GUESS INC - Quarter Report: 2011 April (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 April 30, 2011

 

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x 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 June 2, 2011 the registrant had 92,592,444 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 April 30, 2011 and January 29, 2011	1
	Condensed Consolidated Statements of Income — Three Months Ended April 30, 2011 and May 1, 2010	2
	Condensed Consolidated Statements of Comprehensive Income — Three Months Ended April 30, 2011 and May 1, 2010	3
	Condensed Consolidated Statements of Cash Flows — Three Months Ended April 30, 2011 and May 1, 2010	4
	Notes to Condensed Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	26
Item 4.	Controls and Procedures	28
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	28
Item 1A.	Risk Factors	28
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	28
Item 6.	Exhibits	29

 

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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)

 

		Apr. 30, 2011			Jan. 29, 2011
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	426,774		$	427,037
Short-term investments		15,035			15,087
Accounts receivable, net		377,432			358,482
Inventories		300,713			294,705
Deferred tax assets		19,827			18,121
Other current assets		58,861			50,148
Total current assets		1,198,642			1,163,580
Property and equipment, net		337,161			313,856
Goodwill		31,268			29,595
Other intangible assets, net		10,321			9,192
Long-term deferred tax assets		56,192			55,455
Other assets		129,304			114,126
		$	1,762,888		$	1,685,804
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of capital lease obligations and borrowings		$	2,359		$	2,177
Accounts payable		212,667			233,846
Accrued expenses		213,685			194,993
Total current liabilities		428,711			431,016
Capital lease obligations		12,834			12,218
Deferred rent and lease incentives		77,281			76,455
Other long-term liabilities		87,611			85,210
		606,437			604,899
Redeemable noncontrolling interests		22,238			14,711
Commitments and contingencies (Note 11)
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 137,851,134 and 137,579,379 shares, outstanding 92,573,705 and 92,290,744 shares, at April 30, 2011 and January 29, 2011, respectively		926			923
Paid-in capital		374,732			368,225
Retained earnings		978,544			960,460
Accumulated other comprehensive income (loss)		32,837			(8,578		)
Treasury stock, 45,277,429 and 45,288,635 shares at April 30, 2011 and January 29, 2011, respectively		(266,088		)	(266,154		)
Guess?, Inc. stockholders’ equity		1,120,951			1,054,876
Nonredeemable noncontrolling interests		13,262			11,318
Total stockholders’ equity		1,134,213			1,066,194
		$	1,762,888		$	1,685,804

 

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
		Apr. 30, 2011			May 1, 2010
Net revenue:
Product sales		$	563,399		$	514,055
Net royalties		28,845			25,286
		592,244			539,341
Cost of product sales		343,024			304,090
Gross profit		249,220			235,251
Selling, general and administrative expenses		178,287			158,105
Pension curtailment expense		—			5,819
Earnings from operations		70,933			71,327
Other (expense) income:
Interest expense		(405		)	(195		)
Interest income		1,295			301
Other (expense) income, net		(10,002		)	3,428
		(9,112		)	3,534
Earnings before income tax expense		61,821			74,861
Income tax expense		18,237			23,207
Net earnings		43,584			51,654
Net earnings attributable to noncontrolling interests		902			1,319
Net earnings attributable to Guess?, Inc.		$	42,682		$	50,335
Earnings per common share attributable to common stockholders (Note 2):
Basic		$	0.46		$	0.54
Diluted		$	0.46		$	0.54
Weighted average common shares outstanding attributable to common stockholders (Note 2):
Basic		91,629			91,902
Diluted		92,171			92,768
Dividends declared per common share		$	0.20		$	0.16

 

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
		Apr. 30, 2011			May 1, 2010
Net earnings		$	43,584		$	51,654
Foreign currency translation adjustment		49,733			(12,273		)
Unrealized (loss) gain on hedges, net of tax effect		(8,004		)	1,428
Unrealized gain on investments, net of tax effect		87			175
SERP prior service cost and actuarial valuation loss amortization, including curtailment expense, net of tax effect		641			4,418
Comprehensive income		86,041			45,402
Less comprehensive income attributable to noncontrolling interests		(1,944		)	(1,229		)
Comprehensive income attributable to Guess?, Inc.		$	84,097		$	44,173

