ITEM 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations.
General
Unless the context indicates otherwise, when we refer to “we,” “us,” “our” or the “Company” in this Form 10‑Q, we are referring to Guess?, Inc. (“GUESS?”) and its subsidiaries on a consolidated basis.
Forward-Looking Statements
This Quarterly Report on Form 10-Q, including documents incorporated by reference herein, contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may also be contained in our other reports filed under the Securities Exchange Act of 1934, as amended, in its press releases and in other documents.
Except for historical information contained herein, certain matters discussed in this Quarterly Report, including statements concerning the potential actions and impacts related to the COVID-19 pandemic; statements concerning our future outlook; statements concerning our expectations, goals, future prospects, global cost reduction opportunities, profitability efforts, capital allocation plans, cash needs and current business strategies and strategic initiatives; and statements expressing optimism or pessimism about future opportunities are forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements, which are frequently indicated by terms such as “expect,” “could,” “will,” “should,” “goal,” “strategy,” “believe,” “estimate,” “continue,” “outlook,” “plan,” “create,” “see,” and similar terms, are only expectations, and involve known and unknown risks and uncertainties, which may cause actual results in future periods to differ materially from what is currently anticipated. Factors which may cause actual results in future periods to differ materially from current expectations include, among others: our ability to maintain our brand image and reputation; domestic and international economic or political conditions, including economic and other events that could negatively impact consumer confidence and discretionary consumer spending; the continuation or worsening of impacts related to the COVID-19 pandemic, including business, financial, human capital, litigation and other impacts to us and its partners; our ability to successfully negotiate rent relief or other lease-related terms with our landlords; our ability to maintain adequate levels of liquidity; changes to estimates related to impairments, inventory and other reserves, including the impact of the CARES Act, which were made using the best information available at the time; changes in the competitive marketplace and in our commercial relationships; our ability to anticipate and adapt to changing consumer preferences and trends; our ability to manage our inventory commensurate with customer demand; risks related to the timing and costs of delivering merchandise to our stores and our wholesale customers; unexpected or unseasonable weather conditions; our ability to effectively operate our various retail concepts, including securing, renewing, modifying or terminating leases for store locations; our ability to successfully and/or timely implement our growth strategies and other strategic initiatives; our ability to successfully implement or update information technology systems, including enhancing our global omni-channel capabilities; our ability to expand internationally and operate in regions where we have less experience, including through joint ventures; risks related to our convertible senior notes issued in April 2019, including our ability to settle the liability in cash; our ability to successfully or timely implement plans for cost reductions; our ability to effectively and efficiently manage the volume and costs associated with our European distribution centers without incurring shipment delays; our ability to attract and retain key personnel; obligations or changes in estimates arising from new or existing litigation, income tax and other regulatory proceedings; risks related to the complexity of the Tax Reform, future clarifications and legislative amendments thereto, as well as our ability to accurately interpret and predict its impact on our cash flows and financial condition; the risk of economic uncertainty associated with the United Kingdom’s departure from the European Union (“Brexit”) or any other similar referendums that may be held; the occurrence of unforeseen epidemics, such as the COVID-19 pandemic; other catastrophic events; changes in U.S. or foreign income tax or tariff policy, including changes to tariffs on imports into the U.S.; accounting adjustments to our unaudited financial statements identified during the completion of our annual independent audit of financial statements and financial controls or from subsequent events arising after issuance of this release; risk of future non-cash asset impairments, including goodwill, right-of-use lease assets and/or other
store asset impairments; restructuring charges; our ability to adapt to new regulatory compliance and disclosure obligations; risks associated with our foreign operations, such as violations of laws prohibiting improper payments and the burdens of complying with a variety of foreign laws and regulations (including global data privacy regulations); risks associated with the acts or omissions of our third party vendors, including a failure to comply with our vendor code of conduct or other policies; risks associated with cyber-attacks and other cyber security risks; risks associated with our ability to properly collect, use, manage and secure consumer and employee data; risks associated with our vendors’ ability to maintain the strength and security of information technology systems; and changes in economic, political, social and other conditions affecting our foreign operations and sourcing, including the impact of currency fluctuations, global income tax rates and economic and market conditions in the various countries in which we operate. In addition to these factors, the economic, technological, managerial, and other risks identified in our most recent annual report on Form 10-K, under “Part II, Item 1A. Risk Factors” contained herein, and other filings with the Securities and Exchange Commission, including but not limited to the risk factors discussed therein, could cause actual results to differ materially from current expectations. The current global economic climate, length and severity of the COVID-19 pandemic, and uncertainty surrounding potential changes in U.S. policies and regulations may amplify many of these risks. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
COVID-19 Business Update
The coronavirus (or “COVID-19”) pandemic is continuing to impact the Company’s businesses. During the first quarter of fiscal 2022, the Company experienced significantly higher net revenue compared to the first quarter of fiscal 2021 (when government-mandated store closures were much more widespread) but lower net revenue compared to the pre-pandemic first quarter of fiscal 2020 as it remained challenged by lower demand, temporary store closures and capacity restrictions. In light of the current environment, we continue to strategically manage expenses in order to protect profitability.
In late fiscal 2021, the Company incurred a new round of government-mandated temporary store closures, mostly in Europe. The number of temporarily closed stores ebbed and flowed during the first quarter of fiscal 2022 based on local conditions. The overall impact resulted in stores being closed for less than 20% of the total days during the first quarter of fiscal 2022, primarily in Europe and Canada. As of May 1, 2021 80% of our stores were open, with the majority of closed stores located primarily in Europe and Canada. As of May 19, 2021 nearly 95% of our stores were open.
Business Segments
The Company’s businesses are grouped into five reportable segments for management and internal financial reporting purposes: Americas Retail, Americas Wholesale, Europe, Asia and Licensing. The Company’s Americas Retail, Americas Wholesale, Europe and Licensing reportable segments are the same as their respective operating segments. Certain components of the Company’s Asia operating segment are separate operating segments based on region, which have been aggregated into the Asia reportable segment for disclosure purposes.
Management evaluates segment performance based primarily on revenues and earnings (loss) from operations before corporate performance-based compensation costs, asset impairment charges, net gains (losses) on lease modifications, restructuring charges and certain non-recurring credits (charges), if any. The Company believes this segment reporting reflects how its business segments are managed and how each segment’s performance is evaluated by the Company’s chief operating decision maker to assess performance and make resource allocation decisions. Information regarding these segments is summarized in “Part I, Item 1. Financial Statements – Note 8 – Segment Information.”
Products
We derive our net revenue from the sale of GUESS?, G by GUESS (GbG), GUESS Kids and MARCIANO apparel and our licensees’ products through our worldwide network of directly-operated and
licensed retail stores, wholesale customers and distributors, as well as our online sites. We also derive royalty revenue from worldwide licensing activities.
Foreign Currency Volatility
Since the majority of our international operations are conducted in currencies other than the U.S. dollar (primarily the British pound, Canadian dollar, Chinese yuan, euro, Japanese yen, Korean won, Mexican peso, Polish zloty, Russian rouble and Turkish lira), currency fluctuations can have a significant impact on the translation of our international revenues and earnings (loss) into U.S. dollar amounts.
Some of our transactions that occur primarily in Europe, Canada, South Korea, China, Hong Kong and Mexico are denominated in U.S. dollars, Swiss francs, British pounds and Russian roubles, exposing them to exchange rate fluctuations when these transactions (such as inventory purchases or periodic lease payments) are converted to their functional currencies. As a result, fluctuations in exchange rates can impact the operating margins of our foreign operations and reported earnings (loss), and are largely dependent on the transaction timing and magnitude during the period that the currency fluctuates. When these foreign exchange rates weaken versus the U.S. dollar at the time the respective U.S. dollar denominated payment is made relative to the payments made in the comparable period, our product margins could be unfavorably impacted.
In addition, there are certain real estate leases that are denominated in a currency other than the functional currency of the respective entity that entered into the agreement (primarily Swiss francs, Russian roubles and Polish zloty). As a result, the Company may be exposed to volatility related to unrealized gains or losses on the translation of present value of future lease payment obligations when translated at the exchange rate as of a reporting period-end.
