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CROCS, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Business Overview We are a designer, developer, manufacturer, worldwide marketer and distributor of casual lifestyle footwear, apparel and accessories for men, women and children. We strive to be the global leader in the sale of molded footwear featuring fun, comfort, color and functionality. Our products include footwear and accessories that utilize our proprietary closed cell-resin, called Croslite. The use of this unique material enables us to produce innovative, lightweight, non-marking, and odor-resistant footwear. We currently sell our products in more than 90 countries through domestic and international retailers and distributors and directly to end-user consumers through our company-operated retail stores, outlets, kiosks and webstores. Since the initial introduction and popularity of the Beach and Crocs Classic designs, we have expanded our Croslite products to include a variety of new styles and products and have further extended our product reach through the acquisition of brand platforms. Going forward, we intend to focus our footwear product lines on our core molded footwear heritage, as well as develop innovative casual footwear platforms. We intend to streamline our product portfolio, eliminate non-core product development and explore strategic alternatives for non-core brands. The broad appeal of our footwear has allowed us to market our products to a wide range of distribution channels, including department stores and traditional footwear retailers as well as a variety of specialty and independent retail channels. We intend to drive cohesive global brand positioning from region-to-region and year-to-year to create a clearer and consistent product portfolio and message, resulting in a more powerful consumer connection to the brand. This strategy will be accomplished through developing powerful product stories supported with effective, consistent and clear marketing. As a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar. Sales in international markets in foreign currencies are expected to continue to represent a substantial portion of our revenues. Likewise, we expect that our subsidiaries with functional currencies other than the U.S. Dollar will continue to represent a substantial portion of our overall gross margin and related expenses. Accordingly, changes in foreign currency exchange rates could materially affect revenues and costs or the comparability of revenues and costs from period to period as a result of translating our financial statements into our reporting currency. Use of Non-GAAP Financial Measures In addition to financial measures presented on the basis of accounting principles generally accepted in the United States of America ("U.S. GAAP"), we present current period "adjusted selling, general and administrative expenses", which is a non-GAAP financial measure, within this Management's Discussion and Analysis. Adjusted results exclude the impact of items that management believes affect the comparability or underlying business trends in our condensed consolidated financial statements in the periods presented. We also present certain information related to our current period results of operations in this Item 2 through "constant currency", which is a non-GAAP financial measure and should be viewed as a supplement to our results of operations and presentation of reportable segments under U.S. GAAP. Constant currency represents current period results that have been restated using prior year average foreign exchange rates for the comparative period to enhance the visibility of the underlying business trends excluding the impact of foreign currency exchange rate fluctuations. Management uses adjusted results to assist in comparing business trends from period to period on a consistent basis without regard to the impact of non-GAAP adjustments in communications with the board of directors, stockholders, analysts and investors concerning our financial performance. We believe that these non-GAAP measures are used by, and are useful to, investors and other users of our financial statements in evaluating operating performance by providing better comparability between reporting periods because they provide an additional tool to evaluate our performance without regard to non-GAAP adjustments that may not be indicative of overall business trends. They also provide a better baseline for analyzing trends in our operations. We do not suggest that investors should consider these non-GAAP measures in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP. Please refer to our 'Results of Operations' within this section for a reconciliation of adjusted selling, general and administrative expenses to GAAP selling, general and administrative expenses. 