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RALPH LAUREN CORP - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) The following management's discussion and analysis of financial condition and results of operations ("MD&A") should be read together with our audited consolidated financial statements and footnotes, which are included in this Annual Report on Form 10-K. We utilize a 52-53 week fiscal year ending on the Saturday closest to March 31. As such, Fiscal 2014 ended on March 29, 2014 and was a 52-week period; Fiscal 2013 ended on March 30, 2013 and was a 52-week period; and Fiscal 2012 ended on March 31, 2012 and was a 52-week period. Fiscal 2015 will end on March 28, 2015 and will also be a 52-week period. INTRODUCTION MD&A is provided as a supplement to the accompanying audited consolidated financial statements and footnotes to help provide an understanding of our results of operations, financial condition, and liquidity. MD&A is organized as follows: • Overview. This section provides a general description of our business, current trends and outlook, and a summary of our financial performance for Fiscal 2014. In addition, this section includes a discussion of recent developments and transactions affecting comparability that we believe are important in understanding our results of operations and financial condition, and in anticipating future trends. • Results of operations. This section provides an analysis of our results of operations for Fiscal 2014 as compared to Fiscal 2013 and Fiscal 2013 as compared to Fiscal 2012. • Financial condition and liquidity. This section provides a discussion of our financial condition and liquidity as of March 29, 2014, which includes (i) an analysis of our financial condition compared to the prior fiscal year-end; (ii) an analysis of changes in our cash flows for Fiscal 2014 and Fiscal 2013 as compared to the respective prior fiscal year; (iii) an analysis of our liquidity, including common stock repurchases, payments of dividends, our outstanding debt and covenant compliance, and the availability under our credit facilities; and (iv) a summary of our contractual and other obligations as of March 29, 2014. • Market risk management. This section discusses how we manage our risk exposures related to foreign currency exchange rates, interest rates, and our investments as of March 29, 2014. • Critical accounting policies. This section discusses accounting policies considered to be important to our results of operations and financial condition, which require significant judgment and estimation in their application. In addition, our significant accounting policies are summarized in Note 3 to the accompanying audited consolidated financial statements. • Recently issued accounting standards. This section discusses the potential impact on our reported results of operations and financial condition of certain accounting standards that have been recently issued or proposed. OVERVIEW Our Business Our Company is a global leader in the design, marketing, and distribution of premium lifestyle products, including men's, women's, and children's apparel, accessories, fragrances, and home furnishings. Our long-standing reputation and distinctive image have been consistently developed across an expanding number of products, brands, sales channels, and international markets. Our brand names include Ralph Lauren, Ralph Lauren Collection, Purple Label, Black Label, Polo, Polo Ralph Lauren, Blue Label, RRL, RLX Ralph Lauren, Lauren Ralph Lauren, Ralph Lauren Childrenswear, Denim & Supply Ralph Lauren, Chaps, and Club Monaco, among others. We classify our businesses into three segments: Wholesale, Retail, and Licensing. Our Wholesale business, which represented approximately 47% of our Fiscal 2014 net revenues, consists of sales made principally to major department stores and specialty stores around the world. Our Retail business, which represented approximately 51% of our Fiscal 2014 net revenues, consists of sales made directly to consumers through our integrated retail channel, which includes our retail stores around the world; concession-based shop-within-shops located in Asia, Australia, and Europe; and our retail e-commerce channel in North America, Europe, and Asia. Our Licensing business, which represented approximately 2% of our Fiscal 2014 net revenues, consists of royalty-based arrangements under which we license to unrelated third parties the right to use our various trademarks in connection 36 -------------------------------------------------------------------------------- with the manufacture and sale of designated products, such as apparel, eyewear, and fragrances, in specified geographic areas for specified periods. Approximately 36% of our Fiscal 2014 net revenues were earned in international regions outside of the U.S. See Note 22 to the accompanying audited consolidated financial statements for a summary of net revenues by reportable segment and geographic location. Our business is typically seasonal, with higher levels of wholesale sales in our second and fourth quarters and higher retail sales in our second and third quarters. These trends result primarily from the timing of seasonal wholesale shipments and key vacation travel, back-to-school, and holiday shopping periods in our Retail segment. Current Trends and Outlook Although the global economy has shown signs of improvement, expectations of modest growth reflect sustained uncertainty. The global economic environment continues to negatively impact consumer confidence, which in turn influences the level of spending on discretionary items. Additionally, adverse weather conditions, particularly in the U.S., have resulted in a challenging spring selling season for many retailers. As a result of these factors, consumer retail traffic remains relatively weak and inconsistent, which has led to a more promotional environment due to increased competition and a desire to offset traffic declines with increased levels of conversion. Certain of our retail operations have experienced similar dynamics, which vary across the geographic regions and businesses in which we operate. If the global macroeconomic environment remains volatile or worsens, the constrained level of worldwide consumer spending and modified consumption behavior may continue to have a negative effect on our sales, inventory levels, and operating margin in Fiscal 2015. We will continue to monitor these risks and evaluate and adjust our operating strategies and cost management opportunities to mitigate the related impact on our results of operations, while remaining focused on the long-term growth of our business and protecting the value of our brand. For a detailed discussion of significant risk factors that have the potential to cause our actual results to differ materially from our expectations, see Part I, Item 1A - "Risk Factors" included in this Annual Report on Form 10-K. Summary of Financial Performance Results of Operations In Fiscal 2014, we reported net revenues of $7.450 billion, net income of $776 million, and net income per diluted share of $8.43. This compares to net revenues of $6.945 billion, net income of $750 million, and net income per diluted share of $8.00 in Fiscal 2013. Our operating performance for Fiscal 2014 reflected revenue growth of 7.3% on a reported basis and 7.9% on a constant currency basis, as increased revenues from our wholesale business in the Americas and our retail businesses across all of our major geographies were partially offset by lower revenues from our wholesale businesses in Europe and Asia, as well as net unfavorable foreign currency effects. Our revenue growth for Fiscal 2014 also reflected several changes to our business, including revenues from the previously licensed Chaps Menswear Business and Australia and New Zealand Business (see "Recent Developments" for further discussion), and incremental revenues from certain previously licensed businesses in Latin America that were acquired in June 2012. These increases in revenue were partially offset by the wind-down of our Rugby-branded retail operations, largely during the second half of Fiscal 2013. Our gross margin declined 190 basis points basis points to 57.9% during Fiscal 2014, primarily due to the inclusion of the Chaps Menswear Business and the unfavorable impact of foreign currency. SG&A expenses increased during Fiscal 2014 due to incremental costs associated with newly transitioned operations, including the Chaps Menswear Business and the Australia and New Zealand Business, and costs to support our business growth and continued investments in our strategic growth initiatives and infrastructure. Net income increased by $26 million in Fiscal 2014 as compared to Fiscal 2013, primarily reflecting a $19 million decline in our provision for income taxes, a $3 million increase in operating income, and lower other non-operating charges. The lower income tax provision for Fiscal 2014 was driven by a decline in our reported effective tax rate of 190 basis points, partially offset by slightly higher pretax income. The decline in our reported effective tax rate was primarily attributable to income tax benefits recorded during Fiscal 2014 in connection with the settlement of a tax examination and legal entity restructuring of certain of our foreign operations. Net income per diluted share increased during Fiscal 2014, as compared to Fiscal 2013, due to higher net income and lower weighted-average diluted shares, driven by our share repurchases over the last twelve months. 37 -------------------------------------------------------------------------------- Financial Condition and Liquidity We ended Fiscal 2014 in a net cash and investments position (cash and cash equivalents plus short-term and non-current investments, less total debt) of $987 million, compared to $1.113 billion as of the end of Fiscal 2013. The decline in our net cash and investments position was primarily due to our use of cash to support $390 million in capital expenditures associated with our global retail store expansion, department store renovations, investments in our facilities, and upgrades to our global information technology systems, as well as to support Class A common stock repurchases of $558 million, and to make cash dividend payments of $149 million. The decline in our net cash and investments position was largely offset by our operating cash flows and proceeds from stock-based compensation arrangements. We generated $907 million of cash from operations during Fiscal 2014, compared to $1.019 billion during Fiscal 2013. The decline in our operating cash flows primarily relates to a net unfavorable change in our working capital during Fiscal 2014, compared to the prior fiscal year. Our equity increased to $4.034 billion as of March 29, 2014, compared to $3.785 billion as of March 30, 2013, primarily due to our net income and the impact of stock-based compensation arrangements, partially offset by our repurchases of common stock and dividends declared during Fiscal 2014. Recent Developments Australia and New Zealand Licensed Operations Acquisition In July 2013, in connection with the transition of the Ralph Lauren-branded apparel and accessories business in Australia and New Zealand (the "Australia and New Zealand Business") from a licensed to a wholly-owned operation, we acquired certain net assets from Oroton Group/PRL Australia ("Oroton") in exchange for an aggregate payment of approximately $15 million (the "Australia and New Zealand Licensed Operations Acquisition"). Oroton was our licensee for the Australia and New Zealand Business. The operating results of the acquired business have been consolidated in our operating results beginning on July 1, 2013. Chaps Menswear License Acquisition In April 2013, in connection with the transition of the North American Chaps-branded men's sportswear business (the "Chaps Menswear Business") from a licensed to a wholly-owned operation, we entered into an agreement with The Warnaco Group, Inc. ("Warnaco"), a subsidiary of PVH Corp., to acquire certain net assets in exchange for an aggregate payment of approximately $18 million (the "Chaps Menswear License Acquisition"). Warnaco was our licensee for the Chaps Menswear Business. The operating results of the Chaps Menswear Business have been consolidated in our operating results beginning on April 10, 2013. Rugby Closure Plan In October 2012, we approved a plan to wind-down our Rugby brand retail operations (the "Rugby Closure Plan"). This decision was primarily based on the results of an analysis of the brand concept, as well as an opportunity to reallocate our resources related to these operations to support other high-growth business opportunities and initiatives. In connection with the Rugby Closure Plan, 13 of our 14 global freestanding Rugby stores and our related domestic e-commerce site located at Rugby.com were closed during the second half of Fiscal 2013. The one remaining Rugby store was closed during Fiscal 2014. The Rugby Closure Plan also resulted in a reduction in our workforce of approximately 160 employees. Discontinuance of American Living at JCPenney During the fourth quarter of Fiscal 2012, we decided, along with our wholesale partner J.C. Penney Company, Inc. ("JCPenney"), to discontinue the majority of the products sold under the American Living brand created for and exclusively sold to JCPenney, effective for the Fall 2012 wholesale selling season. The discontinuance of these American Living product lines did not have a material impact on the Company's consolidated or segment results. 38 -------------------------------------------------------------------------------- Transactions Affecting Comparability of Results of Operations and Financial Condition The comparability of our operating results for the three fiscal years presented herein has been affected by certain events, including: • certain pretax asset impairment and restructuring and other charges recorded during the periods presented. A summary of the effect of these items on pretax income for each fiscal year is summarized below (references to "Notes" are to the notes to the accompanying audited consolidated financial statements): Fiscal Years Ended March 29, March 30, March 31, 2014 2013 2012 (millions) Impairments of assets (see Note 11) $ (1 ) $ (19 ) $ (2 ) Restructuring and other charges (see Note 12) (18 ) (12 ) (12 ) • our acquisitions of previously licensed businesses, including the Chaps Menswear License Acquisition in April 2013, which resulted in a $16 million gain recorded during the first quarter of Fiscal 2014; the Australia and New Zealand Licensed Operations Acquisition in July 2013; and our acquisition of the Ralph Lauren-branded business in Latin America in June 2012; • discrete income tax benefits of $10 million and $15 million recognized within our provision for income taxes during Fiscal 2014 and Fiscal 2013, respectively, in connection with the settlements of two separate tax examinations. During Fiscal 2013, the tax benefit from the tax examination settlement was more than offset by a discrete income tax reserve of $16 million for an interest assessment on a prior year withholding tax; and • the wind-down of our Rugby brand operations during the second half of Fiscal 2013 and the discontinuance of products sold under the American Living brand at JCPenney primarily effective for the Fall 2012 selling season. Our "Results of Operations" discussion that follows includes the significant changes in operating results arising from these items affecting comparability. However, unusual items or transactions may occur in any period. Accordingly, investors and other financial statement users should consider the types of events and transactions that have affected operating trends. 