GUESS INC - Quarter Report: 2009 October (Form 10-Q)

Table of Contents

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

x           QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended October 31, 2009

 

OR

 

o              TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from          to         

 

Commission file number:  1-11893

 

GUESS?, INC.

(Exact name of registrant as specified in its charter)

 

 

(213) 765-3100

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x  No  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  o  No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o  No  x

 

As of December 4, 2009, the registrant had 92,376,131 shares of Common Stock, $.01 par value per share, outstanding.

 

 

Table of Contents

 

GUESS?, INC.
FORM 10-Q

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)	1
	Condensed Consolidated Balance Sheets as of October 31, 2009 and January 31, 2009	1
	Condensed Consolidated Statements of Income — Three and Nine Months Ended October 31, 2009 and November 1, 2008	2
	Condensed Consolidated Statements of Comprehensive Income — Three and Nine Months Ended October 31, 2009 and November 1, 2008	3
	Condensed Consolidated Statements of Cash Flows — Nine Months Ended October 31, 2009 and November 1, 2008	4
	Notes to Condensed Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	29
Item 4.	Controls and Procedures	30
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	31
Item 1A.	Risk Factors	31
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	31
Item 3.	Defaults Upon Senior Securities	32
Item 4.	Submission of Matters to a Vote of Security Holders	32
Item 5.	Other Information	32
Item 6.	Exhibits	32

 

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PART I. FINANCIAL INFORMATION

 

ITEM 1.  Financial Statements.

 

GUESS?, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

 

		Oct. 31, 2009			Jan. 31, 2009
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	344,862		$	294,118
Accounts receivable, net		318,472			262,349
Inventories		261,880			239,675
Prepaid expenses and other current assets		51,964			70,769
Deferred tax assets		30,012			27,278
Total current assets		1,007,190			894,189
Property and equipment, net		254,259			221,416
Goodwill		32,273			27,102
Other intangible assets, net		15,509			16,145
Long-term deferred tax assets		51,847			49,689
Other assets		48,240			38,025
		$	1,409,318		$	1,246,566
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of borrowings and capital lease obligations		$	2,577		$	24,018
Accounts payable		170,186			192,168
Accrued expenses		130,514			119,698
Total current liabilities		303,277			335,884
Borrowings and capital lease obligations		15,457			14,586
Deferred rent and lease incentives		60,131			52,563
Other long-term liabilities		59,289			58,029
		438,154			461,062
Commitments and contingencies (Note 11)
Redeemable noncontrolling interests		14,486			10,050
Stockholders’ equity:
Preferred stock, $.01 par value. Authorized 10,000,000 shares; no shares issued and outstanding		—			—
Common stock, $.01 par value. Authorized 150,000,000 shares; issued 136,206,843 and 135,826,959 shares, outstanding 92,368,395 and 92,329,419 shares, at October 31, 2009 and January 31, 2009, respectively		924			923
Paid-in capital		305,379			282,220
Retained earnings		844,117			718,368
Accumulated other comprehensive income (loss)		18,603			(16,421		)
Treasury stock, 43,838,448 and 43,497,540 shares at October 31, 2009 and January 31, 2009, respectively		(217,068		)	(212,089		)
Guess?, Inc. stockholders’ equity		951,955			773,001
Noncontrolling interests		4,723			2,453
Total stockholders’ equity		956,678			775,454
		$	1,409,318		$	1,246,566

 

See accompanying notes to condensed consolidated financial statements.

 

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GUESS?, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share data)
(unaudited)

 

		Three Months Ended						Nine Months Ended
		Oct. 31, 2009			Nov. 1, 2008			Oct. 31, 2009			Nov. 1, 2008
Net revenue:
Product sales		$	494,998		$	499,994		$	1,414,489		$	1,454,685
Net royalties		27,814			27,934			71,947			77,635
		522,812			527,928			1,486,436			1,532,320
Cost of product sales		285,921			286,116			840,265			837,114
Gross profit		236,891			241,812			646,171			695,206
Selling, general and administrative expenses		137,917			142,432			408,049			434,891
Earnings from operations		98,974			99,380			238,122			260,315
Other income (expense):
Interest expense		(778		)	(1,706		)	(1,723		)	(3,530		)
Interest income		277			2,000			1,461			5,086
Other income (expense), net		(1,340		)	(3,717		)	(1,413		)	(5,349		)
		(1,841		)	(3,423		)	(1,675		)	(3,793		)
Earnings before income tax expense		97,133			95,957			236,447			256,522
Income tax expense		32,054			31,721			78,028			89,526
Net earnings		65,079			64,236			158,419			166,996
Net earnings attributable to noncontrolling interests		1,009			219			2,247			1,346
Net earnings attributable to Guess?, Inc.		$	64,070		$	64,017		$	156,172		$	165,650
Earnings per common share attributable to common stockholders (Note 2):
Basic		$	0.69		$	0.68		$	1.70		$	1.75
Diluted		$	0.69		$	0.67		$	1.68		$	1.74
Weighted average common shares outstanding attributable to common stockholders (Note 2):
Basic		90,941			92,438			90,765			92,799
Diluted		91,778			93,140			91,416			93,533
Dividends declared per common share		$	0.125		$	0.10		$	0.325		$	0.26

 

See accompanying notes to condensed consolidated financial statements.