23 -------------------------------------------------------------------------------- Table of Contents Financial Highlights During the three months ended September 30, 2014, we experienced revenue growth of 4.8%. Despite unfavorable exchange rates driven by a stronger U.S. Dollar, we experienced strong revenue results in our Europe wholesale channel. In addition, our Americas segment experienced growth in all three revenue channels, specifically a 17.6% and 12.8% increase in wholesale and internet channels, respectively. We experienced difficulty in our Asia Pacific segment primarily due to decreased performance in our China business as a result of distributor inventory levels and sell through. On a constant-currency basis, our Japan segment experienced a slight decline as macroeconomic turmoil continues to present challenges for the business as we saw the lingering decline of Japanese Yen decrease quarter-over-quarter revenues by almost $1.7 million and operating income by $0.2 million. Globally, we are focused on expanding and improving current relationships with wholesale partners and experienced 7.7% aggregate wholesale growth, specifically 22.9% in our Europe and 17.6% in our Americas segment. We experienced a $0.9 million, or 0.7%, increase in retail channel revenues primarily through the addition of 11 global retail locations (net of store closures) since September 30, 2013 partially offset by a 4.5% decrease in comparable store sales compared to prior year. The following are the more significant developments in our businesses during the three months ended September 30, 2014: † Revenues increased $13.9 million, or 4.8%, to $302.4 million compared to the same period in 2013. Revenue growth was predominately driven by a 10.6% increase in global footwear unit sales partially offset by a 4.4% decrease in global average footwear unit selling price. † Gross profit increased $1.4 million, or 0.9%, to $155.0 million and gross margin percentage decreased 190 basis points to 51.3% compared to the same period in 2013. The decline in gross margin percentage is primarily driven by the evolution of our product assortment and is consistent with our product strategy. As we expand our product lines, product mix shifts into styles that may utilize more expensive materials such as textile fabric and leather compared to the traditional clog. In addition, we experienced sales volume difficulty in our China market leading to decreased gross margins as average margins in China are typically higher than the global average. † Selling, general and administrative expenses increased $8.0 million, or 5.9%, to $143.7 million compared to the same period in 2013. Selling, general and administrative expenses increased predominately due to an increase of $5.2 million in bad debt expense primarily related to delayed payments from distributors in China and Southeast Asia. In addition, we experienced an increase of $2.6 million in expenses that we believe to be non-indicative of our underlying business trends including reorganizational charges as a result of transition activities, additional operating expenses related to our ERP implementation and charges related to litigation settlements. † We incurred $8.2 million in restructuring charges as a result of our strategic plans for long-term improvement and growth of the business. These charges included severance costs related to executive management and employees, retail store closure costs and a write-down of obsolete inventory related to an exited business line. † We incurred $2.6 million in retail asset impairment charges related to certain underperforming retail locations in our Americas, Europe and Asia Pacific segments that were unlikely to generate sufficient cash flows to fully recover the carrying value of the stores' assets over their remaining economic life. † Net income attributable to common stockholders decreased $1.0 million, or 7.9%, to $12.0 million compared to the same period in 2013. Diluted earnings per share decreased from $0.15 during the three months ended September 30, 2013 to $0.12 during the three months ended September 30, 2014. These decreases are primarily the result of certain special charges such as restructuring and asset impairment charges as well as dividends declared on our Series A preferred stock and dividend equivalents as a result of our recent investment from Blackstone Capital Partners VI L.P. ("Blackstone"), which contributed a decrease of $3.8 million in net income attributable to common stockholders. Partially offsetting these decreases was a tax benefit of $15.7 million as a result of the elimination of uncertain tax positions reserves. † We have halted the expansion of our retail channel and have begun to focus on the long-term profitability of current locations. We opened only 12 company-operated