39 -------------------------------------------------------------------------------- RESULTS OF OPERATIONS Fiscal 2014 Compared to Fiscal 2013 The following table summarizes our results of operations and expresses the percentage relationship to net revenues of certain financial statement captions. All percentages shown in the below table and the discussion that follows have been calculated using unrounded numbers. Fiscal Years Ended March 29, March 30, $ % / bps 2014 2013 Change Change (millions, except per share data) Net revenues $ 7,450 $ 6,945 $ 505 7.3 % Cost of goods sold(a) (3,140 ) (2,789 ) (351 ) 12.6 % Gross profit 4,310 4,156 154 3.7 % Gross profit as % of net revenues 57.9 % 59.8 % (190 bps) Selling, general, and administrative expenses(a) (3,142 ) (2,971 ) (171 ) 5.7 % SG&A expenses as % of net revenues 42.2 % 42.8 % (60 bps) Amortization of intangible assets (35 ) (27 ) (8 ) 30.7 % Gain on acquisition of Chaps 16 - 16 NM Impairment of assets (1 ) (19 ) 18 (93.1 %) Restructuring and other charges (18 ) (12 ) (6 ) 52.9 % Operating income 1,130 1,127 3 0.3 % Operating income as % of net revenues 15.2 % 16.2 % (100 bps) Foreign currency losses (8 ) (12 ) 4 (30.1 %) Interest expense (20 ) (22 ) 2 (8.7 %) Interest and other income, net 3 6 (3 ) (38.2 %) Equity in losses of equity-method investees (9 ) (10 ) 1 (1.0 %) Income before provision for income taxes 1,096 1,089 7 0.6 % Provision for income taxes (320 ) (339 ) 19 (5.6 %) Effective tax rate(b) 29.2 % 31.1 % (190 bps) Net income $ 776 $ 750 $ 26 3.4 % Net income per common share: Basic $ 8.55 $ 8.21 $ 0.34 4.1 % Diluted $ 8.43 $ 8.00 $ 0.43 5.4 % (a) Includes total depreciation expense of $223 million and $206 million for Fiscal 2014 and Fiscal 2013, respectively. (b) Effective tax rate is calculated by dividing the provision for income taxes by income before provision for income taxes. NM = Not meaningful. Net Revenues. Net revenues increased by $505 million, or 7.3%, to $7.450 billion in Fiscal 2014 from $6.945 billion in Fiscal 2013. Excluding the effect of foreign currency, net revenues increased by $552 million, or 7.9%. 40 -------------------------------------------------------------------------------- Net revenues for our three business segments, as well as a discussion of the changes in each segment's net revenues from the prior fiscal year, are provided below: Fiscal Years Ended March 29, March 30, $ % 2014 2013 Change Change (millions) Net Revenues: Wholesale $ 3,486 $ 3,138 $ 348 11.1 % Retail 3,798 3,625 173 4.8 % Licensing 166 182 (16 ) (9.0 %) Total net revenues $ 7,450 $ 6,945 $ 505 7.3 % Wholesale net revenues - The net increase primarily reflects: • a $382 million net increase related to our business in the Americas on a constant currency basis, largely due to $210 million of incremental revenues contributed by previously licensed businesses, including the Chaps Menswear Business acquired in April 2013 and certain businesses in Latin America acquired in June 2012. The increase in net revenues also reflected higher domestic revenues from our menswear, womenswear, and childrenswear product lines, as well as increased revenues from our accessories business. These increases were partially offset by lower Home product revenues primarily due to the rebranding of certain of our home products; and • a $7 million net increase in revenues due to the net favorable foreign currency effects, primarily related to the strengthening of the Euro, partially offset by the weakening of the Japanese Yen and the Canadian Dollar against the U.S. Dollar during Fiscal 2014. This net increase was partially offset by: • a $16 million net decrease related to our European business on a constant currency basis, driven by our planned reduction in shipments across our menswear, womenswear, and childrenswear product lines due to the challenging European retail environment and softness in the specialty store business; and • a $23 million net decrease related to our Japanese business on a constant currency basis, primarily reflecting lower sell-throughs and the impact of a business model shift to the retail concessions-based channel. Retail net revenues - Our total reported comparable store sales were flat in Fiscal 2014 compared to the prior fiscal year, but increased approximately 1% on a constant currency basis. Comparable store sales refer to the growth of sales in stores that are open for at least one full fiscal year. Sales for stores that are closed during a fiscal year are excluded from the calculation of comparable store sales. Sales for stores that are either relocated, enlarged (as defined by gross square footage expansion of 25% or greater), or generally closed for 30 or more consecutive days for renovation are also excluded from the calculation of comparable store sales until such stores have been in their new location or in their newly renovated state for at least one full fiscal year. Sales from our e-commerce sites are included within comparable store sales for those geographies that have been serviced by the related e-commerce site for at least one full fiscal year. Consolidated comparable store sales information includes our Ralph Lauren stores (including concession-based shop-within-shops), factory stores, Club Monaco stores and e-commerce sites, and certain of our Ralph Lauren e-commerce sites. Sales from our Rugby stores and related e-commerce site, Rugby.com, are no longer included in comparable store sales due to the wind-down of our Rugby brand retail operations in Fiscal 2013. We use an integrated omni-channel strategy to operate our retail business, in which our e-commerce operations are interdependent with our physical stores. The net increase in Retail net revenues primarily reflects: • a $29 million, or a 1%, net increase in consolidated comparable store sales on a constant currency basis, primarily driven by an increase from our Ralph Lauren e-commerce operations, partially offset by decreases in comparable store sales from our concession shops and our domestic factory stores. Comparable store sales related to our e-commerce operations increased by approximately 14% on a reported basis and 13% on a constant currency basis over the related prior fiscal year, and had a favorable impact on our total comparable store sales of approximately 2% to 3% on a reported basis and approximately 1% to 2% on a constant currency basis. Our consolidated comparable store sales excluding e-commerce decreased approximately 2% to 3% on a reported basis and were flat to down by 1% on a constant currency basis; and 41 -------------------------------------------------------------------------------- • a $197 million, or a 40%, net increase in non-comparable store sales on a constant currency basis, primarily driven by new store openings within the past twelve months, including store openings in Asia, new stores and concession shops assumed in connection with the Australia and New Zealand Licensed Operations Acquisition, other new global store openings, and the expansion of our e-commerce operations, which more than offset the impact of store closings, including those closed in connection with the Rugby Closure Plan. These increases were partially offset by: • a $53 million net decrease in revenues due to unfavorable foreign currency effects, comprised of unfavorable effects of $43 million and $10 million related to our comparable and non-comparable store sales, respectively. The unfavorable currency effects primarily related to the weakening of the Japanese Yen, partially offset by the strengthening of the Euro against the U.S. Dollar during Fiscal 2014 compared to the prior fiscal year. Our global average store count increased by 47 stores and concession shops during Fiscal 2014 compared with the prior fiscal year, primarily due to new store and concession shop openings in Asia and Europe, and stores and concession shops assumed in connection with the Australia and New Zealand Licensed Operations Acquisition, partially offset by store closures, including those associated with the Rugby Closure Plan. The following table details our retail store and e-commerce presence as of the periods presented: March 29, March 30, 2014 2013 Stores: Freestanding stores 433 388 Concession shops 503 494 Total stores 936 882 E-commerce Sites: North American sites(a) 3 3 European sites(b) 3 3 Asian sites(c) 2 1 Total e-commerce sites 8 7 (a) Includes www.RalphLauren.com, www.ClubMonaco.com, and www.ClubMonaco.ca, which collectively service the U.S. and Canada. (b) Includes www.RalphLauren.co.uk (servicing the United Kingdom), www.RalphLauren.fr (servicing Belgium, France, Italy, Luxembourg, the Netherlands, Portugal, and Spain), and www.RalphLauren.de (servicing Germany and Austria). (c) Includes www.RalphLauren.co.jp, which services Japan and, as of March 29, 2014, our new e-commerce site at www.RalphLauren.co.kr, which services South Korea. Licensing revenues - The $16 million net decrease in revenues primarily reflects the transition of certain licensing arrangements, including the Chaps Menswear Business and the Australia and New Zealand Business, to wholly-owned operations and the discontinuance of certain Home licensing arrangements, partially offset by higher apparel and fragrance-related royalties. Gross Profit. Gross profit increased by $154 million, or 3.7%, to $4.310 billion in Fiscal 2014 from $4.156 billion in Fiscal 2013. Gross profit as a percentage of net revenues decreased by 190 basis points to 57.9% in Fiscal 2014 from 59.8% in Fiscal 2013. The gross margin decline was primarily attributable to the inclusion of the Chaps Menswear Business and the unfavorable effects of foreign currency. Gross profit as a percentage of net revenues is dependent upon a variety of factors, including changes in the relative sales mix among distribution channels, changes in the mix of products sold, the timing and level of promotional activities, foreign currency exchange rates, and fluctuations in material costs. These factors, among others, may cause gross profit as a percentage of net revenues to fluctuate from year to year. Selling, General, and Administrative Expenses. SG&A expenses increased by $171 million, or 5.7%, to $3.142 billion in Fiscal 2014 from $2.971 billion in Fiscal 2013. This increase included a net favorable foreign currency effect of approximately 42 -------------------------------------------------------------------------------- $29 million, primarily related to the weakening of the Japanese Yen, partially offset by the strengthening of the Euro against the U.S. Dollar during Fiscal 2014 as compared to the prior fiscal year. SG&A expenses as a percentage of net revenues declined to 42.2% in Fiscal 2014 from 42.8% in Fiscal 2013. The 60 basis point improvement was primarily due to operating leverage on higher net revenues and our operational discipline, which more than offset the increase in operating expenses attributable to our recent acquisitions and new business initiatives, as well as increased investments in our facilities, infrastructure, and information technology. The $171 million net increase in SG&A expenses by functional category is as follows: Fiscal 2014 Compared to Fiscal 2013 (millions) SG&A expense category: Compensation-related expenses(a) $ 44 Marketing, advertising, and promotional expenses 39 Shipping, warehousing, and distribution expenses 28 Rent and occupancy expenses 27 Depreciation expense 17 Acquisition-related costs(b) 7 Other 9 Total change in SG&A expenses(c) $ 171 (a) Primarily due to increased salaries and related expenses to support business growth. (b) Comprised of acquisition-related costs for the Chaps Menswear License Acquisition in April 2013 and for the Australia and New Zealand Licensed Operations Acquisition in July 2013 (see Note 5 to the accompanying audited consolidated financial statements). (c) Includes $62 million of incremental expenses associated with the aforementioned newly acquired businesses and $13 million of incremental expenses incurred in connection with the implementation of our global operating and financial reporting system. During Fiscal 2015, we anticipate a certain amount of operating expense de-leverage due to continued investment in our long-term strategic growth initiatives, including global retail store expansion, the introduction of the Polo store concept around the world, department store renovations, and continued investment in our infrastructure. Amortization of Intangible Assets. Amortization of intangible assets increased by $8 million, or 30.7%, to $35 million in Fiscal 2014 from $27 million in Fiscal 2013. This increase was primarily due to the full amortization of the licensed trademark intangible asset acquired in connection with the Chaps Menswear License Acquisition during Fiscal 2014 (see Note 5 to the accompanying audited consolidated financial statements). Gain on Acquisition of Chaps. During Fiscal 2014, we recorded a $16 million gain on the Chaps Menswear License Acquisition, representing the difference between the acquisition date fair value of net assets acquired and the contractually-defined purchase price under our license agreement with Warnaco, which granted us the right to early-terminate the license upon PVH's acquisition of Warnaco in February 2013 (see Note 5 to the accompanying audited consolidated financial statements). Impairments of Assets. During Fiscal 2014, we recorded non-cash impairment charges of $1 million, to write-off certain long-lived assets relating to our European operations. During Fiscal 2013, we recognized non-cash impairment charges of $19 million, which included charges of $11 