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.
Important Factors Regarding 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 the Company’s other reports filed under the Securities Exchange Act of 1934, as amended, in its press releases and in other documents. In addition, from time-to-time, the Company, through its management, may make oral forward-looking statements. These statements relate to expectations, analyses and other information based on current plans, forecasts of future results and estimates of amounts not yet determinable. These statements also relate to our goals, future prospects, potential actions and impacts related to the coronavirus (or “COVID-19”) pandemic, global cost reduction opportunities and profitability efforts, capital allocation plans, cash needs and current business strategies and strategic initiatives. These forward-looking statements are identified by their use of terms and phrases such as “anticipate,” “believe,” “continue,” “could,” “create,” “estimate,” “expect,” “goal,” “intend,” “may,” “outlook,” “pending,” “plan,” “predict,” “project,” “see,” “should,” “strategy,” “will,” “would,” and other similar terms and phrases, including references to assumptions.
Although we believe that the expectations reflected in any of our forward-looking statements are reasonable, actual results could differ materially from those projected or assumed. 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 the Company and its partners; our ability to successfully negotiate rent relief or other lease-related terms with our landlords; our ability to successfully negotiate or defer our vendor obligations; our ability to maintain adequate levels of liquidity; changes to estimates related to impairments, inventory and other reserves, including the impact of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act enacted in March 2020, 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, tax and other regulatory proceedings; risks related to the complexity of the 2017 Tax Cuts and Jobs Act (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 transition period of 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 tax or tariff policy, including changes to tariffs on imports into the U.S.; 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 tax rates and economic and market conditions in the various countries in which we operate. These risks and uncertainties are discussed in further detail 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 February 1, 2020 and under “Part II, Item 1A. Risk Factors” contained herein, as such risk factors may be updated in our other filings made from time-to-time with the Securities and Exchange Commission (“SEC”) after the date of this report. We do not intend, and undertake no obligation, to update our forward-looking statements to reflect future events or circumstances. If we do update or correct one or more of these statements, investors and others should not conclude that we will make additional updates or corrections.
COVID-19 Business Update
The COVID-19 pandemic, which is ongoing and dynamic in nature, has had and is continuing to have a material impact on the Company’s financial performance. Since the start of the pandemic, the Company has experienced various temporary retail store closures in key regions globally, including the closure of a significant majority of its stores during the first quarter of fiscal 2021. During the second quarter of fiscal 2021, the Company gradually reopened most of its global fleet of stores. Toward the end of the third quarter of fiscal 2021, the Company started to incur a new round of government-mandated temporary store closures, resulting in the closure of just over 5% of our directly operated stores as of October 31, 2020, mostly in Europe. That percentage increased to slightly under 20% during the fiscal month of November, but recent store re-openings have helped decrease the store closure percentage to just under 10% as of November 29, 2020. The overall impact of these closures resulted in stores being closed for over 25% of the total days during the nine months ended October 31, 2020. The store closure impact was minimal during the third quarter of fiscal 2021. The Company will continue to reopen stores (and/or close again, if appropriate) as governmental guidelines and local conditions permit or require, taking an informed, measured approach based on numerous factors. The Company’s e-commerce sites have remained open in all regions throughout the pandemic. In addition to the impact of store closures, retail stores that are open have and continue to experience significant reductions in traffic and revenue. Many of the Company’s wholesale and licensing partners have also substantially reduced their operations. The Company has brought back furloughed store associates and support staff as stores reopen. The extent and duration of the global pandemic remains uncertain and may continue to impact consumer purchasing activity in the foreseeable future.
During the first nine months of fiscal 2021, in addition to the negative impact from lower net revenue, the Company’s operating results reflected asset impairment charges as well as additional inventory valuation reserves and higher allowances for markdowns and doubtful accounts due to the ongoing effects of the COVID-19 pandemic. These charges were partially offset by lower SG&A expenses driven primarily by expense savings, both one-time, such as furloughs and temporary salary reductions, and permanent, such as headcount reductions and lower discretionary spending. In addition, the Company benefited from various government assistance programs related primarily to the recovery of employee payroll costs as well as certain favorable tax treatments.
During the first nine months of fiscal 2021, the Company implemented a number of measures to help mitigate the operating and financial impact of the pandemic, including: (i) furloughing its U.S. and Canada store associates and significant portions of its U.S. and Canada corporate and distribution center associates and permanently reducing U.S. corporate headcount; (ii) implementing temporary tiered salary reductions for management level corporate employees, including its executive officers; (iii) deferring annual merit increases;
(iv) executing substantial reductions in expenses, store occupancy costs, capital expenditures and overall costs, including through reduced inventory purchases; (v) working globally with country management teams to maximize the Company’s participation in all eligible government or other initiatives available to businesses or employees impacted by the COVID-19 pandemic; (vi) drawing down on certain credit facilities and entering into certain term loans to ensure financial flexibility and maintain maximum liquidity; (vii) engaging with landlords to negotiate rent deferrals or other rent concessions; (viii) working with vendors to extend payment terms; and (ix) postponing its decision related to the payment of its quarterly cash dividend.
During the second quarter of fiscal 2021, as the situation began to stabilize, the Company repaid a significant portion of its previously drawn down credit facilities, continued to bring back furloughed employees, eliminated the temporary tiered salary reductions and invested in share repurchases to return value to its shareholders. The Company also announced that it would resume paying its quarterly cash dividend beginning in the third quarter of fiscal 2021, but decided to not declare any cash dividends for the first and second quarters of fiscal 2021.
Although we are unable to determine with any degree of accuracy the length and severity of the COVID-19 pandemic, we expect it will continue to have a material impact on our consolidated financial position, consolidated results of operations, and consolidated cash flows in the foreseeable future.
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. 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 Americas Retail segment includes the Company’s retail and e-commerce operations in the Americas. The Americas Wholesale segment includes the Company’s wholesale operations in the Americas. The Europe segment includes the Company’s retail, e-commerce and wholesale operations in Europe and the Middle East. The Asia segment includes the Company’s retail, e‑commerce and wholesale operations in Asia and the Pacific. The Licensing segment includes the worldwide licensing operations of the Company. The business segment operating results exclude corporate overhead costs, which consist of shared costs of the organization, asset impairment charges, net gains (losses) on lease modifications, restructuring charges and certain non-recurring credits (charges), if any. Corporate overhead costs are presented separately and generally include, among other things, the following unallocated corporate costs: accounting and finance, executive compensation, corporate performance-based compensation, facilities, global advertising and marketing, human resources, information technology and legal. 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 nine months of fiscal 2021, the average U.S. dollar rate was stronger against the Canadian dollar, Chinese yuan, Korean won, Mexican peso, Russian rouble and Turkish lira and weaker against the euro and Japanese yen 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 loss from operations for the nine months ended October 31, 2020 compared to the same prior-year period.
If the U.S. dollar strengthens relative to the respective fiscal 2020 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 2021, 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 2020 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 2021, 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, 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 five years. These priorities are: (i) brand relevancy; (ii) customer centricity; (iii) global footprint; (iv) product excellence; 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 will continue to execute celebrity and influencer partnerships and collaborations as we believe that they are critical to engage more effectively with a younger and broader audience.
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.
Product Excellence. We 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.
Functional Capabilities. We expect to drive material operational improvements in the next five 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.
While we have been challenged with the extremely difficult situation presented by the COVID-19 pandemic, we believe that the opportunities identified above remain in place for the long-term and provide a solid roadmap to grow our business, increase profitability over time and create significant value for our shareholders. In the short-term, we remain focused on enhancing our omni-channel platform centered around our consumer and accelerating efforts to gain efficiencies across our global operations and rationalize our store portfolios, measures which we believe will also maximize our liquidity to address the current crisis.
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 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
Except as described below in connection with the COVID-19 pandemic, 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 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 significant temporary store closures resulting from the COVID-19 pandemic, the Company has not disclosed any comparable store sales measures when discussing the results of operations for the nine months ended October 31, 2020. We believe that comparable store sales measures for the nine months ended October 31, 2020 are not meaningful to the evaluation of the Company’s results until the impact from the temporary store closures resulting from the COVID-19 pandemic has normalized.
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 nine months ended October 31, 2020 had the same number of days as the nine months ended November 2, 2019.
Executive Summary
Overview
Net earnings attributable to Guess?, Inc. increased 112.3% to $26.4 million, or diluted earnings of $0.41 per common share, for the quarter ended October 31, 2020, compared to net earnings attributable to Guess?, Inc. of $12.4 million, or diluted earnings of $0.18 per common share, for the quarter ended November 2, 2019.