stores during the three months ended September 30, 2014, half of which were outlet or low investment kiosk/store-in-store locations, and closed 31 company-operated stores. † We continue to fund the implementation of our customized and fully integrated operations, accounting, and finance ERP system. We recently launched the ERP in Australia and Japan with success and now expect the full implementation to launch globally in early 2015. We believe the introduction of the new ERP system to our current environment will allow for seamless and high-quality data across the Company. As of September 30, 2014, total costs to date related to the ERP implementation were $77.7 million, of which $62.5 million has been capitalized and $15.2 million has been expensed. As of September 30, 2014, we had $12.9 million in outstanding borrowings related to the ERP system under a Master Installment Payment Agreement ("Master IPA") with PNC Equipment Finance, LLC ("PNC Equipment"). Remaining 2014 Outlook We recently announced strategic plans for long-term improvement and growth of the business. These plans comprise four key initiatives including: (1) streamlining the global product and marketing portfolio, (2) reducing direct investment in smaller geographic 24 -------------------------------------------------------------------------------- Table of Contents markets, (3) creating a more efficient organizational structure including reducing duplicative and excess overhead which will also enhance the decision making process, and (4) closing or converting approximately 75 to 100 Crocs branded retail stores around the world. We intend to focus on our core molded footwear heritage, as well as develop innovative casual footwear platforms. We intend to streamline the product portfolio, eliminate non-core product development and will explore strategic alternatives for the non-core products and brands. We expect more centralized product line control will also result in a reduction of the SKU proliferation that has occurred over the past few years, a more simplified and efficient supply chain and a reduction in overall product line costs and inventory levels. Further, we intend to drive cohesive global brand positioning from region-to-region and year-to-year to create a clearer and consistent product portfolio and message, resulting in a more powerful consumer connection to the brand. This strategy will be accomplished through developing powerful product stories supported with effective consistent and clear marketing. Finally, we intend to increase working market spend, defined as funds that put marketing messages in front of consumers, by approximately 50%, funded primarily from a reduction of marketing overhead. We have been rationalizing our product line in order to focus on our core-molded heritage and develop more compelling casual footwear platforms. We have discontinued our Crocs Golf products and closed Ocean Minded as an independent brand. We are currently focusing on products and product stories for Fall/Holiday 2015. Second, we intend to refine our business model around the world, prioritizing direct investment in larger-scale geographies to focus our resources on the biggest opportunities and moving away from direct investment in the retail and wholesale businesses in smaller markets and transferring significant commercial responsibilities to distributors and third-party agents. These re-alignments are already underway in Brazil, Taiwan and other markets around the globe. Further, we intend to expand engagement with leading wholesale accounts in select markets to drive sales growth, optimize product placement and enhance brand reputation. Third, we have reorganized key business functions to improve efficiency and have eliminated 185 global positions of which the majority occurred on July 21, 2014, reducing structural complexity, size and cost. In addition, we plan to open a Global Commercial Center in the Boston area in late 2014, housing key merchandising, marketing and retail executives. The Boston location was selected in order to attract experienced senior footwear and business development management talent. The Global Commercial Center in Boston will join the Product Creation and Global Shared Services Center in Niwot, Colorado, the cornerstone of support for Crocs' global business. We intend to strengthen our Regional Commercial Centers in the Netherlands, Singapore and Japan with responsibility for managing Crocs' global business. We have made multiple organizational changes including the hiring of Michelle Poole, who has been named Senior Vice President of Global Product Creation and Merchandising, and Bob Munroe, who has been named the new general manager of our Americas segment. We are excited to enrich our team as we focus on the future and potential growth opportunities