plus Jimmy Choo. Jimmy Choo was acquired on November 1, 2017, so its results are included in the current periods but not the prior-year comparisons. The company agreed to acquire Versace on September 24, 2018 and said it intended to change its name to Capri Holdings Limited in connection with closing.
Financial performance and liquidity
Amounts below are in millions of U.S. dollars except per-share data. Comparisons are with the corresponding prior-year period.
| Metric | Three months | Six months |
|---|---|---|
| Revenue | $1,253.8; +9.3% | $2,456.3; +17.0% |
| Gross profit / gross margin | $763.1 / 60.9% (prior 60.2%) | $1,513.9 / 61.6% (prior 60.3%) |
| Operating income / margin | $189.4 / 15.1% (prior $199.1 / 17.4%) | $404.6 / 16.5% (prior $348.5 / 16.6%) |
| Net income attributable to company | $137.6 (prior $202.9); diluted EPS $0.91 (prior $1.32) | $324.0 (prior $328.4); diluted EPS $2.13 (prior $2.11) |
| Operating cash flow | Not presented separately for the quarter | $263.7 (prior $329.1) |
| Cash and cash equivalents at period end | $155.2, versus $163.1 at March 31, 2018 | |
| Debt carrying value at period end | $759.6, including $255.0 short-term and $504.6 long-term debt; $874.4 at March 31, 2018 |
For the quarter, revenue growth included $116.7 from Jimmy Choo; Michael Kors segment revenue declined 0.8%. The six-month increase also included $289.4 from Jimmy Choo. Wholesale was the strongest Michael Kors segment for the six months, with revenue up 7.0% and operating income up 39.5%. Michael Kors comparable sales fell 2.1% in the quarter and 1.0% for the six months; management said e-commerce inclusion benefited those figures by 190 and 220 basis points, respectively.
Quarterly operating income fell despite higher gross margin: selling, general and administrative expenses rose 22.4% to $495.8, while total operating expenses rose 16.7%. Jimmy Choo reported an operating loss of $18.4 for the quarter and $2.3 for the six months, after purchase-accounting amortization and transition costs. Interest expense and foreign currency movements also weighed on earnings. The quarter recorded a $33.0 foreign currency loss versus a $40.5 gain a year earlier; the six-month comparison was a $35.9 loss versus a $41.7 gain. The current-period loss primarily reflected the Versace acquisition currency hedge.
Six-month operating cash flow decreased by $65.4, which management attributed primarily to working-capital timing, including licensing and tax-related receipts. Inventory used $126.1 of cash and receivables used $55.4. Capital expenditures were $89.8 in the six months; management expected approximately $135.0 more for the remainder of Fiscal 2019. Working capital was $476.2 at September 29, compared with $301.8 at March 31. The company reported $728.9 available under its revolving facility and said it was in compliance with debt covenants.
Material changes, outlook, risks and unusual items
- Versace acquisition: The announced purchase price was based on enterprise value of approximately €1.83 billion (about $2.12 billion), subject to adjustments, with closing expected in the fourth quarter of Fiscal 2019 and customary closing conditions. The agreement was not subject to financing conditions. The company planned to fund the cash consideration with cash on hand, revolver borrowings and committed underwritten bank term loans it was arranging. It entered into approximately $2.001 billion of euro forward contracts to hedge the purchase; the contracts were undesignated for hedge accounting. A 10% U.S. dollar move versus the euro was estimated to change their fair value by approximately $195.5 million.
- Store optimization: The company planned to close 100–125 Michael Kors stores, had closed 66 through the period (including 19 during the six months), and expected to complete the remaining closures by the end of Fiscal 2020. It continued to estimate $100–$125 million of one-time costs and approximately $60 million of annual savings.
- Other unusual items: Restructuring and other charges were $18.2 in the quarter and $29.5 for the six months, including Jimmy Choo transition costs and Versace transaction and transition costs. Foreign-currency translation reduced six-month other comprehensive income by $128.2, including a $105.1 translation loss relating to Jimmy Choo. The company repurchased $100.0 of shares under its buyback program during the six months, with $542.2 of authorization remaining.
- Tax and accounting: Effective tax rates were 9.8% for the quarter and 9.6% for the six months, below prior-year rates; management cited share-based compensation tax benefits and tax-law effects. Liabilities for uncertain tax positions, including accrued interest, were $124.6; management anticipated a possible $37.1 reduction in gross unrecognized tax benefits over the next 12 months, but outcomes and timing were uncertain. ASC 606 adoption added $6.7 net of tax to opening retained earnings. The company expected the forthcoming lease standard to significantly increase recognized assets and liabilities.
- Risks and contingencies: Management highlighted acquisition integration and execution, foreign-exchange volatility, shifting shopping toward e-commerce, shipping and distribution disruptions, and raw-material, labor and tariff costs. Routine legal proceedings were not expected by management to have a material adverse effect. No specific revenue or earnings guidance was provided in this filing; management did state it expected available cash, operating cash flow and borrowing capacity to meet working-capital needs for the next 12 months.
Important facts for investors to verify
- Versace closing conditions, final consideration and financing terms, and the effect of the acquisition on leverage and liquidity.
- Whether Michael Kors comparable-sales trends and retail margins improve, and whether wholesale performance can offset retail and licensing weakness.
- Jimmy Choo’s operating trajectory after transition costs and purchase-accounting amortization.
- Cash conversion and working-capital needs, including inventory growth, capital spending and remaining share repurchases.
- Exposure to the Versace currency hedge and other foreign-exchange movements, as well as the resolution of uncertain tax positions.
- Progress, total cost and realized savings from planned store closures; the filing’s annual savings figure is an expectation, not a guarantee.