 

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)

 

		Three Months Ended
		Apr. 30, 2011			May 1, 2010
Cash flows from operating activities:
Net earnings		$	43,584		$	51,654
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization of property and equipment		19,260			14,564
Amortization of intangible assets		634			1,187
Share-based compensation expense		7,255			8,068
Unrealized forward contract losses (gains)		13,758			(1,974		)
Net loss on disposition of property and equipment		1,150			986
Pension curtailment expense		—			5,819
Other items, net		(158		)	(2,000		)
Changes in operating assets and liabilities:
Accounts receivable		2,663			(7,169		)
Inventories		4,442			4,751
Prepaid expenses and other assets		(5,152		)	(13,435		)
Accounts payable and accrued expenses		(40,885		)	(22,752		)
Deferred rent and lease incentives		398			3,295
Other long-term liabilities		886			4,790
Net cash provided by operating activities		47,835			47,784
Cash flows from investing activities:
Purchases of property and equipment		(30,894		)	(19,405		)
Acquisition of lease interest		(1,339		)	(2,249		)
Net cash settlement of forward contracts		(1,600		)	609
Purchases of long-term investments		(10,248		)	(2,414		)
Net cash used in investing activities		(44,081		)	(23,459		)
Cash flows from financing activities:
Certain short-term borrowings, net		—			442
Repayment of borrowings and capital lease obligations		(444		)	(390		)
Dividends paid		(18,582		)	(14,925		)
Issuance of common stock, net of nonvested award repurchases		(1,296		)	2,606
Excess tax benefits from share-based compensation		913			5,612
Net cash used in financing activities		(19,409		)	(6,655		)
Effect of exchange rates on cash and cash equivalents		15,392			(2,028		)
Net (decrease) increase in cash and cash equivalents		(263		)	15,642
Cash and cash equivalents at beginning of period		427,037			502,063
Cash and cash equivalents at end of period		$	426,774		$	517,705
Supplemental cash flow data:
Interest paid		$	267		$	76
Income taxes paid		$	9,063		$	10,099

 

See accompanying notes to condensed consolidated financial statements.

 

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GUESS?, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

April 30, 2011

(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 April 30, 2011 and January 29, 2011, and the condensed consolidated statements of income, comprehensive income and cash flows for the three months ended April 30, 2011 and May 1, 2010. 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 months ended April 30, 2011 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 29, 2011.

 

The three months ended April 30, 2011 had the same number of days as the three months ended May 1, 2010. All references herein to “fiscal 2012”, “fiscal 2011” and “fiscal 2010” represent the results of the 52-week fiscal years ending January 28, 2012 and ended January 29, 2011 and January 30, 2010, respectively.

 

Loyalty Programs

 

The Company launched customer loyalty programs for its G by GUESS, GUESS? and GUESS by MARCIANO stores in July 2009, August 2008 and September 2007, respectively. The GUESS? and GUESS by MARCIANO loyalty programs were merged in May 2009. Under the programs, customers accumulate points based on purchase activity. Once a loyalty program member achieves a certain point level, the member earns awards that may only be redeemed for merchandise. In all of the programs, unredeemed points generally expire after six months and unredeemed awards generally expire after two months. Due to the relative newness of the programs, prior to the fourth quarter of fiscal 2011, all unexpired, unredeemed points and awards were accrued in current liabilities and recorded as a reduction of net sales as points and awards were accumulated by the member. In the fourth quarter of fiscal 2011, based on the accumulation of multiple cycles of actual redemptions experienced since inception of the programs, the Company revised its approach to estimate the value of future award redemptions under the existing loyalty program by incorporating these historical redemption rates. In connection with this revision, the Company recorded a cumulative adjustment of $6.7 million in the fourth quarter of fiscal 2011 to increase net revenue and to adjust the current liability balance to an amount reflecting estimated future award redemptions.  The aggregate dollar value of the loyalty program accruals included in accrued liabilities was $2.5 million and $2.7 million at April 30, 2011 and January 29, 2011, respectively. Future revisions to the estimated liability may result in changes to net revenue.