During the quarter ended October 31, 2020, the Company recognized $10.3 million of asset impairment charges; minimal net gains on lease modifications; a net credit of $0.2 million of certain professional services and legal fees and related costs; $0.7 million of separation charges; $2.6 million of amortization of debt discount related to the Company’s convertible senior notes and $0.6 million in additional tax expense from certain discrete tax adjustments (or a combined $11.0 million, or $0.17 per share, negative impact after considering the related tax benefit of these adjustments of $3.1 million). Excluding the impact of these items, adjusted net earnings attributable to Guess?, Inc. were $37.4 million and adjusted diluted earnings were $0.58 per common share for the quarter ended October 31, 2020. During the quarter ended November 2, 2019, the Company recognized $1.8 million of asset impairment charges; a net credit of $1.4 million of certain professional services and legal fees and related costs and $2.4 million of amortization of debt discount related to the Company’s convertible senior notes (or a combined $2.5 million, or $0.04 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 $14.9 million and adjusted diluted earnings were $0.22 per common share for the quarter ended November 2, 2019. 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 October 31, 2020 compared to the same prior-year period are presented below, followed by a more comprehensive discussion under “Results of Operations”:
Operations
•Total net revenue decreased 7.6% to $569.3 million for the quarter ended October 31, 2020, from $615.9 million in the same prior-year quarter. In constant currency, net revenue decreased by 10.1%.
•Gross margin (gross profit as a percentage of total net revenue) increased 480 basis points to 42.1% for the quarter ended October 31, 2020, from 37.3% in the same prior-year period.
•Selling, general and administrative (“SG&A”) expenses as a percentage of total net revenue (“SG&A rate”) decreased 80 basis points to 32.5% for the quarter ended October 31, 2020, compared to 33.3% in the same prior-year period. SG&A expenses decreased 9.9% to $184.7 million for the quarter ended October 31, 2020, from $205.0 million in the same prior-year period.
•During the quarter ended October 31, 2020, the Company recognized asset impairment charges of $10.3 million, compared to $1.8 million in the same prior-year period.
•Operating margin increased 410 basis points to 7.8% for the quarter ended October 31, 2020, compared to 3.7% in the same prior-year period, driven primarily by the benefit of higher wholesale revenue in Europe as we elongated the fall-winter season’s shipment window and, to a lesser extent, higher initial markups in Europe and overall lower expenses, partially offset by the unfavorable impact from negative comparable sales. Higher asset impairment charges unfavorably impacted operating margin by 150 basis points during the quarter ended October 31, 2020 compared to the same prior-year period. Lower net credits related to certain professional service and legal fees and related costs unfavorably impacted operating margin by 30 basis points during the quarter ended October 31, 2020. Separation charges unfavorably impacted operating margin by 10 basis points during the quarter ended October 31, 2020. Earnings from operations were $44.5
million for the quarter ended October 31, 2020, compared to $22.6 million in the same prior-year period.
•Other expense, net (including interest income and expense), was $11.8 million for the quarter ended October 31, 2020, compared to $4.5 million in the same prior-year period.
•The effective income tax rate decreased to 15.7% for the quarter ended October 31, 2020, compared to 25.1% in the same prior-year period. The Company’s effective tax rate for the quarter ended October 31, 2020 included the unfavorable impact from certain discrete tax adjustments totaling $0.6 million.
Key Balance Sheet Accounts
•The Company had $365.3 million in cash and cash equivalents and $0.2 million in restricted cash as of October 31, 2020, compared to $110.1 million in cash and cash equivalents and $0.5 million in restricted cash at November 2, 2019.
◦As of October 31, 2020, the Company had $51.9 million in outstanding borrowings under its term loans and $9.2 million in outstanding borrowings under its credit facilities to help ensure financial flexibility and liquidity in response to uncertainty surrounding the COVID-19 pandemic.
◦During the nine months ended October 31, 2020, the Company repurchased 4.0 million shares of its common stock for $38.9 million (including commissions). During fiscal 2020, the Company used $170 million of proceeds from its offering of convertible senior notes to enter into an accelerated share repurchase program (“ASR Contract”), pursuant to which it received a total of approximately 10.6 million shares. The Company also repurchased shares of its common stock for $118.1 million (including commissions) during fiscal 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 $0.2 million, or 0.1%, to $300.4 million as of October 31, 2020, from $300.2 million at November 2, 2019. On a constant currency basis, accounts receivable decreased by $5.5 million, or 1.8%, when compared to November 2, 2019.
•Inventory decreased by $126.7 million, or 24.4%, to $393.2 million as of October 31, 2020, from $519.9 million at November 2, 2019. On a constant currency basis, inventory decreased by $127.9 million, or 24.6%, when compared to November 2, 2019.
Global Store Count
In the third quarter of fiscal 2021, together with our partners, we opened 17 new stores worldwide, consisting of ten stores in Europe and the Middle East, six stores in Asia and the Pacific and one store in Central and South America. Together with our partners, we closed 35 stores worldwide, consisting of 15 stores in Asia and the Pacific, ten stores in Europe and the Middle East, five stores in the U.S., four stores in Central and South America and one store in Canada.
We ended the third quarter of fiscal 2021 with 1,604 stores and 368 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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254
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252
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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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78
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78
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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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107
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72
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35
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27
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27
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—
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Total Americas
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439
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402
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37
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28
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27
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1
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Europe and the Middle East
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742
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511
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231
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43
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43
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—
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Asia and the Pacific
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423
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155
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268
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297
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109
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188
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Total
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1,604
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1,068
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536
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368
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179
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189
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Of the total 1,604 stores, 1,325 were GUESS? stores, 178 were GUESS? Accessories stores, 63 were G by GUESS (GbG) stores and 38 were MARCIANO stores.
Results of Operations
Three Months Ended October 31, 2020 and November 2, 2019
Consolidated Results
Net Revenue. Net revenue decreased by $46.7 million, or 7.6%, to $569.3 million for the quarter ended October 31, 2020, from $615.9 million for the quarter ended November 2, 2019. In constant currency, net revenue decreased by 10.1%, driven primarily by the unfavorable impact on revenue due primarily to negative comparable sales driven primarily by lower store traffic and, to a lesser extent, lower wholesale shipments in Americas Wholesale resulting from lower demand as a result of the COVID-19 pandemic. This was partially offset by the benefit of higher European wholesale revenue as we elongated the fall-winter season’s shipment window. Currency translation fluctuations relating to our foreign operations favorably impacted net revenue by $15.5 million, compared to the same prior-year period.
Gross Margin. Gross margin increased 480 basis points to 42.1% for the quarter ended October 31, 2020, compared to 37.3% in the same prior-year period, of which 280 basis points was due to a lower occupancy rate and 200 basis points due to higher product margins. The lower occupancy rate was driven primarily by leveraging of occupancy costs due mainly to higher European wholesale revenue and, to a lesser extent, the favorable impact from rent concessions granted related to the COVID-19 pandemic primarily in Europe, partially offset by the unfavorable impact from negative comparable sales. The higher product margins were driven primarily by higher initial markups in Europe during the quarter ended October 31, 2020, compared to the same prior-year period.
Gross Profit. Gross profit increased by $10.0 million, or 4.4%, to $239.5 million for the quarter ended October 31, 2020, compared to $229.5 million in the same prior-year period. The increase in gross profit, which included the favorable impact of currency translation, was due primarily to lower occupancy costs and, to a lesser extent, higher overall product margins, partially offset by the unfavorable impact on gross profit from lower revenue. Currency translation fluctuations relating to our foreign operations favorably impacted gross profit by $6.9 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 80 basis points to 32.5% for the quarter ended October 31, 2020, from 33.3% in the same prior-year period. The Company’s SG&A rate included the unfavorable impact of 30 basis points from lower net credits related to certain professional service and legal fees and related costs which the Company otherwise would not have incurred as part of its business operations and the unfavorable impact of 10 basis points from separation charges. Excluding these items, the SG&A rate would have decreased by 120 basis points during the quarter ended October 31, 2020 compared to the same prior-year period, driven by leveraging of expenses due to higher European wholesale revenue and, to a lesser extent, lower store selling expenses in Americas Retail, partially offset by the unfavorable impact from negative comparable sales.
SG&A Expenses. SG&A expenses decreased by $20.3 million, or 9.9%, to $184.7 million for the quarter ended October 31, 2020, from $205.0 million in the same prior-year period. The decrease, which included the unfavorable impact of currency translation, was driven primarily by lower store selling expenses and, to a lesser extent, lower overall discretionary expenses. Currency translation fluctuations relating to our foreign operations unfavorably impacted SG&A expenses by $5.1 million.