During the first three months of fiscal 2022, the average U.S. dollar rate was weaker against the Euro, Canadian dollar, Chinese yuan, Mexican peso, Japanese Yen and Korean won, and stronger against the Russian Ruble and Turkish lira compared to the average rate in the same prior-year period. This had an overall favorable impact on the translation of our international revenues and an unfavorable impact on earnings from operations for the three months ended May 1, 2021 compared to the same prior-year period.
If the U.S. dollar strengthens in fiscal 2022 relative to the respective fiscal 2021 foreign exchange rates, foreign exchange could negatively impact our revenues and operating results, as well as our international cash and other balance sheet items, during the remainder of fiscal 2022, particularly in Canada, Europe (primarily with respect to the euro, Turkish lira and Russian rouble) and Mexico. Alternatively, if the U.S. dollar weakens relative to the respective fiscal 2021 foreign exchange rates, our revenues and operating results, as well as our other cash balance sheet items, could be positively impacted by foreign currency fluctuations during the remainder of fiscal 2022, particularly in these regions.
The Company enters into derivative financial instruments to offset some, but not all, of the exchange risk on foreign currency transactions. For additional discussion regarding our exposure to foreign currency risk, forward contracts designated as hedging instruments and forward contracts not designated as hedging instruments, refer to “Item 3. Quantitative and Qualitative Disclosures About Market Risk.”
Strategy
In December 2019 and updated in March 2021, Carlos Alberini, the Company’s Chief Executive Officer, shared his strategic vision and implementation plan for execution which included the identification of several key priorities to drive revenue and operating profit growth over the next several years. These priorities are: (i) brand relevancy; (ii) product excellence; (iii) customer centricity; (iv) global footprint; and (v) functional capabilities; each as further described below:
Brand Relevancy. We plan to optimize our brand architecture to be relevant with our three target consumer groups: Heritage, Millennials, and Generation Z. We also plan to elevate our brand and improve the quality of our products. We will continue to use unique go-to-market strategies and execute celebrity and influencer partnerships and collaborations as we believe that they are critical to engage more effectively with a younger and broader audience.
Product Excellence. We believe product is a key factor of success in our business. We strive to design and make great products and will extend our product offering to provide our customers with products for the different occasions of their lifestyles. We will seek to better address local product needs.
Customer Centricity. We intend to place the customer at the center of everything we do. We plan to implement processes and platforms to provide our customers with a seamless omni-channel experience.
Global Footprint. We will continue to expand the reach of our brands by optimizing the productivity and profitability of our current footprint and expanding our distribution channels.
Functional Capabilities. We expect to drive material operational improvements in the next four years to leverage and support our global business more effectively, primarily in the areas of logistics, sourcing, product development and production, inventory management, and overall infrastructure.
Capital Allocation
We plan to continue to prioritize capital allocation toward investments that support growth and infrastructure, while remaining highly disciplined in the way we allocate capital across projects, including new store development, store remodels, technology and logistics investments and others. When we prioritize investments, we will focus on their strategic significance and their return on invested capital expectations. We also plan to manage product buys and inventory ownership rigorously and optimize overall working capital management consistently.
Comparable Store Sales
The Company reports National Retail Federation calendar comparable store sales on a quarterly basis for our retail businesses which include the combined results from our brick-and-mortar retail stores and our e-commerce sites. We also separately report the impact of e-commerce sales on our comparable store sales metric. As a result of our omni-channel strategy, our e-commerce business has become strongly intertwined with our brick-and-mortar retail store business. Therefore, we believe that the inclusion of e-commerce sales in our comparable store sales metric provides a more meaningful representation of our retail results.
Sales from our brick-and-mortar retail stores include purchases that are initiated, paid for and fulfilled at our retail stores and directly-operated concessions as well as merchandise that is reserved online but paid for and picked up at our retail stores. Sales from our e-commerce sites include purchases that are initiated and paid for online and shipped from either our distribution centers or our retail stores as well as purchases that are initiated in a retail store, but due to inventory availability at the retail store, are ordered and paid for online and shipped from our distribution centers or picked up from a different retail store.
Store sales are considered comparable after the store has been open for 13 full fiscal months. If a store remodel results in a square footage change of more than 15%, or involves a relocation or a change in store concept, the store sales are removed from the comparable store base until the store has been opened at its new size, in its new location or under its new concept for 13 full fiscal months. Stores that are permanently closed or temporarily closed (including as a result of pandemic-related closures) for more than seven days in any fiscal month are excluded from the calculation in the fiscal month that they are closed. E-commerce sales are considered comparable after the online site has been operational in a country for 13 full fiscal months and exclude any related revenue from shipping fees. These criteria are consistent with the metric used by management for internal reporting and analysis to measure performance of the store or online sites. Definitions and calculations of comparable store sales used by the Company may differ from similarly titled measures reported by other companies.
As a result of the significant and varying temporary store closures and various other restrictions during the COVID-19 pandemic, both in fiscal 2021 and 2022, the Company believes that comparable store sales during these periods are not as meaningful to the evaluation of the Company’s results as they would be during more normalized periods.
Other
The Company operates on a 52/53-week fiscal year calendar, which ends on the Saturday nearest to January 31 of each year. The three months ended May 1, 2021 had the same number of days as the three months ended May 2, 2020.
Executive Summary
Overview
Net earnings attributable to Guess?, Inc. increased 107.6% to $12.0 million, or diluted earnings of $0.18 per common share, for the quarter ended May 1, 2021, compared to net loss attributable to Guess?, Inc. of $157.7 million, or diluted loss of $2.40 per common share, for the quarter ended May 2, 2020.
During the quarter ended May 1, 2021, the Company recognized $0.4 million of asset impairment charges; $2.1 million net gains on lease modifications; $1.1 million of certain professional services and legal fees and related net credits; $2.8 million of amortization of debt discount related to the Company’s convertible senior notes; and $0.1 million in additional tax expense from certain discrete tax adjustments (or a combined $1.9 million, or $0.03 per share, negative impact after considering the related tax benefit of these adjustments of $0.4 million). Excluding the impact of these items, adjusted net earnings attributable to Guess?, Inc. were $13.9 million and adjusted diluted earnings were $0.21 per common share for the quarter ended May 1, 2021. During the quarter ended May 2, 2020, the Company recognized $53.0 million of asset impairment charges; $0.5 million of net losses on lease terminations; $0.3 million of certain professional services and legal fees and related net credits; $0.2 million of separation charges; $2.6 million of amortization of debt discount related to the Company’s convertible senior notes; and a benefit of $7.9 million from certain discrete tax adjustments (or a combined $38.8 million, or $0.59 per share, negative impact after considering the related tax benefit of these adjustments of $9.8 million). Excluding the impact of these items, adjusted net loss attributable to Guess?, Inc. was $118.9 million and adjusted diluted loss was $1.81 per common share for the quarter ended May 2, 2020. References to financial results excluding the impact of these items are non-GAAP measures and are addressed below under “Non-GAAP Measures.”
Highlights of the Company’s performance for the quarter ended May 1, 2021 compared to the same prior-year period are presented below followed by a more comprehensive discussion under “Results of Operations”:
Operations
•Total net revenue increased 99.8% to $520.0 million for the quarter ended May 1, 2021, from $260.3 million in the same prior-year quarter. In constant currency, net revenue increased by 90.3%.
•Gross margin (gross profit as a percentage of total net revenue) increased 27.5% to 40.7% for the quarter ended May 1, 2021, from 13.2% in the same prior-year period.
•Selling, general and administrative (“SG&A”) expenses as a percentage of total net revenue (“SG&A rate”) decreased 19.1% to 35.9% for the quarter ended May 1, 2021, compared to 55.0% in the same prior-year period. SG&A expenses increased 30.3% to $186.7 million for the quarter ended May 1, 2021, from $143.3 million in the same prior-year period.
•During the quarter ended May 1, 2021, the Company recognized asset impairment charges of $0.4 million, compared to $53.0 million in the same prior-year period.
•Operating margin increased 67.5% to 5.1% for the quarter ended May 1, 2021, compared to negative 62.4% in the same prior-year period, driven primarily by overall leveraging of expenses. Lower asset impairment charges favorably impacted operating margin by 20.3% during the quarter ended May 1, 2021 compared to the same prior-year period. Earnings from operations were $26.6 million for the quarter ended May 1, 2021, compared to losses from operations of $162.5 million in the same prior-year period.