million to write-off certain Rugby brand-related long-lived assets in connection with the Rugby Closure Plan and charges of $8 million to reduce the carrying values of long-lived assets of certain underperforming European stores to their fair values, as well as to write-off the fixed assets of certain wholesale locations in Europe that were expected to close (see Note 11 to the accompanying audited consolidated financial statements). Restructuring and Other Charges. Restructuring and other charges increased by $6 million to $18 million in Fiscal 2014 from $12 million in Fiscal 2013. During Fiscal 2014, we recorded restructuring charges of $8 million, primarily related to severance 43 -------------------------------------------------------------------------------- and benefit costs associated with our corporate operations. In addition, during Fiscal 2014, we recorded $10 million of accelerated stock-based compensation expense associated with certain new executive employment agreement provisions. Restructuring and other charges of $12 million recorded during Fiscal 2013 included $7 million of severance and lease termination costs associated with the Rugby Closure Plan and $5 million of other net restructuring charges, which primarily related to the suspension of the Company's operations in Argentina, severance and lease termination costs associated with our European operations, and other severance-related costs primarily within our corporate operations, partially offset by reversals of reserves deemed no longer necessary in connection with our Fiscal 2012 restructuring plan in the Asia-Pacific region (see Note 12 to the accompanying audited consolidated financial statements). Operating Income. Operating income slightly increased by $3 million, or 0.3%, to $1.130 billion in Fiscal 2014 from $1.127 billion in Fiscal 2013. Operating income as a percentage of net revenues declined 100 basis points, to 15.2% in Fiscal 2014 from 16.2% in Fiscal 2013. The decrease in operating income as a percentage of net revenues primarily reflected the decline in our gross profit margin, partially offset by an improvement in SG&A and other operating expenses as a percentage of net revenues, as previously discussed. During the fourth quarter of Fiscal 2014, we changed the manner in which we allocate certain costs for management reporting due to strategic changes we implemented to globalize certain functions that will position us for future growth. These changes included realigning certain costs between segments and retaining other costs at the corporate level for certain of our global functions. We believe that these changes allow for a better representation of segment operations and are aligned with how segment performance is assessed. As a result of these changes, we determined that it is more appropriate to retain certain previously allocated corporate expenses within our unallocated corporate expenses. This expense realignment did not result in a change to our reportable segments. All prior period segment information has been recast to reflect the change in our segment measurement on a comparable basis, including the operating income analyses that follow. This recast had no impact on our segment net revenues or on our consolidated financial statements in any fiscal period. Operating income and margin for each of our three reportable segments, which have been recast to reflect the fourth quarter change in segment measurement, are provided below: Fiscal Years Ended March 29, 2014 March 30, 2013 Operating Operating Operating Operating $ Margin Income Margin Income Margin Change Change (millions) (millions) (millions) Segment: Wholesale $ 963 27.6% $ 903 28.7% $ 60 (110 bps) Retail 572 15.1% 615 17.0% (43 ) (190 bps) Licensing 150 90.2% 152 83.6% (2 ) 660 bps 1,685 1,670 15 Unallocated corporate expenses (553 ) (531 ) (22 ) Gain on acquisition of Chaps 16 - 16 Unallocated restructuring and other charges (18 ) (12 ) (6 ) Total operating income $ 1,130 15.2% $ 1,127 16.2% $ 3 (100 bps) Wholesale operating margin declined by 110 basis points, primarily due to a decline in gross profit margin reflecting the inclusion of the Chaps Menswear Business, a less favorable geographic mix, and the net negative effects related to foreign currency. The decline in Wholesale operating margin was partially offset by improved operating leverage of SG&A expenses on higher wholesale revenues. Retail operating margin declined by 190 basis points, largely due to a lower gross profit margin, primarily reflecting elevated promotional activity within certain of our retail businesses during the fourth quarter of Fiscal 2014 and the unfavorable effect of foreign currency. The decline in Retail operating margin was also due to an increase in SG&A expenses as a percentage of net revenues, primarily driven by incremental operating expenses associated with the Australia and New Zealand Business, and expenses associated with our global store and e-commerce development efforts. 44 -------------------------------------------------------------------------------- Licensing operating margin improvement was primarily due to reduced operating expenses reflecting the transition of certain licensing arrangements to wholly-owned operations, partially offset by lower net revenues. Unallocated corporate expenses increased by $22 million, reflecting higher advertising, marketing, and promotional costs, acquisition-related costs, and increased global information technology-related costs. Gain on Acquisition of Chaps was $16 million for Fiscal 2014, as previously described above and in Note 5 to the accompanying audited consolidated financial statements. Unallocated restructuring and other charges increased by $6 million to $18 million in Fiscal 2014, from $12 million in Fiscal 2013, as previously described above and in Note 12 to the accompanying audited consolidated financial statements. Foreign Currency Losses. The effect of foreign currency exchange rate fluctuations resulted in losses of $8 million in Fiscal 2014, compared to losses of $12 million in Fiscal 2013. The net decline in foreign currency losses was primarily related to the revaluation and settlement of foreign currency-denominated third-party and intercompany receivables and payables, and net gains related to foreign currency hedge contracts. Foreign currency gains and losses do not result from the translation of the operating results of our foreign subsidiaries to U.S. dollars. Interest Expense. Interest expense includes the borrowing costs related to our outstanding debt, including amortization of debt issuance costs, and interest related to our capital lease obligations. Interest expense declined by $2 million to $20 million in Fiscal 2014, from $22 million in Fiscal 2013, primarily due to the lower interest rate on the 2.125% unsecured senior notes due 2018 (the "Senior Notes") issued in September 2013, as compared to the 4.5% interest rate on the previously outstanding Euro Debt, as defined below (see Note 14 to the accompanying audited consolidated financial statements). This decline was partially offset by additional interest on our increased capital lease obligations. Interest and Other Income, net. Interest and other income, net decreased by $3 million to $3 million in Fiscal 2014, from $6 million in Fiscal 2013, reflecting lower interest income primarily due to changes in our investment portfolio mix. Equity in Losses of Equity-Method Investees. The equity in losses of equity-method investees of $9 million and $10 million in Fiscal 2014 and Fiscal 2013, respectively, reflect our share of losses from our joint venture, the Ralph Lauren Watch and Jewelry Company Sárl (the "RL Watch Company"), which is accounted for under the equity method of accounting. Provision for Income Taxes. The provision for income taxes represents federal, foreign, state and local income taxes. The provision for income taxes decreased by $19 million, or 5.6%, to $320 million in Fiscal 2014 from $339 million in Fiscal 2013. The decrease in the provision for income taxes was primarily due to a decrease in our reported effective tax rate of 190 basis points to 29.2% in Fiscal 2014 from 31.1% in Fiscal 2013, slightly offset by the increase in the overall level of our pretax income. The lower effective tax rate for Fiscal 2014 was primarily due to tax reserve reductions associated with the conclusion of a tax examination during the third quarter of Fiscal 2014, and an income tax benefit resulting from legal entity restructuring of certain of our foreign operations during Fiscal 2014. The effective tax rate for Fiscal 2013 reflected tax reserve reductions associated with the conclusion of a separate tax examination during the third quarter of Fiscal 2013, which were offset by the inclusion of a reserve for an interest assessment on a prior year withholding tax. The effective tax rate differs from statutory rates due to the effect of state and local taxes, tax rates in foreign jurisdictions, and certain nondeductible expenses. Our effective tax rate will change from period to period based on various factors including, but not limited to, the geographic mix of earnings, the timing and amount of foreign dividends, enacted tax legislation, state and local taxes, tax audit findings and settlements, and the interaction of various global tax strategies. Net Income. Net income increased by $26 million, or 3.4%, to $776 million in Fiscal 2014, from $750 million in Fiscal 2013, due to the $19 million reduction in our provision for income taxes, lower non-operating charges of $4 million, and a $3 million increase in operating income, all as previously discussed. Net Income per Diluted Share. Net income per diluted share increased by $0.43, or 5.4%, to $8.43 per share in Fiscal 2014 from $8.00 per share in Fiscal 2013. The increase was primarily attributable to higher net income, as previously discussed, and lower weighted-average diluted shares outstanding during Fiscal 2014, driven by our share repurchases over the last twelve months. 45 -------------------------------------------------------------------------------- Fiscal 2013 Compared to Fiscal 2012 The following table summarizes our results of operations and expresses the percentage relationship to net revenues of certain financial statement captions: Fiscal Years Ended March 30, March 31, $ % / bps 2013 2012 Change Change (millions, except per share data) Net revenues $ 6,945 $ 6,860 $ 85 1.2 % Cost of goods sold(a) (2,789 ) (2,862 ) 73 (2.5 %) Gross profit 4,156 3,998 158 3.9 % Gross profit as % of net revenues 59.8 % 58.3 % 150 bps Selling, general, and administrative expenses(a) (2,971 ) (2,916 ) (55 ) 1.9 % SG&A expenses as % of net revenues 42.8 % 42.5 % 30 bps Amortization of intangible assets (27 ) (29 ) 2 (7.3 %) Impairments of assets (19 ) (2 ) (17 ) NM Restructuring and other charges (12 ) (12 ) - (5.6 %) Operating income 1,127 1,039 88 8.4 % Operating income as % of net revenues 16.2 % 15.2 % 100 bps Foreign currency losses (12 ) (2 ) (10 ) NM Interest expense (22 ) (24 ) 2 (9.8 %) Interest and other income, net 6 11 (5 ) (48.2 %) Equity in losses of equity-method investees (10 ) (9 ) (1 ) 2.2 % Income before provision for income taxes 1,089 1,015 74 7.3 % Provision for income taxes (339 ) (334 ) (5 ) 1.6 % Effective tax rate (b) 31.1 % 32.9 % (180 bps) Net income $ 750 $ 681 $ 69 10.1 % Net income per common share: Basic $ 8.21 $ 7.35 $ 0.86 11.7 % Diluted $ 8.00 $ 7.13 $ 0.87 12.2 % (a) Includes total depreciation expense of $206 million and $196 million for Fiscal 2013 and Fiscal 2012, respectively. (b) Effective tax rate is calculated by dividing the provision for income taxes by income before provision for income taxes. NM = Not meaningful. Net Revenues. Net revenues increased by $85 million, or 1.2%, to $6.945 billion in Fiscal 2013 from $6.860 billion in Fiscal 2012. The increase was primarily due to higher revenues from our retail businesses, which were partially offset by lower revenues from our wholesale businesses and net unfavorable foreign currency effects. Excluding the effect of foreign currency, net revenues increased by $183 million, or 2.7%. 46 -------------------------------------------------------------------------------- Net revenues for our three reportable business segments are provided below: Fiscal Years Ended March 30, March 31, $ % 2013 2012 Change Change (millions) Net Revenues: Wholesale $ 3,138 $ 3,247 $ (109 ) (3.3 %) Retail 3,625 3,432 193 5.6 % Licensing 182 181 1 0.7 % Total net revenues $ 6,945 $ 6,860 $ 85 1.2 % Wholesale net revenues - The net decrease primarily reflects: • a $78 million net decrease related to our European businesses on a constant currency basis driven by reduced shipments across our core menswear, womenswear, and childrenswear product lines, reflecting the challenging European retail environment and softness in the specialty store business, particularly in Southern Europe. These decreases were partially offset by increased sales from our accessories product lines, driven by new product offerings and an increased department store presence; • a $15 million net decrease related to our Japanese businesses on a constant currency basis, primarily due to the impact of our business model shift to the retail concession-based channel and the softness in the department store business; and • a $50 million net decrease in revenues due to net unfavorable foreign currency effects, primarily related to the weakening of the Euro against the U.S. Dollar during Fiscal 2013. These decreases were partially offset by: • a $33 million net increase related to our businesses in the Americas, reflecting higher menswear and womenswear revenues due in part to additional product line offerings, partially offset by declines due to the discontinuance of the majority of product categories under the American Living brand sold to JCPenney. The increase in net revenues was also due to incremental Home product revenues related to our assumption of control over the distribution of the previously licensed bedding and bath business on May 1, 2011, which was partially offset by lower revenues from our childrenswear product line. Retail net revenues - Our total reported comparable store sales increased approximately 3% in Fiscal 2013 compared to Fiscal 2012, but increased approximately 4% on a constant currency basis. The net increase in Retail net revenues primarily reflected: • a $119 million, or a 4%, net increase in consolidated comparable store sales on a constant currency basis, primarily driven by increases from our North American and European factory stores and our Ralph Lauren e-commerce operations, partially offset by decreases in comparable store sales from certain of our Ralph Lauren stores and our concession shops in Asia. Comparable store sales related to our e-commerce operations increased by approximately 18% on both a reported and constant currency basis over Fiscal 2012, and had a favorable impact on our total comparable store sales of 1% to 2% on both a reported and constant currency basis. Our consolidated comparable store sales excluding e-commerce increased between 1% and 2% on a reported basis and between 2% and 3% on a constant currency basis; and • a $120 million, or a 22%, net increase in non-comparable store sales on a constant currency basis, driven by new store openings over the past twelve months and the growth of our e-commerce operations through our recently launched Ralph Lauren e-commerce sites in Germany and Japan and Club Monaco e-commerce sites in North America. The effect of these new openings and launches more than offset the impact of store closings in the Asia-Pacific region due to our network repositioning initiative. 