of the Crocs brand. Fourth, we plan to rationalize under-performing business units, in order to re-align cost-structure and place greater focus on assets and operations with higher profit potential. During the three months ended September 31, 2014, we closed 31 company-operated stores. We plan to close an additional 25 to 30 stores in the fourth quarter of 2014. The impact of these closures and conversions is expected to reduce annual revenue by approximately $35.0 to $50.0 million and reduce selling, general and administrative expenses by approximately $17.5 to $27.5 million, with an insignificant impact on future operating income. We intend to consolidate global company-operated e-commerce sites from 21 to 11. Overall, we undertook a comprehensive strategic review of the business and its operations globally, and identified four key areas of opportunity in the business: products, geographies, organization and channels. These plans prioritize earnings growth and our focus on becoming the leading brand in casual lifestyle footwear. 25 -------------------------------------------------------------------------------- Table of Contents Results of Operations Comparison of the Three Months Ended September 30, 2014 and 2013 Three Months Ended September 30, Change ($ thousands, except per share data and average footwear selling price) 2014 2013 $ % Revenues $ 302,401 $ 288,524 $ 13,877 4.8 % Cost of sales 146,801 134,943 11,858 8.8 Restructuring charges 583 - 583 * Gross profit 155,017 153,581 1,436 0.9 Selling, general and administrative expenses 143,719 135,674 8,045 5.9 Restructuring charges 7,585 - 7,585 * Asset impairment charges 2,600 - 2,600 * Income from operations 1,113 17,907 (16,794 ) (93.8 ) Foreign currency transaction losses, net 1,290 1,043 247 23.7 Interest income (424 ) (853 ) 429 (50.3 ) Interest expense 366 44 322 731.8 Other (income) expense, net (217 ) 13 (230 ) (1,769.2 ) Income before income taxes 98 17,660 (17,562 ) (99.4 ) Income tax (benefit) expense (15,669 ) 4,624 (20,293 ) (438.9 ) Net income 15,767 13,036 2,731 20.9 Dividends on Series A convertible preferred shares 3,067 - 3,067 * Dividend equivalents on Series A convertible preferred shares related to redemption value accretion and beneficial conversion feature 691 - 691 * Net income attributable to common stockholders $ 12,009 $ 13,036 $ (1,027 ) (7.9 )% Net income per common share: Basic $ 0.12 $ 0.15 $ (0.03 ) (18.7 )% Diluted $ 0.12 $ 0.15 $ (0.03 ) (19.4 )% Gross margin 51.3 % 53.2 % (190 )bps (3.6 )% Operating margin 0.4 % 6.2 % (580 )bps (93.5 )% Footwear unit sales 13,290 12,012 1,278 10.6 % Average footwear selling price $ 22.09 $ 23.11 $ (1.02 ) (4.4 )% -------------------------------------------------------------------------------- * Percentage change is not relevant as prior year amounts were zero. 26 -------------------------------------------------------------------------------- Table of Contents Revenues. During the three months ended September 30, 2014, revenues increased $13.9 million, or 4.8%, compared to the same period in 2013, primarily due to an increase of 1.3 million, or 10.6%, in global footwear unit sales primarily driven by improved year-over-year performance in our wholesale channel partially offset by a decrease of $1.02 per unit, or 4.4%, in average footwear selling price as a result of discounted sales and product eliminations. For the three months ended September 30, 2014, revenues from our wholesale channel increased $10.8 million, or 7.7%, compared to the same period in 2013, which was primarily driven by an increase in our Americas and Europe segments as a result of product volume expansion through new wholesale doors and continued support from existing customers partially offset by decreased wholesale channel revenues in our Asia Pacific and Japan segments primarily due to a year-over-year decline in China wholesale volume. For the three months ended September 30, 2014, revenues from our retail channel increased $0.9 million, or 0.7%, compared to the same period in 2013, which was primarily driven by our global retail expansion as we opened 11 company-operated stores (net of store closures) since September 30, 2013 partially offset by a 4.5% decrease in comparable store sales. Although we slightly expanded our global retail presence since 2013, we have begun to and plan on continuing to moderate the pace of our retail expansion in 2014 with a focus on outlet and kiosk locations and consolidating and enhancing the profitability of existing locations. For the three months ended September 30, 2014, revenues from our internet channel increased $2.2 million, or 9.3%, compared to the same period in 2013, which was primarily driven by strong internet sales in our Americas segment. Our internet sales equated to approximately 8.5% and 8.1% of our consolidated net