Business context and reporting period
Ralph Lauren Corporation designs, markets and distributes premium lifestyle products through wholesale, retail and licensing channels across North America, Europe and Asia. This unaudited Form 10-Q covers the 13-week second quarter and six months of Fiscal 2018 ended September 30, 2017; comparisons are to the corresponding periods ended October 1, 2016.
Financial results and liquidity
| Metric | Q2 FY2018 | Q2 FY2017 | Six months FY2018 | Six months FY2017 |
|---|---|---|---|---|
| Net revenue | $1,664.2 million | $1,820.6 million | $3,011.3 million | $3,372.8 million |
| Gross margin | 59.8% | 52.4% | 61.3% | 54.8% |
| Operating income | $193.3 million | $76.3 million | $283.6 million | $45.1 million |
| Operating margin | 11.6% | 4.2% | 9.4% | 1.3% |
| Net income | $143.8 million | $45.7 million | $203.3 million | $23.4 million |
| Diluted EPS | $1.75 | $0.55 | $2.47 | $0.28 |
- Revenue and margins: Q2 revenue fell 8.6% reported (9.0% constant currency); six-month revenue fell 10.7% (10.3% constant currency). Gross-margin gains largely reflected substantially lower restructuring-related inventory charges than in the prior year, alongside less promotion, favorable mix and lower sourcing costs. SG&A was 46.1% of revenue in Q2, up 200 basis points, and 49.0% year to date, up 100 basis points, reflecting sales deleverage and mix.
- Cash flow: Six-month operating cash flow was $437.0 million, versus $232.6 million a year earlier. Capital expenditures were $74.7 million, compared with $165.4 million. Cash, cash equivalents and restricted cash totaled $1,158.9 million at quarter-end.
- Liquidity and debt: Cash and short- and long-term investments totaled $1,701.3 million; debt was $590.4 million, producing reported net cash and investments of $1,110.9 million. The company had no commercial-paper or credit-facility borrowings; $9.3 million of letters of credit reduced availability under the $500 million combined program. The $298.6 million 2.125% notes due September 2018 were classified as current debt.
- Other: Inventory was $864.6 million, up from $791.5 million at April 1, 2017. The quarterly dividend declared was $0.50 per share; $81.1 million of dividends were paid during the six-month period.
Material changes versus the prior comparable period
- North America was the principal source of revenue weakness: Q2 sales fell 16.1% and six-month sales fell 16.5%, driven by reduced wholesale shipments and distribution, brand discontinuances and softer demand. Q2 comparable sales declined 5% overall; e-commerce comparable sales fell 13%.
- Europe revenue rose 3.9% in Q2, including favorable currency effects, but declined 4.5% year to date. Asia revenue was nearly flat in Q2 and down 0.4% year to date, though up 2.4% on a constant-currency basis.
- Reported operating income improved materially, but the comparison benefited from lower special charges: restructuring, impairment and other charges totaled $30.4 million in Q2 versus $149.5 million, and $77.6 million for six months versus $308.6 million, in the prior-year periods. These charges reduced current-period diluted EPS by approximately $0.24 for Q2 and $0.63 year to date.
- Six-month effective tax rate declined to 26.9% from 42.2%, in part because of prior-year tax reserves and settlements and the mix of foreign earnings. Adoption of share-based-payment guidance increased the current-period tax provision by $15.5 million for six months.
Outlook, management commentary, risks and unusual items
- The Way Forward Plan focuses on core brands, product and marketing, improved quality of sales, shorter supply-chain lead times, cost reductions and a more disciplined distribution strategy. Management said these initiatives may pressure near-term operating profit as sales reductions can outpace expense reductions.
- The company expects gross annualized savings of approximately $180–$220 million from actions substantially completed in Fiscal 2017, plus approximately $140 million from additional actions expected to be substantially completed by the end of Fiscal 2018. Total estimated plan charges were stated at approximately $770 million. Management reported Fiscal 2018 capital expenditures of approximately $225 million expected, reduced from its prior $300 million estimate. It did not expect share repurchases under the program during Fiscal 2018. No full-year revenue or earnings guidance is stated in the supplied filing text.
- Actions include closing 20%–25% of underperforming U.S. department-store points of distribution by Fiscal 2018 year-end, discontinuing Denim & Supply, closing the 711 Fifth Avenue Polo store, and moving to Salesforce Commerce Cloud. CEO Patrice Louvet took office in July 2017 after Stefan Larsson’s departure; the company recorded related departure charges and said it expected no further such charges.
- A customs dispute remains unresolved. The company paid a $34.1 million assessment and is contesting it; in October 2017, the tax tribunal directed customs officials to conduct a second re-audit. The original asserted exposure was up to $46 million, including interest and penalties; a successful appeal could result in a refund with interest.
- Key stated risks include continued promotional pressure and declining store traffic, wholesale customer and retail-industry disruption, inventory and demand forecasting, currency and trade exposure, restructuring execution, technology and cybersecurity, and management transition. Three key wholesale customers represented approximately 32% of gross receivables at September 30, 2017. Management reported no material change to previously disclosed risk factors. The company also noted SAP implementation-related changes to internal controls in Europe; disclosure controls were assessed as effective.
Important facts for investors to verify
- How much of the reported margin and earnings improvement reflects durable operating progress versus the prior-year inventory, restructuring and impairment charges.
- Whether revenue declines, especially in North America and e-commerce, stabilize as distribution reductions and lower promotion continue.
- Progress against the stated savings targets, the remaining restructuring costs, and delivery of the revised $225 million capital-expenditure plan.
- The outcome and timing of the customs re-audit and any potential recovery of the $34.1 million payment.
- Debt refinancing or repayment plans for the $298.6 million notes due in September 2018, and the effect of tax, currency and customer concentration risks on liquidity.