 

New Accounting Guidance

 

In January 2010, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance that expands the required disclosures about fair value measurements. This guidance provides for new disclosures requiring the Company to (a) disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers, and (b) present separately information about purchases, sales, issuances and settlements in the reconciliation of Level 3 fair value measurements. This guidance also provides clarification of existing disclosures requiring the Company to (i) determine each class of assets and liabilities based on the nature and risks of the investments rather than by major security type, and (ii) for each class of assets and liabilities, disclose the valuation techniques and inputs used to measure fair value for both Level 2 and Level 3 fair value measurements. The Company adopted the guidance effective January 31, 2010, except for the presentation of purchases, sales, issuances and settlements in the reconciliation of Level 3 fair value measurements, which was adopted effective January 30, 2011. The adoption of this guidance did not have an impact on the disclosures within the Company’s consolidated financial statements.

 

(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 represents 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 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 earnings per common share attributable to common stockholders is as follows (in thousands):

 

		Three Months Ended
		Apr. 30, 2011			May 1, 2010
Net earnings attributable to Guess?, Inc.		$	42,682		$	50,335
Net earnings attributable to nonvested restricted stockholders		304			553
Net earnings attributable to common stockholders		$	42,378		$	49,782
Weighted average shares used in basic computations		91,629			91,902
Effect of dilutive securities:
Stock options and restricted stock units		542			866
Weighted average shares used in diluted computations		92,171			92,768
Earnings per common share attributable to common stockholders:
Basic		$	0.46		$	0.54
Diluted		$	0.46		$	0.54

 

For the three months ended April 30, 2011 and May 1, 2010, equity awards granted for 435,583 and 282,955, 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.

 

On March 14, 2011, the Company’s Board of Directors terminated the previously authorized 2008 share repurchase program (which had $84.9 million capacity remaining) and authorized a new program to repurchase, from time-to-time and as market and business conditions warrant, up to $250.0 million of the Company’s common stock (the “2011 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. There were no share repurchases under the 2011 or 2008 Share Repurchase Programs during the three months ended April 30, 2011 or the three months ended May 1, 2010. At April 30, 2011, the Company had remaining authority under the 2011 Share Repurchase Program to purchase $250.0 million of its common stock.

 

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(3)           Stockholders’ Equity and Redeemable Noncontrolling Interests

 

A reconciliation of the total carrying amount of total stockholders’ equity, Guess?, Inc. stockholders’ equity and stockholders’ equity attributable to nonredeemable and redeemable noncontrolling interests for the fiscal year ended January 29, 2011 and three months ended April 30, 2011 is as follows (in thousands):

 

		Stockholders’ Equity
		Guess?, Inc. Stockholders’ Equity			Nonredeemable Noncontrolling Interests			Total			Redeemable Noncontrolling Interests
Balances at January 30, 2010		$	1,020,211		$	6,132		$	1,026,343		$	13,813
Issuance of common stock under stock compensation plans, net of tax effect		18,236			—			18,236			—
Issuance of stock under ESPP		1,309			—			1,309			—
Share-based compensation		29,312			—			29,312			—
Dividends		(247,570		)	—			(247,570		)	—
Share repurchases		(49,361		)	—			(49,361		)	—
Redeemable noncontrolling interest redemption value adjustment		(1,143		)	—			(1,143		)	1,143
Comprehensive income (loss) (a):
Net earnings		289,508			4,995			294,503			—
Foreign currency translation adjustment		(1,631		)	191			(1,440		)	(245		)
Unrealized loss on hedges, net of income tax of $399		(3,634		)	—			(3,634		)	—
Unrealized gain on investments, net of income tax of $72		116			—			116			—
SERP prior service cost and actuarial valuation loss amortization, net of income tax of $251		(477		)	—			(477		)	—
Balances at January 29, 2011		$	1,054,876		$	11,318		$	1,066,194		$	14,711
Issuance of common stock under stock compensation plans, net of tax effect		(937		)	—			(937		)	—
Issuance of stock under ESPP		375			—			375			—
Share-based compensation		7,255			—			7,255			—
Dividends		(18,484		)	—			(18,484		)	—
Redeemable non-controlling interest redemption value adjustment		(6,231		)	—			(6,231		)	6,231
Comprehensive income (loss) (a):
Net earnings		42,682			902			43,584			—
Foreign currency translation adjustment		48,691			1,042			49,733			1,296
Unrealized loss on hedges, net of income tax of $1,706		(8,004		)	—			(8,004		)	—
Unrealized gain on investments, net of income tax of $50		87			—			87			—
SERP prior service cost and actuarial valuation loss amortization, net of income tax of $335		641			—			641			—
Balances at April 30, 2011		$	1,120,951		$	13,262		$	1,134,213		$	22,238

 

(a) Total comprehensive income consists of net earnings, Supplemental Executive Retirement Plan (“SERP”) prior service cost and actuarial valuation gains or losses and related amortization, 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.