47 -------------------------------------------------------------------------------- These increases were partially offset by: • a $46 million net decrease in revenues due to unfavorable foreign currency effects, comprised of unfavorable effects of $36 million and $10 million related to our comparable and non-comparable store sales, respectively, primarily related to the weakening of the Euro and the Yen against the U.S. Dollar during Fiscal 2013. Our global average store count declined by three stores and concession shops during Fiscal 2013, as store closures associated with the Asia-Pacific Restructuring Plan at the end of Fiscal 2012 and the Rugby Closure Plan in Fiscal 2013 were largely offset by new store openings, primarily in Asia and Europe. The following table details our retail store and e-commerce presence as of the periods presented: March 30, March 31, 2013 2012 Stores: Freestanding stores 388 379 Concession shops 494 474 Total stores 882 853 E-commerce Sites: North American sites(a) 3 3 European sites(b) 3 3 Asian site(c) 1 - Total e-commerce sites 7 6 (a) Our North American e-commerce sites as of March 30, 2013 include www.RalphLauren.com, www.ClubMonaco.com, and www.ClubMonaco.ca, which collectively service the U.S. and Canada. As of March 31, 2012, our North American e-commerce sites included www.RalphLauren.com, www.ClubMonaco.com, and www.Rugby.com. (b) Includes www.RalphLauren.co.uk (servicing the United Kingdom), www.RalphLauren.fr (servicing Belgium, France, Italy, Luxembourg, the Netherlands, Portugal, and Spain), and www.RalphLauren.de (servicing Germany and Austria). (c) Includes www.RalphLauren.co.jp servicing Japan, which was launched in Fiscal 2013. Licensing revenues - The $1 million net increase in licensing revenues reflects an approximate $5 million increase in product licensing royalties, primarily driven by higher apparel and fragrance-related royalties, largely offset by an approximate $4 million decline in Home licensing revenues due to the discontinuance of certain licensing arrangements. Gross Profit. Gross profit increased by $158 million, or 3.9%, to $4.156 billion in Fiscal 2013 from $3.998 billion in Fiscal 2012. Gross profit as a percentage of net revenues increased by 150 basis points to 59.8% in Fiscal 2013 from 58.3% in Fiscal 2012, primarily reflecting lower sourcing costs compared to higher cost benchmarks in the prior year period across most of our global businesses, favorable product mix across most of our wholesale businesses, and the growth of our retail businesses, which generally carry higher gross margins. The improvement in our gross profit margin was partially offset by a less favorable geographic mix and elevated promotional activity across certain of our North American retail businesses. Selling, General, and Administrative Expenses. SG&A expenses increased by $55 million, or 1.9%, to $2.971 billion in Fiscal 2013 from $2.916 billion in Fiscal 2012. This increase included a net favorable foreign currency effect of approximately $43 million, primarily related to the weakening of the Euro and the Japanese Yen against the U.S. Dollar during Fiscal 2013. Excluding the effect of foreign currency, SG&A expenses increased by $98 million, or 3.4%. SG&A expenses as a percentage of net revenues increased to 42.8% in Fiscal 2013 from 42.5% in Fiscal 2012. The 30 basis point increase was primarily due to an increase in operating expenses attributable to the growth in our retail businesses (which typically carry higher operating expense margins), our new business initiatives, and our repositioning efforts in the Asia-Pacific region, partially offset by our operating leverage on higher net revenues. 48 -------------------------------------------------------------------------------- The $55 million net increase in SG&A expenses by functional category is as follows: Fiscal 2013 Compared to Fiscal 2012 (millions) SG&A expense category: Compensation-related expenses(a) $ 26 Selling expenses 7 Depreciation expense 7 Shipping, warehousing, and distribution expenses 6 Rent and occupancy-related expenses 5 Marketing, advertising, and promotional expenses 4 Total change in SG&A expenses $ 55 (a) Primarily related to increased salaries to support retail growth and higher stock-based compensation expenses. Amortization of Intangible Assets. Amortization of intangible assets decreased by $2 million, or 7.3%, to $27 million in Fiscal 2013 from $29 million in Fiscal 2012. This decrease reflects the absence of expense in Fiscal 2013 related to certain customer relationship intangible assets that were fully amortized as of the end of Fiscal 2012. Impairments of Assets. Asset impairment charges increased by $17 million to $19 million in Fiscal 2013 from $2 million in Fiscal 2012. The non-cash impairment charges of $19 million recognized in Fiscal 2013 included charges of $11 million to write-off certain Rugby brand-related long-lived assets in connection with the Rugby Closure Plan and charges of $8 million to reduce the carrying values of long-lived assets of certain underperforming European stores to their fair values, as well as to write-off the fixed assets of certain wholesale locations in Europe that were expected to close. During Fiscal 2012, we recorded non-cash impairment charges of $2 million, primarily to reduce the carrying value of the long-lived assets of certain underperforming European retail stores to their estimated fair values. See Note 11 to the accompanying audited consolidated financial statements for further discussion. Restructuring and Other Charges. Restructuring and other charges were $12 million in each of Fiscal 2013 and Fiscal 2012. Net restructuring charges of $12 million recorded in Fiscal 2013 included $7 million of severance and lease termination costs associated with the Rugby Closure Plan and $5 million of other net restructuring charges, which primarily related to the suspension of the Company's operations in Argentina, severance and lease termination costs associated with our European operations, and other severance-related costs primarily within our corporate operations, partially offset by reversals of reserves deemed no longer necessary in connection with our Fiscal 2012 restructuring plan in the Asia-Pacific region. Net restructuring charges of $12 million recorded during Fiscal 2012 primarily related to employee termination costs and costs associated with the closure of certain retail stores and concession shops in connection with our restructuring plan in the Asia-Pacific region, as well as severance related to the planned discontinuance of the majority of the products sold under the American Living brand at JCPenney. See Note 12 to the accompanying audited consolidated financial statements for further discussion. Operating Income. Operating income increased by $88 million, or 8.4%, to $1.127 billion in Fiscal 2013 from $1.039 billion in Fiscal 2012. Operating income as a percentage of net revenues increased 100 basis points, to 16.2% in Fiscal 2013 from 15.2% in Fiscal 2012. The increase in operating income as a percentage of net revenues primarily reflects the improvement in gross profit margin, partially offset by higher SG&A expenses and impairment charges as a percentage of revenue, as previously discussed. 49 -------------------------------------------------------------------------------- Operating income and margin for our three business segments, which have been recast to reflect the fourth quarter Fiscal 2014 change in segment measurement, are as follows: Fiscal Years Ended March 30, 2013 March 31, 2012 Operating Operating Operating Operating $ Margin Income Margin Income Margin Change Change (millions) (millions) (millions) Segment: Wholesale $ 903 28.7 % $ 835 25.7 % $ 68 300 bps Retail 615 17.0 % 553 16.1 % 62 90 bps Licensing 152 83.6 % 149 82.6 % 3 100 bps 1,670 1,537 133 Unallocated corporate expenses (531 ) (486 ) (45 ) Unallocated restructuring and other charges, net (12 ) (12 ) - Total operating income $ 1,127 16.2 % $ 1,039 15.2 % $ 88 100 bps Wholesale operating margin increased by 300 basis points, primarily due to increased global gross margins, reflecting lower sourcing costs compared to higher cost benchmarks in the prior year period and a favorable product mix across most of our global wholesale businesses. Retail operating margin increased by 90 basis points, including an unfavorable impact of 20 basis points related to asset impairment charges associated with the Rugby Closure Plan. The increase in the Retail operating margin was primarily due to improved operating leverage of SG&A expenses, including rent and occupancy and compensation-related costs, on higher retail revenues. This increase was partially offset by the lower gross profit margin, primarily reflecting elevated promotional activity across certain of our North American retail businesses. Licensing operating margin increased by 100 basis points, primarily due to reduced operating expenses reflecting the discontinuance of certain licensing arrangements, as well as slightly higher licensing revenues. Unallocated corporate expenses increased by $45 million, primarily due to increased compensation-related costs, including stock-based compensation, higher advertising, marketing, and promotional costs, and higher rent and occupancy related expenses. Unallocated restructuring and other charges were $12 million in each of Fiscal 2013 and Fiscal 2012. See Notes 12 and 22 to the accompanying audited consolidated financial statements for further discussion of the related charges. Foreign Currency Losses. The effect of foreign currency exchange rate fluctuations resulted in losses of $12 million in Fiscal 2013, compared to losses of $2 million in Fiscal 2012. The higher foreign currency losses were primarily attributable to the weakening of the Euro during Fiscal 2013, and were primarily related to the settlement of foreign currency-denominated third-party and intercompany receivables and payables. Interest Expense. Interest expense decreased by $2 million, or 9.8%, to $22 million in Fiscal 2013 from $24 million in Fiscal 2012. The decrease in interest expense was primarily due to favorable foreign currency effects related to the weakening of the Euro during Fiscal 2013, which reduced interest expense related to our Euro Debt (as defined below). The decline in interest expense was also attributable to the absence of interest incurred on Fiscal 2012 borrowings under our Global Credit Facility (as defined in Note 14 to the accompanying audited consolidated financial statements). Interest and Other Income, net. Interest and other income, net decreased by $5 million, or 48.2%, to $6 million in Fiscal 2013 from $11 million in Fiscal 2012. The decline was principally due to lower rates of interest and lower investment balances within our European investment portfolio, as well as the absence of pretax income of approximately $1 million recorded in Fiscal 2012 in connection with the change in fiscal year of our Japanese subsidiary to conform to our consolidated fiscal year basis. Equity in Losses of Equity-Method Investees. The equity in losses of equity-method investees of $10 million and $9 million in Fiscal 2013 and Fiscal 2012, respectively, is related to our share of losses from the RL Watch Company. 50 -------------------------------------------------------------------------------- Provision for Income Taxes. The provision for income taxes increased by $5 million, or 1.6%, to $339 million in Fiscal 2013 from $334 million in Fiscal 2012. The increase in our provision for income taxes was primarily due to an increase in the overall level of our pretax income, largely offset by a decrease in our effective tax rate of 180 basis points, to 31.1% in Fiscal 2013 from 32.9% in Fiscal 2012. Our lower effective tax rate was primarily due to a greater proportion of earnings generated in lower-taxed jurisdictions, as well as tax reserve reductions associated with the conclusion of a tax examination and other net favorable discrete tax items, partially offset by the inclusion of a reserve for an interest assessment on a prior year withholding tax. Net Income. Net income increased by $69 million, or 10.1%, to $750 million in Fiscal 2013 from $681 million in Fiscal 2012. The higher net income was primarily driven by the $88 million increase in operating income, partially offset by higher foreign currency losses of $10 million and the increase in our provision for income taxes of $5 million, as previously discussed. Fiscal 2013 results were negatively impacted by $19 million of pretax charges related to asset impairments and restructuring in connection with the Rugby Closure Plan, which had an after-tax effect of reducing net income by $12 million. Net Income per Diluted Share. Net income per diluted share increased by $0.87, or 12.2%, to $8.00 per share in Fiscal 2013 from $7.13 per share in Fiscal 2012. The increase was due to the higher level of net income, as previously discussed, and lower weighted-average diluted shares outstanding during Fiscal 2013, primarily driven by our share repurchases over the last twelve months. Fiscal 2013 results were negatively impacted by $19 million of pretax charges related to asset impairments and restructurings in connection with the Rugby Closure Plan, which had an after-tax effect of reducing net income per diluted share by $0.13. FINANCIAL CONDITION AND LIQUIDITY Financial Condition The following table presents our financial condition as of March 29, 2014 and March 30, 2013. March 29, March 30, $ 2014 2013 Change (millions) Cash and cash equivalents $ 797 $ 974 $ (177 ) Short-term investments 488 325 163 Non-current investments 2 81 (79 ) Current portion of long-term debt(a) - (267 ) 267 Long-term debt (300 ) - (300 ) Net cash and investments(b) $ 987 $ 1,113 $ (126 ) Equity $ 4,034 $ 3,785 $ 249 (a) Represents our Euro Debt, which was repaid upon maturity on October 4, 2013. (b) "Net cash and investments" is defined as cash and cash equivalents, plus short-term and non-current investments, less total debt. The decline in our net cash and investments position at March 29, 2014 as compared to March 30, 2013 was primarily due to our use of cash to support our Class A common stock repurchases of $558 million, to invest in our business through $390 million in capital expenditures, and to make cash dividend payments of $149 million during Fiscal 2014, partially offset by our operating cash flows of $907 million and proceeds from stock-based compensation arrangements of $86 million. The increase in equity was primarily attributable to our net income and the impact of stock-based compensation arrangements, largely offset by our share repurchase activity and dividends declared during Fiscal 2014. 