 

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GUESS?, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)
(unaudited)

 

		Three Months Ended						Nine Months Ended
		Oct. 31, 2009			Nov. 1, 2008			Oct. 31, 2009			Nov. 1, 2008
Net earnings		$	65,079		$	64,236		$	158,419		$	166,996
Foreign currency translation adjustment		10,154			(49,946		)	44,852			(43,270		)
Unrealized (loss) gain on hedges, net of tax effect		(1,282		)	8,071			(10,219		)	10,256
Unrealized (loss) gain on investments, net of tax effect		38			(121		)	98			(230		)
SERP prior service cost and actuarial valuation loss amortization, net of tax effect		292			449			868			1,303
Comprehensive income		74,281			22,689			194,018			135,055
Less comprehensive loss (income) attributable to noncontrolling interests		(515		)	1,780			(2,822		)	200
Comprehensive income attributable to Guess?, Inc.		$	73,766		$	24,469		$	191,196		$	135,255

 

See accompanying notes to condensed consolidated financial statements.

 

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GUESS?, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)
(unaudited)

 

		Nine Months Ended
		Oct. 31, 2009			Nov. 1, 2008
Cash flows from operating activities:
Net earnings		$	158,419		$	166,996
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization of property and equipment		41,380			38,828
Amortization of intangible assets		5,713			6,187
Share-based compensation expense		19,447			17,053
Unrealized forward contract losses (gains)		4,614			(18,668		)
Net loss on disposition of long-term assets and property and equipment		1,289			2,891
Other items, net		(2,884		)	16,310
Changes in operating assets and liabilities:
Accounts receivable		(22,522		)	(87,275		)
Inventories		(3,658		)	(36,806		)
Prepaid expenses and other assets		(62		)	1,584
Accounts payable and accrued expenses		(42,436		)	(18,511		)
Deferred rent and lease incentives		7,568			5,899
Other long-term liabilities		(1,467		)	(1,041		)
Net cash provided by operating activities		165,401			93,447
Cash flows from investing activities:
Purchases of property and equipment		(61,913		)	(69,391		)
Proceeds from dispositions of long-term assets and property and equipment		474			—
Acquisition of businesses, net of cash acquired		549			—
Net cash settlement of forward contracts		429			(3,526		)
Purchases of long-term investments		(5,597		)	(9,518		)
Net cash used in investing activities		(66,058		)	(82,435		)
Cash flows from financing activities:
Certain short-term borrowings, net		(22,628		)	11,301
Proceeds from borrowings		40,000			—
Repayment of borrowings and capital lease obligation		(41,266		)	(2,317		)
Dividends paid		(30,008		)	(24,594		)
Noncontrolling interest capital contributions		650			1,408
Noncontrolling interest capital distributions		(1,311		)	—
Issuance of common stock, net of nonvested award repurchases		2,865			690
Excess tax benefits from share-based compensation		2,651			5,328
Purchase of treasury stock		(5,309		)	(33,051		)
Net cash used in financing activities		(54,356		)	(41,235		)
Effect of exchange rates on cash and cash equivalents		5,757			(8,771		)
Net increase (decrease) in cash and cash equivalents		50,744			(38,994		)
Cash and cash equivalents at beginning of period		294,118			275,595
Cash and cash equivalents at end of period		$	344,862		$	236,601
Supplemental cash flow data:
Interest paid		$	1,538		$	3,090
Income taxes paid		$	75,482		$	77,905

 

See accompanying notes to condensed consolidated financial statements.

 

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GUESS?, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

October 31, 2009

(unaudited)

 

(1)           Basis of Presentation

 

In the opinion of management, the accompanying unaudited condensed consolidated financial statements of Guess?, Inc. and its subsidiaries (the “Company”) contain all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation of the condensed consolidated balance sheets as of October 31, 2009 and January 31, 2009, and the condensed consolidated statements of income and condensed consolidated statements of comprehensive income for the three and nine months ended October 31, 2009 and November 1, 2008, and the condensed consolidated statements of cash flows for the nine months ended October 31, 2009 and November 1, 2008.  The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and the instructions to Rule 10-01 of Regulation S-X of the Securities and Exchange Commission (the “SEC”). Accordingly, they have been condensed and do not include all of the information and footnotes required by GAAP for complete financial statements. The results of operations for the three and nine months ended October 31, 2009 are not necessarily indicative of the results of operations to be expected for the full fiscal year. These financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended January 31, 2009.