 

Redeemable Noncontrolling Interests

 

In connection with the acquisition of two majority-owned subsidiaries, the Company is party to put arrangements with respect to the common securities that represent the remaining noncontrolling interests of the acquired companies. Each put arrangement is exercisable by the counter-party outside the control of the Company by requiring the Company to redeem the counterparty’s entire equity stake in the subsidiary at a put price based on a multiple of earnings formula. Each put arrangement is recorded on the balance sheet at its redemption value and classified as a redeemable noncontrolling interest outside of permanent equity. As of April 30, 2011, the redeemable noncontrolling interests of $22.2 million was composed of redemption values related to the Focus Europe S.r.l. (“Focus”) and Guess Sud SAS (“Guess Sud”) put arrangements of $14.7 million and $7.5 million, respectively. As of January 29, 2011, the redeemable noncontrolling interests of $14.7 million was composed of redemption values related to the Focus and Guess Sud put arrangements of $10.7 million and $4.0 million, respectively.

 

The put arrangement for Focus, representing 25% of the total outstanding equity interest of that subsidiary, may be exercised at the discretion of the minority owner by providing written notice to the Company no later than June 27, 2012. The redemption value of the Focus put arrangement is based on a multiple of Focus’s net earnings.

 

The put arrangement for Guess Sud, representing 40% of the total outstanding equity interest of that subsidiary, may be exercised at the discretion of the minority owners by providing written notice to the Company anytime after January 30, 2012 or sooner in certain limited circumstances. The redemption value of the Guess Sud put arrangement is based on a multiple of Guess Sud’s earnings before interest, taxes, depreciation and amortization.

 

(4)           Accounts Receivable

 

Accounts receivable consists of trade receivables relating primarily to the Company’s wholesale businesses in Europe, North America and Asia. The Company provided for allowances relating to these receivables of $33.8 million and $29.9 million at April 30, 2011 and January 29, 2011, respectively. In addition, accounts receivable includes royalty receivables relating to licensing operations of $24.4 million and $27.5 million at April 30, 2011 and January 29, 2011, respectively, for which the Company recorded an allowance for doubtful accounts of $0.7 million and $0.8 million at April 30, 2011 and January 29, 2011, 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):

 

		Apr. 30, 2011			Jan. 29, 2011
Raw materials		$	12,938		$	10,312
Work in progress		3,343			2,280
Finished goods		284,432			282,113
		$	300,713		$	294,705

 

As of April 30, 2011 and January 29, 2011, inventories had been written down to the lower of cost or market by $20.6 million and $19.0 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 29.5% for the three months ended April 30, 2011 from 31.0% for the three months ended May 1, 2010, due primarily to a higher estimated proportion of annual earnings in lower tax jurisdictions in fiscal 2012 and the unfavorable impact of a change in certain state tax regulations relating to fiscal 2011.

 

From time to time, the Company is subject to routine compliance reviews on various tax matters around the world in the ordinary course of business.  As of April 30, 2011, several income tax audits were underway for various periods in multiple jurisdictions. As required under applicable accounting rules, the Company accrues an amount for its estimate of additional income tax liability which the Company, more likely than not, could incur as a result of the ultimate resolution of the audits (“uncertain tax positions”). The Company reviews and updates the accrual for uncertain tax positions as more definitive information becomes available from taxing authorities, upon completion of tax audits, upon expiration of statutes of limitation, or upon occurrence of other events.

 

As of April 30, 2011 and January 29, 2011, the Company had $18.2 million and $17.0 million, respectively, of aggregate accruals for uncertain tax positions, including penalties and interest and net of federal tax benefits. The change in the accrual balance from January 29, 2011 to April 30, 2011 resulted from foreign currency translation and interest.