51 -------------------------------------------------------------------------------- Cash Flows Fiscal 2014 Compared to Fiscal 2013 Fiscal Years Ended March 29, March 30, $ 2014 2013 Change (millions)Net cash provided by operating activities $ 907 $ 1,019 $ (112 ) Net cash used in investing activities (488 ) (113 ) (375 ) Net cash used in financing activities (599 ) (595 ) (4 ) Effect of exchange rate changes on cash and cash equivalents 3 (9 ) 12 Net increase (decrease) in cash and cash equivalents $ (177 ) $ 302 $ (479 ) Net Cash Provided by Operating Activities. Net cash provided by operating activities decreased to $907 million during Fiscal 2014, from $1.019 billion during Fiscal 2013. The net decrease in cash provided by operating activities was primarily due to the net unfavorable change related to our working capital, including: • an increase associated with the changes in our accounts receivable balance, resulting from higher revenues at the end of Fiscal 2014 and the timing of cash collections; and • an increase in prepaid expenses and other current assets, primarily attributable to an increase in non-income tax receivables related to our foreign operations and the timing of related payments. These declines in cash from operating activities were partially offset by: • increases related to accounts payable and accrued liabilities and income taxes, primarily due to the timing of the related payments. Net Cash Used in Investing Activities. Net cash used in investing activities was $488 million during Fiscal 2014, as compared to $113 million during Fiscal 2013. The $375 million net increase in cash used in investing activities was primarily driven by: • a $238 million increase in cash used to purchase investments, less proceeds from sales and maturities of investments. During Fiscal 2014, we made net investment purchases of $56 million, as compared to net investment sales of $182 million during Fiscal 2013; • a $114 million increase in cash used for capital expenditures. During Fiscal 2014, we spent $390 million on capital expenditures, as compared to $276 million during Fiscal 2013. Our capital expenditures were primarily associated with global retail store expansion, department store renovations, the purchase and expansion of a distribution facility in High Point, North Carolina, and enhancements to our global information technology systems, including the continued implementation of our new global operating and financial reporting information technology system, SAP. In Fiscal 2015, we expect to spend between $400 million and $500 million in capital expenditures, primarily to support our global retail store expansion, including the opening of our first Polo flagship store in New York City, the introduction of the Polo store concept around the world, new store openings in Asia, including the opening of our first flagship store in Hong Kong, and the expansion of the Chaps brand. Our capital expenditures will also be focused on department store renovations, the continued implementation of SAP and other systems, and further development of our infrastructure, including investment in a new global e-commerce platform; and • an $18 million increase in cash used to fund our acquisitions and ventures. During Fiscal 2014, we used $40 million of cash to fund our acquisitions and ventures, including $18 million to fund the Chaps Menswear License Acquisition, $15 million to fund the Australia and New Zealand Licensed Operations Acquisition, as well as amounts to support the continued funding of our joint venture, the RL Watch Company. During Fiscal 2013, we used $22 million of cash, primarily in connection with our acquisition of the previously licensed business in Latin America, and to fund the operations of the RL Watch Company. 52 -------------------------------------------------------------------------------- Net Cash Used in Financing Activities. Net cash used in financing activities was $599 million during Fiscal 2014, as compared to $595 million during Fiscal 2013. The net increase in cash used in financing activities was primarily driven by: • a $21 million increase in cash used to pay dividends. During Fiscal 2014, we used $149 million to pay dividends, as compared to $128 million during Fiscal 2013, primarily due to the increase in the quarterly cash dividend from $0.40 per share to $0.45 per share, effective in November 2013; and • an $11 million increase in cash used to repurchase shares of our Class A common stock. During Fiscal 2014, we used $498 million to repurchase shares of Class A common stock pursuant to our common stock repurchase program, and an additional $60 million in shares of Class A common stock were surrendered or withheld in satisfaction of withholding taxes in connection with the vesting of awards under our 1997 Long-Term Stock Incentive Plan, as amended (the "1997 Incentive Plan") and our 2010 Long-Term Stock Incentive Plan, as amended (the "2010 Incentive Plan"). On a comparative basis, during Fiscal 2013, we used $450 million to repurchase shares of Class A common stock pursuant to our common stock repurchase program, and an additional $47 million in shares of Class A common stock were surrendered or withheld for taxes. In addition, during Fiscal 2013, we made a $50 million payment in connection with our prepaid share repurchase program. These increases in cash used in financing activities were partially offset by: • $31 million in proceeds from the issuance of long-term debt, net of repayments. During Fiscal 2014, we received $300 million in proceeds from our issuance of 2.125% unsecured Senior Notes in September 2013. A portion of these proceeds was used to repay the $269 million principal amount outstanding of the 4.5% Euro-denominated notes upon their maturity on October 4, 2013. Fiscal 2013 Compared to Fiscal 2012 Fiscal Years Ended March 30, March 31, $ 2013 2012 Change (millions)Net cash provided by operating activities $ 1,019 $ 885 $ 134 Net cash used in investing activities (113 ) (249 ) 136 Net cash used in financing activities (595 ) (408 ) (187 ) Effect of exchange rate changes on cash and cash equivalents (9 ) (9 ) - Net increase in cash and cash equivalents $ 302 $ 219 $ 83 Net Cash Provided by Operating Activities. Net cash provided by operating activities increased to $1.019 billion during Fiscal 2013, as compared to $885 million during Fiscal 2012. This net increase in cash provided by operating activities was primarily driven by: • an increase in net income before depreciation and amortization, stock-based compensation, impairment charges, and other non-cash items; and • a net improvement in our working capital, primarily reflecting a smaller increase in inventories than in the prior fiscal year, as increased inventory levels to support our new product offerings, store openings, and new e-commerce sites were partially offset by the timing of inventory receipts, inventory management initiatives, and lower sourcing costs in Fiscal 2013. In addition, accounts receivable declined due to lower wholesale revenues and higher cash collections in Fiscal 2013, resulting in an improvement in days sales outstanding of approximately three days. These increases in cash were largely offset by declines related to income taxes and accounts payable and accrued expenses, primarily related to the timing of payments. 53 -------------------------------------------------------------------------------- Net Cash Used in Investing Activities. Net cash used in investing activities decreased to $113 million during Fiscal 2013, as compared to $249 million during Fiscal 2012. The net decrease in cash used in investing activities was primarily driven by: • an increase in proceeds from sales and maturities of investments, less cash used to purchase investments. During Fiscal 2013, we received net proceeds of $182 million on our investments, as compared to net proceeds of $34 million in Fiscal 2012. The above increase in cash was partially offset by: • a $10 million increase in net cash used to fund our acquisitions and ventures. In Fiscal 2013, we used $22 million of cash to fund the acquisitions of certain previously licensed businesses and to provide continued funding to our joint venture, the RL Watch Company. In Fiscal 2012, we used $12 million, primarily to fund the RL Watch Company's operations; and • an increase in cash used for capital expenditures. In Fiscal 2013, we spent $276 million for capital expenditures, as compared to $272 million in Fiscal 2012. Our capital expenditures were primarily associated with global retail store expansion and construction, our renovation of department store shop-within-shops, investments in our facilities, and enhancements to our global information technology systems. Net Cash Used in Financing Activities. Net cash used in financing activities was $595 million during Fiscal 2013, as compared to $408 million during Fiscal 2012. The net increase in cash used in financing activities was primarily driven by: • an increase in cash used in connection with repurchases of our Class A common stock. During Fiscal 2013, we repurchased 3.0 million shares of Class A common stock at a cost of $450 million pursuant to our common stock repurchase program, and 0.4 million shares of Class A common stock at a cost of $47 million were surrendered or withheld in satisfaction of withholding taxes in connection with the vesting of awards under our 1997 Incentive Plan and our 2010 Incentive Plan. In addition, during Fiscal 2013, we made a $50 million payment in connection with our prepaid share repurchase program. On a comparative basis, during Fiscal 2012, 3.2 million shares of Class A common stock at a cost of $395 million were repurchased pursuant to our common stock repurchase program, and 0.2 million shares of Class A common stock at a cost of $24 million were withheld in satisfaction of withholding taxes in connection with the vesting of awards under our 1997 Incentive Plan and our 2010 Incentive Plan; • an increase in cash used to pay dividends. During Fiscal 2013, we used $128 million to pay dividends, as compared to $74 million during Fiscal 2012; and • a decrease in cash received from stock option exercises. In Fiscal 2013, we received $49 million from the exercise of employee stock options, as compared to $61 million in Fiscal 2012. Liquidity Our primary sources of liquidity are the cash flows generated from our operations, $500 million of availability under our Global Credit Facility (as defined below), the availability under our Pan-Asia Credit Facilities (as defined below), our available cash and cash equivalents and short-term investments, and our other available financing options. Most of our cash and short-term investments are held outside the U.S. in jurisdictions where we intend to permanently reinvest any undistributed earnings to support our continued growth. However, we are not dependent on foreign cash to fund our domestic operations and do not expect to repatriate these balances to meet our domestic cash needs. Our sources of liquidity are used to fund our ongoing cash requirements, including working capital requirements, global retail store and e-commerce development and expansion, construction and renovation of shop-within-shops, investment in infrastructure, including technology, acquisitions, joint ventures, payment of dividends, debt repayments, common stock repurchases, settlement of contingent liabilities (including uncertain tax positions), and other corporate activities. We believe that our existing sources of cash, as well as our ability to access capital markets, will be sufficient to support our operating, capital, and debt service requirements for the foreseeable future, the ongoing development of our businesses, and our plans for further business expansion. As discussed in the "Debt and Covenant Compliance" section below, we had no revolving credit facility borrowings outstanding under our Global Credit Facility or our Pan-Asia Credit Facilities as of March 29, 2014. We may elect to draw on our credit facilities or other potential sources of financing for, among other things, a material acquisition, settlement of a material contingency (including uncertain tax positions), or a material adverse business or macroeconomic development, as well as for other general corporate business purposes. 