 

The Company has made certain reclassifications to the prior year’s consolidated financial statements to conform to classifications in the current year. These reclassifications, none of which are material, had no impact on previously reported results of operations or net cash provided by operating activities. The Company adopted authoritative guidance issued by the Financial Accounting Standards Board (“FASB”) in the first quarter ended May 2, 2009, which requires that redeemable noncontrolling interests be reclassified outside of permanent equity as a component of mezzanine instruments. The Company has restated the opening balance sheet as of January 31, 2009 to reflect the reclassification of $10.1 million to redeemable noncontrolling interests.

 

The three and nine-month periods ended October 31, 2009 had the same number of days as the three and nine-month periods ended November 1, 2008.

 

Recent Accounting Guidance Adopted

 

In December 2007, the FASB issued authoritative guidance that establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. The guidance also modifies the recognition for preacquisition contingencies, such as environmental or legal issues, restructuring plans and acquired research and development value in purchase accounting. The guidance requires the acquirer to recognize changes in the amount of its deferred tax benefits that are recognizable because of a business combination either in income from continuing operations in the period of the combination or directly in contributed capital, depending on the circumstances. The guidance also establishes disclosure requirements which will enable users to evaluate the nature and financial effects of the business combination. The Company adopted the guidance on February 1, 2009 and has applied the provisions of the statement to all acquisitions from such date.

 

In December 2007, the FASB issued authoritative guidance which clarifies the classification of noncontrolling interests in consolidated statements of financial position and the accounting for and reporting of transactions between the reporting entity and holders of such noncontrolling interests. The Company adopted the guidance on February 1, 2009. Refer to Note 3 for further information. The guidance has been applied prospectively with the exception of reclassifying nonredeemable noncontrolling interests to equity in the Company’s consolidated balance sheets and recasting consolidated net earnings to include net earnings prior to fiscal 2010 attributable to both the controlling and noncontrolling interests, which are required to be adopted retrospectively.

 

In February 2008, the FASB issued authoritative guidance that relates to the measurement of fair value for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The Company adopted the guidance effective February 1, 2009 for all nonfinancial assets and liabilities as required. Refer to Note 13 for additional information. The adoption of the guidance did not have a material impact on the Company’s financial position or results of operations.

 

In March 2008, the FASB issued authoritative guidance that expands disclosures to include information about the fair value of derivatives, related credit risks and a company’s strategies and objectives for using derivatives. The Company adopted the guidance on February 1, 2009 and has included the expanded disclosures in Note 14.

 

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In June 2008, the FASB issued authoritative guidance, which requires unvested share-payment awards that contain rights to receive non-forfeitable dividends or dividend equivalents to be included in the two-class method of computing earnings per share. The guidance also requires retrospective application to all periods presented. The Company adopted the guidance on February 1, 2009 and applied it retrospectively to all periods presented. Refer to Note 2. The adoption resulted in a reduction in diluted earnings per common share of approximately $0.03 per share for both the nine months ended October 31, 2009 and November 1, 2008.

 

In April 2009, the FASB issued authoritative guidance to improve the presentation and disclosure of other-than-temporary impairment on debt and equity securities in the financial statements. The guidance does not amend existing recognition and measurement guidance related to other-than-temporary impairment of equity securities. The guidance is effective for interim reporting periods ending after June 15, 2009 and was adopted by the Company during the second quarter of fiscal 2010.  The adoption of the guidance did not have a material impact on the Company’s financial position or results of operations.  See additional disclosure in Note 13.

 

In April 2009, the FASB issued authoritative guidance to require disclosures about the fair value of financial instruments in interim reporting periods. Such disclosures were previously required only in annual financial statements. The guidance is effective for interim reporting periods ending after June 15, 2009 and was adopted by the Company during the second quarter of fiscal 2010.  The adoption of the guidance did not have a material impact on the Company’s financial position or results of operations.  See additional disclosure in Note 13.

 

In May 2009, the FASB issued authoritative guidance, which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued.  The guidance is effective for interim reporting periods ending after June 15, 2009. The Company adopted the guidance during the second quarter of fiscal 2010 and, accordingly, evaluates subsequent events through the date its financial statements are issued.  See Note 15 for additional information.

 

In June 2009, the FASB issued authoritative guidance, which establishes the FASB Accounting Standards Codification.  This has become the source of authoritative generally accepted accounting principles in the United States, and superseded all existing non-SEC accounting and reporting standards but does not change U.S. GAAP. The Codification is effective for interim and annual periods ending after September 15, 2009, and was adopted by the Company during the third quarter of fiscal 2010.  Accordingly, references to standards issued prior to the codification have been replaced with a description of the applicable accounting guidance.

 

(2)           Earnings Per Share

 

Basic earnings per share represents net earnings attributable to common stockholders divided by the weighted-average number of common shares outstanding for the period.  Diluted earnings per share represent net earnings attributable to common stockholders divided by the weighted-average number of common shares outstanding, inclusive of the dilutive impact of common equivalent shares outstanding during the period. However, nonvested restricted stock awards (referred to as participating securities) are excluded from the dilutive impact of common equivalent shares outstanding in accordance with FASB issued authoritative guidance under the two-class method since the nonvested restricted stockholders are entitled to participate in dividends declared on common stock as if the shares were fully vested and hence are deemed to be participating securities.  Under the two-class method, earnings attributable to nonvested restricted stockholders are excluded from net earnings attributable to common stockholders for purposes of calculating basic and diluted earnings per common share.