 

(7)           Segment Information

 

The Company’s businesses are grouped into five reportable segments for management and internal financial reporting purposes:  North American Retail, Europe, Asia, North American Wholesale and Licensing. Management evaluates segment performance based primarily on revenues and earnings from operations. The Company believes this segment reporting reflects how its five business segments are managed and each segment’s performance is evaluated. The North American Retail segment includes the Company’s retail operations in North America. The Europe segment includes the Company’s wholesale and retail operations in Europe and the Middle East. The Asia segment includes the Company’s wholesale and retail operations in Asia. The North American Wholesale segment includes the Company’s wholesale operations in North America. 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. These costs are presented separately and generally include, among other things, the following unallocated corporate costs: information technology, human resources, global advertising and marketing, accounting and finance, executive compensation, facilities and legal.

 

Net revenue and earnings from operations are summarized as follows for the three months ended April 30, 2011 and May 1, 2010 (in thousands):

 

		Three Months Ended
		April 30, 2011			May 1, 2010
Net revenue:
North American Retail		$	247,457		$	235,773
Europe		210,209			186,968
Asia		60,087			48,586
North American Wholesale		45,646			42,728
Licensing		28,845			25,286
		$	592,244		$	539,341
Earnings (loss) from operations:
North American Retail		$	18,630		$	24,372
Europe		33,181			34,482
Asia		7,101			7,137
North American Wholesale		11,114			10,211
Licensing		25,290			21,860
Corporate overhead		(24,383		)	(26,735		)
		$	70,933		$	71,327

 

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.

 

(8)           Borrowings and Capital Lease Obligations

 

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

 

		Apr. 30, 2011			Jan. 29, 2011
European capital lease, maturing quarterly through 2016		$	14,674		$	13,871
Other		519			524
		15,193			14,395
Less current installments		2,359			2,177
Long-term capital lease obligations		$	12,834		$	12,218

 

The Company entered into a capital lease in December 2005 for a new building in Florence, Italy. At April 30, 2011, the capital lease obligation was $14.7 million. The Company entered into a separate interest rate swap agreement designated as a non-hedging instrument that resulted 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 April 30, 2011 was approximately $0.5 million.

 

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. The Company is in discussions with potential lenders and fully expects to have a replacement facility in place prior to the scheduled maturity on September 30, 2011.  The size, rates and other key terms of the replacement facility have yet to be determined. At April 30, 2011, the Company had $1.4 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 $267.7 million, limited primarily by accounts receivable balances at the time of borrowing. Based on the applicable accounts receivable balances at April 30, 2011, the Company could have borrowed up to approximately $264.4 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 April 30, 2011, the Company had no outstanding borrowings and $7.5 million in outstanding documentary letters of credit under these credit agreements. The agreements are denominated primarily in euros and provide for annual interest rates ranging from 0.9% to 3.6%. 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 up to $51.8 million that has a minimum net equity requirement, there are no other financial ratio covenants.

 

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

 

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(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 months ended April 30, 2011 and May 1, 2010 (in thousands):

 

		Three Months Ended
		Apr. 30, 2011			May 1, 2010
Stock options		$	1,313		$	1,859
Nonvested stock awards/units		5,829			6,115
Employee Stock Purchase Plan		113			94
Total share-based compensation expense		$	7,255		$	8,068

 

Unrecognized compensation cost, adjusted for estimated forfeitures, related to nonvested stock options and nonvested stock awards/units totaled approximately $12.5 million and $32.0 million, respectively, as of April 30, 2011.  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 1.5 years.  The weighted average fair values of stock options granted during the three months ended April 30, 2011 and May 1, 2010 were $12.21 and $15.38, respectively.

 

On April 15, 2011, the Company made an annual grant of 284,200 stock options and 256,100 nonvested stock awards/units to its employees. On April 29, 2010, the Company made an annual grant of 237,400 stock options and 230,300 nonvested 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 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. Therefore, in April 2009, the Compensation Committee modified the performance goals of that year’s tranche of the outstanding performance-based stock awards and options to address the challenges associated with the economic environment. During the three months ended April 30, 2011 and May 1, 2010, the Compensation Committee modified the performance goals of the respective year’s tranche of the outstanding performance based stock awards to address the continuing challenges associated with the economic environment. None of the modifications had 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 four of these leases in effect at April 30, 2011 with expiration dates ranging from 2012 to 2020.

