Capri Holdings Ltd annual report, FY2020

Business context and reporting period

Capri Holdings Limited’s fiscal 2020 Form 10-K covers the 52 weeks ended March 28, 2020, with comparison to the 52 weeks ended March 30, 2019. Capri is a global luxury group comprising Versace, Jimmy Choo and Michael Kors. Versace was consolidated from December 31, 2018, so fiscal 2020 includes a full year of Versace revenue while fiscal 2019 includes only a partial year. The filing was signed July 8, 2020 and includes important subsequent events.

Financial performance and liquidity

Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.

Metric	Fiscal 2020	Fiscal 2019
Revenue	$5,551	$5,238
Gross profit / gross margin	$3,271 / 58.9%	$3,180 / 60.7%
Operating income (loss) / margin	($192) / (3.5%)	$735 / 14.0%
Net income (loss) attributable to Capri	($223)	$543
Diluted earnings (loss) per share	($1.48)	$3.58
Cash from operating activities	$859	$694
Capital expenditures	$223	$181
Cash and cash equivalents at year-end	$592	$172
Working capital at year-end	$493	$187

• Revenue rose 6.0% as reported, or 6.8% at constant currency. The increase chiefly reflects approximately $723 million of incremental Versace revenue from the acquisition and full-year consolidation; Jimmy Choo and Michael Kors revenue declined, with COVID-19 contributing to the decreases.
• Gross margin fell 180 basis points. Capri cited $92 million of incremental COVID-19 inventory reserves and increased Michael Kors markdowns; Versace’s inclusion partly offset the decline.
• Operating expenses rose 41.6% to $3,463 million, including $708 million of impairment charges, compared with $21 million in fiscal 2019. The impairment included $357 million for retail long-lived assets, $171 million for Jimmy Choo goodwill and $180 million for the Jimmy Choo brand intangible asset. Capri also recorded $119 million of COVID-19-related charges, principally inventory reserves and bad debt provisions; these are included in reported expenses, not additional to them.
• Cash from operations increased despite the net loss, mainly because of working-capital movements, including reduced inventory purchases and payment/receipt timing. Investing cash flow was positive $62 million, including proceeds from terminating euro net-investment hedges. Financing cash flow was negative $497 million.
• At March 28, 2020, debt carrying value was approximately $2.179 billion: $167 million short-term and $2.012 billion long-term. Debt was approximately $2.2 billion before unamortized issuance costs and discount. The company also reported $2.188 billion of operating lease liabilities after adopting ASC 842; undiscounted operating lease payments totaled $2.407 billion.
• Revolving facilities had $720 million outstanding and $301 million of availability under the main $1 billion facility; total remaining availability across listed facilities was $356 million. These amounts are at fiscal year-end and should not be taken as current liquidity.

Brand and segment results

• Versace: revenue $843 million versus $137 million in fiscal 2019, reflecting the differing consolidation periods; operating loss was $8 million versus $11 million.
• Jimmy Choo: revenue declined 5.9% to $555 million; operating result shifted to a $13 million loss from $20 million income.
• Michael Kors: revenue declined 7.9% to $4.153 billion; operating income fell 11.8% to $850 million. E-commerce sales increased 9%, partly offsetting lower accessories and watch sales and weaker comparable-store sales.

Material changes versus the prior comparable period

• Capri moved from $543 million of attributable net income to a $223 million attributable net loss, and from a 14.0% operating margin to a 3.5% operating loss margin. The comparison was materially affected by impairments, pandemic-related reserves and costs, and the different Versace consolidation periods.
• Year-end cash increased by $420 million, while cash from operations rose by $165 million. Lower inventory purchases helped cash generation; the $296 million cash receipt from terminating euro net-investment hedges supported investing cash flow.
• The company adopted ASC 842 lease accounting in fiscal 2020, recognizing $1.625 billion of right-of-use assets and $2.188 billion of lease liabilities at year-end. Adoption also reduced opening retained earnings by $152 million, net of tax, for impairment of certain lease assets.
• Capri completed its prior Michael Kors store optimization plan, closing 143 stores at a total cost of $99 million. The total store count at fiscal year-end was 1,271, compared with 1,249 a year earlier.

Outlook, risks, contingencies and unusual items

• COVID-19: Store closures, reduced traffic and tourism, weaker discretionary spending, wholesale customer stress, order cancellations, delayed receivable collections and supply-chain disruption materially affected results and created continuing uncertainty. Capri said it could not reliably predict the pandemic’s duration or financial impact and might not provide quarterly or year-end guidance for the foreseeable future.
• Liquidity and debt: Subsequent to year-end, the June 25, 2020 credit amendment added a $230 million 364-day revolving facility, waived the specified leverage covenant through the quarter ending June 26, 2021, and introduced minimum liquidity requirements of $300 million, rising to $400 million on October 1, 2020 and $500 million on December 1, 2020. It also added collateral and other restrictions. The leverage covenant is scheduled to return with a maximum net leverage ratio of 4.00:1.0. Capri disclosed that ratings were downgraded by Moody’s in March 2020 and Fitch in April 2020.
• After year-end, Capri reported approximately $328 million of net payments during fiscal 2021 to reduce revolving-facility borrowings. It expected fiscal 2021 capital expenditures of approximately $130 million, substantially below fiscal 2020, and had suspended share repurchases.
• Store plans: On July 7, 2020, the board approved a plan to close approximately 170 stores over fiscal 2021 and fiscal 2022, with expected one-time costs of approximately $75 million; the timing and amount of actual charges were not yet determinable. Capri also disclosed that it had suspended rent payments on certain closed North American and European stores and was negotiating with landlords, creating potential dispute, litigation and lease-termination risks.
• Other material risks: High fixed lease commitments, substantial indebtedness and covenant compliance; further impairment risk, particularly for Jimmy Choo and Versace; reliance on wholesale customers and third-party manufacturers; competitive discounting and excess inventory; foreign-exchange and tariff exposure; cyber and systems risks; and tax exposures. Versace’s retail reporting-unit fair value exceeded carrying value by only 4%, and its wholesale brand intangible fair value exceeded carrying value by 3%, making the stated headroom sensitive to assumptions.
• Management stated that cash, operating cash flows and available revolving borrowings were expected to meet working-capital needs for the next 12 months, while also emphasizing that pandemic conditions could materially affect cash flows and access to credit. Bain-Altagamma forecast a 20%–35% contraction in the personal luxury goods market in 2020; this is an industry forecast cited by Capri, not company guidance.
• Ernst & Young issued an unqualified opinion on the consolidated financial statements and internal control over financial reporting. The audit highlighted impairment valuation, lease accounting adoption and retail-asset impairment as critical audit matters. Capri reported routine legal proceedings and did not believe their aggregate outcome would be material.

Important facts for investors to verify

1. Current cash, revolver availability, debt outstanding and compliance with the amended credit facility’s stepped liquidity requirements and reinstated leverage covenant.
2. Store reopening, traffic, e-commerce trends, wholesale orders, receivable collections and inventory levels after March 28, 2020.
3. The assumptions and sensitivity behind the $708 million impairment, including Jimmy Choo valuations and the limited reported Versace fair-value headroom.
4. Actual costs, cash savings and timing for the planned 170 store closures, together with outcomes of rent negotiations and any landlord disputes.
5. Whether operating cash flow remains sustainable after the temporary benefit of reduced inventory purchases and working-capital timing.