 

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The computation of basic and diluted net earnings per common share attributable to common stockholders is as follows (in thousands):

 

		Three Months Ended						Nine Months Ended
		Oct. 31, 2009			Nov. 1, 2008			Oct. 31, 2009			Nov. 1, 2008
Net earnings attributable to Guess?, Inc.		$	64,070		$	64,017		$	156,172		$	165,650
Net earnings attributable to nonvested restricted stockholders		886			1,159			2,302			3,164
Net earnings attributable to common stockholders		$	63,184		$	62,858		$	153,870		$	162,486
Weighted average shares used in basic computations		90,941			92,438			90,765			92,799
Effect of dilutive securities:
Stock options and restricted stock units		837			702			651			734
Weighted average shares used in diluted computations		91,778			93,140			91,416			93,533
Net earnings per common share attributable to common stockholders:
Basic		$	0.69		$	0.68		$	1.70		$	1.75
Diluted		$	0.69		$	0.67		$	1.68		$	1.74

 

For the three months ended October 31, 2009 and November 1, 2008, equity awards granted for 650,361 and 763,050, respectively, of the Company’s common shares and for the nine months ended October 31, 2009 and November 1, 2008, equity awards granted for 1,365,817 and 573,319, respectively, of the Company’s common shares were outstanding but were excluded from the computation of diluted weighted average common shares and common share equivalents outstanding because their effect would have been anti-dilutive.

 

In addition to the participating securities discussed above, the Company also excluded 563,400 nonvested stock options granted to certain employees from the computation of diluted weighted average common shares and common share equivalents outstanding, because they are subject to certain performance-based annual vesting conditions which had not been achieved by October 31, 2009.  Assuming the current fiscal year’s annual performance criteria had been achieved as of October 31, 2009, the incremental dilutive impact would have been approximately 29,189 shares for the three-month period then ended.

 

In March 2008, the Company’s Board of Directors terminated the previously authorized 2001 share repurchase program and authorized a new program to repurchase, from time-to-time and as market and business conditions warrant, up to $200 million of the Company’s common stock (the “2008 Share Repurchase Program”). Repurchases 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 and the program may be discontinued at any time, without prior notice. During the nine months ended October 31, 2009, the Company repurchased 407,600 shares under the 2008 Share Repurchase Program at an aggregate cost of $5.3 million.  All such share repurchases were made during the three months ended May 2, 2009.

 

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(3)           Stockholders’ Equity

 

A reconciliation of the total carrying amount of total stockholders’ equity, Guess?, Inc. stockholders’ equity and stockholders’ equity attributable to noncontrolling interests for the nine months ended October 31, 2009 is as follows (in thousands):

 

		Comprehensive Income (Loss)			Guess?, Inc. Stockholders’ Equity			Nonredeemable Noncontrolling Interests			Total Stockholders’ Equity
Balances at January 31, 2009					$	773,001		$	2,453		$	775,454
Issuance of common stock under stock compensation plans, net of tax effect					3,126			—			3,126
Issuance of stock under ESPP					1,026			—			1,026
Stock based compensation					19,447			—			19,447
Dividends					(30,008		)	—			(30,008		)
Purchase of treasury stock					(5,309		)	—			(5,309		)
Redeemable noncontrolling interest					(415		)	—			(415		)
Noncontrolling interest capital contribution					—			650			650
Noncontrolling interest capital distribution					(109		)	(1,202		)	(1,311		)
Comprehensive income (loss):
Net earnings		$	158,419		156,172			2,247			158,419
Foreign currency translation adjustment (a)		44,852			44,277			575			44,852
Unrealized loss on hedges, net of income tax of $2,734 (b)		(10,219		)	(10,219		)	—			(10,219		)
Unrealized gain on investments, net of income tax of $49 (b)		98			98			—			98
SERP prior service cost, net of income tax of $439 (b)		868			868			—			868
Total comprehensive income (c)		$	194,018
Balances at October 31, 2009					$	951,955		$	4,723		$	956,678

 

(a) The gain of $44.9 million related to foreign currency translation adjustments for the nine months ended October 31, 2009 reflects the impact of the strengthening of certain foreign currencies relative to the U.S. dollar during that period.  As of October 31, 2009, approximately 51% of the Company’s assets were denominated in currencies other than the U.S. dollar.

 

(b) The consolidated statement of comprehensive income is presented net of taxes.  The income tax expense on unrealized gain on hedges, unrealized loss on investments and Supplemental Executive Retirement Plan (“SERP”) prior service cost and actuarial valuation loss amortization were $3.5 million, $0.2 million and $0.7 million, respectively, for the nine months ended November 1, 2008.

 

(c) Total comprehensive income consists of net earnings, SERP related prior service cost, unrealized gains or losses on investments available for sale, foreign currency translation adjustments and the effective portion of the change in the fair value of cash flow hedges.