 

Aggregate rent and property tax expense under these related party leases for the three months ended April 30, 2011 and May 1, 2010 was $1.2 million and $1.1 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 independent third party management companies contracted by MPM Financial to manage its aircraft. Under an informal arrangement with MPM Financial and the third party management companies, 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 companies’ preferred customer hourly charter rates. The total fees paid under these arrangements for the three months ended April 30, 2011 and May 1, 2010 were approximately $0.4 million and $0.1 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 29, 2011.

 

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(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 11%, 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 January 2016. As discussed in further detail in Note 8, the Company leases a building in Florence, Italy under a capital lease.

 

Incentive Bonuses

 

Certain officers and key employees of the Company are eligible to receive annual cash incentive bonuses based on the achievement of specified 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

 

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 is vigorously defending the allegations.  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 position 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 financial position or results of operations. No material amounts were accrued as of April 30, 2011 related to any of the Company’s legal proceedings.

 

(12)         Supplemental Executive Retirement Plan

 

The components of net periodic pension cost for the three months ended April 30, 2011 and May 1, 2010 were as follows (in thousands):

 

		Three Months Ended
		Apr. 30, 2011			May 1, 2010
Service cost		$	—		$	69
Interest cost		657			558
Net amortization of unrecognized prior service cost		388			436
Net amortization of actuarial losses		589			140
Curtailment expense		—			5,819
Net periodic defined benefit pension cost		$	1,634		$	7,022

 

As a non-qualified pension plan, no dedicated funding of the SERP is required; however, the Company has and expects to continue to make periodic payments into insurance policies held in a rabbi trust to fund the expected obligations arising under the non-qualified SERP. 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. The cash surrender values of the insurance policies were $34.4 million and $32.9 million as of April 30, 2011 and January 29, 2011, 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 of $1.5 million and 1.3 million in other income and expense during the three months ended April 30, 2011 and May 1, 2010, respectively.

 

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During the three months ended May 1, 2010, the Company recorded a supplemental executive retirement plan curtailment expense of $5.8 million before taxes related to the accelerated amortization of prior service cost resulting from the departure of Carlos Alberini, the Company’s former President and Chief Operating Officer. Mr. Alberini’s departure resulted in a significant reduction in the total expected remaining years of future service of all participants combined, resulting in the pension curtailment. Mr. Alberini did not receive any termination payments in connection with his departure and, as of the date of his departure, he ceased vesting or accruing any additional benefits under the terms of the SERP.

 

A reconciliation of the changes in the projected benefit obligation for the fiscal year ended January 29, 2011 and three months ended April 30, 2011 is as follows (in thousands):

 

		Projected Benefit Obligation
Balance at January 30, 2010		$	37,165
Service cost		69
Interest cost		2,177
Actuarial losses		8,361
Balance at January 29, 2011		$	47,772
Interest cost		657
Balance at April 30, 2011		$	48,429

 

(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:

 

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 April 30, 2011 and January 29, 2011 (in thousands):

 

		Fair Value Measurements at Apr. 30, 2011												Fair Value Measurements at Jan. 29, 2011
Recurring Fair Value Measures		Level 1			Level 2			Level 3			Total			Level 1			Level 2			Level 3			Total
Assets:
Foreign exchange currency contracts		$	—		$	1,342		$	—		$	1,342		$	—		$	3,227		$	—		$	3,227
Held-to-maturity securities		15,035			—			—			15,035			15,087			—			—			15,087
Available-for-sale securities		16,497			—			—			16,497			6,139			—			—			6,139
Total		$	31,532		$	1,342		$	—		$	32,874		$	21,226		$	3,227		$	—		$	24,453
Liabilities:
Foreign exchange currency contracts		$	—		$	29,238		$	—		$	29,238		$	—		$	7,766		$	—		$	7,766
Interest rate swaps		—			767			—			767			—			868			—			868
Deferred compensation obligations		—			7,152			—			7,152			—			6,456			—			6,456
Total		$	—		$	37,157		$	—		$	37,157		$	—		$	15,090		$	—		$	15,090

 

The fair values of the Company’s available-for-sale and held-to-maturity securities are based on quoted prices. The fair value of the interest rate swaps are based upon inputs corroborated by observable market data. 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 foreign exchange forward rates 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.