•Other expense, net (including interest income and expense), was $8.3 million for the quarter ended May 1, 2021, compared to $24.4 million in the same prior-year period.
•The effective income tax rate was an expense of 29.8% for the quarter ended May 1, 2021, compared to a benefit of 14.1% in the same prior-year period. The Company’s effective income tax rate for the quarter ended May 2, 2020 included the favorable impact from certain discrete income tax adjustments totaling $7.9 million.
Key Balance Sheet Accounts
•The Company had $395.1 million in cash and cash equivalents and $0.2 million in restricted cash as of May 1, 2021, compared to $419.4 million in cash and cash equivalents and $0.2 million in restricted cash at May 2, 2020.
◦As of May 1, 2021, the Company had $56.0 million in outstanding borrowings under its term loans and $5.1 million in outstanding borrowings under its credit facilities compared to $193.7 million in outstanding borrowings under its credit facilities and $24.7 million in outstanding borrowings under its term loans as of May 2, 2020.
◦There were no share repurchases during the quarters ended May 1, 2021 and May 2, 2020.
•Accounts receivable consists of trade receivables relating primarily to the Company’s wholesale business in Europe and, to a lesser extent, to its wholesale businesses in the Americas and Asia, royalty receivables relating to its licensing operations, credit card and retail concession receivables related to its retail businesses and certain other receivables. Accounts receivable increased by $66.8 million, or 27.9%, to $306.3 million as of May 1, 2021 compared to $239.5 million at May 2, 2020. On a constant currency basis, accounts receivable increased by $45.7 million, or 19.1%, when compared to May 2, 2020.
•Inventory increased by $12.4 million, or 3.1%, to $404.9 million as of May 1, 2021, from $392.5 million at May 2, 2020. On a constant currency basis, inventory decreased by $15.7 million, or 4.0%, when compared to May 2, 2020.
Global Store Count
In the first quarter of fiscal 2022, together with our partners, we opened 34 new stores worldwide, consisting of ten stores in Europe and the Middle East and 24 stores in Asia and the Pacific. Together with our partners, we closed 24 stores worldwide, consisting of ten stores in Asia and the Pacific, seven stores in Europe and the Middle East, five stores in the U.S., and two stores in Canada.
We ended the first quarter of fiscal 2022 with 1,580 stores and 362 concessions worldwide, comprised as follows:
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Stores
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Concessions
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Region
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Total
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Directly-Operated
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Partner Operated
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Total
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Directly-Operated
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Partner Operated
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United States
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246
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244
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2
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1
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—
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1
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Canada
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74
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74
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—
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—
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—
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—
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Central and South America
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105
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70
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35
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29
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29
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—
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Total Americas
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425
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388
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37
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30
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29
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1
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Europe and the Middle East
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728
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511
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217
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45
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45
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—
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Asia and the Pacific
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427
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142
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285
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287
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92
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195
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Total
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1,580
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1,041
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539
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362
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166
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196
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Of the total 1,580 stores, 1,316 were GUESS? stores, 171 were GUESS? Accessories stores, 58 were G by GUESS (GbG) stores and 35 were MARCIANO stores.
Results of Operations
Three Months Ended May 1, 2021 and May 2, 2020
Consolidated Results
Net Revenue. Net revenue increased by $259.8 million, or 99.8%, to $520.0 million for the quarter ended May 1, 2021, from $260.3 million for the quarter ended May 2, 2020. In constant currency, net revenue increased by 90.3%, driven by lower comparable sales driven by reduced store traffic and temporary store closures resulting from the COVID-19 pandemic in the same prior-year period and, to a lesser extent, a shift in European wholesale shipments into fiscal 2022. Currency translation fluctuations relating to our foreign operations favorably impacted net revenue by $24.8 million, compared to the same prior-year period.
Gross Margin. Gross margin increased 27.5% to 40.7% for the quarter ended May 1, 2021, compared to 13.2% in the same prior-year period, of which 21.0% was due to lower occupancy rate and 650 basis points was due to higher product margins. The lower occupancy rate resulted primarily from leveraging occupancy costs due mainly to the impact of prior-year temporary store closures in Americas Retail and, to a lesser extent, a shift in European wholesale shipments into fiscal 2022. The product margins were higher as the prior year’s quarter included significant inventory reserves.
Gross Profit. Gross profit increased by $177.3 million, or 518.1%, to $211.6 million for the quarter ended May 1, 2021, compared to $34.2 million in the same prior-year period. The increase in gross profit, which included the favorable impact of currency translation, was due primarily to the favorable impact on gross profit from higher revenue, as well as lower occupancy costs. Currency translation fluctuations relating to our foreign operations favorably impacted gross profit by $8.1 million.
The Company includes inbound freight charges, purchasing costs and related overhead, retail store occupancy costs, including lease costs and depreciation and amortization, and a portion of the Company’s distribution costs related to its retail business in cost of product sales. The Company also includes net royalties received on the Company’s inventory purchases of licensed product as a reduction to cost of product sales. The Company’s gross margin may not be comparable to that of other entities since some entities include all of the costs related to their distribution in cost of product sales and others, like the Company, generally exclude wholesale-related distribution costs from gross margin, including them instead in SG&A expenses. Additionally, some entities include retail store occupancy costs in SG&A expenses and others, like the Company, include retail store occupancy costs in cost of product sales.
SG&A Rate. The Company’s SG&A rate decreased 19.1% to 35.9% for the quarter ended May 1, 2021, from 55.0% in the same prior-year period, driven by leveraging of expenses due to higher European wholesale revenues and, to a lesser extent, temporary store closures in Americas Retail in the same prior-year period.
SG&A Expenses. SG&A expenses increased by $43.4 million, or 30.3%, to $186.7 million for the quarter ended May 1, 2021, from $143.3 million in the same prior-year period. The increase, which included the unfavorable impact of currency translation, was driven primarily by higher variable expenses in the current year quarter as well as lower payroll and overall discretionary expenses due to significant COVID-19 impacts in the same prior-year period. Currency translation fluctuations relating to our foreign operations unfavorably impacted SG&A expenses by $9.0 million.
Asset Impairment Charges. During the quarter ended May 1, 2021, the Company recognized minimal impairment of certain operating lease right-of-use (“ROU”) assets and $0.4 million of impairment charges of property and equipment related to certain retail locations compared to impairments of $28.2 million of certain operating lease ROU assets and $24.8 million of property and equipment during the quarter ended May 2, 2020, resulting from lower revenue and future cash flow projections from the ongoing effects of the COVID-19 pandemic. Currency translation fluctuations relating to our foreign operations had minimal unfavorable impact on asset impairment charges.
Operating Margin. Operating margin increased 67.5% to 5.1% for the quarter ended May 1, 2021, compared to negative 62.4% in the same prior-year period, driven primarily by overall leveraging of expenses and, to a
lesser extent, lower asset impairment charges. Lower asset impairment charges favorably impacted operating margin by 20.3% during the quarter ended May 1, 2021 compared to the same prior-year period. Excluding the impact of lower asset impairment charges, net gains on lease modifications compared to net losses on lease modifications, and increased expenses related to certain professional services and legal fees and related net credits, the Company’s operating margin would have increased 46.7% compared to the same prior-year period. The negative impact of currency on operating margin for the quarter was approximately 40 basis points.
Earnings from Operations. Earnings from operations increased by $189.1 million, or 116.4%, to $26.6 million for the quarter ended May 1, 2021, compared to a loss from operations of $162.5 million in the same prior-year period. Currency translation fluctuations relating to our foreign operations unfavorably impacted earnings from operations by $0.7 million.
Interest Expense, Net. Interest expense, net, was $5.6 million for the quarter ended May 1, 2021, compared to $4.9 million for the quarter ended May 2, 2020.
Other Expense, Net. Other expense, net, was $2.7 million for the quarter ended May 1, 2021, compared to $19.6 million in the same prior-year period. The change was driven primarily by market volatility which resulted in lower net unrealized losses on the translation of foreign currency balances compared to higher net unrealized losses in the quarter ended May 2, 2020.
