Coach Inc. Predicts Lower Profitability As It Integrates the Kate Spade Brand

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Coach (NYSE: COH) this week announced results for its fiscal fourth quarter, and gave investors an updated prediction for the year ahead.

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More on that new operating forecast in a moment. First, here's how the latest headline numbers compared to the prior year period:

 Metric

Q4 2017

Q4 2016

Year-Over-Year Change

Revenue

$1.13 billion

$1.15 billion

(2%)

Net Income

$152 million

$82 million

85%

EPS

$0.53

$0.29

83%

What happened this quarter?

Revenue ticked lower, but only because the prior year period included an extra sales week. After accounting for that calendar shift, Coach managed accelerating sales growth paired with a slight weakening of profitability.

Here are the key highlights of the quarter:

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  • Excluding the extra sales week, Coach brand sales rose 5% compared to a 4% dip last quarter. The bounce was powered by a mix of improving comparable-store sales and higher e-commerce revenue in the U.S. market. Together, these trends offset the lost sales from the company's pullback from the department store sales channel.
  • The international segment expanded at a 9% rate thanks to especially strong demand in China.
  • Gross profit margin slipped to 67% of sales from 69%.
  • Expenses dove, which propelled operating income upward to $193 million from $117 million. Coach's operating margin jumped to 18.6% of sales from 10.7% a year ago. However, operating margin still came in just below management's forecast for the full year.
  • The Stuart Weitzman segment continued its recent trend of solid sales and gross profit growth.

What management had to say

Executives said the results showed progress in Coach's turnaround plan. "Our strong fourth quarter results," CEO Victor Luis said in a press release, "capped an excellent [fiscal 2017] performance for the company." The highlights of the year included a double-digit boost in net income, improving comps in the U.S. market, and solid international sales in Europe and China, management explained.

At the same time, Luis and his team believe they made big strides in repositioning the luxury brand through marketing and product shifts and major acquisitions. "We are evolving to drive our long-term success by reinventing ourselves, moving from a single-brand, specialty retailer, to a true house of emotional, desirable brands built on our unique values," Luis said.

Looking forward

Management's fiscal 2018 forecast was a mixed bag for investors. The good news for shareholders is that the Kate Spade acquisition will help revenue soar by about 30% over the next year, Coach predicted. Yet the boost should include only modest organic growth (in the low single digits) and will come mainly from the simple addition of Kate Spade's $1.2 billion of annual revenue.

Coach's profit margin, meanwhile, is projected to slump as the company works to integrate the Kate Spade business. As part of that combination strategy, Luis and his executive team plan to pull the brand back from more promotional sales channels, which will hurt earnings. In fact, operating income is projected to rise by between 22% and 25%, trailing the expected 30% spike in revenue.

The retailer is also predicting elevated expenses during the year that will only be partially offset by the savings management is expecting to come directly from the merger. Thus, Coach projects a profit increase of between 10% and 12% in fiscal 2018 as earnings rise to between $2.35 per share and $2.40 per share.

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Demitrios Kalogeropoulos has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Coach. The Motley Fool has a disclosure policy.