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Item 2.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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This Quarterly Report on Form 10-Q contains forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, including but not limited to statements relating to the Company’s strategic initiatives. Forward-looking statements typically are identified by use of terms such as “may,” “will,” “should,” “plan,” “project,” “expect,” “anticipate,” “estimate” and similar words, although some forward-looking statements are expressed differently. These forward-looking statements are based upon the Company's current expectations and assumptions and are subject to various risks and uncertainties that could cause actual results and performance to differ materially. Some of these risks and uncertainties are described in the Company's filings with the Securities and Exchange Commission, including in the “Risk Factors” section of its Annual Report on Form 10-K for the fiscal year ended
January 28, 2017
. Included among the risks and uncertainties that could cause actual results and performance to differ materially are the risk that the Company will be unsuccessful in gauging fashion trends and changing consumer preferences, the risks resulting from the highly competitive nature of the Company’s business and its dependence on consumer spending patterns, which may be affected by weakness in the economy that continues to affect the Company’s target customer, the risk that the Company’s strategic initiatives to increase sales and margin are delayed or do not result in anticipated improvements, the risk of delays, interruptions and disruptions in the Company’s global supply chain, including resulting from foreign sources of supply in less developed countries or more politically unstable countries, the risk that the cost of raw materials or energy prices will increase beyond current expectations or that the Company is unable to offset cost increases through value engineering or price increases, and the uncertainty of weather patterns. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date they were made. The Company undertakes no obligation to release publicly any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
The following discussion should be read in conjunction with the Company’s unaudited financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the annual audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended
January 28, 2017
.
Terms that are commonly used in our management’s discussion and analysis of financial condition and results of operations are defined as follows:
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Third Quarter 2017
— The thirteen weeks ended
October 28, 2017
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•
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Third Quarter 2016
— The thirteen weeks ended
October 29, 2016
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Year-To-Date 2017
— The thirty-nine weeks ended
October 28, 2017
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Year-To-Date 2016
— The thirty-nine weeks ended
October 29, 2016
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Comparable Retail Sales — Net sales, in constant currency, from stores that have been open for at least 14 consecutive months and from our e-commerce store, excluding postage and handling fees. Store closures in the current fiscal year will be excluded from Comparable Retail Sales beginning in the fiscal quarter in which the store closes. Stores that temporarily close for non- substantial remodeling will be excluded from Comparable Retail Sales for only the period that they were closed. A store is considered substantially remodeled if it has been relocated or materially changed in size and will be excluded from Comparable Retail Sales for at least 14 months beginning in the period in which the remodel occurred.
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AUR — Average unit retail
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Gross Margin — Gross profit expressed as a percentage of net sales
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SG&A — Selling, general, and administrative expenses
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FASB — Financial Accounting Standards Board
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SEC — U.S. Securities and Exchange Commission
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U.S. GAAP — Generally Accepted Accounting Principles in the United States
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FASB ASC — FASB Accounting Standards Codification, which
serves as the source for authoritative U.S. GAAP, except that rules and interpretive releases by the SEC are also sources of authoritative U.S. GAAP for SEC registrants
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Our Business
We are the largest pure-play children's specialty apparel retailer in North America. The Company provides apparel, accessories, footwear, and other items for children. We design, contract to manufacture, sell at retail and wholesale, and license to sell trend right, high-quality merchandise at value prices, the substantial majority of which is under our proprietary “The Children's Place”, “Place” and "Baby Place" brand names. As of
October 28, 2017
, we operated
1,027
stores across North America, our e-commerce business at
www.childrensplace.com
, and had 168 international points of distribution open and operated by our seven franchise partners in 19 countries.
Segment Reporting
In accordance with the “
Segment Reporting
” topic of the FASB ASC, we report segment data based on geography: The Children’s Place U.S. and The Children’s Place International. Each segment includes an e-commerce business located at
www.childrensplace.com
. Included in The Children’s Place U.S. segment are our U.S. and Puerto Rico-based stores and revenue from our U.S.-based wholesale business. Included in The Children's Place International segment are our Canadian- based stores, revenue from the Company's Canadian wholesale business, as well as revenue from international franchisees. We measure our segment profitability based on operating income, defined as income before interest and taxes. Net sales and direct costs are recorded by each segment. Certain inventory procurement functions such as production and design as well as corporate overhead, including executive management, finance, real estate, human resources, legal and information technology services are managed by The Children’s Place U.S. segment. Expenses related to these functions, including depreciation and amortization, are allocated to The Children’s Place International segment based primarily on net sales. The assets related to these functions are not allocated. We periodically review these allocations and adjust them based upon changes in business circumstances. Net sales from external customers are derived from merchandise sales and we have no major customers that account for more than
10%
of our net sales. As of
October 28, 2017
, The Children’s Place U.S. operated
898
stores and The Children’s Place International operated
129
stores. As of
October 29, 2016
, The Children’s Place U.S. operated
930
stores and The Children’s Place International operated
131
stores.
Operating Highlights
Our Comparable Retail Sales, which excludes stores closed for an extended period of time due to hurricanes, increased 5.1% and 4.8% during the
Third Quarter 2017
and
Year-To-Date 2017
, respectively, despite the impact of hurricanes in Texas, Florida, and Puerto Rico, as well as unseasonably warm weather across most of the country during the
Third Quarter 2017
. Net sales
increased by $16.2 million, or 3.4%, to $490.0 million during the
Third Quarter 2017
and increased $35.8 million, or 2.8%, to $1,300.3 million during
Year-To-Date 2017
. We believe that our e-commerce and brick-and-mortar retail store operations are highly interdependent, with both sharing common customers purchasing from a common pool of product inventory. Accordingly, we believe that consolidated omni-channel reporting presents the most meaningful and appropriate measure of our performance, including Comparative Retail Sales and revenues.