 

(4)           Accounts Receivable

 

Accounts receivable consists of trade receivables primarily relating to the Company’s wholesale businesses in Europe, North America and Asia. The Company provided for allowances relating to these receivables of $26.9 million and $21.3 million at October 31, 2009 and January 31, 2009, respectively. In addition, accounts receivable includes royalty receivables relating to licensing operations of $23.4 million and $20.7 million at October 31, 2009 and January 31, 2009, respectively, for which the Company recorded an allowance for doubtful accounts of $0.6 million and $0.5 million at October 31, 2009 and January 31, 2009, respectively.  The accounts receivable allowance includes allowances for doubtful accounts, wholesale sales returns and wholesale markdowns. Retail sales returns allowances are included in accrued expenses.

 

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(5)           Inventories

 

Inventories consist of the following (in thousands):

 

		Oct. 31, 2009			Jan. 31, 2009
Raw materials		$	9,464		$	8,615
Work in progress		2,760			2,286
Finished goods		249,656			228,774
		$	261,880		$	239,675

 

As of October 31, 2009 and January 31, 2009, inventories had been written down to the lower of cost or market by $20.1 million and $20.0 million, respectively.

 

(6)           Income Taxes

 

Income tax expense for the interim periods was computed using the effective tax rate estimated to be applicable for the full fiscal year.  The Company’s effective income tax rate decreased to 33.0% for the nine months ended October 31, 2009 from 34.9% in the nine months ended November 1, 2008 primarily due to a higher estimated proportion of annual earnings in lower tax jurisdictions.

 

(7)           Segment Information

 

The business segments of the Company are retail, wholesale, European and licensing. Management evaluates segment performance based primarily on revenues and earnings from operations.  Corporate overhead, interest income and interest expense and other income and expense are evaluated on a consolidated basis and are not allocated to the Company’s business segments.

 

Net revenue and earnings from operations are summarized as follows for the three and nine months ended October 31, 2009 and November 1, 2008 (in thousands):

 

		Three Months Ended						Nine Months Ended
		Oct. 31, 2009			Nov. 1, 2008			Oct. 31, 2009			Nov. 1, 2008
Net revenue:
Retail operations		$	239,518		$	235,074		$	674,538		$	689,371
Wholesale operations		86,651			78,760			215,265			226,257
European operations		168,829			186,160			524,686			539,057
Licensing operations		27,814			27,934			71,947			77,635
		$	522,812		$	527,928		$	1,486,436		$	1,532,320
Earnings (loss) from operations:
Retail operations		$	33,110		$	27,378		$	81,325		$	80,358
Wholesale operations		17,717			13,839			35,031			37,184
European operations		40,801			49,541			116,233			129,628
Licensing operations		24,176			24,075			61,863			66,852
Corporate overhead		(16,830		)	(15,453		)	(56,330		)	(53,707		)
		$	98,974		$	99,380		$	238,122		$	260,315

 

Due to the seasonal nature of the Company’s business segments, the above net revenue and operating results are not necessarily indicative of the results that may be expected for the full fiscal year.

 

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(8)           Borrowings and Capital Lease Obligations

 

Borrowings and capital lease obligations are summarized as follows (in thousands):

 

		Oct. 31, 2009			Jan. 31, 2009
Short-term borrowings with European banks		$	13		$	22,304
European capital lease, maturing quarterly through 2016		17,174			16,300
Other		847			—
		18,034			38,604
Less current installments		2,577			24,018
Long-term borrowings and capital lease obligations		$	15,457		$	14,586

 

On September 19, 2006, the Company and certain of its subsidiaries entered into a credit facility led by Bank of America, N.A., as administrative agent for the lenders (the “Credit Facility”). The Credit Facility provides for an $85 million revolving multicurrency line of credit and is available for direct borrowings and the issuance of letters of credit, subject to certain letters of credit sublimits. The Credit Facility is scheduled to mature on September 30, 2011. At October 31, 2009, the Company had $12.7 million in outstanding standby letters of credit, no outstanding documentary letters of credit and no outstanding borrowings under the Credit Facility.

 

The Company, through its European subsidiaries, maintains short-term borrowing agreements, primarily for working capital purposes, with various banks in Europe. Under these agreements, which are generally secured by specific accounts receivable balances, the Company can borrow up to $239.7 million, limited primarily by accounts receivable balances at the time of borrowing. Based on the applicable accounts receivable balances at October 31, 2009, the Company could have borrowed up to approximately $232.0 million under these agreements. However, the Company’s ability to borrow through foreign subsidiaries is generally limited to $185.0 million under the terms of the Credit Facility. At October 31, 2009, the Company had negligible outstanding borrowings and $13.3 million in outstanding documentary letters of credit under these agreements. The agreements are primarily denominated in Euros and provide for annual interest rates ranging from 0.7% to 3.5%. The maturities of the short-term borrowings are generally linked to the credit terms of the underlying accounts receivable that secure the borrowings. With the exception of one facility for $22.1 million that has a minimum net equity requirement, there are no other financial ratio covenants.