Income Tax Expense (Benefit). Income tax expense for the quarter ended May 1, 2021 was $5.5 million, or a 29.8% effective tax rate, compared to income tax benefit of $26.4 million, or a 14.1% effective tax rate, in the same prior-year period. Generally, income taxes for the interim periods are computed using the tax rate estimated to be applicable for the full fiscal year, adjusted for discrete items, which is subject to ongoing review and evaluation by management.
During the three months ended May 2, 2020, the Company recognized a tax benefit of approximately $11.8 million from a tax rate change related to the ability to carryback net operating losses to tax years with a higher federal corporate tax rate as allowed under the CARES Act enacted in March 2020. This benefit was partially offset by a valuation allowance of $3.7 million resulting from jurisdictions where there have been cumulative net operating losses, limiting the Company’s ability to consider other subjective evidence to continue to recognize the existing deferred tax assets. Excluding the impact of these items, the increase in the effective tax rate was due primarily to a change in the mix of statutory earnings for the three months ended May 1, 2021, compared to the same prior-year period.
Net Earnings (Loss) Attributable to Noncontrolling Interests. Net earnings (loss) attributable to noncontrolling interests were $0.9 million and $(2.9) million, net of taxes, for the quarters ended May 1, 2021 and May 2, 2020, respectively.
Net Earnings (Loss) Attributable to Guess?, Inc. Net earnings (loss) attributable to Guess?, Inc. were $12.0 million for the quarter ended May 1, 2021, compared to $(157.7) million in the same prior-year period. Diluted earnings per share (“EPS”) were $0.18 for the quarter ended May 1, 2021, compared to diluted loss per share of $2.40 in the same prior-year period. The Company estimates a positive impact from its share buybacks and currency of $0.01 and $0.09, respectively, on diluted EPS in the first quarter of fiscal 2022. During the quarter ended May 1, 2021, the Company recognized $0.4 million of asset impairment charges; $2.1 million net gains on lease modifications; $1.1 million of certain professional services and legal fees and related net credits; $2.8 million of amortization of debt discount related to the Company’s convertible senior notes; and $0.1 million in additional tax expense from certain discrete tax adjustments (or a combined $1.9 million, or $0.03 per share, negative impact after considering the related tax benefit of these adjustments of $0.4 million). Excluding the impact of these items, adjusted net earnings attributable to Guess?, Inc. were $13.9 million and adjusted diluted earnings were $0.21 per common share for the quarter ended May 1, 2021. The Company estimates its share buybacks and currency had a positive impact of $0.01 and $0.09, respectively, on adjusted diluted EPS in the first quarter of fiscal 2022. During the quarter ended May 2, 2020, the Company recognized $53.0 million of asset impairment charges; $0.5 million of net losses on lease terminations; $0.3 million of certain professional services and legal fees and related net credits; $0.2 million of separation charges; $2.6 million of amortization
of debt discount related to the Company’s convertible senior notes; and a benefit of $7.9 million from certain discrete tax adjustments (or a combined $38.8 million, or $0.59 per share, negative impact after considering the related tax benefit of these adjustments of $9.8 million). Excluding the impact of these items, adjusted net loss attributable to Guess?, Inc. was $118.9 million and adjusted diluted loss was $1.81 per common share for the quarter ended May 2, 2020. References to financial results excluding the impact of these items are non-GAAP measures and are addressed below under “Non-GAAP Measures.”
Information by Business Segment
The following table presents our net revenue and earnings (loss) from operations by segment for the three months ended May 1, 2021 and May 2, 2020 (dollars in thousands):
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Three Months Ended
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May 1, 2021
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May 2, 2020
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$ Change
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% Change
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Net revenue:
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Americas Retail
|
$
|
155,535
|
|
|
$
|
74,584
|
|
|
$
|
80,951
|
|
|
108.5
|
%
|
Americas Wholesale
|
45,430
|
|
|
25,875
|
|
|
19,555
|
|
|
75.6
|
%
|
Europe
|
241,852
|
|
|
106,473
|
|
|
135,379
|
|
|
127.1
|
%
|
Asia
|
55,660
|
|
|
40,385
|
|
|
15,275
|
|
|
37.8
|
%
|
Licensing
|
21,525
|
|
|
12,934
|
|
|
8,591
|
|
|
66.4
|
%
|
Total net revenue
|
$
|
520,002
|
|
|
$
|
260,251
|
|
|
$
|
259,751
|
|
|
99.8
|
%
|
Earnings (loss) from operations:
|
|
|
|
|
|
|
|
Americas Retail
|
$
|
20,274
|
|
|
$
|
(36,673)
|
|
|
$
|
56,947
|
|
|
(155.3
|
%)
|
Americas Wholesale
|
11,555
|
|
|
1,624
|
|
|
9,931
|
|
|
611.5
|
%
|
Europe
|
4,198
|
|
|
(44,406)
|
|
|
48,604
|
|
|
(109.5
|
%)
|
Asia
|
(1,808)
|
|
|
(22,777)
|
|
|
20,969
|
|
|
(92.1
|
%)
|
Licensing
|
19,431
|
|
|
10,094
|
|
|
9,337
|
|
|
92.5
|
%
|
Total segment earnings (loss) from operations
|
53,650
|
|
|
(92,138)
|
|
|
145,788
|
|
|
(158.2
|
%)
|
Corporate overhead
|
(28,776)
|
|
|
(16,921)
|
|
|
(11,855)
|
|
|
70.1
|
%
|
|
|
|
|
|
|
|
|
Asset impairment charges
|
(441)
|
|
|
(52,972)
|
|
|
52,531
|
|
|
(99.2
|
%)
|
Net gains (losses) on lease modifications
|
2,145
|
|
|
(456)
|
|
|
2,601
|
|
|
(570.4
|
%)
|
Total earnings (loss) from operations
|
$
|
26,578
|
|
|
$
|
(162,487)
|
|
|
$
|
189,065
|
|
|
(116.4
|
%)
|
|
|
|
|
|
|
|
|
Operating margins:
|
|
|
|
|
|
|
|
Americas Retail
|
13.0
|
%
|
|
(49.2
|
%)
|
|
|
|
|
Americas Wholesale
|
25.4
|
%
|
|
6.3
|
%
|
|
|
|
|
Europe
|
1.7
|
%
|
|
(41.7
|
%)
|
|
|
|
|
Asia
|
(3.2
|
%)
|
|
(56.4
|
%)
|
|
|
|
|
Licensing
|
90.3
|
%
|
|
78.0
|
%
|
|
|
|
|
Total Company
|
5.1
|
%
|
|
(62.4
|
%)
|
|
|
|
|
Americas Retail
Net revenue from our Americas Retail segment increased by $81.0 million, or 108.5%, to $155.5 million for the quarter ended May 1, 2021, from $74.6 million in the same prior-year period. In constant currency, net revenue increased by 105.9%, due primarily to lower comparable sales driven by reduced store traffic and temporary store closures resulting from the COVID-19 pandemic in the same prior-year period. Comparable store sales (including e-commerce) increased 6% in U.S. dollars and 5% in constant currency compared to the same prior-year period. The inclusion of our e-commerce sales increased the comparable sales percentage by 16% in U.S. dollars and constant currency. Excluding the impact from the temporary store closures, the store base for the U.S. and Canada decreased by an average of 37 net stores during the quarter ended May 1, 2021 compared to the same prior-year period, resulting in a 7.7% net decrease in average square footage. Currency translation fluctuations relating to our non-U.S. retail stores and e-commerce sites favorably impacted net revenue by $2.0 million.
Operating margin increased 62.2% to 13.0% for the quarter ended May 1, 2021, from negative 49.2% in the same prior-year quarter, driven primarily by leveraging of expenses as well as lower markdowns.
Earnings from operations from our Americas Retail segment increased by $56.9 million, or 155.3%, to $20.3 million for the quarter ended May 1, 2021, from loss from operations of $36.7 million in the same prior-year period. The increase is due primarily to the favorable impact on earnings from higher revenue and leveraging of expenses.
Americas Wholesale
Net revenue from our Americas Wholesale segment increased by $19.6 million, or 75.6%, to $45.4 million for the quarter ended May 1, 2021, from $25.9 million in the same prior-year period. In constant currency, net revenue increased by 71.0%, driven primarily by increased demand in our U.S. wholesale business. Currency translation fluctuations relating to our non-U.S. wholesale businesses favorably impacted net revenue by $1.2 million.