54 -------------------------------------------------------------------------------- We believe that our Global Credit Facility is adequately diversified with no undue concentration in any one financial institution. In particular, as of March 29, 2014, there were ten financial institutions participating in the Global Credit Facility, with no one participant maintaining a maximum commitment percentage in excess of 16%. We have no reason to believe that the participating institutions will be unable to fulfill their obligations to provide financing in accordance with the terms of the Global Credit Facility and the Pan-Asia Credit Facilities in the event of our election to draw funds in the foreseeable future. Common Stock Repurchase Program A summary of our repurchases of Class A common stock under our common stock repurchase program is presented below: Fiscal Years Ended March 29, March 30, March 31, 2014 2013 2012 (in millions)Cost of shares repurchased $ 548 (a) $ 450 $ 395 Number of shares repurchased 3.2 (a) 3.0 3.2 (a) Includes a $50 million prepayment made in March 2013 under our share repurchase program with a third-party financial institution, in exchange for the right to receive shares of our Class A common stock at the conclusion of the 93-day repurchase term. The $50 million prepayment was recorded as a reduction to additional paid-in capital in our consolidated balance sheet as of March 30, 2013. The related 0.3 million shares were delivered to us during Fiscal 2014, based on the volume-weighted average market price of our Class A common stock over the 93-day repurchase term, less a discount. As of March 29, 2014, the remaining availability under our Class A common stock repurchase program was approximately $580 million, reflecting the February 4, 2014 approval by our Board of Directors to expand the program by up to an additional $500 million of Class A common stock repurchases. Repurchases of shares of Class A common stock are subject to overall business and market conditions. In addition, during Fiscal 2014, Fiscal 2013, and Fiscal 2012, 0.4 million, 0.4 million, and 0.2 million shares of Class A common stock, respectively, at a cost of $60 million, $47 million, and $24 million, respectively, were surrendered or withheld in satisfaction of withholding taxes in connection with the vesting of awards under our 1997 Incentive Plan and our 2010 Incentive Plan. Repurchased and surrendered shares are accounted for as treasury stock at cost and held in treasury for future use. Dividends Since 2003, we have maintained a regular quarterly cash dividend program on our common stock. On May 21, 2012, our Board of Directors approved an increase in the quarterly cash dividend on our common stock from $0.20 per share to $0.40 per share. On November 5, 2013, our Board of Directors approved a further increase to the quarterly cash dividend on our common stock from $0.40 to $0.45 per share. Dividends paid amounted to $149 million, $128 million, and $74 million in Fiscal 2014, Fiscal 2013, and Fiscal 2012, respectively. We intend to continue to pay regular quarterly dividends on our outstanding common stock. However, any decision to declare and pay dividends in the future will be made at the discretion of our Board of Directors and will depend on, among other things, our results of operations, cash requirements, financial condition, and other factors that the Board of Directors may deem relevant. Debt and Covenant Compliance Senior Notes In September 2013, we completed a registered public debt offering and issued $300 million aggregate principal amount of Senior Notes due September 26, 2018 at a price equal to 99.896% of their principal amount. The Senior Notes bear interest at a fixed rate of 2.125%, payable semi-annually. The proceeds from this offering were used for general corporate purposes, including the repayment of our €209 million principal amount outstanding of 4.5% Euro-denominated notes (the "Euro Debt"), which matured on October 4, 2013. 55 -------------------------------------------------------------------------------- The Indenture governing the Senior Notes (the "Indenture") contains certain covenants that restrict our ability, subject to specified exceptions, to incur certain liens; enter into sale and leaseback transactions; consolidate or merge with another party; or sell, lease, or convey all or substantially all of our property or assets to another party. However, the Indenture does not contain any financial covenants. Revolving Credit Facilities Global Credit Facility We have a credit facility that provides for a $500 million senior unsecured revolving line of credit through March 2016, which may also be used to support the issuance of letters of credit and the initiation and maintenance of a commercial paper program (the "Global Credit Facility"). Borrowings under the Global Credit Facility may be denominated in U.S. Dollars and other currencies, including Euros, Hong Kong Dollars, and Japanese Yen. We have the ability to expand our borrowing availability under the Global Credit Facility to $750 million, subject to the agreement of one or more new or existing lenders under the facility to increase their commitments. There are no mandatory reductions in borrowing ability throughout the term of the Global Credit Facility. As of March 29, 2014, there were no borrowings outstanding under the Global Credit Facility and we were contingently liable for $8 million of outstanding letters of credit. The Global Credit Facility contains a number of covenants that, among other things, restrict our ability, subject to specified exceptions, to incur additional debt; incur liens; sell or dispose of assets; merge with or acquire other companies; liquidate or dissolve itself; engage in businesses that are not in a related line of business; make loans, advances, or guarantees; engage in transactions with affiliates; and make certain investments. The Global Credit Facility also requires us to maintain a maximum ratio of Adjusted Debt to Consolidated EBITDAR (the "leverage ratio") of no greater than 3.75 as of the date of measurement for the four most recent consecutive fiscal quarters. Adjusted Debt is defined generally as consolidated debt outstanding plus eight times consolidated rent expense for the last four consecutive fiscal quarters. Consolidated EBITDAR is defined generally as consolidated net income plus (i) income tax expense, (ii) net interest expense, (iii) depreciation and amortization expense, and (iv) consolidated rent expense. As of March 29, 2014, no Event of Default (as such term is defined pursuant to the Global Credit Facility) has occurred under the Company's Global Credit Facility. Upon the occurrence of an Event of Default under the Global Credit Facility, the lenders may cease making loans, terminate the Global Credit Facility, and declare all amounts outstanding to be immediately due and payable. The Global Credit Facility specifies a number of events of default (many of which are subject to applicable grace periods), including, among others, the failure to make timely principal, interest, and fee payments or to satisfy the covenants, including the financial covenant described above. Additionally, the Global Credit Facility provides that an Event of Default will occur if Mr. Ralph Lauren, our Chairman of the Board and Chief Executive Officer, and entities controlled by the Lauren family fail to maintain a specified minimum percentage of the voting power of our common stock. Pan-Asia Credit Facilities Certain of our subsidiaries in Asia have uncommitted credit facilities with regional branches of JPMorgan Chase (the "Banks") in China, Malaysia, South Korea, and Taiwan (the "Pan-Asia Credit Facilities"). These credit facilities are subject to annual renewal and may be used to fund general working capital and corporate needs of our operations in the respective regions. Our subsidiaries' borrowings under the Pan-Asia Credit Facilities are guaranteed by the parent company. The Pan-Asia Credit Facilities do not contain any financial covenants. As of March 29, 2014, the Pan-Asia Credit Facilities provided for revolving lines of credit of up to $33 million, granted at the sole discretion of the Banks, subject to availability of the Banks' funds and satisfaction of certain regulatory requirements. As of March 29, 2014, there were no borrowings outstanding under any of the Pan-Asia Credit Facilities. See Note 14 to the accompanying audited consolidated financial statements for additional information relating to our credit facilities. 56 -------------------------------------------------------------------------------- Contractual and Other Obligations Firm Commitments The following table summarizes certain of our aggregate contractual obligations as of March 29, 2014, and the estimated timing and effect that such obligations are expected to have on our liquidity and cash flows in future periods. We expect to fund these firm commitments with operating cash flows generated in the normal course of business and, if necessary, through availability under our credit facilities or other accessible sources of financing. Fiscal Fiscal Fiscal Fiscal 2020 and 2015 2016-2017 2018-2019 Thereafter Total (millions) Senior Notes $ - $ - $ 300 $ - $ 300 Interest payments on Senior Notes 6 13 10 - 29 Capital leases 24 48 46 98 216 Operating leases 336 605 518 927 2,386 Inventory purchase commitments 1,106 - - - 1,106 Other commitments 81 58 43 55 237 Total $ 1,553 $ 724 $ 917 $ 1,080 $ 4,274 The following is a description of our material, firmly committed obligations as of March 29, 2014: • Senior Notes represents the principal amount of our outstanding unsecured senior notes due September 26, 2018. Amount does not include any fair value adjustments, call premiums, or interest payments (see below); • Interest payments on Senior Notes represent the semi-annual contractual interest payments due on our Senior Notes, which bear interest at a fixed annual rate of 2.125%; • Lease obligations represent the minimum lease rental payments due under noncancelable leases for our real estate and operating equipment in various locations around the world. In addition to such amounts, we are normally required to pay taxes, insurance, and occupancy costs relating to our leased real estate properties, which are not included in the table above. Approximately 70% of these lease obligations relate to our retail operations. Information has been presented separately for operating and capital leases. In Fiscal 2014, we entered into a build-to-suit lease agreement for a new Polo flagship store on Fifth Avenue in New York City. The total commitment related to this lease is $235 million, comprised of a $74 million operating lease obligation related to the land portion of the lease (included in the operating lease obligations above) and a $161 million obligation related to the building portion of the lease (included in the capital lease obligations above); • Inventory purchase commitments represent our legally-binding agreements to purchase fixed or minimum quantities of goods at determinable prices; and • Other commitments primarily represent our legally-binding obligations under sponsorship, licensing, and other marketing and advertising agreements; distribution-related agreements; information technology-related service agreements; and pension-related obligations. Excluded from the above contractual obligations table is the non-current liability for unrecognized tax benefits of $132 million as of March 29, 2014, as we cannot make a reliable estimate of the period in which the liability will be settled, if ever. The above table also excludes the following: (i) amounts recorded in current liabilities in our consolidated balance sheet as of March 29, 2014, which will be paid within one year; and (ii) non-current liabilities that have no cash outflows associated with them (e.g., deferred revenue), or the cash outflows associated with them are uncertain or do not represent a "purchase obligation" as the term is used herein (e.g., deferred taxes and other miscellaneous items). We also have certain contractual arrangements that would require us to make payments if certain events or circumstances occur. See Note 17 to the accompanying audited consolidated financial statements for a description of our contingent commitments not included in the above table. 57 -------------------------------------------------------------------------------- Off-Balance Sheet Arrangements In addition to the commitments included in the above table, our other off-balance sheet firm commitments relating to our outstanding letters of credit amounted to approximately $9 million as of March 29, 2014. We do not maintain any other off-balance sheet arrangements, transactions, obligations, or other relationships with unconsolidated entities that would be expected to have a material current or future effect on our consolidated financial statements. MARKET RISK MANAGEMENT As discussed in Note 16 to the accompanying audited consolidated financial statements, we are exposed to a variety of risks, including changes in foreign currency exchange rates relating to certain anticipated cash flows from our international operations and possible declines in the value of reported net assets of certain of our foreign operations, as well as changes in the fair value of our fixed-rate debt relating to changes in interest rates. Consequently, at times, in the normal course of business, we employ established policies and procedures, including the use of derivative financial instruments, to manage such risks. We do not enter into derivative transactions for speculative or trading purposes. As a result of the use of derivative instruments, we are exposed to the risk that counterparties to our derivative contracts will fail to meet their contractual obligations. To mitigate such counterparty credit risk, we have a policy of only entering into contracts with carefully selected financial institutions based upon evaluation of their credit ratings and other financial factors. Our established policies and procedures for mitigating credit risk from derivative transactions include ongoing review and assessment of the creditworthiness of our counterparties. We also enter into master netting arrangements with counterparties when possible to mitigate credit risk associated with our derivative instruments. As a result of the above considerations, we do not believe that we are exposed to any undue concentration of counterparty risk with respect to our derivative contracts as of March 29, 2014. However, we do have in aggregate approximately $7 million of derivative instruments in net asset positions with two creditworthy financial institutions. Foreign Currency Risk Management We manage our exposure to changes in foreign currency exchange rates through the use of forward foreign currency exchange contracts. Refer to Note 16 to the accompanying audited consolidated financial statements for a summary of the notional amounts and fair values of our forward foreign currency exchange contracts outstanding as of March 29, 2014. Forward Foreign Currency Exchange Contracts We enter into forward foreign currency exchange derivative contracts as hedges to reduce our risk related to exchange rate fluctuations on inventory purchases, intercompany royalty payments made by certain of our international operations, intercompany contributions made to fund certain marketing efforts of our international operations, and other foreign currency-denominated operational cash flows. As part of our overall strategy to manage the level of exposure to the risk of foreign currency exchange rate fluctuations, primarily to changes in the value of the Euro, the Japanese Yen, the Hong Kong Dollar, the South Korean Won, and the Australian Dollar, we generally hedge a portion of our foreign currency exposures anticipated over a two-year period. In doing so, we use forward foreign currency exchange contracts that generally have maturities of three months to two years to provide continuing coverage throughout the hedging period. Our foreign exchange risk management activities are governed by our Company's established policies and procedures. These policies and procedures provide a framework that allows for the management of currency exposures while ensuring the activities are conducted within our established guidelines. Our policies include guidelines for the organizational structure of our risk management function and for internal controls over foreign exchange risk management activities, including, but not limited to, authorization levels, transaction limits, and credit quality controls, as well as various measurements for monitoring compliance. We monitor foreign exchange risk using different techniques, including a periodic review of market values and sensitivity analyses. We record our forward foreign currency exchange contracts at fair value in our consolidated balance sheets. To the extent forward foreign currency exchange contracts designated as cash flow hedges at hedge inception are highly effective in offsetting changes in the value of the hedged item, the related gains or losses are initially deferred in equity as a component of accumulated other comprehensive income ("AOCI") and are subsequently recognized in our consolidated statements of income as follows: • Forecasted Inventory Purchases - Recognized as part of the cost of the inventory being hedged within cost of goods sold when the related inventory is sold to a third party. 