Asset Impairment Charges. During the quarter ended October 31, 2020, the Company recognized $5.6 million in impairment of certain operating lease right-of-use assets and $4.7 million in 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. This compares to $1.3 million in impairment of property and equipment and $0.5 million in impairment of certain operating lease right-of-use assets related to certain retail locations resulting from under-performance and expected store closures during the quarter ended November 2, 2019. Currency translation fluctuations relating to our foreign operations unfavorably impacted asset impairment charges by $0.2 million.
Operating Margin. Operating margin increased 410 basis points to 7.8% for the quarter ended October 31, 2020, compared to 3.7% in the same prior-year period, driven primarily by the benefit of higher wholesale revenue in Europe as we elongated the fall-winter season’s shipment window and, to a lesser extent, higher initial markups in Europe and overall lower expenses, partially offset by the unfavorable impact from negative comparable sales. Higher asset impairment charges unfavorably impacted operating margin by 150 basis points during the quarter ended October 31, 2020 compared to the same prior-year period. Lower net credits related to certain professional service and legal fees and related costs unfavorably impacted operating margin by 30 basis points during the quarter ended October 31, 2020. Separation charges unfavorably impacted operating margin by 10 basis points during the quarter ended October 31, 2020. Excluding the impact of these items, the Company’s operating margin would have increased 600 basis points 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 $21.8 million, or 96.3%, to $44.5 million for the quarter ended October 31, 2020, compared to $22.6 million in the same prior-year period. Currency translation fluctuations relating to our foreign operations favorably impacted earnings from operations by $1.6 million.
Interest Expense, Net. Interest expense, net, was $5.2 million for the quarter ended October 31, 2020, compared to $4.5 million for the quarter ended November 2, 2019.
Other Expense, Net. Other expense, net, was $6.5 million for the quarter ended October 31, 2020, compared to $0.1 million in the same prior-year period. The change was driven primarily by market volatility which resulted in net unrealized losses on the translation of foreign currency balances and, to a lesser extent, net unrealized losses on our SERP-related assets, compared to net unrealized gains in the same prior-year quarter. This was partially offset by lower net losses related to one of our minority investments during the quarter ended October 31, 2020, compared to the same prior-year quarter.
Income Tax Expense. Income tax expense for the quarter ended October 31, 2020 was $5.1 million, or a 15.7% effective tax rate, compared to $4.5 million, or a 25.1% 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 quarter ended October 31, 2020, the Company recognized valuation allowances of $1.2 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. This was partially offset by a discrete tax benefit of approximately $0.7 million related to lower forecasts for the current fiscal year which changes the estimate of the net operating losses that the Company can carryback to tax years with a higher federal corporate tax rate as allowed under the CARES Act. Excluding the impact from these items, the change in the effective tax rate was due primarily to a shift in the distribution of earnings among the Company’s tax jurisdictions during the quarter ended October 31, 2020, compared to the same prior-year period.
Net Earnings Attributable to Noncontrolling Interests. Net earnings attributable to noncontrolling interests were $1.2 million, net of taxes, for each of the quarters ended October 31, 2020 and November 2, 2019.
Net Earnings Attributable to Guess?, Inc. Net earnings attributable to Guess?, Inc. were $26.4 million for the quarter ended October 31, 2020, compared to $12.4 million in the same prior-year period. Diluted earnings per share were $0.41 for the quarter ended October 31, 2020, compared to $0.18 in the same prior-year period. We estimate that the favorable impact from the Company’s share repurchases was $0.03 on diluted earnings per share for the quarter ended October 31, 2020. We also estimate that the negative impact of currency on diluted earnings per share for the quarter ended October 31, 2020 was approximately $0.11 per share. During the quarter ended October 31, 2020, the Company recognized $10.3 million of asset impairment charges; minimal net gains on lease modifications; a net credit of $0.2 million of certain professional services and legal fees and related costs; $0.7 million of separation charges; $2.6 million of amortization of debt discount related to the Company’s convertible senior notes and $0.6 million in additional tax expense from certain discrete tax adjustments (or a combined $11.0 million, or $0.17 per share, negative impact after considering the related tax benefit of these adjustments of $3.1 million). Excluding the impact of these items, adjusted net earnings attributable to Guess?, Inc. were $37.4 million and adjusted diluted earnings were $0.58 per common share for the quarter ended October 31, 2020. We estimate that the favorable impact from the Company’s share repurchases was $0.05 on adjusted diluted earnings per share for the quarter ended October 31, 2020. During the quarter ended November 2, 2019, the Company recognized $1.8 million of asset impairment charges; a net credit of $1.4 million of certain professional services and legal fees and related costs and $2.4 million of amortization of debt discount related to the Company’s convertible senior notes (or a combined $2.5 million, or $0.04 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 $14.9 million and adjusted diluted earnings were $0.22 per common share for the quarter ended November 2, 2019. 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 October 31, 2020 and November 2, 2019 (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
Oct 31, 2020
|
|
Nov 2, 2019
|
|
$ Change
|
|
% Change
|
Net revenue:
|
|
|
|
|
|
|
|
Americas Retail
|
$
|
130,328
|
|
|
$
|
177,824
|
|
|
$
|
(47,496)
|
|
|
(26.7
|
%)
|
Americas Wholesale
|
35,971
|
|
|
56,398
|
|
|
(20,427)
|
|
|
(36.2
|
%)
|
Europe
|
321,574
|
|
|
277,253
|
|
|
44,321
|
|
|
16.0
|
%
|
Asia
|
61,978
|
|
|
82,261
|
|
|
(20,283)
|
|
|
(24.7
|
%)
|
Licensing
|
19,433
|
|
|
22,208
|
|
|
(2,775)
|
|
|
(12.5
|
%)
|
Total net revenue
|
$
|
569,284
|
|
|
$
|
615,944
|
|
|
$
|
(46,660)
|
|
|
(7.6
|
%)
|
Earnings (loss) from operations:
|
|
|
|
|
|
|
|
Americas Retail
|
$
|
473
|
|
|
$
|
1,601
|
|
|
$
|
(1,128)
|
|
|
(70.5
|
%)
|
Americas Wholesale
|
8,247
|
|
|
11,216
|
|
|
(2,969)
|
|
|
(26.5
|
%)
|
Europe
|
51,476
|
|
|
19,475
|
|
|
32,001
|
|
|
164.3
|
%
|
Asia
|
1,415
|
|
|
(2,432)
|
|
|
3,847
|
|
|
158.2
|
%
|
Licensing
|
18,228
|
|
|
19,372
|
|
|
(1,144)
|
|
|
(5.9
|
%)
|
Total segment earnings from operations
|
79,839
|
|
|
49,232
|
|
|
30,607
|
|
|
62.2
|
%
|
Corporate overhead
|
(25,058)
|
|
|
(24,736)
|
|
|
(322)
|
|
|
1.3
|
%
|
|
|
|
|
|
|
|
|
Asset impairment charges
|
(10,335)
|
|
|
(1,847)
|
|
|
(8,488)
|
|
|
459.6
|
%
|
Net gains on lease modifications
|
21
|
|
|
—
|
|
|
21
|
|
|
|
Total earnings from operations
|
$
|
44,467
|
|
|
$
|
22,649
|
|
|
$
|
21,818
|
|
|
96.3
|
%
|
|
|
|
|
|
|
|
|
Operating margins:
|
|
|
|
|
|
|
|
Americas Retail
|
0.4
|
%
|
|
0.9
|
%
|
|
|
|
|
Americas Wholesale
|
22.9
|
%
|
|
19.9
|
%
|
|
|
|
|
Europe
|
16.0
|
%
|
|
7.0
|
%
|
|
|
|
|
Asia
|
2.3
|
%
|
|
(3.0
|
%)
|
|
|
|
|
Licensing
|
93.8
|
%
|
|
87.2
|
%
|
|
|
|
|
Total Company
|
7.8
|
%
|
|
3.7
|
%
|
|
|
|
|
Americas Retail
Net revenue from our Americas Retail segment decreased by $47.5 million, or 26.7%, to $130.3 million for the quarter ended October 31, 2020, from $177.8 million in the same prior-year period. In constant currency, net revenue decreased by 26.2%, due primarily to lower comparable sales driven primarily by reduced store traffic resulting from the COVID-19 pandemic and, to a lesser extent, the negative impact from permanent store closures. Comparable sales (including e-commerce) decreased 21% in U.S. dollars and 20% in constant currency compared to the same prior-year period. The inclusion of our e-commerce sales increased the comparable sales percentage by 2% 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 32 net stores during the quarter ended October 31, 2020 compared to the same prior-year period, resulting in a 6.0% net decrease in average square footage. Currency translation fluctuations relating to our non-U.S. retail stores and e-commerce sites unfavorably impacted net revenue by $0.9 million.