Gross margin increased 20 and 30 basis points, respectively, during the
Third Quarter 2017
and
Year-To-Date 2017
. The increase in gross margin resulted primarily from an increase in merchandise margin resulting from strong product acceptance and the leverage of fixed costs, partially offset by the increased penetration of our e-commerce business, which generally has a lower gross margin due to higher fulfillment costs.
Selling, general, and administrative expenses increased $2.9 million to $118.3 million during the
Third Quarter 2017
from $115.4 million during the
Third Quarter 2016
. As a percentage of net sales, SG&A decreased 30 basis points to 24.1% during the
Third Quarter 2017
from 24.4% during the
Third Quarter 2016
. The leverage was primarily due to strong Comparable Retail Sales, decreased store expenses, including lower credit card fees, and lower incentive compensation expenses, partially offset by expenses related to the continued investment in our transformation initiatives.
Asset impairment charges
were $3.2 million during the
Third Quarter 2017
, of which $0.8 million related to the full impairment of eight stores, and $2.4 million related to the write-down of information technology systems. Asset impairment charges during the
Third Quarter 2016
were $0.4 million, which related to the partial impairment of nine stores.
We continue to make significant progress on our key strategic growth initiatives--superior product, business transformation through technology, alternate channels of distribution and fleet optimization.
Focus on product remains our top priority. Strong product acceptance and our inventory management are delivering gross margin and inventory productivity benefits, as evidenced by the Third Quarter 2017 being our 11th consecutive quarter of merchandise margin expansion.
Our business transformation through technology initiative has two key components: inventory management and digital transformation. With respect to digital transformation, we are in the process of developing and implementing a personalized customer contact strategy. Our goal is to deliver dynamic and personalized customer content that will drive increased customer acquisition, retention and engagement, intended to result in increases in incremental sales and profitability.
The transformation of our digital capabilities has continued with the deployment of four of our five digital releases planned for fiscal 2017, resulting in the migration to a new digital platform. In conjunction with this migration, we launched "BOPIS," or Buy Online Pick Up In Store, to our entire U.S. store fleet during the Third Quarter 2017. We also tested ship from store capabilities in a few locations during the Third Quarter 2017 and will continue to roll these capabilities to more stores during the fourth quarter of fiscal 2017. Additionally, during the fourth quarter of fiscal 2017, we will install wireless networks and mobile point of sale to our entire U.S. fleet as part of our connected store initiative.
With respect to alternate channels of distribution, we continued our international expansion program and added seven additional international points of distribution (stores, shop in shops, e-commerce site) during the Third Quarter 2017 bringing our total count to 168, operating in 19 countries. In addition, our newest franchise partner, Gill Capital, opened five stores in Indonesia during the fourth quarter of fiscal 2017, and expects to open 25 stores in Indonesia over time. In our wholesale business, our relationship with Amazon continues to develop with the expansion of our replenishment program and the launch with Amazon Canada for holiday 2017.
We continue to evaluate our store fleet as part of our fleet optimization initiative to improve store productivity and plan to close approximately 300 stores through fiscal 2020, which includes the 156 stores we closed since the announcement of this initiative.
During
Year-To-Date 2017
, we repurchased approximately 0.8 million shares for approximately $85.4 million, inclusive of shares repurchased and surrendered to cover tax withholdings associated with the vesting of equity awards held by management. As of
October 28, 2017
, there was approximately
$277.6 million
in aggregate remaining on the 2015 $250 Million and 2017 Share Repurchase Programs. During
Year-To-Date 2017
, we paid cash dividends of $21.1 million and our fourth quarter 2017 dividend of $0.40 per share will be paid on January 3, 2018 to shareholders of record on the close of business on December 13, 2017.
Net income was $44.1 million during the
Third Quarter 2017
compared to $44.2 million during the
Third Quarter 2016
due to the factors listed above and a higher effective tax rate that was primarily the result of a result of a $1.6 million tax benefit recorded for uncertain tax positions during the
Third Quarter 2016
. Earnings per diluted share was $2.44 in the
Third Quarter 2017
compared to $2.36 in the
Third Quarter 2016
. This increase in earnings per share is due to the factors noted above and a lower weighted average common shares outstanding of approximately 0.6 million, which is the result of our share repurchase programs.
Net income was $94.6 million during
Year-To-Date 2017
compared to $68.1 million during
Year-To-Date 2016
. Earnings per diluted share was $5.19 during
Year-To-Date 2017
compared to $3.56 per diluted share during
Year-To-Date 2016
. This increase in earnings per share is due to the increase in net income due to the factors noted above, tax benefits of $16.5 million for excess stock compensation benefits, given our adoption of FASB guidance relating to the accounting for share-based payment transactions, and a lower weighted average common shares outstanding of approximately 0.9 million, which is the result of our share repurchase programs.
We have subsidiaries whose operating results are based in foreign currencies and are thus subject to the fluctuations of the corresponding translation rates into U.S. dollars. The table below summarizes those average translation rates that most impact our operating results:
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Thirteen Weeks Ended
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Thirty-nine Weeks Ended
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October 28,
2017
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October 29,
2016
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October 28,
2017
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October 29,
2016
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Average Translation Rates
(1)
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Canadian Dollar
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0.8001
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0.7630
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0.7700
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0.7628
|
Hong Kong Dollar
|
0.1280
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0.1289
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0.1283
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|
0.1288
|
China Yuan Renminbi
|
0.1509
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|
0.1497
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0.1476
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0.1516
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__________________________________________________
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(1)
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The average translation rates are the average of the monthly translation rates used during each period to translate the respective income statements. The rates represent the U.S. dollar equivalent of a unit of each foreign currency.