58 -------------------------------------------------------------------------------- • Intercompany Royalty Payments and Marketing Contributions - Recognized within foreign currency gains (losses) in the period in which the related royalties or marketing contributions being hedged are received or paid. We recognized net gains on forward foreign currency exchange contracts in earnings of approximately $30 million and $32 million during Fiscal 2014 and Fiscal 2013, respectively, and net losses of approximately $4 million during Fiscal 2012. Sensitivity We perform a sensitivity analysis to determine the effects that market risk exposures may have on the fair values of our forward foreign currency exchange contracts. To perform the sensitivity analysis, we assess the risk of loss in fair values from the effect of hypothetical changes in foreign currency exchange rates. This analysis assumes a like movement by the foreign currencies in our hedge portfolio against the U.S. Dollar. As of March 29, 2014, a 10% appreciation or depreciation of the U.S. Dollar against the exchange rates for foreign currencies under contract would result in a net increase or decrease, respectively, in the fair value of our derivative portfolio of approximately $52 million. As our outstanding forward foreign currency exchange contracts are primarily designated as cash flow hedges of forecasted transactions, this hypothetical net change in fair value would be largely offset by the net change in the fair values of the underlying hedged items. Interest Rate Risk Management Sensitivity As of March 29, 2014, we had no variable-rate debt outstanding. As such, our exposure to changes in interest rates primarily relates to a change in the fair value of our fixed-rate Senior Notes. As of March 29, 2014, both the carrying value and the fair value of our Senior Notes was $300 million. A 25 basis point increase or decrease in the level of interest rates would decrease or increase, respectively, the fair value of our Senior Notes by approximately $3 million. Such potential increases or decreases in the fair value of our debt would only be relevant if we were to retire all or a portion of the debt prior to its maturity, and are based on certain simplifying assumptions, including an immediate across-the-board increase or decrease in the level of interest rates with no other subsequent changes for the remainder of the period. Investment Risk Management As of March 29, 2014, we had cash and cash equivalents on-hand of $797 million, primarily on deposit in interest bearing accounts and invested in money market funds and time deposits with original maturities of 90 days or less. Our other significant investments included $488 million of short-term investments, primarily in time deposits with original maturities greater than 90 days, and $46 million of restricted cash placed in escrow with certain banks as collateral, primarily to secure guarantees in connection with certain international tax matters. We actively monitor our exposure to changes in the fair value of our global investment portfolio in accordance with our established policies and procedures, which include monitoring both general and issuer-specific economic conditions. Our investment objectives include capital preservation, maintaining adequate liquidity, diversification to minimize liquidity and credit risk, and achievement of maximum returns within the guidelines set forth in our investment policy. See Note 16 to the accompanying audited consolidated financial statements for further detail of the composition of our investment portfolio as of March 29, 2014. We evaluate investments held in unrealized loss positions for other-than-temporary impairment on a quarterly basis. This evaluation involves a variety of considerations, including assessments of risks and uncertainties associated with general economic conditions and distinct conditions affecting specific issuers. We consider the following factors: (i) the length of time and the extent to which the fair value has been below cost, (ii) the financial condition, credit worthiness, and near-term prospects of the issuer, (iii) the length of time to maturity, (iv) future economic conditions and market forecasts, (v) our intent and ability to retain our investment for a period of time sufficient to allow for recovery of market value, and (vi) an assessment of whether it is more likely than not that we will be required to sell our investment before recovery of market value. No significant realized or unrealized gains or losses on available-for-sale investments or other-than-temporary impairment charges were recorded in any of the fiscal years presented. CRITICAL ACCOUNTING POLICIES An accounting policy is considered to be critical if it is important to our results of operations, financial condition, and cash flows, and requires significant judgment and estimates on the part of management in its application. Our estimates are often based on complex judgments, assessments of probability, and assumptions that management believes to be reasonable, but that are 59 -------------------------------------------------------------------------------- inherently uncertain and unpredictable. It is also possible that other professionals, applying reasonable judgment to the same set of facts and circumstances, could develop and support a range of alternative estimated amounts. We believe that the following list represents our critical accounting policies. For a discussion of all of our significant accounting policies, see Note 3 to the accompanying audited consolidated financial statements. Sales Reserves and Uncollectible Accounts A significant area of judgment affecting reported revenue and net income involves estimating sales reserves, which represent the portion of gross revenues not expected to be realized. In particular, wholesale revenue is reduced by estimates of returns, discounts, end-of-season markdowns, and operational chargebacks. Retail revenue, including e-commerce sales, is also reduced by an estimate of returns. In determining estimates of returns, discounts, end-of-season markdowns, and operational chargebacks, we analyze historical trends, seasonal results, current economic and market conditions, and retailer performance. We review and refine these estimates on a quarterly basis. Our historical estimates of these costs have not differed materially from actual results. A hypothetical 1% increase in our reserves for returns, discounts, end-of-season markdowns, and operational chargebacks as of March 29, 2014 would have decreased our Fiscal 2014 net revenues by approximately $3 million. Similarly, we evaluate accounts receivable to determine if they will ultimately be collected. Significant judgments and estimates are involved in this evaluation, including an analysis of specific risks on a customer-by-customer basis for larger accounts and customers, and a receivables aging analysis that determines the percentage of receivables that has historically been uncollected by aged category. Based on this information, we provide a reserve for the estimated amounts believed to be uncollectible. Although we believe that we have adequately provided for those risks as part of our bad debt reserve, a severe and prolonged adverse impact on our major customers' business operations could have a corresponding material adverse effect on our net sales, cash flows, and/or financial condition. See "Accounts Receivable" in Note 3 to the accompanying audited consolidated financial statements for an analysis of the activity in our sales reserves and allowance for doubtful accounts for each of the three fiscal years presented. Inventories We hold inventory that is sold through wholesale distribution channels to major department stores and specialty retail stores, including our own retail stores. We also hold retail inventory that is sold in our own stores and e-commerce sites directly to consumers. Wholesale and retail inventories are stated at the lower of cost or estimated net realizable value, with cost primarily determined on a weighted-average basis. We continuously evaluate the composition of our inventories, assessing slow-turning product and fashion product. Estimated net realizable value of inventory is determined based on an analysis of historical sales trends of our individual product lines, the impact of market trends and economic conditions, and a forecast of future demand, giving consideration to the value of current orders in-house relating to future sales of inventory, as well as plans to sell inventory through our factory stores. Estimates may differ from actual results due to the quantity, quality, and mix of products in inventory, consumer and retailer preferences, and market conditions. Reserves for inventory shrinkage, representing the risk of physical loss of inventory, are estimated based on historical experience and are adjusted based upon physical inventory counts. Our historical estimates of these costs and the provisions have not differed materially from actual results. A hypothetical 1% increase in the level of our inventory reserves as of March 29, 2014 would have decreased our Fiscal 2014 gross profit by approximately $1 million. Business Combinations In connection with our business combinations, we are required to record all of the assets and liabilities of the acquired business at their acquisition date fair value; recognize contingent consideration at fair value on the acquisition date; and, for certain arrangements, recognize changes in fair value in earnings until settlement. These fair value determinations require our judgment and may involve the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows, discount rates, asset lives, and market multiples, among other items. We may utilize independent valuation firms to assist in making these fair value determinations. In addition, in connection with our business acquisitions, we evaluate the terms of any pre-existing relationships to determine whether a gain or loss on settlement of the pre-existing relationship exists. These pre-existing relationships primarily relate to 60 -------------------------------------------------------------------------------- licensing agreements. If the terms of the pre-existing relationships were determined to not be reflective of market, a settlement gain or loss would be recognized in earnings, measured by the amount by which the contract is favorable or unfavorable to us when compared with pricing for current market transactions for the same or similar items. We allocate the aggregate consideration exchanged in these transactions between the value of the business acquired and the value of the settlement of any pre-existing relationships in proportion to estimates of their respective fair values. Accordingly, significant judgment is required to determine the respective fair values of the business acquired and the value of the settlement of the pre-existing relationship. We may utilize independent valuation firms to assist in the determination of fair value. See Note 5 to the accompanying audited consolidated financial statements for detailed disclosures related to our acquisitions. Fair Value Measurements We use judgment when evaluating the inputs used to measure the fair value of a particular asset or liability, notably the extent to which the inputs are market-based (observable) or internally-derived (unobservable). See Note 15 to the accompanying audited consolidated financial statements for further discussion of our fair value measurements. The fair values of derivative assets and liabilities are determined using a pricing model, which is primarily based on market observable external inputs, including forward and spot currency exchange rates, and considers the impact of our own credit risk, if any. Changes in counterparty credit risk are also considered in the valuation of derivative financial instruments. Refer to "Market Risk Management" for a discussion of the sensitivity of our derivative financial instruments' fair values to changes in foreign currency exchange rates. Our Senior Notes are recorded at carrying value in our consolidated balance sheets, adjusted for any unamortized discount, and may differ from its fair value. The fair value of our Senior Notes is estimated based on external pricing data, including available quoted market prices of the Senior Notes and of comparable debt instruments with similar interest rates, credit ratings, and trading frequency, among other factors. Refer to "Market Risk Management" for a discussion of the sensitivity of our Senior Notes' fair value to changes in interest rates. Impairment of Goodwill and Other Intangible Assets Goodwill and certain other intangible assets deemed to have indefinite useful lives, are not amortized. Rather, goodwill and indefinite-lived intangible assets are assessed for impairment at least annually. Finite-lived intangible assets are amortized over their respective estimated useful lives and, along with other long-lived assets, are evaluated for impairment periodically whenever events or changes in circumstances indicate that their carrying amounts may not be fully recoverable. We perform our annual goodwill