Operating margin increased 19.1% to 25.4% for the quarter ended May 1, 2021, compared to 6.3% in the same prior-year quarter, due mainly to lower markdowns and leveraging of expenses.
Earnings from operations from our Americas Wholesale segment increased by $9.9 million, or 611.5%, to $11.6 million for the quarter ended May 1, 2021, from $1.6 million in the same prior-year period. The increase reflects the favorable impact on earnings from higher revenue.
Europe
Net revenue from our Europe segment increased by $135.4 million, or 127.1%, to $241.9 million for the quarter ended May 1, 2021, compared to $106.5 million in the same prior-year period. In constant currency, net revenue increased by 110.0%, driven primarily by a shift in wholesale shipments into fiscal 2022. Comparable store sales (including e-commerce) increased 44% in U.S. dollars and 32% in constant currency compared to the same prior-year period. The inclusion of our e-commerce sales increased the comparable sales percentage by 43% in U.S. dollars and 38% in constant currency. As of May 1, 2021, the Company directly operated 511 stores in Europe compared to 517 stores at May 2, 2020, excluding concessions, which represents a 1.2% decrease over the same prior-year period. Currency translation fluctuations relating to our European operations favorably impacted net revenue by $18.2 million.
Operating margin increased 43.4% to 1.7% for the quarter ended May 1, 2021, compared to negative 41.7% in the same prior-year quarter, driven by overall leveraging of expenses due to a shift in wholesale shipments.
Earnings from operations from our Europe segment increased by $48.6 million, or 109.5%, to $4.2 million for the quarter ended May 1, 2021, compared to loss from operations of $44.4 million in the same prior-year period, driven primarily by the favorable impact on earnings from higher revenue and overall leveraging of expenses. Currency translation fluctuations relating to our European operations unfavorably impacted earnings from operations by $1.4 million.
Asia
Net revenue from our Asia segment increased by $15.3 million, or 37.8%, to $55.7 million for the quarter ended May 1, 2021, from $40.4 million in the same prior-year period. In constant currency, net revenue increased by 29.3%, due primarily to lower comparable sales driven by reduced store traffic resulting from the COVID-19 pandemic in the same prior-year period. Comparable store sales (including e-commerce) increased 32% in U.S. dollars and 23% in constant currency. The inclusion of the Company’s e-commerce sales decreased the comparable sales percentage by 11% in U.S. dollars and constant currency. Currency translation fluctuations relating to our Asian operations favorably impacted net revenue by $3.4 million.
Operating margin increased 53.2% to negative 3.2% for the quarter ended May 1, 2021, from negative 56.4% in the same prior-year quarter, as the prior year’s quarter included significant inventory reserves and the current quarter benefited from leveraging of expenses.
Loss from operations from our Asia segment was $1.8 million for the quarter ended May 1, 2021, compared to loss from operations of $22.8 million in the same prior-year period. The decrease was due to
significant inventory reserves in the prior year quarter and the leveraging of expenses in the current year quarter.
Licensing
Net royalty revenue from our Licensing segment increased by $8.6 million, or 66.4%, to $21.5 million for the quarter ended May 1, 2021, from $12.9 million in the same prior-year period, due primarily to higher demand and strong performance in handbags, fragrance, and footwear.
Earnings from operations from our Licensing segment increased by $9.3 million, or 92.5%, to $19.4 million for the quarter ended May 1, 2021, from $10.1 million in the same prior-year period. The increase was mainly due to leveraging of expenses.
Corporate Overhead
Unallocated corporate overhead increased by $11.9 million to $28.8 million for the quarter ended May 1, 2021, compared to $16.9 million in the same prior-year period. The increase was due to lower expenses in the prior year quarter mainly related to expense savings in response to the pandemic and lower performance-based compensation.
Non-GAAP Measures
The financial information presented in this Quarterly Report includes non-GAAP financial measures, such as adjusted results and constant currency financial information. For the three months ended May 1, 2021 and May 2, 2020, the adjusted results exclude the impact of certain professional service, legal fees and related net credits, certain separation charges, asset impairment charges, net (gains) losses on lease modifications, non-cash amortization of debt discount on the Company’s convertible senior notes, the related income tax impacts of these adjustments as well as certain discrete income tax adjustments, where applicable. These non-GAAP measures are provided in addition to, and not as alternatives for, the Company’s reported GAAP results.
These items affect the comparability of the Company’s reported results. The financial results are also presented on a non-GAAP basis, as defined in Section 10(e) of Regulation S-K of the SEC, to exclude the effect of these items. The Company has excluded these items from its adjusted financial measures primarily because it believes these items are not indicative of the underlying performance of its business and the adjusted financial information provided is useful for investors to evaluate the comparability of the Company’s operating results and its future outlook (when reviewed in conjunction with the Company’s GAAP financial statements). A reconciliation of reported GAAP results to comparable non-GAAP results is provided in the accompanying tables.
The adjusted measures for the three months ended May 1, 2021 exclude the impact of $0.4 million of asset impairment charges; $2.1 million net gains on lease modifications; $1.1 million of certain professional services and legal fees and related net credits; $2.8 million of amortization of debt discount on the Company’s convertible senior notes; and $0.1 million in additional tax expense from certain discrete tax adjustments. The asset impairment charges related primarily to impairment of property and equipment related to certain retail locations resulting from lower revenue and future cash flow projections from the ongoing effects of the COVID-19 pandemic. Certain professional service and legal fees and related net credits were primarily due to amounts which the Company otherwise would not have incurred as part of its business operations. These items resulted in a combined $1.9 million negative impact (after considering the related tax benefit of $0.4 million), or an unfavorable $0.03 per share impact during the three months ended May 1, 2021. Net earnings attributable to Guess?, Inc. were $12.0 million and diluted earnings were $0.18 per common share for the three months ended May 1, 2021. Excluding the impact of these items, adjusted net earnings attributable to Guess?, Inc. were $13.9 million and adjusted diluted earnings were $0.21 per common share for the three months ended May 1, 2021.
The adjusted measures for the three months ended May 2, 2020 exclude the impact of $53.0 million of asset impairment charges; $0.5 million of net losses on lease terminations; $0.3 million of certain professional services and legal fees and related net credits; $0.2 million of separation charges; $2.6 million of amortization
of debt discount on the Company’s convertible senior notes; and a benefit of $7.9 million from certain discrete tax adjustments. The asset impairment charges related to the impairment of certain operating lease right-of-use assets and, to a lesser extent, impairment of property and equipment related to certain retail locations resulting from lower revenue and future cash flow projections due to the ongoing effects of the COVID-19 pandemic. The net losses on lease terminations related primarily to the early termination of certain lease agreements. Certain professional service and legal fees and related net credits were primarily due to amounts which the Company otherwise would not have incurred as part of its business operations. The separation-related charges mainly related to certain cash severance payments, partially offset by adjustments to non-cash stock-based compensation expense related to our former Chief Executive Officer resulting from changes in expected performance conditions of certain previously granted stock awards that were no longer subject to service vesting requirements after his departure. During the three months ended May 2, 2020, the Company recognized a tax benefit of approximately $11.8 million from a tax rate change related to the ability to carryback net operating losses to tax years with a higher federal corporate tax rate as allowed under the CARES Act enacted in March 2020. This benefit was partially offset by a valuation allowance of $3.7 million resulting from jurisdictions where there have been cumulative net operating losses, limiting the Company’s ability to consider other subjective evidence to continue to recognize the existing deferred tax assets. These items resulted in a combined $38.8 million negative impact (after considering the related tax benefit of $9.8 million), or an unfavorable $0.59 per share impact during the three months ended May 2, 2020. Net loss attributable to Guess?, Inc. was $157.7 million and diluted loss was $2.40 per common share for the three months ended May 2, 2020. Excluding the impact of these items, adjusted net loss attributable to Guess?, Inc. was $118.9 million and adjusted diluted loss was $1.81 per common share for the three months ended May 2, 2020.