 

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At April 30, 2011, the Company’s held-to-maturity securities consist of government agency notes maturing in June 2011 which are recorded at amortized cost and presented as short-term investments in the accompanying condensed consolidated balance sheets. The amortized cost of held-to-maturity securities at April 30, 2011 and January 29, 2011 was $15.0 million and $15.1 million, respectively, which approximated fair value. The Company presently does not intend to sell these investments and believes it is more likely than not that the Company will not be required to sell the investments before recovery of their amortized cost bases.

 

Available-for-sale securities are recorded at fair value and are included in other assets in the accompanying condensed consolidated balance sheets. At April 30, 2011, available-for-sale securities consisted of $16.0 million of corporate bonds with maturity dates ranging from January 2013 to September 2014 and $0.5 million of marketable equity securities. At January 29, 2011, available-for-sale securities consisted of $5.7 million of corporate bonds and $0.4 million of marketable equity securities. Unrealized gains (losses), net of taxes, are included as a component of stockholders’ equity and comprehensive income. The accumulated unrealized gains, net of taxes, included in accumulated other comprehensive income related to available-for-sale securities owned by the Company at April 30, 2011 and January 29, 2011 were minimal.

 

The carrying amount of the Company’s remaining 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 April 30, 2011 and January 29, 2011, 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.

 

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. Recoverability of assets 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 the asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the estimated fair value, which is determined based on discounted future cash flows. The impairment loss calculations require 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 are considered a Level 3 input as defined above.

 

(14)         Derivative Financial Instruments

 

Hedging Strategy

 

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 in accordance with authoritative guidance for certain of these hedges.

 

The Company’s objective is to hedge the variability in forecasted cash flows 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 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 sales, operating expenses and tax 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. The Company enters into derivative financial instruments, including forward exchange contracts to manage exchange risk on certain of these 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 April 30, 2011, 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 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 capital lease obligation, thus reducing the impact of interest rate changes on future interest payment cash flows. Refer to Note 8 for further information.

 

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Hedge Accounting Policy

 

U.S. dollar forward contracts are used to hedge forecasted merchandise purchases over specific months. Changes in the fair value of these U.S. dollar forward contracts, designated as cash flow hedges, are recorded as a component of accumulated other comprehensive income within stockholders’ equity, and are recognized in cost of product sales in the period which approximates the time the hedged merchandise inventory is sold.  The Company also hedges forecasted intercompany royalties over specific months. Changes in the fair value of these U.S. dollar forward contracts designated as cash flow hedges are recorded as a component of accumulated other comprehensive income within stockholders’ equity, and are recognized in other income and expense in the period in which the royalty expense is incurred.

 

From time to time, Swiss franc forward contracts are used to hedge certain anticipated Swiss operating expenses over specific months. Changes in the fair value of Swiss franc forward contracts designated as cash flow hedges are recorded as a component of accumulated other comprehensive income within stockholders’ equity, and are recognized in selling, general and administrative (“SG&A”) expenses in the period which approximates the time the expenses are incurred.

 

The Company also has foreign currency contracts that are not designated as hedges for accounting purposes.  Changes in fair value of foreign currency contracts not qualifying as cash flow hedges are reported in net earnings as part of other income and expense.

 

Summary of Derivative Instruments

 

The fair value of derivative instruments in the condensed consolidated balance sheet as of April 30, 2011 and January 29, 2011 was as follows (in thousands):

 

		Derivative Balance Sheet Location		Fair Value at Apr. 30, 2011			Fair Value at Jan. 29, 2011
ASSETS:
Derivatives designated as hedging instruments:
Foreign exchange currency contracts		Other current assets		$	—		$	1,137
Derivatives not designated as hedging instruments:
Foreign exchange currency contracts		Other current assets		1,342			2,090
Total				$	1,342		$	3,227
LIABILITIES:
Derivatives designated as hedging instruments:
Foreign exchange currency contracts		Current liabilities		$	11,487		$	1,598
Derivatives not designated as hedging instruments:
Foreign exchange currency contracts		Current liabilities		17,751			6,168
Interest rate swaps		Long-term liabilities		767			868
Total derivatives not designated as hedging instruments				18,518			7,036
Total				$	30,005		$	8,634