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CRITICAL ACCOUNTING POLICIES
The preparation of consolidated financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenues and expenses during the reported period. In many cases, there are alternative policies or estimation techniques that could be used. We continuously review the application of our accounting policies and evaluate the appropriateness of the estimates used in preparing our financial statements; however, estimates routinely require adjustment based on changing circumstances and the receipt of new or better information. Consequently, actual results could differ from our estimates.
The accounting policies and estimates discussed below include those that we believe are the most critical to aid in fully understanding and evaluating our financial results. Senior management has discussed the development and selection of our critical accounting policies and estimates with the Audit Committee of our Board of Directors, which has reviewed our related disclosures herein.
Inventory Valuation
- We value inventory at the lower of cost or net realizable value, with cost determined using an average cost method. The estimated market value of inventory is determined based on an analysis of historical sales trends of our individual product categories, the impact of market trends and economic conditions and a forecast of future demand, as well as plans to sell through inventory. Estimates may differ from actual results due to the quantity, quality, and mix of products in inventory, consumer and retailer preferences and market conditions. Our historical estimates have not differed materially from actual results and a 10% difference in our reserve as of
October 28, 2017
would have impacted net income by approximately $0.2 million. Our reserve balance at
October 28, 2017
was approximately $2.3 million compared to $2.5 million at
October 29, 2016
.
Reserves for inventory shrinkage, representing the risk of physical loss of inventory, are estimated based on historical experience and are adjusted based upon physical inventory counts. A 0.5% difference in our shrinkage rate as a percentage of cost of goods sold could impact each quarter's net income by approximately $0.7 million.
Stock-Based Compensation
- We account for stock-based compensation according to the provisions of FASB ASC 718--
Compensation-Stock Compensation
.
Time Vesting and Performance-Based Awards
We generally grant time vesting and performance-based stock awards to employees at management levels and above. We also grant time vesting stock awards to our non-employee directors. Time vesting awards are granted in the form of restricted stock units that require each recipient to complete a service period ("Deferred Awards"). Deferred Awards granted to employees generally vest ratably over three years. Deferred Awards granted to non-employee directors generally vest after one year. Performance-based stock awards are granted in the form of restricted stock units which have a performance criteria that must be achieved for the awards to be earned in addition to a service period requirement ("Performance Awards") and each Performance Award has a defined number of shares that an employee can earn (the "Target Shares"). With the approval of the Board's Compensation Committee, the Company may settle vested Deferred Awards and Performance Awards to the employee in shares, in a cash amount equal to the market value of such shares at the time all requirements for delivery of the award have been met, or in part shares and cash. For Performance Awards issued during fiscal 2014 and 2015 (the “2014 and 2015 Performance Awards”), the Target Shares earned can range from 0% to 300% and depend on the achievement of adjusted earnings per share for the cumulative three-fiscal year performance period and our total shareholder return (“TSR”) relative to that of companies in our peer group. The 2014 and 2015 Performance Awards generally cliff vest, if earned, after the completion of the applicable three year performance period. The 2014 and 2015 Performance Awards grant date fair value was estimated using a Monte Carlo simulation covering the period from the valuation date through the end of the applicable performance period using our simulated stock price as well as the TSR of companies in our peer group. For Performance Awards issued during fiscal 2016 and fiscal 2017 (the “2016 and 2017 Performance Awards”), an employee may earn from 0% to 200% of their Target Shares based on the achievement of cumulative adjusted earnings per share achieved for the three-year performance period, adjusted operating margin expansion achieved for the three-year performance period, and adjusted return on invested capital achieved at the end of the performance period. The 2016 and 2017 Performance Awards cliff vest, if earned, after completion of the applicable three year performance period. The fair value of the 2016 and 2017 Performance Awards granted is based on the closing price of our common stock on the grant date. Compensation expense is recognized ratably over the related service period reduced for estimated forfeitures of those awards not expected to vest due to employee turnover. While actual forfeitures could vary significantly from those estimated, a 10% change in our estimated forfeiture rate would impact our fiscal 2017 net income by approximately $0.5 million.
Impairment of Long-Lived Assets
- We periodically review our long-lived assets when events indicate that their carrying value may not be recoverable. Such events include a historical or projected trend of cash flow losses or a future expectation that we will sell or dispose of an asset significantly before the end of its previously estimated useful life. In reviewing for impairment, we group our long-lived assets at the lowest possible level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. In that regard, we group our assets into two categories: corporate-related and store-related. Corporate-related assets consist of those associated with our corporate offices, distribution centers, and our information technology systems. Store-related assets consist of leasehold improvements, furniture and fixtures, certain computer equipment, and lease-related assets associated with individual stores.