Our discussion and analysis herein also includes certain constant currency financial information. Foreign currency exchange rate fluctuations affect the amount reported from translating the Company’s foreign revenue, expenses and balance sheet amounts into U.S. dollars. These rate fluctuations can have a significant effect on reported operating results under GAAP. The Company provides constant currency information to enhance the visibility of underlying business trends, excluding the effects of changes in foreign currency translation rates. To calculate net revenue and earnings (loss) from operations on a constant currency basis, operating results for the current-year period are translated into U.S. dollars at the average exchange rates in effect during the comparable period of the prior year. To calculate balance sheet amounts on a constant currency basis, the current period balance sheet amount is translated into U.S. dollars at the exchange rate in effect at the comparable prior-year period end. The constant currency calculations do not adjust for the impact of revaluing specific transactions denominated in a currency that is different from the functional currency of that entity when exchange rates fluctuate. The constant currency information presented may not be comparable to similarly titled measures reported by other companies.
In calculating the estimated impact of currency fluctuations (including translational and transactional impacts) on other measures such as earnings (loss) per share, the Company estimates gross margin (including the impact of foreign exchange currency contracts designated as cash flow hedges for anticipated merchandise purchases) and expenses using the appropriate prior-year rates, translates the estimated foreign earnings (loss) at the comparable prior-year rates and excludes the year-over-year earnings impact of gains or losses arising from balance sheet remeasurement and foreign exchange currency contracts not designated as cash flow hedges for merchandise purchases.
Liquidity and Capital Resources
We need liquidity globally primarily to fund our working capital, occupancy costs, interest payments on our debt, remodeling and rationalization of our retail stores, shop-in-shop programs, concessions, systems, infrastructure, other existing operations, expansion plans, international growth and potential acquisitions and investments. In addition, in the U.S. we need liquidity to fund share repurchases and payment of dividends to our stockholders. Generally, our working capital needs are highest during the late summer and fall as our inventories increase before the holiday selling period. During the three months ended May 1, 2021, we relied primarily on trade credit, available cash, real estate and other operating leases, finance leases, proceeds from
our credit facilities and term loans and internally generated funds to finance our operations. We anticipate that we will be able to satisfy our ongoing cash requirements during the next 12 months for working capital, capital expenditures, payments on our debt, finance leases and operating leases as well as lease modification payments, potential acquisitions and investments, and share repurchases and dividend payments to stockholders, primarily with cash flow from operations and existing cash balances as supplemented by borrowings under our existing Credit Facility in the U.S. and Canada as well as bank facilities in Europe and China and proceeds from our term loans, as needed. Due to the seasonality of our business and cash needs, we may increase borrowings under our established credit facilities from time-to-time during the next 12 months. If we experience a sustained decrease in consumer demand related to the COVID-19 pandemic, we may require access to additional credit, which may not be available to us on commercially acceptable terms or at all.
Our outstanding convertible senior notes may be converted at the option of the holders as described in “Part I, Item 1, Financial Statements – Note 10 – Convertible Senior Notes and Related Transactions” of this Form 10-Q and in “Note 10 – Convertible Senior Notes and Related Transactions” of the Consolidated Financial Statements included in our Annual Report on Form 10-K. As of May 1, 2021, none of the conditions allowing holders of the convertibles notes to convert had been met. If our trading price exceeds 130% of the conversion price of the convertible notes for at least 20 trading days during the 30 consecutive trading-day period ending on, and including, September 30, 2021, holders of the convertible notes would have the right to convert their convertible notes during the calendar quarter beginning October 1, 2021. Upon conversion, we will pay or deliver, as the case may be, cash, shares of our common stock or a combination of cash and shares of our common stock, at our election, in the manner and subject to the terms and conditions provided in the indenture governing the convertible notes. The convertible note hedge transaction we entered into in connection with our issuance of the convertible notes is expected generally to reduce the potential dilution upon conversion of the convertible notes and/or offset any cash payments we are required to make in excess of the principal amount of convertible notes that are converted, as the case may be. We expect to settle the principal amount of our outstanding convertible senior notes in 2024 in cash and any excess in shares.
On March 27, 2020, the U.S. government enacted the CARES Act to provide economic relief from the COVID-19 pandemic. Among other provisions, the CARES Act allows for a full offset of taxable income in a five-year carryback period for net operating losses, which will reduce current period tax expense and may result in a refund of previously paid income tax amounts at higher historical tax rates.
The Company has historically considered the undistributed earnings of its foreign subsidiaries to be indefinitely reinvested. As a result of the Tax Reform, the Company had a substantial amount of previously taxed earnings that could be distributed to the U.S. without additional U.S. taxation. The Company continues to evaluate its plans for reinvestment or repatriation of unremitted foreign earnings and regularly reviews its cash positions and determination of permanent reinvestment of foreign earnings. If the Company determines that all or a portion of such foreign earnings are no longer indefinitely reinvested, it may be subject to additional foreign withholding taxes and U.S. state income taxes, beyond the Tax Reform’s one-time transition tax. The Company intends to indefinitely reinvest the remaining earnings from the Company’s foreign subsidiaries for which a deferred tax liability has not already been recorded. It is not practicable to estimate the amount of tax that might be payable if these earnings were repatriated due to the complexities associated with the hypothetical calculation. As of May 1, 2021, the Company had cash and cash equivalents of $395.1 million, of which approximately $101.0 million was held in the U.S.
Excess cash and cash equivalents, which represent the majority of our outstanding cash and cash equivalents balance, are held primarily in overnight deposit and short-term time deposit accounts and money market accounts. Please see “—Important Factors Regarding Forward-Looking Statements” discussed above, “Part II, Item 1A. Risk Factors” in this Form 10-Q and “Part I, Item 1A. Risk Factors” contained in the Company’s most recent Annual Report on Form 10-K for the fiscal year ended January 30, 2021 for a discussion of risk factors which could reasonably be likely to result in a decrease of internally generated funds available to finance capital expenditures and working capital requirements.
COVID-19 Impact on Liquidity
Refer to the “COVID-19 Business Update” section above for a discussion of the impact from the COVID-19 pandemic on our financial performance and our liquidity.
In light of store closures and reduced traffic in stores, the Company has taken certain actions with respect to certain of its existing leases, including engaging with landlords to discuss rent deferrals as well as other rent concessions. Throughout the COVID-19 pandemic, we have suspended rental payments and/or paid reduced rental amounts with respect to our retail stores that were closed or experiencing drastically reduced customer traffic as a result of the COVID-19 pandemic. Over the last year, we have successfully negotiated with several landlords, including some of our larger landlords and have received rent abatement benefits as well as new lease terms for some of our affected leases. The Company continues to engage in discussions with additional affected landlords in an effort to achieve appropriate rent relief and other lease concessions and, in some cases, to terminate existing leases. In some instances, where negotiations with landlords have proven unsuccessful, the Company is engaged in litigation related to rent obligations both during the COVID-19 pandemic and through the term of the lease.
Three Months Ended May 1, 2021 and May 2, 2020
The Company has presented below the cash flow performance comparison of the three months ended May 1, 2021, compared to the three months ended May 2, 2020.
Operating Activities
Net cash used in operating activities was $53.6 million for the three months ended May 1, 2021, compared to $61.6 million for the three months ended May 2, 2020, or an improvement of $7.9 million. This improvement was driven primarily by higher cash flows generated from net earnings, partially offset by unfavorable changes in working capital.
Investing Activities
Net cash used in investing activities was $7.8 million for the three months ended May 1, 2021, compared to $5.7 million for the three months ended May 2, 2020. Net cash used in investing activities for the three months ended May 1, 2021 related primarily to capital expenditures incurred on leasehold improvements, investments in technology infrastructure and, to a lesser extent, existing store remodeling programs and international retail expansion.
The increase in cash used in investing activities was driven primarily by higher strategic investments in technology and retail remodels during the three months ended May 1, 2021 compared to the same prior-year period. During the three months ended May 1, 2021, the Company opened 11 directly-operated stores compared to five directly-operated stores that were opened in the same prior-year period.
Financing Activities
Net cash used in financing activities was $9.7 million for the three months ended May 1, 2021, compared to net cash provided by financing activities of $210.1 million for the three months ended May 2, 2020. Net cash used in financing activities for the three months ended May 1, 2021 related primarily to payment of dividends and repayments on borrowings and finance lease obligations, partially offset by proceeds from borrowings.