Operating margin decreased 50 basis points to 0.4% for the quarter ended October 31, 2020, from 0.9% in the same prior-year quarter, due to lower gross margins and, to a lesser extent, a higher SG&A rate. The lower gross margins were driven primarily by overall deleveraging of occupancy costs due primarily to negative comparable sales, partially offset by lower lease costs. The higher SG&A rate was driven primarily by overall deleveraging of expenses, partially offset by lower store selling expenses due primarily to lower payroll costs.
Earnings from operations from our Americas Retail segment decreased by $1.1 million, or 70.5%, to $0.5 million for the quarter ended October 31, 2020, from $1.6 million in the same prior-year period. The
deterioration is due primarily to the unfavorable impact on earnings from lower revenue, partially offset by lower store selling expenses and lower occupancy costs.
Americas Wholesale
Net revenue from our Americas Wholesale segment decreased by $20.4 million, or 36.2%, to $36.0 million for the quarter ended October 31, 2020, from $56.4 million in the same prior-year period. In constant currency, net revenue decreased by 34.2%, driven primarily by our U.S. wholesale business due mainly to lower demand resulting from the COVID-19 pandemic. Currency translation fluctuations relating to our non-U.S. wholesale businesses unfavorably impacted net revenue by $1.2 million.
Operating margin increased 300 basis points to 22.9% for the quarter ended October 31, 2020, compared to 19.9% in the same prior-year quarter, due primarily to overall higher product margins.
Earnings from operations from our Americas Wholesale segment decreased by $3.0 million, or 26.5%, to $8.2 million for the quarter ended October 31, 2020, from $11.2 million in the same prior-year period. The decrease reflects the unfavorable impact on earnings from lower revenue.
Europe
Net revenue from our Europe segment increased by $44.3 million, or 16.0%, to $321.6 million for the quarter ended October 31, 2020, compared to $277.3 million in the same prior-year period. In constant currency, net revenue increased by 10.2%, driven primarily by the benefit of higher wholesale revenue as we elongated the fall-winter season’s shipment window, partially offset by lower comparable sales driven by reduced store traffic resulting from the COVID-19 pandemic. Comparable sales (including e-commerce) decreased 9% in U.S. dollars and 13% in constant currency compared to the same prior-year period. The inclusion of our e-commerce sales increased the comparable sales percentage by 6% in U.S. dollars and 5% in constant currency. As of October 31, 2020, we directly operated 511 stores in Europe compared to 516 stores at November 2, 2019, excluding concessions, which represents a 1.0% decrease over the same prior-year period. Currency translation fluctuations relating to our European operations favorably impacted net revenue by $16.0 million.
Operating margin increased 900 basis points to 16.0% for the quarter ended October 31, 2020, compared to 7.0% in the same prior-year quarter, due to higher overall gross margins and, to a lesser extent, a lower SG&A rate. The higher gross margins were driven primarily by higher initial markups and, to a lesser extent, overall leveraging of occupancy costs due to higher wholesale revenue and the favorable impact from certain rent concessions granted related to the COVID-19 pandemic. The lower SG&A rate was due primarily to overall leveraging of expenses resulting from higher wholesale revenue.
Earnings from operations from our Europe segment increased by $32.0 million, or 164.3%, to $51.5 million for the quarter ended October 31, 2020, compared to $19.5 million in the same prior-year period, driven primarily by the favorable impact on earnings from higher revenue. Currency translation fluctuations relating to our European operations favorably impacted earnings from operations by $2.4 million.
Asia
Net revenue from our Asia segment decreased by $20.3 million, or 24.7%, to $62.0 million for the quarter ended October 31, 2020, from $82.3 million in the same prior-year period. In constant currency, net revenue decreased by 26.6%, due primarily to the negative impact from permanent store closures and, to a lesser extent, lower comparable sales driven by reduced store traffic resulting from the COVID-19 pandemic. As of October 31, 2020, we and our partners operated 423 stores and 297 concessions in Asia, compared to 519 stores and 327 concessions at November 2, 2019. As of October 31, 2020, we directly operated 155 stores and 109 concessions in Asia, compared to 219 directly-operated stores and 154 concessions at November 2, 2019. Comparable sales (including e-commerce) decreased 15% in U.S. dollars and 18% in constant currency. The inclusion of our e-commerce sales decreased the comparable sales percentage by 1% in U.S. dollars and constant currency. Currency translation fluctuations relating to our Asian operations favorably impacted net revenue by $1.6 million.
Operating margin increased 530 basis points to 2.3% for the quarter ended October 31, 2020, from negative 3.0% in the same prior-year quarter, driven by higher gross margins and, to a lesser extent, a lower SG&A rate. The higher gross margins were driven primarily by overall higher product margins. The lower SG&A rate was driven primarily by the favorable impact of business mix.
Earnings from operations from our Asia segment was $1.4 million for the quarter ended October 31, 2020, compared to loss from operations of $2.4 million in the same prior-year period. The improvement was driven primarily by the favorable impact on earnings from lower SG&A expenses and, to a lesser extent, lower occupancy costs, partially offset by the unfavorable impact from lower revenue.
Licensing
Net royalty revenue from our Licensing segment decreased by $2.8 million, or 12.5%, to $19.4 million for the quarter ended October 31, 2020, from $22.2 million in the same prior-year period, due primarily to lower demand resulting from the COVID-19 pandemic.
Earnings from operations from our Licensing segment decreased by $1.1 million, or 5.9%, to $18.2 million for the quarter ended October 31, 2020, from $19.4 million in the same prior-year period. The decrease was driven by the unfavorable impact to earnings from lower revenue.
Corporate Overhead
Unallocated corporate overhead increased by $0.3 million to $25.1 million for the quarter ended October 31, 2020, compared to $24.7 million in the same prior-year period.
Nine Months Ended October 31, 2020 and November 2, 2019
Consolidated Results
Net Revenue. Net revenue decreased by $607.8 million, or 33.1%, to $1.23 billion for the nine months ended October 31, 2020, compared to $1.84 billion for the nine months ended November 2, 2019. In constant currency, net revenue decreased by 33.4%, driven primarily by the unfavorable impact on revenue due to temporary store closures and lower store traffic and, to a lesser extent, lower wholesale shipments resulting from lower demand as a result of the COVID-19 pandemic. Currency translation fluctuations relating to our foreign operations unfavorably impacted net revenue by $5.0 million, compared to the same prior-year period.
Gross Margin. Gross margin decreased 260 basis points to 34.3% for the nine months ended October 31, 2020, from 36.9% in the same prior-year period, of which 280 basis points was due to a higher occupancy rate, partially offset by 20 basis points due to higher product margins. The higher occupancy rate was driven primarily by overall deleveraging of occupancy costs due mainly to lower revenue resulting from the impact of the COVID-19 pandemic, partially offset by the favorable impact from rent concessions granted related to the COVID-19 pandemic primarily in Europe. The higher product margins were driven primarily by higher initial markups in Europe, partially offset by higher inventory reserves in Asia during the nine months ended October 31, 2020, compared to the same prior-year period.
Gross Profit. Gross profit decreased by $256.3 million, or 37.9%, to $420.8 million for the nine months ended October 31, 2020, from $677.1 million in the same prior-year period. The decrease in gross profit, which included the favorable impact of currency translation, was due primarily to the unfavorable impact on gross profit from lower revenue, partially offset by lower occupancy costs. Currency translation fluctuations relating to our foreign operations favorably impacted gross profit by $5.5 million.
SG&A Rate. The Company’s SG&A rate increased 480 basis points to 39.0% for the nine months ended October 31, 2020, compared to 34.2% in the same prior-year period. The Company’s SG&A rate included the unfavorable impact of 30 basis points from separation charges and the unfavorable impact of 10 basis from lower net credits related to certain professional service and legal fees and related costs which the Company otherwise would not have incurred as part of its business operations. Excluding these items, the Company’s SG&A rate would have increased by 440 basis points during nine months ended October 31, 2020 compared to
the same prior-year period, driven by overall deleveraging of expenses due mainly to lower revenue resulting from the impact of the COVID-19 pandemic, partially offset by expense savings.