For store-related assets, we review all stores that have been open for at least two years, or sooner if circumstances should dictate, on at least an annual basis. We believe waiting two years allows a store to reach a maturity level where a more comprehensive analysis of financial performance can be performed. For each store that shows indications of operating losses, we project future cash flows over the remaining life of the lease and compare the total undiscounted cash flows to the net book value of the related long-lived assets. If the undiscounted cash flows are less than the related net book value of the long-lived assets, they are written down to their fair market value. We primarily determine fair market value to be the discounted future cash flows associated with those assets. In evaluating future cash flows, we consider external and internal factors. External factors comprise the local environment in which the store resides, including mall traffic, competition, and their effect on sales trends. Internal factors include our ability to gauge the fashion taste of our customers, control variable costs such as cost of sales and payroll, and in certain cases, our ability to renegotiate lease costs. If external factors should change unfavorably, if actual sales should differ from our projections, or if our ability to control costs is insufficient to sustain the necessary cash flows, future impairment charges could be material. At
October 28, 2017
, the average net book value per store was approximately $0.1 million.
Income Taxes
- We utilize the liability method of accounting for income taxes as set forth in FASB ASC 740--
Income Taxes.
Under the liability method, deferred taxes are determined based on the temporary differences between the financial statement and tax basis of assets and liabilities, as well as for net operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using currently enacted tax rates that apply to taxable income in effect for the years in which
the basis differences and tax assets are expected to be realized. A valuation allowance is recorded when it is more likely than not that some of the deferred tax assets will not be realized. In determining the need for valuation allowances we consider projected future taxable income and the availability of tax planning strategies. If, in the future we determine that we would not be able to realize our recorded deferred tax assets, an increase in the valuation allowance would decrease earnings in the period in which such determination is made.
We assess our income tax positions and record tax benefits for all years subject to examination based upon our evaluation of the facts, circumstances and information available at the reporting date. For those tax positions where it is more likely than not that a tax benefit will be sustained, we have recorded the largest amount of tax benefit with a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where it is not more likely than not that a tax benefit will be sustained, no tax benefit has been recognized in the financial statements.
Fair Value Measurement and Financial Instruments-
FASB ASC 820--
Fair Value Measurements and Disclosure
provides a single definition of fair value, together with a framework for measuring it and requires additional disclosure about the use of fair value to measure assets and liabilities.
This topic defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date and establishes a three-level hierarchy, which encourages an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of the hierarchy are defined as follows:
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Level 1 - inputs to the valuation techniques that are quoted prices in active markets for identical assets or liabilities
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Level 2 - inputs to the valuation techniques that are other than quoted prices but are observable for the assets or liabilities, either directly or indirectly
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Level 3 - inputs to the valuation techniques that are unobservable for the assets or liabilities
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Our cash and cash equivalents, short-term investments, accounts receivable, assets of the Company’s Deferred Compensation Plan, accounts payable and revolving loan are all short-term in nature. As such, their carrying amounts approximate fair value and fall within Level 1 of the fair value hierarchy. The Company stock included in the Deferred Compensation Plan is not subject to fair value measurement.
Our assets measured at fair value on a nonrecurring basis include long-lived assets. We review the carrying amounts of such assets when events indicate that their carrying amounts may not be recoverable. Any resulting asset impairment would require that the asset be recorded at its fair value. The resulting fair value measurements of the assets are considered to fall within Level 3 of the fair value hierarchy.
Our derivative assets and liabilities include foreign exchange forward contracts that are measured at fair value using observable market inputs such as forward rates, our credit risk and our counterparties’ credit risks. Based on these inputs, our derivative assets and liabilities are classified within Level 2 of the valuation hierarchy.
Insurance and Self-Insurance Liabilities
- Based on our assessment of risk and cost efficiency, we self-insure as well as purchase insurance policies to provide for workers' compensation, general liability and property losses, cyber-security coverage, as well as directors' and officers' liability, vehicle liability and employee medical benefits. We estimate risks and record a liability based upon historical claim experience, insurance deductibles, severity factors and other actuarial assumptions. These estimates include inherent uncertainties due to the variability of the factors involved, including type of injury or claim, required services by the providers, healing time, age of claimant, case management costs, location of the claimant and governmental regulations. While we believe that our risk assessments are appropriate, these uncertainties or a deviation in future claims trends from recent historical patterns could result in our recording additional or reduced expenses, which may be material to our results of operations. Our historical estimates have not differed materially from actual results and a 10% difference in our insurance reserves as of
October 28, 2017
would have impacted net income by approximately $0.7 million.
Recently Issued Accounting Standards
Adopted in Fiscal 2017
In March 2016, the FASB issued guidance relating to the accounting for share-based payment transactions. This guidance involves several aspects of the accounting for share-based payment transactions, including the income tax consequences, classifications of awards as either equity or liabilities and classification on the statement of cash flows. With respect to the accounting for income taxes, this guidance requires, on a prospective basis, recognition of excess tax benefits and tax deficiencies (resulting from an increase or decrease in the fair value of an award from grant date to the vesting date) in the
provision for income taxes as a discrete item in the quarterly period in which they occur. The guidance also requires that the value of shares withheld from employees upon vesting of stock awards in order to satisfy any applicable tax withholding requirements be presented within financing activities in the consolidated statement of cash flows. This presentation requirement is consistent with the Company’s current presentation, and will therefore have no impact to the Company. The Company adopted this guidance prospectively in the first fiscal quarter of 2017 and the adoption resulted in a reduction of our provision for income taxes of approximately $16.5 million for
Year-To-Date 2017
.
The future impacts that this adoption will have on our provision or benefit for income taxes are dependent in part upon future grants and vesting of stock-based compensation awards and other factors that are not fully controllable or predicable by the Company, such as the future market price of the Company's common stock and the future achievement of performance criteria that affect performance-based awards. Therefore, the impact on the consolidated financial statements will be dependent upon future events which are unpredictable. However, based on the number of outstanding unvested Deferred and Performance Awards expected to vest during the remainder of fiscal 2017, the adoption of this guidance will not have a significant impact on our provision for income taxes and net income during the remainder of fiscal 2017.