impairment assessment using a qualitative approach to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. Performance of the qualitative assessment requires judgment in identifying and considering the significance of relevant key factors, events, and circumstances that affect the fair values of our reporting units. This requires consideration and assessment of external factors such as macroeconomic, industry, and market conditions, as well as entity-specific factors, such as our actual and planned financial performance. We also give consideration to the difference between each reporting unit's fair value and carrying value as of the most recent date a fair value measurement was performed. If the results of the qualitative assessment conclude that it is not more likely than not that the fair value of a reporting unit exceeds its carrying value, additional quantitative impairment testing is performed. The quantitative goodwill impairment test, if necessary, is a two-step process. The first step is to identify the existence of potential impairment by comparing the fair value of a reporting unit with its net book value (or carrying value), including goodwill. If the fair value of a reporting unit exceeds its carrying value, the reporting unit's goodwill is considered not to be impaired and performance of the second step of the quantitative goodwill impairment test is unnecessary. However, if the carrying value of a reporting unit exceeds its fair value, the second step of the quantitative goodwill impairment test is performed to measure the amount of impairment loss to be recorded, if any. The second step of the quantitative goodwill impairment test compares the implied fair value of the reporting unit's goodwill with the carrying value of that goodwill. If the carrying value of the reporting unit's goodwill exceeds its implied fair value, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined using the same approach as employed when determining the amount of goodwill that would be recognized in a business combination. That is, the fair value of the reporting unit is allocated to all of its assets and liabilities (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the fair value was the purchase price paid to acquire the reporting unit. Determining the fair value of a reporting unit under the first step of the quantitative goodwill impairment test and determining the fair values of individual assets and liabilities of a reporting unit (including any unrecognized intangible assets) under the second 61 -------------------------------------------------------------------------------- step of the quantitative goodwill impairment test requires judgment and often involves the use of significant estimates and assumptions. Similarly, estimates and assumptions are used when determining the fair values of other indefinite-lived intangible assets. These estimates and assumptions could have a significant impact on whether or not an impairment charge is recognized and the magnitude of any such charge. To assist management in the process of determining any potential goodwill impairment, we may review and consider appraisals from independent valuation firms. Estimates of fair value are primarily determined using discounted cash flows, market comparisons, and recent transactions. These approaches use significant estimates and assumptions, including projected future cash flows (including timing), discount rates reflecting the risks inherent in future cash flows, perpetual growth rates, and determination of appropriate market comparables. We performed our annual goodwill impairment assessment during the second quarter of Fiscal 2014 using the qualitative approach discussed above, and giving consideration to our most recent quantitative goodwill impairment test (the results of which indicated that the fair values of its reporting units significantly exceeded their respective carrying values). Based on the results of the qualitative impairment assessment performed as of July 1, 2013, we concluded that it is more likely than not that the fair values of our reporting units significantly exceeded their respective carrying values and there were no reporting units at risk of impairment. Additionally, no goodwill impairment charges have been recorded during any of the three fiscal years presented. In evaluating finite-lived intangible assets for recoverability, we use our best estimate of future cash flows expected to result from the use of the asset and its eventual disposition where probable. To the extent that estimated future undiscounted net cash flows attributable to the asset are less than its carrying value, an impairment loss is recognized equal to the difference between the carrying value of such asset and its fair value. In Fiscal 2013, we recorded aggregate impairment charges of $2 million related to the write-off of certain finite-lived and indefinite-lived intangible assets in connection with the Rugby Closure Plan. There were no other intangible asset impairment charges recorded during any of the three fiscal years presented. Impairment of Other Long-Lived Assets Property and equipment, along with other long-lived assets, are evaluated for impairment periodically whenever events or changes in circumstances indicate that their related carrying amounts may not be recoverable. In evaluating long-lived assets for recoverability, we use our best estimate of future cash flows expected to result from the use of the asset and its eventual disposition, where applicable. To the extent that estimated future undiscounted net cash flows attributable to the asset are less than its carrying amount, an impairment loss is recognized equal to the difference between the carrying value of such asset and its fair value, considering external market participant assumptions. Assets to be disposed of and for which there is a committed plan of disposal are reported at the lower of carrying value or fair value, less costs to sell. In determining future cash flows, we take various factors into account, including changes in merchandising strategy, the emphasis on retail store cost controls, the effects of macroeconomic trends such as consumer spending, and the impacts of more experienced retail store managers and increased local advertising. Since the determination of future cash flows is an estimate of future performance, future impairments may arise in the event that future cash flows do not meet expectations. During Fiscal 2014, Fiscal 2013, and Fiscal 2012, we recorded non-cash impairment charges of $1 million, $19 million (including the $2 million of previously discussed charges related to the write-off of certain intangible assets in connection with the Rugby Closure Plan), and $2 million, respectively, to reduce the net carrying value of certain long-lived assets, primarily in our Retail segment, to their estimated fair values. See Note 11 to the accompanying audited consolidated financial statements for further discussion. Income Taxes In determining our income tax provision for financial reporting purposes, we establish a reserve for uncertain tax positions. If we consider that a tax position is "more likely than not" of being sustained upon audit, based solely on the technical merits of the position, we recognize the tax benefit. We measure the tax benefit by determining the largest amount that is greater than 50% likely of being realized upon settlement, presuming that the tax position is examined by the appropriate taxing authority that has full knowledge of all relevant information. These assessments can be complex and require significant judgment, and we often obtain assistance from external advisors. To the extent that our estimates change or the final tax outcome of these matters is different from the amounts recorded, such differences will impact the income tax provision in the period in which such determinations are made. If the initial assessment fails to result in the recognition of a tax benefit, we regularly monitor our position and subsequently recognize the tax benefit if (i) there are changes in tax law or analogous case law that sufficiently raise the likelihood of prevailing on the technical merits of the position to more likely than not; (ii) the statute of limitations expires; or (iii) there is a completion of an audit resulting in a settlement of that tax year with the appropriate agency. 62 -------------------------------------------------------------------------------- Deferred income taxes reflect the tax effect of certain net operating loss, capital loss, general business credit carryforwards, and the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial statement and income tax purposes, as determined under enacted tax laws and rates. Valuation allowances are established when management determines that it is "more likely than not" that some portion or all of a deferred tax asset will not be realized. Tax valuation allowances are analyzed periodically by assessing the adequacy of future expected taxable income, which typically involves the significant use of estimates. Such allowances are adjusted as events occur, or circumstances change, that warrant adjustments to those balances. See Note 13 to the accompanying audited consolidated financial statements for further discussion of income taxes. Contingencies We are periodically exposed to various contingencies in the ordinary course of conducting our business, including certain litigation, alleged information system security breach matters, contractual disputes, employee relation matters, various tax or other governmental audits, and trademark and intellectual property matters and disputes. We record a liability for such contingencies to the extent that we conclude their occurrence is probable and the related losses are estimable. In addition, if it is reasonably possible that an unfavorable settlement of a contingency could exceed the established liability, we disclose the estimated impact on our liquidity, financial condition, and results of operations, if practicable. Management considers many factors in making these assessments. As the ultimate resolution of contingencies is inherently unpredictable, these assessments can involve a series of complex judgments about future events including, but not limited to, court rulings, negotiations between affected parties, and governmental actions. As a result, the accounting for loss contingencies relies heavily on management's judgment in developing the related estimates and assumptions. Stock-Based Compensation We expense all stock-based compensation awarded to employees and non-employee directors based on the grant date fair value of the awards over the requisite service period, adjusted for estimated forfeitures. Stock Options Stock options are granted to employees and non-employee directors with exercise prices equal to the fair market value of our common stock on the date of grant. We use the Black-Scholes option-pricing model to estimate the grant date fair value of stock options, which requires the use of subjective assumptions. Certain key assumptions involve estimating future uncertain events. The key factors influencing the estimation process include the expected term of the option, expected volatility of our stock price, our expected dividend yield, and the risk-free interest rate, among others. Generally, once stock option values are determined, accounting practices do not permit them to be changed, even if the estimates used are different from actual results. Restricted Stock and Restricted Stock Units ("RSUs") We grant restricted shares of Class A common stock and service-based RSUs to certain of our senior executives and non-employee directors. In addition, we grant performance-based RSUs to such senior executives, to other key executives, and to certain of our other employees. The fair values of restricted stock shares and RSUs are based on the fair value of our unrestricted Class A common stock, adjusted to reflect the absence of dividends for those restricted securities that are not entitled to dividend equivalents. Compensation expense for performance-based RSUs is recognized over the employees' requisite service period when attainment of the performance goals is deemed probable, which involves judgment as to achievement of certain performance metrics. Our performance-based RSU awards with a market condition in the form of a total shareholder return ("TSR") modifier are valued based on the expected attainment of performance at the end of a three-year performance period and TSR achieved relative to the S&P 500 index over the performance period. The fair value of these awards is estimated using a Monte Carlo simulation valuation model prepared by an independent third party. This model utilizes multiple input variables that determine the probability of satisfying each market condition stipulated in the terms of the award to estimate the fair value of these awards. Compensation expense, net of forfeitures, is updated for the expected net income performance level against the related goal at the end of each reporting period. Sensitivity The assumptions used in calculating the grant date fair values of stock-based compensation awards represent our best estimates. In addition, judgment is required in estimating the number of stock-based awards that are expected to be forfeited. If 63 -------------------------------------------------------------------------------- actual results differ significantly from our estimates and assumptions, if we change the assumptions used to estimate the grant date fair value for future stock-based award grants, or if there are changes in market conditions, stock-based compensation expense and, therefore, our results of operations could be materially impacted. A hypothetical 10% change in our stock-based compensation expense would have affected our Fiscal 2014 net income by approximately $6 million. RECENTLY ISSUED ACCOUNTING STANDARDS See Note 4 to the accompanying audited consolidated financial statements for a description of certain recently issued or proposed accounting standards which may impact our consolidated financial statements in future reporting periods. Item 7A. Quantitative and Qualitative Disclosures about Market Risk. For a discussion of our exposure to market risk, see "Market Risk Management" in Item 7 included elsewhere in this Annual Report on Form 10-K. Item 8. Financial Statements and Supplementary Data. See the "Index to Consolidated Financial Statements" appearing at the end of this Annual Report on Form 10-K. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. Not applicable. 64 -------------------------------------------------------------------------------- |