SG&A Expenses. SG&A expenses decreased by $149.5 million, or 23.8%, to $478.3 million for the nine months ended October 31, 2020, from $627.8 million in the same prior-year period. The decrease, which included the unfavorable impact of currency translation, was driven primarily by lower payroll costs and, to a lesser extent, lower overall discretionary expenses. The lower payroll costs were driven primarily by the impact of furloughs and, to a lesser extent, government assistance programs related to the recovery of employee payroll costs, temporary tiered salary reductions for management level corporate employees that have since been restored and permanent headcount reductions. Currency translation fluctuations relating to our foreign operations unfavorably impacted SG&A expenses by $0.3 million.
Asset Impairment Charges. During the nine months ended October 31, 2020, the Company recognized $42.1 million in impairment of certain operating lease right-of-use assets and $33.2 million in 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. This compares to $4.6 million in impairment of property and equipment and $0.5 million in impairment of certain operating lease right-of-use assets related to certain retail locations resulting from under-performance and expected store closures during the nine months ended November 2, 2019. Currency translation fluctuations relating to our foreign operations favorably impacted asset impairment charges by $1.4 million.
Net Gains on Lease Modifications. During the nine months ended October 31, 2020, the Company recorded net gains on lease modifications of $0.5 million related primarily to the early termination of lease agreements for certain of the Company’s retail locations. There were no net gains on lease modifications recorded during the nine months ended November 2, 2019.
Operating Margin. Operating margin decreased 13.2% to negative 10.8% for the nine months ended October 31, 2020, from 2.4% in the same prior-year period, driven primarily by overall deleveraging of expenses due to the negative impact from the COVID-19 pandemic on our global operations and, to a lesser extent, higher asset impairment charges. Higher asset impairment charges negatively impacted operating margin by 580 basis points during the nine months ended October 31, 2020 compared to the same prior-year period. Separation charges unfavorably impacted operating margin by 30 basis points during the nine months ended October 31, 2020. Lower net credits related to certain professional service and legal fees and related costs unfavorably impacted operating margin by 10 basis points during the nine months ended October 31, 2020. Excluding the impact of these items, the Company’s operating margin would have decreased 700 basis points compared to the same prior-year period. The positive impact of currency on operating margin for the first nine months of fiscal 2021 was approximately 20 basis points.
Earnings (Loss) from Operations. Loss from operations was $132.4 million for the nine months ended October 31, 2020, compared to earnings from operations of $44.2 million in the same prior-year period. Currency translation fluctuations relating to our foreign operations favorably impacted loss from operations by $6.7 million.
Interest Expense, Net. Interest expense, net, was $15.6 million for the nine months ended October 31, 2020, compared to $10.0 million for the nine months ended November 2, 2019. The increase in interest expense was due primarily to higher amortization of debt discount and higher interest expense related to the Company’s convertible senior notes during the nine months ended October 31, 2020.
Other Expense, Net. Other expense, net, was $20.6 million for the nine months ended October 31, 2020, compared to $4.3 million in the same prior-year period. The change was due primarily to market volatility which resulted in higher unrealized losses on the translation of foreign currency balances and, to a lesser extent, lower net unrealized gains on our SERP-related assets, compared to the same prior-year period. During the first nine months of fiscal 2021, the Company also recognized net mark-to-market losses on revaluation of foreign exchange currency contracts, compared to gains in the same prior-year period.
Income Tax Expense (Benefit). Income tax benefit for the nine months ended October 31, 2020 was $14.9 million, or an 8.8% effective tax rate, compared to income tax expense of $10.6 million, or a 35.7% 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 nine months ended October 31, 2020, the Company recognized a valuation allowance of $4.9 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. This was partially offset by a tax benefit of approximately $4.6 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. Excluding the impact of these items, the change in the effective tax rate was due primarily to a shift in the distribution of earnings among the Company’s tax jurisdictions during the nine months ended October 31, 2020, compared to the same prior-year period.
Net Earnings (Loss) Attributable to Noncontrolling Interests. Net loss attributable to noncontrolling interests was $2.0 million, net of taxes, for the nine months ended October 31, 2020, compared to net earnings attributable to noncontrolling interests of $2.8 million, net of taxes, for the nine months ended November 2, 2019.
Net Earnings (Loss) Attributable to Guess?, Inc. Net loss attributable to Guess?, Inc. was $151.6 million for the nine months ended October 31, 2020, compared to net earnings attributable to Guess?, Inc. of $16.4 million in the same prior-year period. Diluted loss per share was $2.35 for the nine months ended October 31, 2020, compared to diluted earnings per share of $0.22 in the same prior-year period. We estimate that the unfavorable impact from the Company’s share repurchases and additional interest expense recognized related to the offering of convertible senior notes had a net negative impact on diluted loss per share of $0.35 for the nine months ended October 31, 2020. We also estimate that the negative impact of currency on diluted loss per share for the nine months ended October 31, 2020 was approximately $0.17 per share. During the nine months ended October 31, 2020, the Company recognized $75.3 million of asset impairment charges; $0.5 million of net gains on lease modifications; a net credit of $0.1 million of certain professional services and legal fees and related costs; $3.4 million of separation charges; $7.8 million of amortization of debt discount related to the Company’s convertible senior notes; and $0.8 million in additional tax expense from certain discrete tax adjustments (or a combined $69.5 million, or $1.08 per share, negative impact after considering the related tax benefit of these adjustments of $17.3 million). Excluding the impact of these items, adjusted net loss attributable to Guess?, Inc. was $82.2 million and adjusted diluted loss was $1.27 per common share during the nine months ended October 31, 2020. We estimate that the unfavorable impact from share repurchases and additional interest expense recognized related to the offering of convertible senior notes had a net negative impact of $0.18 on adjusted diluted loss per share for the nine months ended October 31, 2020. During the nine months ended November 2, 2019, the Company recognized $5.1 million of asset impairment charges; a net credit of $0.7 million of certain professional services and legal fees and related costs; and $5.1 million of amortization of debt discount related to the Company’s convertible senior notes (or a combined $6.3 million, or $0.09 per share, negative impact after considering the related tax benefit of these adjustments of $3.2 million). Excluding the impact of these items, adjusted net earnings attributable to Guess?, Inc. were $22.7 million and adjusted diluted earnings per share were $0.31 per common share during the nine months ended November 2, 2019. 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 nine months ended October 31, 2020 and November 2, 2019 (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
Oct 31, 2020
|
|
Nov 2, 2019
|
|
$ Change
|
|
% Change
|
|
|
|
|
Net revenue:
|
|
|
|
|
|
|
|
Americas Retail
|
$
|
314,977
|
|
|
$
|
553,213
|
|
|
$
|
(238,236)
|
|
|
(43.1
|
%)
|
Americas Wholesale
|
82,131
|
|
|
144,505
|
|
|
(62,374)
|
|
|
(43.2
|
%)
|
Europe
|
633,898
|
|
|
827,817
|
|
|
(193,919)
|
|
|
(23.4
|
%)
|
Asia
|
152,554
|
|
|
250,752
|
|
|
(98,198)
|
|
|
(39.2
|
%)
|
Licensing
|
44,514
|
|
|
59,568
|
|
|
(15,054)
|
|
|
(25.3
|
%)
|
Total net revenue
|
$
|
1,228,074
|
|
|
$
|
1,835,855
|
|
|
$
|
(607,781)
|
|
|
(33.1
|
%)
|
Earnings (loss) from operations:
|
|
|
|
|
|
|
|
Americas Retail
|
$
|
(40,904)
|
|
|
$
|
5,746
|
|
|
$
|
(46,650)
|
|
|
(811.9
|
%)
|
Americas Wholesale
|
11,559
|
|
|
27,452
|
|
|
(15,893)
|
|
|
(57.9
|
%)
|
Europe
|
27,865
|
|
|
54,742
|
|
|
(26,877)
|
|
|
(49.1
|
%)
|
Asia
|
(24,729)
|
|
|
(10,435)
|
|
|
(14,294)
|
|
|
(137.0
|
%)
|
Licensing
|
39,833
|
|
|
51,563
|
|
|
(11,730)
|
|
|
(22.7
|
%)
|
Total segment earnings from operations
|
13,624
|
|
|
129,068
|
|
|
(115,444)
|
|
|
(89.4
|
%)
|
Corporate overhead
|
(71,167)
|
|
|
(79,777)
|
|
|
8,610
|
|
|
(10.8
|
%)
|
|
|
|
|
|
|
|
|
Asset impairment charges
|
(75,276)
|
|
|
(5,126)
|
|
|
(70,150)
|
|
|
1,368.5
|
%
|
|
|
|
|
|
|
|
|
Net gains on lease modifications
|
450
|
|
|
—
|
|
|
450
|
|
|
|
|
|
|
|
|
|
|
|
Total earnings (loss) from operations
|
$
|
(132,369)
|
|
|
$
|
44,165
|
|
|
$
|
(176,534)
|
|
|
(399.7
|
%)
|
Operating margins:
|
|
|
|
|
|
|
|
Americas Retail
|
(13.0
|
%)
|
|
1.0
|
%
|
|
|
|
|
Americas Wholesale
|
14.1
|
%
|
|
19.0
|
%
|
|
|
|
|
Europe
|
4.4
|
%
|
|
6.6
|
%
|
|
|
|
|
Asia
|
(16.2
|
%)
|
|
(4.2
|
%)
|
|
|
|
|
Licensing
|
89.5
|
%
|
|
86.6
|
%
|
|
|
|
|
Total Company
|
(10.8
|
%)
|
|
2.4
|
%
|
|
|
|
|
Americas Retail
Net revenue from our Americas Retail segment decreased by $238.2 million, or 43.1%, to $315.0 million for the nine months ended October 31, 2020, compared to $553.2 million in the same prior-year period. In constant currency, net revenue decreased by 42.6%, driven primarily by temporary store closures and, to a lesser extent, lower store traffic resulting from the COVID-19 pandemic. Excluding the impact from the temporary store closures, the store base for the U.S. and Canada decreased by an average of 24 net stores during the nine months ended October 31, 2020 compared to the same prior-year period, resulting in a 4.3% net decrease in average square footage. Currency translation fluctuations relating to our non-U.S. retail stores and e-commerce sites unfavorably impacted net revenue by $2.7 million.