In November 2015, the FASB issued guidance relating to balance sheet classification of deferred taxes. This guidance simplifies the current guidance by requiring entities to classify all deferred tax assets and liabilities, together with any related valuation allowance, as noncurrent on the balance sheet. The Company adopted this guidance in the first fiscal quarter of 2017 and applied its provisions prospectively. As a result, the prior periods were not retrospectively adjusted.
In July 2015, the FASB issued an update to accounting guidance to simplify the measurement of inventory. Prior to adoption, all inventory was measured at the lower of cost or market. The update requires an entity to measure inventory within the scope of the guidance at the lower of cost or net realizable value. Net realizable value is the estimated selling price in the ordinary course of business less reasonably predictable costs of completion, disposal and transportation. The update does not apply to inventory measured using last-in, first-out or the retail inventory methods. The adoption was applied prospectively and did not have a material impact on the Company’s consolidated financial statements.
To Be Adopted After Fiscal 2017
In August 2017, the FASB issued guidance relating to the accounting for hedging activities. This guidance aims to better align an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. The amendments in the guidance expand and refine hedge accounting for both non-financial and financial risk components and align the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. The standard is effective for the Company beginning in its fiscal year 2019, including interim periods within those fiscal years, and early adoption is permitted. The Company is currently reviewing the potential impact of this standard.
In February 2016, the FASB issued guidance relating to the accounting for leases. This guidance applies a right of use model that requires a lessee to record, for all leases with a lease term of more than 12 months, an asset representing its right to use the underlying asset for the lease term and a liability to make lease payments. The lease term is the noncancellable period of the lease, and includes both periods covered by an option to extend the lease, if the lessee is reasonably certain to exercise that option, and periods covered by an option to terminate the lease, if the lessee is reasonably certain not to exercise that termination option. The standard is effective for the Company beginning in its fiscal year 2019, including interim periods within those fiscal years, and early adoption is permitted. We are in the process of developing an implementation plan and gathering information to assess which of our real estate, personal property and other arrangements may meet the definition of a lease as contemplated in the guidance. While we are currently reviewing the potential impact of this standard, we would expect that the adoption of this standard will require us to recognize right-of-use assets and lease liabilities that will be material to our consolidated balance sheet given the extent of our lease portfolio.
In May 2014, the FASB issued guidance relating to revenue recognition from contracts with customers. This guidance requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. In August 2015, the FASB issued guidance to defer the effective date by one year and, therefore, the standard is effective for fiscal years and interim periods within those years beginning after December 15, 2017 and is to be applied retrospectively.
We have substantially completed the process of reviewing our current accounting policies and business practices to identify potential differences that would result from applying the new guidance. The majority of our revenue is generated from sales of finished products directly to the consumer, which will continue to be recognized when control is transferred. We have also evaluated the impact that the guidance may have on the accounting for our retail promotional programs, including our
loyalty and private label credit card programs, as well as gift cards, and the related classification of these items within our consolidated income statement. The new guidance requires gift card breakage income to be recognized in proportion to the pattern of rights exercised by the customer when the Company expects to be entitled to breakage. We plan to adopt this guidance in the first quarter of fiscal 2018 using the modified-retrospective method and do not believe that the adoption of this standard will have a material impact on the Company’s consolidated financial statements. The new guidance will also require expanded disclosures related to revenue streams, performance obligations and consideration and the related judgments used in developing the necessary estimates.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, selected statement of operations data expressed as a percentage of net sales. We primarily evaluate the results of our operations as a percentage of net sales rather than in terms of absolute dollar increases or decreases by analyzing the year over year change in our business expressed as a percentage of net sales (i.e. “basis points”). For example, gross profit increased approximately 20 basis points to 41.3% of net sales during the
Third Quarter 2017
from 41.1% during the
Third Quarter 2016
. Accordingly, to the extent that our sales have increased at a faster rate than our costs (i.e. “leveraging”), the more efficiently we have utilized the investments we have made in our business. Conversely, if our sales decrease or if our costs grow at a faster pace than our sales (i.e. “de-leveraging”), we have less efficiently utilized the investments we have made in our business.
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Thirteen Weeks Ended
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Thirty-nine Weeks Ended
|
|
October 28,
2017
|
|
October 29,
2016
|
|
October 28,
2017
|
|
October 29,
2016
|
Net sales
|
100.0
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%
|
|
100.0
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%
|
|
100.0
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%
|
|
100.0
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%
|
Cost of sales (exclusive of depreciation and amortization)
|
58.7
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|
58.9
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61.4
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61.7
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Gross profit
|
41.3
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41.1
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38.6
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38.3
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Selling, general, and administrative expenses
|
24.1
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24.4
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26.0
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26.3
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Depreciation and amortization
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3.4
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3.5
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3.7
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3.9
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Asset impairment charge
|
0.7
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0.1
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|
0.4
|
|
|
0.3
|
|
Operating income
|
13.1
|
|
|
13.1
|
|
|
8.4
|
|
|
7.8
|
|
Income before income taxes
|
13.1
|
|
|
13.1
|
|
|
8.4
|
|
|
7.8
|
|
Provision for income taxes
|
4.1
|
|
|
3.7
|
|
|
1.1
|
|
|
2.4
|
|
Net income
|
9.0
|
%
|
|
9.3
|
%
|
|
7.3
|
%
|
|
5.4
|
%
|
Number of Company-operated stores, end of period
|
1,027
|
|
|
1,061
|
|
|
1,027
|
|
|
1,061
|
|
____________________________________________
Table may not add due to rounding.