 

Forward Contracts Designated as Cash Flow Hedges

 

During the three months ended April 30, 2011, the Company purchased U.S. dollar forward contracts in Europe and Canada totaling US$59.9 million and US$23.5 million, respectively, to hedge forecasted merchandise purchases and intercompany royalties that were designated as cash flow hedges.  As of April 30, 2011, the Company had forward contracts outstanding for its European and Canadian operations of US$119.9 million and US$64.4 million, respectively, which are expected to mature over the next 14 months.

 

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The following table summarizes the gains (losses) before taxes recognized on the derivative instruments designated as cash flow hedges in other comprehensive income (“OCI”) and net earnings for the three months ended April 30, 2011 and May 1, 2010 (in thousands):

 

		Gain/(Loss) Recognized in OCI						Location of Gain/(Loss)		Gain/(Loss) Reclassified from Accumulated OCI into Income
		Three Months Ended Apr. 30, 2011			Three Months Ended May 1, 2010			Reclassified from Accumulated OCI into Income (1)		Three Months Ended Apr. 30, 2011			Three Months Ended May 1, 2010
Derivatives designated as hedging instruments:
Foreign exchange currency contracts		$	(11,052	)	$	248		Cost of sales		$	(2,333	)	$	(1,102	)
Foreign exchange currency contracts		$	(891	)	$	465		Other income/expense		$	100		$	257

 

(1) The ineffective portion was immaterial during the three months ended April 30, 2011 and May 1, 2010 and was recorded in net earnings and included in other income/expense.

 

As of April 30, 2011, accumulated other comprehensive income included an unrealized loss of approximately US$9.8 million, net of tax, of which US$9.1 million will be recognized in other expense or 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.

 

The following table summarizes net after-tax derivative activity recorded in accumulated other comprehensive income (in thousands):

 

		Three Months Ended Apr. 30, 2011			Three Months Ended May 1, 2010
Beginning balance (loss) gain		$	(1,789	)	$	1,845
Net (losses) gains from changes in cash flow hedges		(9,929		)	836
Net losses reclassified to income		1,925			592
Ending balance (loss) gains		$	(9,793	)	$	3,273

 

As of January 29, 2011, the Company had forward contracts outstanding for its European and Canadian operations of US$71.6 million and US$52.3 million, respectively.

 

Forward Contracts Not Designated as Cash Flow Hedges

 

As of April 30, 2011, the Company had euro foreign currency contracts to purchase US$165.8 million expected to mature over the next 11 months, Canadian dollar foreign currency contracts to purchase US$63.7 million expected to mature over the next 14 months, Swiss franc foreign currency contracts to purchase US$30.6 million expected to mature over the next 14 months and GBP8.0 million of foreign currency contracts to purchase euros expected to mature over the next five months.

 

The following table summarizes the gains (losses) before taxes recognized on the derivative instruments not designated as cash flow hedges in other income and expense for the three months ended April 30, 2011 and May 1, 2010 (in thousands):

 

		Location of		Gain/(Loss) Recognized in Income
		Gain/(Loss) Recognized in Income		Three Months Ended Apr. 30, 2011			Three Months Ended May 1, 2010
Derivatives not designated as hedging instruments:
Foreign exchange currency contracts		Other income/expense		$	(15,676	)	$	3,445
Interest rate swaps		Other income/expense		$	163		$	(173	)

 

As of January 29, 2011, the Company had euro foreign currency contracts to purchase US$70.0 million, Canadian dollar foreign currency contracts to purchase US$67.7 million, Swiss franc foreign currency contracts to purchase US$30.1 million and GBP11.3 million of foreign currency contracts to purchase euros.

 

(15)         Subsequent Events

 

On May 25, 2011, the Company announced a regular quarterly cash dividend of $0.20 per share on the Company’s common stock. The cash dividend will be paid on June 24, 2011 to stockholders of record as of the close of business on June 8, 2011.

 

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