The change in cash provided by (used in) financing activities was driven primarily by lower proceeds received from borrowings and higher payment of dividends during the three months ended May 1, 2021 compared to the same prior-year period.
Effect of Exchange Rates on Cash, Cash Equivalents and Restricted Cash
During the three months ended May 1, 2021, changes in foreign currency translation rates decreased our reported cash, cash equivalents and restricted cash balance by $2.8 million. This compares to a decrease of $8.0 million in cash, cash equivalents and restricted cash driven by changes in foreign currency translation rates during the three months ended May 2, 2020.
Working Capital
As of May 1, 2021, the Company had net working capital (including cash and cash equivalents) of $497.5 million, compared to $470.0 million at January 30, 2021 and $388.2 million at May 2, 2020.
The Company’s primary working capital needs are for the current portion of lease liabilities, accounts receivable and inventory. The accounts receivable balance consists of trade receivables relating primarily to the Company’s wholesale business in Europe and, to a lesser extent, to its wholesale businesses in the Americas and Asia, royalty receivables relating to its licensing operations, credit card and retail concession receivables related to its retail businesses and certain other receivables. Accounts receivable increased by $66.8 million, or 27.9%, to $306.3 million as of May 1, 2021, from $239.5 million at May 2, 2020. On a constant currency basis, accounts receivable increased by $45.7 million, or 19.1%, when compared to May 2, 2020. As of May 1, 2021, approximately 48% of our total net trade receivables and 60% of our European net trade receivables were subject to credit insurance coverage, certain bank guarantees or letters of credit for collection purposes. Our credit insurance coverage contains certain terms and conditions specifying deductibles and annual claim limits. Inventory increased by $12.4 million, or 3.1%, to $404.9 million as of May 1, 2021, from $392.5 million at May 2, 2020. On a constant currency basis, inventory decreased by $15.7 million, or 4.0%, when compared to May 2, 2020, driven primarily by improved inventory management.
Capital Expenditures
Gross capital expenditures totaled $9.1 million, before deducting lease incentives of $1.1 million, for the three months ended May 1, 2021. This compares to gross capital expenditures of $6.0 million, before deducting lease incentives of $0.4 million for the three months ended May 2, 2020.
We will periodically evaluate strategic acquisitions and alliances and pursue those that we believe will support and contribute to our overall growth initiatives.
Dividends
On May 27, 2021, the Company announced a regular quarterly cash dividend of $0.1125 per share on the Company’s common stock. The cash dividend will be paid on June 25, 2021 to shareholders of record as of the close of business on June 9, 2021.
Decisions on whether, when and in what amounts to continue making any future dividend distributions will remain at all times entirely at the discretion of the Company’s Board of Directors, which reserves the right to change or terminate the Company’s dividend practices at any time and for any reason without prior notice. The payment of cash dividends in the future will be based upon a number of business, legal and other considerations, including the Company’s cash flow from operations, capital expenditures, debt service and covenant requirements, cash paid for income taxes, earnings, share repurchases, economic conditions and U.S. and global liquidity.
Share Repurchases
There were no shares repurchased under the Company’s share repurchase program during the three months ended May 1, 2021. As of May 1, 2021, the Company had remaining authority under the program to purchase $47.8 million of its common stock.
Borrowings and Finance Lease Obligations and Convertible Senior Notes
See “Part I, Item 1. Financial Statements – Note 9 – Borrowings and Finance Lease Obligations” and “Part I, Item 1. Financial Statements – Note 10 – Convertible Senior Notes and Related Transactions” in this Form 10-Q for disclosures about our borrowings and finance lease obligations and convertible senior notes.
Supplemental Executive Retirement Plan
As a non-qualified pension plan, no dedicated funding of the Company’s Supplemental Executive Retirement Plan (“SERP”) is required; however, the Company has made periodic payments into insurance policies held in a rabbi trust to fund the expected obligations arising under the non-qualified SERP.
The cash surrender values of the insurance policies were $71.6 million and $72.1 million as of May 1, 2021 and January 30, 2021, respectively, and were included in other assets in the Company’s condensed consolidated balance sheets. As a result of changes in the value of the insurance policy investments, the Company recorded minimal unrealized losses and $3.1 million unrealized losses in other expense during the three months ended May 1, 2021 and May 2, 2020, respectively. The projected benefit obligation was $52.1 million and $52.3 million as of May 1, 2021 and January 30, 2021, respectively, and was included in accrued expenses and other long-term liabilities in the Company’s condensed consolidated balance sheets depending on the expected timing of payments. SERP benefit payments of $0.5 million and $0.6 million were made during the three months ended May 1, 2021 and May 2, 2020, respectively.
Contractual Obligations and Commitments
As of May 1, 2021, there were no material changes to our contractual obligations and commitments outside the ordinary course of business compared to the disclosures included in our Form 10-K for the fiscal year ended January 30, 2021. See “Part I, Item 1. Financial Statements – Note 9 – Borrowings and Finance Lease Obligations” and “Part I, Item 1. Financial Statements – Note 10 – Convertible Senior Notes and Related Transactions” for further information on these arrangements.
Application of Critical Accounting Policies and Estimates
Our critical accounting policies reflecting our estimates and judgments are described in “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the fiscal year ended January 30, 2021 filed with the SEC on April 9, 2021. There have been no significant changes to our critical accounting policies during the three months ended May 1, 2021.
Recently Issued Accounting Guidance
See “Part I, Item 1. Financial Statements – Note 1 – Basis of Presentation and New Accounting Guidance” for disclosures about recently issued accounting guidance.
ITEM 3.Quantitative and Qualitative Disclosures About Market Risk.
Exchange Rate Risk
More than two-thirds of product sales recorded for the three months ended May 1, 2021 were denominated in currencies other than the U.S. dollar. The Company’s primary exchange rate risk relates to operations in Europe, Canada, South Korea, China, Hong Kong and Mexico. Changes in currencies affect our earnings in various ways. For further discussion on currency-related risk, please refer to our risk factors under “Part I, Item 1A. Risk Factors” contained in the Company’s most recent Annual Report on Form 10-K for the fiscal year ended January 30, 2021.
Foreign Currency Translation Adjustment
The local selling currency is typically the functional currency for all of the Company’s significant international operations. In accordance with authoritative guidance, assets and liabilities of the Company’s foreign operations are translated from foreign currencies into U.S. dollars at period-end rates, while income and expenses are translated at the weighted average exchange rates for the period. The related translation adjustments are reflected as a foreign currency translation adjustment in accumulated other comprehensive income (loss) within stockholders’ equity. In addition, the Company records foreign currency translation adjustments related to its noncontrolling interests within stockholders’ equity. Accordingly, our reported other comprehensive income (loss) could be unfavorably impacted if the U.S. dollar strengthens, particularly against the British pound, Canadian dollar, Chinese yuan, euro, Japanese yen, Korean won, Mexican peso, Polish zloty, Russian rouble and Turkish lira. Alternatively, if the U.S. dollar weakens relative to those currencies, our reported other comprehensive income (loss) could be favorably impacted. Our foreign currency translation adjustments recorded in other comprehensive income (loss) are significantly impacted by net assets denominated in euros.
Periodically, the Company may also use foreign exchange currency contracts to hedge the translation and economic exposures related to its net investments in certain of its international subsidiaries. Changes in the fair values of these foreign exchange currency contracts, designated as net investment hedges, are recorded in foreign currency translation adjustment as a component of accumulated other comprehensive income (loss) within stockholders’ equity.
During the three months ended May 1, 2021, the total foreign currency translation adjustment decreased stockholders’ equity by $2.2 million, driven primarily by the weakening of the U.S. dollar against the euro.
Foreign Currency Transaction Gains and Losses
Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency, including gains and losses on foreign exchange currency contracts (see below), are included in the condensed consolidated statements of income (loss). Net foreign currency transaction losses of $4.1 million and $10.5 million were included in the determination of net earnings (loss) for the three months ended May 1, 2021 and May 2, 2020, respectively.