The following tables set forth net sales by segment, for the periods indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Thirteen Weeks Ended
|
|
Thirty-nine Weeks Ended
|
|
October 28,
2017
|
|
October 29,
2016
|
|
October 28,
2017
|
|
October 29,
2016
|
Net sales:
|
(In thousands)
|
|
|
|
|
|
|
The Children’s Place U.S.
|
$
|
427,603
|
|
|
$
|
412,380
|
|
|
$
|
1,149,741
|
|
|
$
|
1,106,676
|
|
The Children’s Place International
|
62,423
|
|
|
61,397
|
|
|
150,562
|
|
|
157,868
|
|
Total net sales
|
$
|
490,026
|
|
|
$
|
473,777
|
|
|
$
|
1,300,303
|
|
|
$
|
1,264,544
|
|
Third Quarter 2017
Compared to the
Third Quarter 2016
Net sales
increased by $16.2 million, or 3.4%, to $490.0 million during the
Third Quarter 2017
from $473.8 million during the
Third Quarter 2016
. Our net sales increased by $24.2 million driven primarily by a Comparable Retail Sales increase of 5.1% and favorable changes in the Canadian exchange rate of $2.6 million, partially offset by a $10.6 million decrease in sales primarily due to operating fewer stores.
The Children’s Place U.S. net sales increased $15.2 million, or 3.7%, to $427.6 million in the
Third Quarter 2017
compared to $412.4 million in the
Third Quarter 2016
. This increase primarily resulted from a U.S. Comparable Retail Sales increase of 5.9%, partially offset by operating fewer stores.
The Children’s Place International net sales increased $1.0 million, or 1.6%, to $62.4 million in the
Third Quarter 2017
compared to $61.4 million in the
Third Quarter 2016
. The increase resulted primarily from favorable changes in the Canadian exchange rate, primarily offset by a Canadian Comparable Retail Sales decrease of 1.2%.
Gross profit
increased by $7.9 million to $202.4 million during the
Third Quarter 2017
from $194.5 million during the
Third Quarter 2016
. Gross margin leveraged 20 basis points to 41.3% during the
Third Quarter 2017
from 41.1% during the
Third Quarter 2016
. The increase in gross margin resulted primarily from merchandise margin expansion and the leverage of fixed expenses, partially offset by the increased penetration of our e-commerce business, which operates at a lower gross margin rate due to higher fulfillment costs.
Gross profit as a percentage of net revenues is dependent upon a variety of factors, including changes in the relative sales mix among distribution channels, changes in the mix of products sold, the timing and level of promotional activities, foreign currency exchange rates, and fluctuations in material costs. These factors, among others, may cause gross profit as a percentage of net revenues to fluctuate from period to period.
Selling, general, and administrative expenses
increased $2.9 million to $118.3 million during the
Third Quarter 2017
from $115.4 million during the
Third Quarter 2016
. As a percentage of net sales, SG&A decreased 30 basis points to 24.1% during the
Third Quarter 2017
from 24.4% during the
Third Quarter 2016
. The leverage was primarily due to strong Comparable Retail Sales, decreased store expenses, including lower credit card fees, and lower incentive compensation expenses, partially offset by expenses related to the continued investment in our transformation initiatives.
Asset impairment charges
were $3.2 million during the
Third Quarter 2017
, of which $0.8 million related to the full impairment of eight stores, and $2.4 million related to the write-down of information technology systems. Asset impairment charges during the
Third Quarter 2016
were $0.4 million, which related to the partial impairment of nine stores.
Provision for income taxes
was $20.0 million during the
Third Quarter 2017
compared to $17.8 million during the
Third Quarter 2016
. Our effective tax rate was 31.2% and 28.7% in the
Third Quarter 2017
and the
Third Quarter 2016
, respectively. The effective tax rate was higher primarily as a result of a $1.6 million tax benefit recorded for uncertain tax positions during the
Third Quarter 2016
.
Net income
was $44.1 million during the
Third Quarter 2017
compared to $44.2 million during the
Third Quarter 2016
, due to the factors discussed above. Earnings per diluted share was $2.44 in the
Third Quarter 2017
compared to $2.36 per diluted share in the
Third Quarter 2016
. This increase in earnings per share is due to the factors noted above and a lower weighted average common shares outstanding of approximately 0.6 million, which is the result of our share repurchase program.
Year-To-Date 2017
Compared to the
Year-To-Date 2016
Net sales
increased by $35.8 million, or 2.8%, to $1,300.3 million during
Year-To-Date 2017
from $1,264.5 million during
Year-To-Date 2016
. Our net sales increased by $59.4 million driven primarily by a Comparable Retail Sales increase of
4.8% and favorable changes in the Canadian exchange rate of $1.4 million, partially offset by a $25.0 million decrease in sales primarily due to operating fewer stores.
The Children’s Place U.S. net sales increased $43.0 million, or 3.9%, to $1,149.7 million during
Year-To-Date 2017
compared to $1,106.7 million during
Year-To-Date 2016
. This increase primarily resulted from a U.S. Comparable Retail Sales increase of 5.8%, partially offset by operating fewer stores.
The Children’s Place International net sales decreased $7.3 million, or 4.6%, to $150.6 million during
Year-To-Date 2017
compared to $157.9 million during
Year-To-Date 2016
. The decrease resulted primarily from a Canadian Comparable Retail Sales decrease of 2.4%, as well as from operating fewer stores in the current year, partially offset by favorable changes in the Canadian exchange rate.