 

The Company entered into a capital lease in December 2005 for a new building in Florence, Italy. At October 31, 2009, the capital lease obligation was $17.2 million. The Company entered into a separate interest rate swap agreement designated as a non-hedging instrument that results in a swap fixed rate of 3.55%. This interest rate swap agreement matures in 2016 and converts the nature of the capital lease obligation from Euribor floating rate debt to fixed rate debt. The fair value of the interest rate swap liability as of October 31, 2009 was approximately $0.8 million.

 

From time-to-time the Company will obtain other short term financing in foreign countries for working capital to finance its local operations.

 

(9)           Share-Based Compensation

 

The following table summarizes the share-based compensation expense recognized under all of the Company’s stock plans during the three and nine months ended October 31, 2009 and November 1, 2008 (in thousands):

 

		Three Months Ended						Nine Months Ended
		Oct. 31, 2009			Nov. 1, 2008			Oct. 31, 2009			Nov. 1, 2008
Stock options		$	2,140		$	1,456		$	5,763		$	4,202
Nonvested stock awards/units		4,214			4,575			13,377			12,381
Employee Stock Purchase Plan		57			95			307			470
Total stock-based compensation expense		$	6,411		$	6,126		$	19,447		$	17,053

 

Unrecognized compensation cost related to nonvested stock options and nonvested stock awards/units totaled approximately $16.7 million and $38.8 million, respectively, as of October 31, 2009.  This unrecognized expense assumes the performance-based equity awards vest in the future. This cost is expected to be recognized over a weighted-average period of 1.7 years.  The weighted average fair values of stock options granted during the nine months ended October 31, 2009 and November 1, 2008 were $8.94 and $16.35, respectively.

 

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On April 14, 2009, the Company made an annual grant of 1,105,400 stock options and 106,400 nonvested stock awards/units to its employees.

 

On May 1, 2008, the Company granted an aggregate of 167,000 nonvested stock awards to certain employees which are subject to certain annual performance-based vesting conditions over a five-year period.  On October 30, 2008, the Company granted an aggregate of 563,400 nonvested stock options to certain employees which are scheduled to vest over a four-year period, subject to the achievement of performance-based vesting conditions for fiscal 2010.  During the first quarter of fiscal 2010, the Compensation Committee determined that the performance goals established in the prior year were no longer set at an appropriate level to incentivize and help retain employees given the greater than previously anticipated deterioration of the economy that had occurred since the goals were established. In April 2009, the Compensation Committee modified the performance goals of the outstanding performance-based stock awards and options to address the challenges associated with the current economic environment. The modifications did not have a material impact on the consolidated financial statements of the Company.

 

(10)         Related Party Transactions

 

The Company and its subsidiaries periodically enter into transactions with other entities or individuals that are considered related parties, including certain transactions with entities affiliated with trusts for the respective benefit of Maurice and Paul Marciano, who are executives of the Company, Armand Marciano, their brother and former executive of the Company, and certain of their children (the “Marciano Trusts”).

 

Leases

 

The Company leases warehouse and administrative facilities, including the Company’s corporate headquarters in Los Angeles, California, from partnerships affiliated with the Marciano Trusts and certain of their affiliates. There were three of these leases in effect at October 31, 2009 with expiration dates in February 2010, December 2014 and July 2018.

 

Aggregate rent expense under these related party leases for the nine months ended October 31, 2009 and November 1, 2008 was $2.9 million and $2.8 million, respectively. The Company believes the related party lease terms have not been significantly affected by the fact that the Company and the lessors are related.

 

Aircraft Arrangements

 

The Company periodically charters aircraft owned by MPM Financial, LLC (“MPM Financial”), an entity affiliated with the Marciano Trusts, through an independent third party management company contracted by MPM Financial to manage its aircraft. Under an informal arrangement with MPM Financial and the third party management company, the Company has chartered and may from time-to-time continue to charter aircraft owned by MPM Financial at a discount from the third party management company’s preferred customer hourly charter rates. The total fees paid under these arrangements for the nine months ended October 31, 2009 and November 1, 2008 were approximately $0.5 million and $1.2 million, respectively.

 

These related party disclosures should be read in conjunction with the disclosure concerning related party transactions in the Company’s Annual Report on Form 10-K for the year ended January 31, 2009.

 

(11)         Commitments and Contingencies

 

Leases

 

The Company leases its showrooms and retail store locations under operating lease agreements expiring on various dates through September 2027. Some of these leases require the Company to make periodic payments for property taxes, utilities and common area operating expenses. Certain retail store leases provide for rents based upon the minimum annual rental amount and a percentage of annual sales volume, generally ranging from 3% to 6%, when specific sales volumes are exceeded. Some leases include lease incentives, rent abatements and fixed rent escalations, which are amortized and recorded over the initial lease term on a straight-line basis. The Company also leases some of its equipment under operating lease agreements expiring at various dates through August 2013.