Operating margin decreased 14.0% to negative 13.0% for the nine months ended October 31, 2020, from 1.0% in the same prior-year period, due to lower gross margins and, to a lesser extent, a higher SG&A rate. The lower gross margins were driven primarily by overall deleveraging of occupancy costs due primarily to the negative impact from temporary store closures and lower store traffic. The higher SG&A rate was driven primarily by overall deleveraging of expenses, partially offset by lower store selling expenses due to payroll savings resulting from the temporary furlough of the Company’s store associates in the U.S. and Canada and lower overall payroll costs.
Loss from operations from our Americas Retail segment was $40.9 million for the nine months ended October 31, 2020, compared to earnings from operations of $5.7 million in the same prior-year period. The deterioration is primarily due to the unfavorable impact on earnings from lower revenue, partially offset by lower store selling expenses and lower occupancy costs.
Americas Wholesale
Net revenue from our Americas Wholesale segment decreased by $62.4 million, or 43.2%, to $82.1 million for the nine months ended October 31, 2020, from $144.5 million in the same prior-year period. In constant currency, net revenue decreased by 40.8%, driven primarily by our U.S. wholesale business due mainly to lower demand resulting from the COVID-19 pandemic. Currency translation fluctuations relating to our non-U.S. wholesale businesses unfavorably impacted net revenue by $3.4 million.
Operating margin decreased 490 basis points to 14.1% for the nine months ended October 31, 2020, from 19.0% in the same prior-year period, due primarily to a higher SG&A rate driven primarily by overall deleveraging of expenses resulting from lower wholesale shipments.
Earnings from operations from our Americas Wholesale segment decreased by $15.9 million, or 57.9%, to $11.6 million for the nine months ended October 31, 2020, from $27.5 million in the same prior-year period. The decrease reflects the unfavorable impact on earnings from lower revenue.
Europe
Net revenue from our Europe segment decreased by $193.9 million, or 23.4%, to $633.9 million for the nine months ended October 31, 2020, from $827.8 million in the same prior-year period. In constant currency, net revenue decreased by 24.9%, driven primarily by temporary store closures and lower store traffic resulting from the COVID-19 pandemic and, to a lesser extent, lower wholesale shipments resulting from lower demand. Currency translation fluctuations relating to our European operations favorably impacted net revenue by $12.0 million.
Operating margin decreased 220 basis points to 4.4% for the nine months ended October 31, 2020, from 6.6% in the same prior-year period, driven by a higher SG&A rate, partially offset by higher gross margins. The higher SG&A rate was due primarily to overall deleveraging of expenses resulting from lower revenue. The higher gross margins were driven primarily by the favorable impact from certain rent concessions granted related to the COVID-19 pandemic and, to a lesser extent, higher initial markups, partially offset by overall deleveraging of occupancy costs due to lower revenue.
Earnings from operations from our Europe segment decreased by $26.9 million, or 49.1%, to $27.9 million for the nine months ended October 31, 2020, from $54.7 million in the same prior-year period. The decrease was driven primarily by the unfavorable impact on earnings from lower revenue, partially offset by lower occupancy costs and, to a lesser extent, lower SG&A expenses. Currency translation fluctuations relating to our European operations favorably impacted earnings from operations by $4.7 million.
Asia
Net revenue from our Asia segment decreased by $98.2 million, or 39.2%, to $152.6 million for the nine months ended October 31, 2020, compared to $250.8 million in the same prior-year period. In constant currency, net revenue decreased by 38.8%, driven primarily by lower store traffic and, to a lesser extent, permanent store closures and temporary store closures resulting from the COVID-19 pandemic. Currency translation fluctuations relating to our Asian operations unfavorably impacted net revenue by $0.9 million.
Operating margin decreased 12.0% to negative 16.2% for the nine months ended October 31, 2020, from negative 4.2% in the same prior-year period, driven by lower gross margins and, to a lesser extent, a higher SG&A rate. The lower gross margins were due primarily to the negative impacts from the COVID-19 pandemic which resulted in higher inventory reserves. The higher SG&A rate was driven primarily by overall deleveraging of expenses, partially offset by the favorable impact of business mix.
Loss from operations from our Asia segment deteriorated by $14.3 million, or 137.0%, to $24.7 million for the nine months ended October 31, 2020, from $10.4 million in the same prior-year period. The deterioration was driven primarily by the unfavorable impact on earnings from lower revenue and, to a lesser extent, lower product margins, partially offset by lower SG&A expenses and, to a lesser extent, lower occupancy costs. Currency translation fluctuations relating to our Asian operations favorably impacted loss from operations by $1.0 million.
Licensing
Net royalty revenue from our Licensing segment decreased by $15.1 million, or 25.3%, to $44.5 million for the nine months ended October 31, 2020, compared to $59.6 million in the same prior-year period, due primarily to lower demand resulting from the COVID-19 pandemic.
Earnings from operations from our Licensing segment decreased by $11.7 million, or 22.7%, to $39.8 million for the nine months ended October 31, 2020, compared to $51.6 million in the same prior-year period. The decrease was driven primarily by the unfavorable impact to earnings from lower revenue.
Corporate Overhead
Unallocated corporate overhead decreased by $8.6 million to $71.2 million for the nine months ended October 31, 2020, from $79.8 million in the same prior-year period, due primarily to lower performance-based compensation and, to a lesser extent, lower overall discretionary expenses.
Non-GAAP Measures
The Company’s reported financial results are presented in accordance with GAAP. The reported net earnings (loss) attributable to Guess?, Inc. and diluted earnings (loss) per share for the three and nine months ended October 31, 2020 reflect the impact of asset impairment charges, net gains on lease modifications, certain professional service and legal fees and related net credits, certain separation charges, amortization of debt discount on the Company’s convertible senior notes and the tax effects of these adjustments as well as certain discrete tax adjustments. The reported net earnings attributable to Guess?, Inc. and diluted earnings per share for the three and nine months ended November 2, 2019 reflect the impact of asset impairment charges, certain professional service and legal fees and related net credits, amortization of debt discount on the Company’s convertible senior notes and the tax effects of these adjustments as well as adjustments to uncertain tax positions excluded from results in prior years. 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 believes that these items are not indicative of the underlying performance of its business and that the “non-GAAP” or “adjusted” 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. The non-GAAP measures are provided in addition to, and not as alternatives for, the Company’s reported GAAP results.