Gross profit
increased by $17.7 million to $501.4 million during
Year-To-Date 2017
from $483.7 million during
Year-To-Date 2016
. Gross margin increased 30 basis points to 38.6% during
Year-To-Date 2017
from 38.3% during
Year-To-Date 2016
. The increase in gross margin resulted primarily from merchandise margin expansion and the leverage of fixed expenses, partially offset by the increased penetration of our e-commerce business, which operates at a lower gross margin rate due to higher fulfillment costs.
Gross profit as a percentage of net revenues is dependent upon a variety of factors, including changes in the relative sales mix among distribution channels, changes in the mix of products sold, the timing and level of promotional activities, foreign currency exchange rates, and fluctuations in material costs. These factors, among others, may cause gross profit as a percentage of net revenues to fluctuate from period to period.
Selling, general, and administrative expenses
increased $6.0 million to $338.6 million during
Year-To-Date 2017
from $332.6 million during
Year-To-Date 2016
. As a percentage of net sales, SG&A decreased 30 basis points to 26.0% during
Year-To-Date 2017
from 26.3% during
Year-To-Date 2016
. The comparability of our SG&A was affected by costs related to a provision for a legal settlement, costs related to foreign exchange control penalties, and a sales tax and use tax audit settlement, and costs arising out of the restructuring of certain store and corporate operations totaling approximately $6.9 million during
Year-To-Date 2017
and by income related to the restructuring of certain store and corporate operations totaling $0.4 million during
Year-To-Date 2016
. Excluding this impact, our SG&A decreased $1.3 million and leveraged 80 basis points. The leverage was primarily due to decreased store expenses, including credit card fees, and lower incentive compensation expenses, partially offset by expenses related to the continued investment in our transformation initiatives.
Asset impairment charges
were $4.7 million during
Year-To-Date 2017
, of which $2.3 million related to the full impairment of 17 stores, and $2.4 million related to the write-down of obsolete information technology systems. Asset impairment charges during
Year-To-Date 2016
were $3.2 million, of which $1.9 million related to 21 stores, four of which were fully impaired and 17 which were partially impaired, and $1.3 million related to the write-down of some previously capitalized development costs and information technology systems.
Provision for income taxes
was $14.6 million during
Year-To-Date 2017
compared to $30.2 million during
Year-To-Date 2016
. Our effective tax rate was a 13.4% compared to a provision of 30.7% during
Year-To-Date 2017
and
Year-To-Date 2016
, respectively. The decrease in the effective tax rate was primarily a result of tax benefits of $16.5 million for excess stock compensation benefits, due to the Company's adoption of FASB guidance relating to the accounting for share-based payment transactions, as well as the release of a $4.0 million reserve for an uncertain tax position that was resolved during the first quarter of fiscal 2017 compared to a $1.6 million tax benefit recorded for uncertain tax positions during
Year-To-Date 2016
.
Net income
was $94.6 million during
Year-To-Date 2017
compared to $68.1 million during
Year-To-Date 2016
, due to the factors discussed above. Earnings per diluted share was $5.19 during
Year-To-Date 2017
compared to $3.56 per diluted share during
Year-To-Date 2016
. This increase in earnings per share is due to the increase in net income, the aforementioned tax benefits for excess stock compensation benefits and a lower weighted average common shares outstanding of approximately 0.9 million, which is the result of our share repurchase program.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
Our working capital needs follow a seasonal pattern, peaking during the third fiscal quarter based on seasonal inventory purchases. Our primary uses of cash are working capital requirements, which are principally inventory purchases, and the financing of capital projects, including investments in new systems, and the repurchases of our common stock and payment of dividends.
Our working capital decreased $12.9 million to $262.5 million at
October 28, 2017
compared to $275.4 million at
October 29, 2016
, partially due to the prospective adoption of FASB guidance issued in November 2015 classifying deferred tax assets as noncurrent on the balance sheet. During
Year-To-Date 2017
, we repurchased approximately 0.8 million shares for approximately $85.4 million, inclusive of shares repurchased and surrendered to cover tax withholdings associated with the vesting of equity awards. During
Year-To-Date 2016
, we repurchased approximately 1.5 million shares for approximately $112.3 million. We also paid cash dividends of $21.1 million and $11.2 million during
Year-To-Date 2017
and
Year-To-Date 2016
, respectively. Subsequent to
October 28, 2017
and through November 17, 2017, we repurchased approximately 50 thousand shares for approximately $5.7 million and declared a quarterly cash dividend of
$0.40
per share to be paid on January 3, 2018 to shareholders of record on the close of business on December 13, 2017.
Our credit facility provides for borrowings up to the lesser of $250.0 million or our borrowing base, as defined by the credit facility agreement (see “Credit Facility” below). At
October 28, 2017
, we had $56.4 million of outstanding borrowings and $186.6 million available for borrowing. In addition, at
October 28, 2017
, we had $7.0 million of outstanding letters of credit with an additional $43.0 million available for issuing letters of credit.
As of
October 28, 2017
, we had $257.7 million of cash and cash equivalents, of which approximately $246.0 million of cash and cash equivalents were held in foreign subsidiaries, of which approximately $133.6 million was in our Canadian subsidiaries, approximately $108.4 million was in our Hong Kong subsidiaries and approximately $4.0 million was in other foreign subsidiaries. As of
October 28, 2017
, we also had short-term investments of $15.0 million in Hong Kong. Because all of our earnings in our foreign subsidiaries are permanently and fully reinvested, any repatriation of cash from these subsidiaries would require the accrual and payment of U.S. federal and certain state taxes. Due to the complexities associated with the hypothetical calculation, including the availability of foreign tax credits, we have concluded it is not practicable to determine the unrecognized deferred tax liability related to the undistributed earnings. We currently do not intend to repatriate cash from any of these foreign subsidiaries.