 

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Incentive Bonuses

 

Certain officers and key employees of the Company are eligible to receive annual cash incentive bonuses based on the achievement of certain performance criteria. These bonuses are based on performance measures such as earnings per share and earnings from operations of the Company or particular segments thereof, as well as other objective and subjective criteria as determined by the Compensation Committee of the Board of Directors. In addition to such annual incentive opportunities, Paul Marciano, Chief Executive Officer and Vice Chairman of the Company, is entitled to receive a $3.5 million special cash bonus in December 2012, subject to the receipt by the Company of a fixed cash rights payment of $35.0 million that is due in January 2012 from one of its licensees. In connection with this special bonus, the Company will accrue an expense of $3.5 million, plus applicable payroll taxes, through December 2012.

 

Litigation

 

In 2006, the Officers of the Florence Customs Authorities (“Customs Authorities”) began an import customs audit with respect to the Company’s Italian subsidiary, Maco Apparel S.p.A. (“Maco”), which the Company acquired in 2005. Prior to the acquisition, Maco was the Italian licensee of GUESS? jeanswear for men and women in Europe. The Customs Authorities contended that the Italian subsidiary should have included the royalty expense payable to Guess?, Inc., the parent company, as part of the cost of the product subject to customs duties. The Company disagreed with this position and disputed the assessment in a series of hearings on the matter with the Florence Provincial Tax Commission beginning in October 2007. At the request of a judge from the Tax Commission, the Company and the Customs Authorities entered into settlement discussions in 2009. These discussions ultimately led to the execution of a full out-of-court settlement agreement in October 2009, which should be final by December 31, 2009. The settlement was consistent in amount with the Company’s previous accrual recorded in the fourth quarter of fiscal year 2009 and did not include any admission of liability or wrongdoing on the part of the Company. The resolution of this matter did not have a material impact on the Company’s financial results or financial position.

 

On May 6, 2009, Gucci America, Inc. filed a complaint in the U.S. District Court for the Southern District of New York against Guess?, Inc. and Guess Italia, S.r.l. asserting, among other things, trademark and trade dress law violations and unfair competition. The complaint seeks injunctive relief, unspecified compensatory damages, including treble damages, and certain other relief. A similar complaint has also been filed in the Court of Milan, Italy. The Company plans to defend the allegations vigorously.  The Company believes that it is too early to predict the outcome of this action or whether the outcome will have a material impact on the Company’s financial condition or results of operations.

 

The Company is also involved in various other claims and other matters incidental to the Company’s business, the resolution of which is not expected to have a material adverse effect on the Company’s consolidated results of operations or financial position. No material amounts were accrued as of October 31, 2009 related to any of the Company’s legal proceedings.

 

(12)         Supplemental Executive Retirement Plan

 

The components of net periodic pension cost for the three and nine months ended October 31, 2009 and November 1, 2008 were as follows (in thousands):

 

		Three Months Ended						Nine Months Ended
		Oct. 31, 2009			Nov. 1, 2008			Oct. 31, 2009			Nov. 1, 2008
Service cost		$	53		$	61		$	159		$	183
Interest cost		513			579			1,539			1,737
Net amortization of unrecognized prior service cost		436			436			1,308			1,308
Net amortization of actuarial losses		—			232			—			696
Net periodic defined benefit pension cost		$	1,002		$	1,308		$	3,006		$	3,924

 

As a non-qualified pension plan, no funding of the SERP is required. However, the Company expects to make periodic payments into insurance policies held in a rabbi trust to fund the expected obligations arising under the non-qualified SERP. The cash surrender value of the insurance policies was $20.7 million as of October 31, 2009 and is included in other assets. The amount of future payments may vary, depending on the future years of service, future annual compensation of the participants and investment performance of the trust. As a result of the change in value of the insurance policy investments, the Company recorded in other income and expenses the mark-to-market gain of $0.7 million and $2.9 million during the three and nine months ended October 31, 2009, respectively, and the mark-to market loss of $2.0 million and $2.5 million during the three and nine months ended November 1, 2008, respectively.

 

(13)         Fair Value Measurements

 

Authoritative guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The guidance establishes a fair value hierarchy, which prioritizes the inputs used in measuring fair value into three broad levels as follows:

 

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Level 1 - Inputs are unadjusted quoted prices in active markets for identical assets or liabilities that can be accessed at the measurement date.

 

Level 2 - Inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (i.e. interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs).

 

Level 3 - Unobservable inputs that reflect assumptions about what market participants would use in pricing the asset or liability. These inputs would be based on the best information available, including the Company’s own data.