The adjusted measures for the three months ended October 31, 2020 exclude the impact of $10.3 million of asset impairment charges; minimal net gains on lease modifications; a net credit of $0.2 million of certain professional services and legal fees and related costs; $0.7 million of separation charges; $2.6 million of amortization of debt discount on the Company’s convertible senior notes and $0.6 million in additional tax expense 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 from the ongoing effects of the COVID-19 pandemic. Certain professional service and legal fees and related (credits) costs 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 cash severance payments as a result of headcount reductions in response to the pandemic. During the three months ended October 31, 2020, the Company recognized valuation allowances of $1.2 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. This was partially offset by a discrete tax benefit of approximately $0.7 million related to lower forecasts for the current fiscal year which changes the estimate of the net operating losses that the Company can carryback to tax years with a higher federal corporate tax rate as allowed under the CARES Act. These items resulted in a combined $11.0 million negative impact (after considering the related tax benefit of $3.1 million), or an unfavorable $0.17 per share impact during the three months ended October 31, 2020. Net earnings attributable to Guess?, Inc. were $26.4 million and diluted earnings were $0.41 per common share for the three months ended October 31, 2020. Excluding the impact of
these items, adjusted net earnings attributable to Guess?, Inc. were $37.4 million and adjusted diluted earnings were $0.58 per common share for the three months ended October 31, 2020.
The adjusted measures for the nine months ended October 31, 2020 exclude the impact of $75.3 million of asset impairment charges; $0.5 million of net gains on lease modifications; a net credit of $0.1 million of certain professional services and legal fees and related costs; $3.4 million of separation charges; $7.8 million of amortization of debt discount related to the Company’s convertible senior notes; and $0.8 million in additional tax expense 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 from the ongoing effects of the COVID-19 pandemic. The net gains on lease modifications related primarily to the early termination of lease agreements for certain of the Company’s retail locations. 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 nine months ended October 31, 2020, the Company recognized a valuation allowance of $4.9 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. This was partially offset by a tax benefit of approximately $4.6 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. These items resulted in a combined $69.5 million negative impact (after considering the related tax benefit of $17.3 million), or an unfavorable $1.08 per share impact during the nine months ended October 31, 2020. Net loss attributable to Guess?, Inc. was $151.6 million and diluted loss was $2.35 per common share for the nine months ended October 31, 2020. Excluding the impact of these items, adjusted net loss attributable to Guess?, Inc. was $82.2 million and adjusted diluted loss was $1.27 per common share for the nine months ended October 31, 2020.
The adjusted measures for the three months ended November 2, 2019 exclude the impact of $1.8 million of asset impairment charges; a net credit of $1.4 million of certain professional services and legal fees and related costs and $2.4 million of amortization of debt discount on the Company’s convertible senior notes. The asset impairment charges related primarily to the impairment of property and equipment and, to a lesser extent, impairment of certain operating lease right-of-use assets related to certain retail locations resulting from under-performance and expected store closures. These items resulted in a combined $2.5 million negative impact (after considering the related tax benefit of $0.4 million), or an unfavorable $0.04 per share impact during the three months ended November 2, 2019. Net earnings attributable to Guess?, Inc. were $12.4 million and diluted earnings were $0.18 per common share for the three months ended November 2, 2019. Excluding the impact of these items, adjusted net earnings attributable to Guess?, Inc. were $14.9 million and adjusted diluted earnings were $0.22 per common share for the three months ended November 2, 2019.
The adjusted measures for the nine months ended November 2, 2019 exclude the impact of $5.1 million of asset impairment charges; a net credit of $0.7 million of certain professional services and legal fees and related costs and $5.1 million of amortization of debt discount on the Company’s convertible senior notes. The asset impairment charges related primarily to the impairment of property and equipment and, to a lesser extent, impairment of certain operating lease right-of-use assets related to certain retail locations resulting from under-performance and expected store closures. These items resulted in a combined $6.3 million negative impact (after considering the related tax benefit of $3.2 million), or an unfavorable $0.09 per share impact during the nine months ended November 2, 2019. Net earnings attributable to Guess?, Inc. were $16.4 million and diluted earnings were $0.22 per common share for the nine months ended November 2, 2019. Excluding the impact of these items, adjusted net earnings attributable to Guess?, Inc. were $22.7 million and adjusted diluted earnings were $0.31 per common share for the nine months ended November 2, 2019.
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 nine months ended October 31, 2020, 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 termination 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. As further noted above under the “—COVID-19 Business Update” section, the Company has also implemented a number of other measures to help preserve liquidity in response to the COVID-19 pandemic. We expect to settle the principal amount of our outstanding convertible senior notes in 2024 in cash and any excess in shares. Such arrangements are described further in “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” of this Form 10-Q. 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.
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. During the nine months ended October 31, 2020, the Company recognized a tax benefit of approximately $4.6 million related to this provision.
In December 2017, the U.S. government enacted the Tax Reform, which significantly changed the U.S. corporate income tax laws, including moving from a global taxation regime to a territorial regime and lowering the U.S. federal corporate income tax rate from 35% to 21%. The Tax Reform also required a one-time mandatory transition tax on accumulated foreign earnings. Any income tax payable related to the transition tax is due over an eight-year period beginning in calendar 2018. The balance related to this transition tax included in other long-term liabilities was $19.9 million (excluding related interest) for each of the periods ended October 31, 2020 and February 1, 2020.
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. As of October 31, 2020, the Company had cash and cash equivalents of $365.3 million, of which approximately $80.2 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 February 1, 2020 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. Since April 2020, we have suspended rental payments and/or paid reduced rental amounts with respect to our retail stores that were closed or were experiencing drastically reduced customer traffic as a result of the COVID-19 pandemic. We are engaging in discussions with the affected landlords in an effort to achieve appropriate rent relief and other lease concessions and, in some cases, to terminate existing leases. However, there can be no assurances related to the outcome of such negotiations.
Nine Months Ended October 31, 2020 and November 2, 2019
The Company has presented below the cash flow performance comparison of the nine months ended October 31, 2020, compared to the nine months ended November 2, 2019.
Operating Activities
Net cash provided by operating activities was $98.4 million for the nine months ended October 31, 2020, compared to net cash used in operating activities of $28.0 million for the nine months ended November 2, 2019, or an improvement of $126.4 million. This improvement was driven primarily by favorable changes in working capital, partially offset by lower cash flows generated from net earnings. The favorable changes in working capital were due primarily to the extension of vendor payment terms on our accounts payable balances and the suspension and/or reduction of our operating lease payments, which could be temporary, as well as overall lower expenditures and improved inventory management. In addition, during the nine months ended November 2, 2019, net cash used in operating activities included the payment of the European Commission fine of $45.6 million which was imposed and accrued in fiscal 2019.
Investing Activities
Net cash used in investing activities was $14.6 million for the nine months ended October 31, 2020, compared to $48.0 million for the nine months ended November 2, 2019. Net cash used in investing activities for the nine months ended October 31, 2020 related primarily to capital expenditures incurred on investments in technology infrastructure and, to a lesser extent, existing store remodeling programs and international retail expansion. In addition, purchases of investments, settlements of forward exchange currency contracts and proceeds from the sale of long-term assets are also included in cash flows used in investing activities.
The decrease in cash used in investing activities was driven primarily by lower spending on retail expansion during the nine months ended October 31, 2020 compared to the same prior-year period. During the nine months ended October 31, 2020, the Company opened 13 directly-operated stores compared to 60 directly-operated stores that were opened in the same prior-year period.
Financing Activities
Net cash used in financing activities was $4.5 million for the nine months ended October 31, 2020, compared to net cash used in financing activities of $21.7 million for the nine months ended November 2, 2019. Net cash used in financing activities for the nine months ended October 31, 2020 related primarily to repurchases of shares of the Company’s common stock. In addition, payment of dividends, cash activity from the issuance of common stock under our equity plans, payments related to finance lease obligations, net proceeds from borrowings and net proceeds related to issuance of convertible senior notes and related warrants are also included in cash flows from financing activities.
The decrease in cash used in financing activities was driven primarily by the lower investments made in share repurchases and, to a lesser extent, lower payment of dividends and higher net proceeds received from borrowings during the nine months ended October 31, 2020 compared to the same prior-year period. This was partially offset by net proceeds from the issuance of convertible senior notes and related warrants during the nine months ended November 2, 2019.
Effect of Exchange Rates on Cash, Cash Equivalents and Restricted Cash
During the nine months ended October 31, 2020, changes in foreign currency translation rates increased our reported cash, cash equivalents and restricted cash balance by $1.4 million. This compares to a decrease of $2.7 million in cash, cash equivalents and restricted cash driven by changes in foreign currency translation rates during the nine months ended November 2, 2019.