We expect to be able to meet our working capital and capital expenditure requirements for the foreseeable future by using our cash on hand, cash flows from operations, and availability under our credit facility.
Credit Facility
We and certain of our domestic subsidiaries maintain a credit agreement with Wells Fargo Bank, National Association (“Wells Fargo”), Bank of America, N.A., HSBC Business Credit (USA) Inc., and JPMorgan Chase Bank, N.A. as lenders (collectively, the “Lenders”) and Wells Fargo, as Administrative Agent, Collateral Agent and Swing Line Lender (the “Credit Agreement”). The Credit Agreement was amended on September 15, 2015 and the provisions below reflect the amended and extended Credit Agreement.
The Credit Agreement, which expires in September 2020, consists of a
$250 million
asset based revolving credit facility, with a
$50 million
sublimit for standby and documentary letters of credit and an uncommitted accordion feature that could provide up to
$50 million
of additional availability. Revolving credit loans outstanding under the Credit Agreement bear interest, at the Company’s option, at:
|
|
(i)
|
the prime rate plus a margin of
0.50%
to
0.75%
based on the amount of our average excess availability under the facility; or
|
|
|
(ii)
|
the London InterBank Offered Rate, or “LIBOR”, for an interest period of
one, two, three or six
months, as selected by us, plus a margin of
1.25%
to
1.50%
based on the amount of our average excess availability under the facility.
|
We are charged an unused line fee of
0.25%
on the unused portion of the commitments. Letter of credit fees range from
0.625%
to
0.750%
for commercial letters of credit and range from
0.75%
to
1.00%
for standby letters of credit. Letter of credit fees are determined based on the amount of our average excess availability under the facility. The amount available for loans and letters of credit under the Credit Agreement is determined by a borrowing base consisting of certain credit card receivables, certain trade and franchise receivables, certain inventory and the fair market value of certain real estate, subject to certain reserves.
The outstanding obligations under the Credit Agreement may be accelerated upon the occurrence of certain events, including, among others, non-payment, breach of covenants, the institution of insolvency proceedings, defaults under other material indebtedness and a change of control, subject, in the case of certain defaults, to the expiration of applicable grace periods. We are not subject to any early termination fees.
The Credit Agreement contains covenants, which include conditions on stock repurchases and the payment of cash dividends or similar payments. Credit extended under the Credit Agreement is secured by a first priority security interest in substantially all of our U.S. assets excluding intellectual property, software, equipment and fixtures.
We have capitalized an aggregate of approximately
$4.3 million
in deferred financing costs related to the Credit Agreement. The unamortized balance of deferred financing costs at
October 28, 2017
was approximately
$0.8 million
. Unamortized deferred financing costs are amortized over the remaining term of the Credit Agreement.
Cash Flows/Capital Expenditures
During
Year-To-Date 2017
, cash flows provided by operating activities were $129.9 million compared to $125.6 million during
Year-To-Date 2016
, resulting primarily from operating performance.
During
Year-To-Date 2017
, cash flows used in investing activities were $4.2 million compared to $61.8 million during
Year-To-Date 2016
. This change was primarily due to a $34.3 million net redemption of short-term investments into cash and cash equivalents for working capital needs during
Year-To-Date 2017
compared to a $35.0 million net purchase of short-term investments during
Year-To-Date 2016
partially offset by an $11.4 million increase in capital expenditures.
During
Year-To-Date 2017
, cash flows used in financing activities were $65.5 million compared to $62.1 million during
Year-To-Date 2016
. The increase primarily resulted from borrowings under our revolving credit facility and an increase in cash dividends paid, partially offset by a decrease in purchases of our common stock.
We anticipate that total capital expenditures will be approximately $65 million in fiscal 2017, primarily related to our business transformation initiatives, compared to $35 million in fiscal 2016. Our ability to continue to meet our capital requirements in fiscal 2017 depends on our cash on hand, our ability to generate cash flows from operations, and our available borrowings under our credit facility. Cash flow generated from operations depends on our ability to achieve our financial plans. During
Year-To-Date 2017
, we were able to fund our capital expenditures with cash on hand and cash generated from operating activities supplemented by funds from our credit facility. We believe that our existing cash on hand, cash generated from operations and funds available to us through our credit facility will be sufficient to fund our capital and other cash requirements for the foreseeable future.
Derivative Instruments
We are exposed to gains and losses resulting from fluctuations in foreign currency exchange rates attributable to inventory purchases denominated in a foreign currency. Specifically, our Canadian subsidiary’s functional currency is the Canadian dollar, but purchases inventory from suppliers in U.S. dollars. In order to mitigate the variability of cash flows associated with certain of these forecasted inventory purchases, we enter into foreign exchange forward contracts. These contracts typically mature within 12 months. We do not use forward contracts to engage in currency speculation and we do not enter into derivative financial instruments for trading purposes.
All derivative instruments are presented at gross fair value on the Consolidated Balance Sheets within either prepaid expenses and other current assets or accrued expenses and other current liabilities. As of
October 28, 2017
, we had foreign exchange forward contracts with an aggregate notional amount of
$26.1 million
and the fair value of the derivative instruments was an asset of
$1.6 million
.