 

The following table presents the fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis as of October 31, 2009 and January 31, 2009 (in thousands):

 

		Fair Value Measurements at Oct. 31, 2009												Fair Value Measurements at Jan. 31, 2009
Recurring Fair Value Measures		Level 1			Level 2			Level 3			Total			Level 1			Level 2			Level 3			Total
Assets:
Foreign exchange currency contracts		$	—		$	970		$	—		$	970		$	—		$	21,737		$	—		$	21,737
Securities available for sale		391			—			—			391			712			—			—			712
Total		$	391		$	970		$	—		$	1,361		$	712		$	21,737		$	—		$	22,449
Liabilities:
Foreign exchange currency contracts		$	—		$	7,421		$	—		$	7,421		$	—		$	—		$	—		$	—
Interest rate swaps		—			1,222			—			1,222			—			574			—			574
Deferred compensation obligations		—			11,184			—			11,184			—			7,287			—			7,287
Total		$	—		$	19,827		$	—		$	19,827		$	—		$	7,861		$	—		$	7,861

 

The fair values of the Company’s available-for-sale securities are based on quoted prices. Fair value of the interest rate swaps are based upon inputs corroborated by observable market data. The foreign exchange forward contracts are entered into by the Company principally to hedge the future payment of inventory and intercompany transactions by non-U.S. subsidiaries. The fair values of the Company’s foreign exchange forward contracts are based on quoted forward foreign exchange prices at the reporting date. Deferred compensation obligations to employees are adjusted based on changes in the fair value of the underlying employee-directed investments. Fair value of these obligations is based upon inputs corroborated by observable market data.

 

The carrying amount of the Company’s financial instruments, which principally include cash and cash equivalents, trade receivables, accounts payable and accrued expenses, approximates fair value due to the relatively short maturity of such instruments. The fair values of the Company’s debt instruments (see Note 8) are based on the amount of future cash flows associated with each instrument discounted using the Company’s incremental borrowing rate. At October 31, 2009, the carrying value of all financial instruments was not materially different from fair value, as the interest rates on variable rate debt including the capital lease obligation approximated rates currently available to the Company.

 

Investments are recorded at fair value and consist of certain marketable equity securities of $0.4 million and $0.7 million at October 31, 2009 and January 31, 2009, respectively, and are included in other assets in the accompanying condensed consolidated balance sheets. Unrealized gains (losses), net of taxes, are included as a component of stockholders’ equity and comprehensive income. The accumulated unrealized losses, net of taxes, included in accumulated other comprehensive income related to marketable equity securities owned by the Company at October 31, 2009 and January 31, 2009 were $0.1 million and $0.2 million, respectively.

 

Long-lived assets, such as property, plant, and equipment, and purchased intangibles that are subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The recoverability of assets that are to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by such asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of such asset exceeds its fair value. The fair value calculation requires management to apply judgment in estimating future cash flows and the discount rates that reflect the risk inherent in the future cash flows. The estimated cash flows used for this nonrecurring fair value measurement is considered a Level 3 input as defined above.

 

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(14)         Derivative Financial Instruments

 

The Company operates in foreign countries, which exposes it to market risk associated with foreign currency exchange rate fluctuations. The Company has entered into certain forward contracts to hedge the risk of foreign currency rate fluctuations. The Company has elected to apply the hedge accounting rules as required by authoritative guidance for certain of these hedges.

 

In March 2008, the FASB expanded required disclosures to include information about the fair value of derivatives, related credit risks and a company’s strategies and objectives for using derivatives.  The Company adopted the provisions of the new guidance on February 1, 2009 and the required disclosures are provided below.

 

The Company’s objective is to hedge the variability in forecasted cash flow due to the foreign currency risk. Various transactions that occur in Canada, Europe and South Korea are denominated in U.S. dollars, British Pounds or Swiss Francs and thus are exposed to earnings risk as a result of exchange rate fluctuations when converted to their local functional currencies. These types of transactions include U.S. dollar denominated purchases of merchandise and U.S. dollar and British Pound intercompany liabilities. In addition, certain operating expenses are denominated in Swiss Francs and are exposed to earnings risk as a result of exchange rate fluctuations when converted to the functional currency. The Company enters into derivative financial instruments, including forward exchange contracts to manage exchange risk on certain anticipated foreign currency transactions. The Company does not hedge all transactions denominated in foreign currency.

 

The impact of the credit risk of the counterparties to the derivative contracts is considered in determining the fair value of the foreign currency forward contracts. As of October 31, 2009, credit risk has not had a significant effect on the fair value of the Company’s foreign currency contracts.

 

The Company also has interest rate swap agreements which are not designated as hedges for accounting purposes, to effectively convert a portion of 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 variable rate debt, thus reducing the impact of interest rate changes on future interest cash flows. Refer to Note 8 for further information.

 

The fair value of derivative instruments in the consolidated balance sheet as of October 31, 2009 was as follows (in thousands):

 

		Asset Derivatives					Liability Derivatives
		Balance Sheet Location		Fair Value			Balance Sheet Location		Fair Value
Derivatives designated as hedging instruments:
Foreign exchange currency contracts		Other current assets		$	492		Current liabilities		$	2,441
Total derivatives designated as hedging instruments				492					2,441
Derivatives not designated as hedging instruments:
Foreign exchange currency contracts		Other current assets		478			Current liabilities		4,980
Interest rate swaps				—			Current liabilities		1,222
Total derivatives not designated as hedging instruments				478					6,202
Total derivatives				$	970				$	8,643

 

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