Working Capital
As of October 31, 2020, the Company had net working capital (including cash and cash equivalents) of $397.5 million, compared to $425.8 million at February 1, 2020 and $340.8 million at November 2, 2019.
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 $0.2 million, or 0.1%, to $300.4 million as of October 31, 2020, from $300.2 million at November 2, 2019. On a constant currency basis, accounts receivable decreased by $5.5 million, or 1.8%, when compared to November 2, 2019. As of October 31, 2020, approximately 48% of our total net trade receivables and 61% 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 decreased by $126.7 million, or 24.4%, to $393.2 million as of October 31, 2020, from $519.9 million at November 2, 2019. On a constant currency basis, inventory decreased by $127.9 million, or 24.6%, when compared to November 2, 2019, driven primarily by improved inventory management compared to the same prior-year period.
Capital Expenditures
Gross capital expenditures totaled $12.4 million, before deducting lease incentives of $1.2 million, for the nine months ended October 31, 2020. This compares to gross capital expenditures of $49.0 million, before deducting lease incentives of $5.0 million for the nine months ended November 2, 2019.
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 December 2, 2020, 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 January 4, 2021 to shareholders of record as of the close of business on December 16, 2020.
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
On June 26, 2012, the Company’s Board of Directors authorized a program to repurchase, from time-to-time and as market and business conditions warrant, up to $500 million of the Company’s common stock. Repurchases under the program may be made on the open market or in privately negotiated transactions, pursuant to Rule 10b5-1 trading plans or other available means. There is no minimum or maximum number of shares to be repurchased under the program, which may be discontinued at any time, without prior notice. There were 4,000,000 shares repurchased at an aggregate cost of $38.8 million under the program during the nine months ended October 31, 2020. The shares were repurchased during the three months ended August 1, 2020. During the nine months ended November 2, 2019, the Company repurchased 16,412,609 shares under the program at an aggregate cost of $280.5 million, which is inclusive of the shares repurchased under the ASR Contract. The Company repurchased 10,264,052 shares at an aggregate cost of $201.5 million during the three months ended May 4, 2019, 749,252 shares at an aggregate cost of $11.0 million during the three months ended August 3, 2019 and an additional 5,399,305 shares at an aggregate cost of $68.0 million during the three months ended November 2, 2019. As of October 31, 2020, 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
On August 23, 2005, the Board of Directors of the Company adopted a Supplemental Executive Retirement Plan (“SERP”) which became effective January 1, 2006. The SERP provides select employees who satisfy certain eligibility requirements with certain benefits upon retirement, termination of employment, death, disability or a change in control of the Company, in certain prescribed circumstances.
As a non-qualified pension plan, no dedicated funding of the 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 amount of any future payments into the insurance policies, if any, may vary depending on investment performance of the trust. The cash surrender values of the insurance policies were $68.1 million and $67.7 million as of October 31, 2020 and February 1, 2020, 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 unrealized gains (losses) of $(0.3) million and $1.7 million in other income (expense) during the three and nine months ended October 31, 2020, respectively, and unrealized gains of $2.0 million and $5.0 million in other income during the three and nine months ended November 2, 2019, respectively. The projected benefit obligation was $51.6 million and $51.9 million as of October 31, 2020 and February 1, 2020, 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 $0.4 million and $1.3 million were made during the three and nine months ended October 31, 2020, respectively. SERP benefit payments of $0.4 million and $1.3 million were made during the three and nine months ended November 2, 2019, respectively.
Contractual Obligations and Commitments
During the nine months ended October 31, 2020, the Company entered into certain term loans to ensure financial flexibility and maintain maximum liquidity in response to uncertainty surrounding the COVID-19 pandemic. See “Part I, Item 1. Financial Statements – Note 9 – Borrowings and Finance Lease Obligations” for further information on these arrangements. As of October 31, 2020, there were no other 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 February 1, 2020.
Wholesale Backlog
We generally receive orders for fashion apparel three to six months prior to the time the products are delivered to our customers’ stores. The backlog of wholesale orders at any given time is affected by various factors, including pricing, seasonality, cancellations, the scheduling of market weeks, and the timing of the receipt and shipment of orders and may include orders for multiple seasons. Accordingly, a comparison of backlogs of wholesale orders from period-to-period is not necessarily meaningful and may not be indicative of eventual actual shipments. This is particularly true in light of recent events resulting from the COVID-19 pandemic, which we expect could continue to have a material impact on our wholesale orders and backlog.
U.S. and Canada Backlog. Our U.S. and Canadian wholesale backlog as of November 30, 2020, consisting primarily of orders for fashion apparel, was $36.5 million in constant currency, compared to $47.5 million at December 2, 2019, a decrease of 23.3%.
Europe Backlog. As of November 29, 2020, the European wholesale backlog was €321.9 million, compared to €296.0 million at December 1, 2019, an increase of 8.8%. The backlog as of November 29, 2020 is comprised primarily of sales orders for the Spring/Summer 2021 and Fall/Winter 2021 seasons.
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 February 1, 2020 filed with the SEC on April 1, 2020. There have been no significant changes to our critical accounting policies during the nine months ended October 31, 2020.
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 and licensing revenue recorded for the nine months ended October 31, 2020 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 February 1, 2020.
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 (see below). 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 nine months ended October 31, 2020, the total foreign currency translation adjustment increased stockholders’ equity by $13.3 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 gains (losses) of $(10.2) million and $3.1 million were included in the determination of net earnings (loss) for the nine months ended October 31, 2020 and November 2, 2019, 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 nine months ended October 31, 2020, the Company purchased U.S. dollar forward contracts in Europe totaling US$85.0 million that were designated as cash flow hedges. As of October 31, 2020, the Company had forward contracts outstanding for its European operations of US$106.0 million to hedge forecasted merchandise purchases, which are expected to mature over the next 14 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 October 31, 2020, accumulated other comprehensive income (loss) related to foreign exchange currency contracts included a net unrealized loss of approximately $0.9 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 October 31, 2020, the net unrealized loss of the remaining open forward contracts recorded in the Company’s condensed consolidated balance sheet was approximately $1.2 million.
At February 1, 2020, the Company had forward contracts outstanding for its European operations of US$148.6 million that were designated as cash flow hedges. At February 1, 2020, the net unrealized gain of these open forward contracts recorded in the Company’s condensed consolidated balance sheet was approximately $4.0 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 nine months ended October 31, 2020, the Company recorded a net loss of $3.1 million for its euro dollar foreign exchange currency contracts not designated as hedges, which has been included in other income (expense). As of October 31, 2020, the Company had euro foreign exchange currency contracts to purchase US$38.0 million expected to mature over the next seven months. As of October 31, 2020, the net unrealized loss of these open forward contracts recorded in the Company’s condensed consolidated balance sheet was approximately $0.8 million.
At February 1, 2020, the Company had euro foreign exchange currency contracts to purchase US$46.1 million. At February 1, 2020, the net unrealized gain of these open forward contracts recorded in the Company’s condensed consolidated balance sheet was approximately $0.9 million.
Sensitivity Analysis
As of October 31, 2020, 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$144.0 million, the fair value of the instruments would have decreased by $16.0 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 $13.1 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
During fiscal 2017, the Company entered into an interest rate swap agreement with a notional amount of $21.5 million, designated as a cash flow hedge, to hedge the variability of cash flows in interest payments associated with the Company’s floating-rate real estate secured loan (the “Mortgage Debt”). This interest rate swap agreement matures in January 2026 and converts the nature of the Company’s Mortgage Debt from LIBOR floating-rate debt to fixed-rate debt, resulting in a swap fixed rate of approximately 3.06%. 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 October 31, 2020, accumulated other comprehensive income (loss) related to the interest rate swap agreement included a net unrealized loss of $0.8 million net of tax, which will be recognized in interest expense after 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 October 31, 2020, the net unrealized loss of the interest rate swap recorded in the Company’s condensed consolidated balance sheet was approximately $1.1 million. As of February 1, 2020, the net unrealized loss of the interest rate swap recorded in the Company’s condensed consolidated balance sheet was approximately $0.3 million.
Sensitivity Analysis
As of October 31, 2020, the Company had borrowings under its credit facility arrangements of $9.2 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 a significant effect on interest expense for the nine months ended October 31, 2020.
As of October 31, 2020, the Company also had indebtedness related to term loans of $51.9 million, finance lease obligations of $22.2 million and its Mortgage Debt of $18.7 million. The term loans provide for annual interest rates ranging between 0.5% to 1.5%. 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 October 31, 2020 and February 1, 2020, 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 third quarter of fiscal 2021 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.