Foreign Exchange Currency Contracts
The Company operates in foreign countries, which exposes it to market risk associated with foreign currency exchange rate fluctuations. Various transactions that occur primarily in Europe, Canada, South Korea, China, Hong Kong and Mexico are denominated in U.S. dollars, British pounds and Russian roubles and thus are exposed to earnings risk as a result of exchange rate fluctuations when converted to their functional currencies. These types of transactions include U.S. dollar-denominated purchases of merchandise and U.S. dollar- and British pound-denominated intercompany liabilities. In addition, certain operating expenses, tax liabilities and pension-related liabilities are denominated in Swiss francs and are exposed to earnings risk as a result of exchange rate fluctuations when converted to the functional currency. Further, there are certain real estate leases that are denominated in a currency other than the functional currency of the respective entity that entered into the agreement (primarily Swiss francs, Russian roubles and Polish zloty). As a result, the Company may be exposed to volatility related to unrealized gains or losses on the translation of present value of future lease payment obligations when translated at the exchange rate as of a reporting period-end. The Company is also subject to certain translation and economic exposures related to its net investment in certain of its international subsidiaries. The Company enters into derivative financial instruments to offset some, but not all, of its exchange risk. In addition, some of the derivative contracts in place will create volatility during the fiscal year as they are marked-to-market according to the accounting rules and may result in revaluation gains or losses in different periods from when the currency impact on the underlying transactions are realized.
Foreign Exchange Currency Contracts Designated as Cash Flow Hedges
During the three months ended May 1, 2021, the Company purchased U.S. dollar forward contracts in Europe totaling US$40.0 million that were designated as cash flow hedges. As of May 1, 2021, the Company had forward contracts outstanding for its European operations of US$126.0 million to hedge forecasted merchandise purchases, which are expected to mature over the next 15 months. The Company’s foreign exchange currency contracts are recorded in its condensed consolidated balance sheet at fair value based on quoted market rates. Changes in the fair value of the U.S. dollar forward contracts, designated as cash flow hedges for forecasted merchandise purchases, are recorded as a component of accumulated other comprehensive income (loss) within stockholders’ equity and are recognized in cost of product sales in the period that approximates the time the hedged merchandise inventory is sold. Changes in the fair value of the U.S. dollar forward contracts, designated as cash flow hedges for forecasted intercompany royalties, are recorded as a component of accumulated other comprehensive income (loss) within stockholders’ equity and are recognized in other income (expense) in the period in which the royalty expense is incurred.
As of May 1, 2021, accumulated other comprehensive income (loss) related to foreign exchange currency contracts included a net unrealized loss of approximately $2.3 million net of tax, which will be recognized in cost of product sales over the following 12 months, at the then current values on a pre-tax basis, which can be different than the current quarter-end values.
As of May 1, 2021, the net unrealized loss of the remaining open forward contracts recorded in the Company’s condensed consolidated balance sheet was approximately $1.3 million.
At January 30, 2021, the Company had forward contracts outstanding for its European operations of US$100.0 million that were designated as cash flow hedges. At January 30, 2021, the net unrealized loss of these open forward contracts recorded in the Company’s condensed consolidated balance sheet was approximately $3.3 million.
Foreign Exchange Currency Contracts Not Designated as Hedging Instruments
The Company has also foreign exchange currency contracts that are not designated as hedging instruments for accounting purposes. Changes in fair value of foreign exchange currency contracts not designated as hedging instruments are reported in net earnings (loss) as part of other income (expense). For the three months ended May 1, 2021, the Company recorded a net gain of $0.1 million for its euro dollar foreign exchange currency contracts not designated as hedges, which has been included in other income (expense). As of May 1, 2021, the Company had euro foreign exchange currency contracts to purchase US$19.0 million expected to mature over the next one month. As of May 1, 2021, the net unrealized loss of these open forward contracts recorded in the Company’s condensed consolidated balance sheet was approximately $0.9 million.
At January 30, 2021, the Company had euro foreign exchange currency contracts to purchase US$19.0 million. At January 30, 2021, the net unrealized loss of these open forward contracts recorded in the Company’s condensed consolidated balance sheet was approximately $1.2 million.
Sensitivity Analysis
As of May 1, 2021, a sensitivity analysis of changes in foreign currencies when measured against the U.S. dollar indicates that, if the U.S. dollar had uniformly weakened by 10% against all of the U.S. dollar denominated foreign exchange derivatives totaling US$145.0 million, the fair value of the instruments would have decreased by $16.1 million. Conversely, if the U.S. dollar uniformly strengthened by 10% against all of the U.S. dollar denominated foreign exchange derivatives, the fair value of these instruments would have increased by $13.2 million. Any resulting changes in the fair value of the hedged instruments may be partially offset by changes in the fair value of certain balance sheet positions (primarily U.S. dollar denominated liabilities in our foreign operations) impacted by the change in the foreign currency rate. The ability to reduce the exposure of currencies on earnings depends on the magnitude of the derivatives compared to the balance sheet positions during each reporting cycle.
Interest Rate Risk
The Company is exposed to interest rate risk on its floating-rate debt. The Company has entered into interest rate swap agreements for certain of these agreements to effectively convert its floating-rate debt to a fixed-rate basis. The principal objective of these contracts is to eliminate or reduce the variability of the cash flows in interest payments associated with the Company’s floating-rate debt, thus reducing the impact of interest rate changes on future interest payment cash flows. The Company has elected to apply the hedge accounting rules in accordance with authoritative guidance for certain of these contracts.
In April 2019, the Company issued $300 million principal amount of convertible senior notes in a private offering. The fair value of the convertible senior notes is subject to interest rate risk, market risk and other factors due to its conversion feature. The fair value of the convertible senior notes will generally increase as our common stock price increases and will generally decrease as our common stock price declines. The interest and market value changes affect the fair value of the convertible senior notes but do not impact our financial position, cash flows or results of operations due to the fixed nature of the debt obligation. Additionally, we carry the convertible senior notes at face value, less any unamortized discount on our balance sheet and we present the fair value for disclosure purposes only.
Interest Rate Swap Agreement Designated as Cash Flow Hedge
The fair value of the interest rate swap agreement is based upon inputs corroborated by observable market data. Changes in the fair value of the interest rate swap agreement, designated as a cash flow hedge to hedge
the variability of cash flows in interest payments associated with the Company’s floating-rate Mortgage Debt, are recorded as a component of accumulated other comprehensive income (loss) within stockholders’ equity and are amortized to interest expense over the term of the related debt.
As of May 1, 2021, accumulated other comprehensive income (loss) related to the interest rate swap agreement included a net unrealized loss of $0.5 million net of tax, which will be recognized in interest expense over the following 12 months, at the then current values on a pre-tax basis, which can be different than the current quarter-end values. As of May 1, 2021, the net unrealized loss of the interest rate swap recorded in the Company’s condensed consolidated balance sheet was approximately $0.7 million. As of January 30, 2021, the net unrealized loss of the interest rate swap recorded in the Company’s condensed consolidated balance sheet was approximately $1.0 million.
Sensitivity Analysis
As of May 1, 2021, the Company had borrowings under its credit facility arrangements of $5.1 million which are based on variable rates of interest. Accordingly, changes in interest rates would impact the Company’s results of operations in future periods. A 100 basis point increase in interest rates would not have had a significant effect on interest expense for the three months ended May 1, 2021.
As of May 1, 2021, the Company also had indebtedness related to term loans of $56.0 million, finance lease obligations of $22.4 million and its Mortgage Debt of $18.3 million. The term loans provide for annual interest rates ranging between 0.5% to 2.2%. The finance lease obligations are based on fixed interest rates derived from the respective agreements. The Mortgage Debt is covered by a separate interest rate swap agreement with a swap fixed interest rate of approximately 3.06% that matures in January 2026. The interest rate swap agreement is designated as a cash flow hedge and converts the nature of the Company’s Mortgage Debt from LIBOR floating-rate debt to fixed-rate debt.
The fair values of the Company’s debt instruments are based on the amount of future cash flows associated with each instrument discounted using the Company’s incremental borrowing rate. As of May 1, 2021 and January 30, 2021, the carrying value was not materially different from fair value, as the interest rates on the Company’s debt approximated rates currently available to the Company. The fair value of the Company’s convertible senior notes is determined based on inputs that are observable in the market and have been classified as Level 2 in the fair value hierarchy.
ITEM 4. Controls and Procedures.
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the quarterly period covered by this report.
There was no change in our internal control over financial reporting during the first quarter of fiscal 2022 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.