Tapestry, Inc. — Form 10-Q Summary
Period clarification: The request identifies “2017 Q3,” but the filing is for the third quarter of fiscal 2018, ended March 31, 2018, with comparative results for the quarter ended April 1, 2017. The nine-month period also ended March 31, 2018. Amounts are in U.S. dollars.
Business context and reporting period
Tapestry owns Coach, Kate Spade and Stuart Weitzman, selling accessories, footwear, apparel and lifestyle products through retail, online, wholesale and distributor channels. The company acquired Kate Spade on July 11, 2017, and during the reported quarter acquired certain distributors and obtained operational control of Kate Spade’s China-region joint ventures. Their results are included from the relevant transaction dates, so year-over-year comparisons are affected by the acquisitions. Fiscal 2018 ends June 30, 2018.
Key financial results
| Metric | Q3 FY2018 | Q3 FY2017 | Nine months FY2018 | Nine months FY2017 |
|---|---|---|---|---|
| Net sales | $1,322.4 million | $995.2 million | $4,396.3 million | $3,354.5 million |
| Gross profit | $908.9 million | $705.7 million | $2,850.7 million | $2,326.6 million |
| Gross margin | 68.7% | 70.9% | 64.8% | 69.4% |
| Operating income | $159.0 million | $151.1 million | $483.6 million | $594.4 million |
| Operating margin | 12.0% | 15.2% | 11.0% | 17.7% |
| Net income | $140.3 million | $122.2 million | $185.8 million | $439.3 million |
| Diluted EPS | $0.48 | $0.43 | $0.65 | $1.56 |
| Net interest expense | $16.9 million | $4.0 million | $59.6 million | $14.8 million |
Q3 sales rose 32.9% year over year, or 29.9% excluding favorable currency effects, primarily reflecting Kate Spade and growth in Coach and Stuart Weitzman. Nine-month sales increased 31.1%, or 30.3% excluding currency effects. GAAP nine-month net income fell 57.7%; results included substantial acquisition-related charges and the tax-law transition charge described below.
- Q3 segments: Coach sales were $969.3 million (+5.9%) and operating income was $240.9 million. Kate Spade sales were $269.3 million and operating income was $3.8 million. Stuart Weitzman sales were $83.8 million (+4.8%) and it recorded an $11.6 million operating loss.
- Nine-month segments: Coach sales were $3,122.6 million and operating income was $800.4 million. Kate Spade sales were $972.8 million and it recorded an $85.8 million operating loss on a reported basis. Stuart Weitzman sales were $300.9 million and operating income was $18.1 million.
- Management’s non-GAAP adjustments excluded specified acquisition, integration, restructuring and tax items. On that basis, Q3 diluted EPS was $0.54 versus $0.46; nine-month diluted EPS was $2.03 versus $1.66. These are supplemental, company-defined measures, not GAAP results.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $586.5 million, compared with $530.0 million a year earlier. Investing activities used $2,081.1 million, largely reflecting $2,373.2 million of acquisitions, net of cash acquired. Financing activities used $158.4 million; the company paid $287.1 million in dividends.
- Cash and cash equivalents were $1,031.7 million at March 31, 2018, down from $2,672.9 million at July 1, 2017. Short- and long-term investments totaled $6.7 million.
- Reported long-term debt, net, was $1,599.5 million; outstanding senior notes had $1.6 billion aggregate principal. No borrowings were outstanding under the $900 million revolving credit facility. The company reported total available liquidity of $1,938.4 million, including cash, investments and the undrawn revolver.
- Approximately 67% of cash and short-term investments were held outside the United States. Management said operating cash flow, cash, credit access and capital-market access should support foreseeable operating, capital and debt-service needs, while noting funding depends on future performance and market conditions.
- Fiscal 2018 capital expenditures were expected to be approximately $300 million. The filing does not provide a clear revenue or earnings forecast.
Material changes, outlook and risks
- Acquisitions and costs: Kate Spade was acquired for approximately $2.4 billion. The company recorded $271.3 million of integration and acquisition-related charges in the first nine months, including $110.9 million in cost of sales and $160.4 million in SG&A. It expected a further $20–30 million of pre-tax charges in the remainder of fiscal 2018, including $5–10 million expected to be non-cash. The Operational Efficiency Plan had incurred $77.4 million cumulatively, with about $5 million of additional charges expected.
- Tax legislation: The company recorded a provisional $304.3 million transition-tax charge and a $104.7 million benefit from deferred-tax remeasurement, among other tax effects. It expected the full fiscal 2018 transition tax to be approximately $315 million, payable over eight years, with the first payment expected in fiscal 2019. These estimates remained subject to refinement. The U.S. federal statutory rate was 28% for fiscal 2018 and was expected to be 21% from fiscal 2019.
- Trading and brand risks: Management described inconsistent retail traffic, promotional pressure, competition and constrained discretionary spending. Stuart Weitzman faced production delays and supply-chain challenges, hurting sales and margins; management expected some negative effects through the Fall/Winter season while adding capacity and infrastructure. Kate Spade comparable-store sales fell 9.3% in Q3, mainly due to a strategic reduction in Internet flash sales. Coach comparable-store sales rose 2.8% in Q3.
- Other exposures: Foreign-exchange volatility, geopolitical and economic uncertainty, changing fashion trends, and potential store impairments were cited as risks. Stuart Weitzman’s fair value exceeded carrying value by a relatively limited margin; management said further profitability declines could lead to an impairment test and possible impairment. The company also cited a 20-year headquarters lease commitment of approximately $1.05 billion, partly offset by a sublease that was expected to begin generating rent in 2019.
- The company reported routine legal proceedings and stated that their aggregate outcome was not expected to have a material adverse effect. It reported effective disclosure controls and no material changes to internal control over financial reporting during the quarter.
Important facts for investors to verify
- How Kate Spade and the newly consolidated distributor and joint-venture operations perform on a comparable, post-acquisition basis, and whether expected acquisition synergies are realized.
- Whether integration costs remain within the stated estimate, and how much of reported profit and margin changes reflect recurring operations versus purchase-accounting and other excluded charges.
- Final transition-tax and deferred-tax calculations, including potential GILTI exposure and the timing of cash tax payments.
- Whether Stuart Weitzman resolves production and delivery issues, restores margins and avoids impairment; and whether Kate Spade’s sales trends stabilize.
- Cash generation, debt service, dividend capacity and liquidity after acquisition spending, capital expenditures and tax payments.