sales in the three months ended September 30, 2014 and 2013, respectively. We continue to benefit from our online presence through webstores worldwide enabling us to have increased access to our customers in a low cost, attractive manner and providing an opportunity to educate them about our products and brand. However, we intend to consolidate global company-operated e-commerce sites in order to focus our internet strategy in our principal geographical locations. Impact on Revenues due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates used to translate revenues from our functional currencies to our reporting currency during the three months ended September 30, 2014 decreased our revenues by $1.6 million compared to the same period in 2013. 27 -------------------------------------------------------------------------------- Table of Contents The following table summarizes our total revenue by channel for the three months ended September 30, 2014 and 2013: Three Months Ended September 30, Change Constant Currency Change(1) ($ thousands) 2014 2013 $ % $ % Channel revenues: Wholesale: Americas $ 53,097 $ 45,134 $ 7,963 17.6 % $ 8,160 18.1 % Asia Pacific 42,363 43,268 (905 ) (2.1 ) (1,074 ) (2.5 ) Japan 21,609 24,536 (2,927 ) (11.9 ) (1,879 ) (7.7 ) Europe 33,691 27,414 6,277 22.9 6,710 24.5 Other businesses 435 37 398 1075.7 393 1062.2 Total Wholesale 151,195 140,389 10,806 7.7 12,310 8.8 Consumer-direct: Retail: Americas 61,721 59,839 1,882 3.1 2,179 3.6 Asia Pacific 32,733 33,469 (736 ) (2.2 ) (1,600 ) (4.8 ) Japan 11,654 12,397 (743 ) (6.0 ) (223 ) (1.8 ) Europe 19,494 18,995 499 2.6 531 2.8 Total Retail 125,602 124,700 902 0.7 887 0.7 Internet: Americas 12,657 11,221 1,436 12.8 1,476 13.2 Asia Pacific 3,231 2,669 562 21.1 537 20.1 Japan 2,256 2,051 205 10.0 299 14.6 Europe 7,460 7,494 (34 ) (0.5 ) (37 ) (0.5 ) Total Internet 25,604 23,435 2,169 9.3 2,275 9.7 Total revenues: $ 302,401 $ 288,524 $ 13,877 4.8 % $ 15,472 5.4 % -------------------------------------------------------------------------------- (1) Reflects quarter over quarter change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Use of Non-GAAP Financial Measures" above for more information. The table below illustrates the overall growth in the number of our company-operated retail locations by type of store and reportable operating segment from September 30, 2013 to September 30, 2014: Company-operated retail locations: September 30, 2013 Opened Closed December 31, 2013 Opened Closed September 30, 2014 Type: Kiosk/Store in Store 122 2 (2 ) 122 5 (27 ) 100 Retail Stores 315 14 (2 ) 327 39 (37 ) 329 Outlet Stores 157 14 (1 ) 170 21 (15 ) 176 Total 594 30 (5 ) 619 65 (79 ) 605 Operating segment: Americas 208 8 - 216 16 (21 ) 211 Asia Pacific 221 18 (3 ) 236 34 (48 ) 222 Japan 50 - (1 ) 49 5 (1 ) 53 Europe 115 4 (1 ) 118 10 (9 ) 119 Total 594 30 (5 ) 619 65 (79 ) 605 28 -------------------------------------------------------------------------------- Table of Contents The table below sets forth our comparable store sales by reportable operating segment for the three months ended September 30, 2014 as compared to 2013: Constant Currency Constant Currency Three Months Ended Three Months Ended Comparable store sales (1) September 30, 2014 (2) September 30, 2013 (2) Americas (3.1 )% (8.3 )% Asia Pacific (9.2 ) 6.0 Japan (8.0 ) (16.3 ) Europe 0.1 8.8 Global (4.5 )% (4.2 )% -------------------------------------------------------------------------------- (1) Comparable store status is determined on a monthly basis. Comparable store sales begin in the thirteenth month of a store's operation. Stores in which selling square footage has changed more than 15% as a result of a remodel, expansion or reduction are excluded until the thirteenth month in which they have comparable prior year sales. Temporarily closed stores are excluded from the comparable store sales calculation during the month of closure. Location closures in excess of three months are excluded until the thirteenth month post re-opening. Comparable store sales exclude the impact of our internet channel revenues and are calculated on a currency neutral basis using historical annual average currency rates. (2) Reflects quarter over quarter change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Use of Non-GAAP Financial Measures" above for more information. Gross profit. During the three months ended September 30, 2014, gross profit increased $1.4 million, or 0.9%, compared to the same period in 2013, which was primarily attributable to a $13.9 million, or 4.8%, increase in revenues partially offset by an $11.9 million, or 8.8%, increase in cost of sales. Gross margin percentage decreased 190 basis points compared to the same period in 2013 primarily driven by the evolution of our product assortment and is consistent with our product strategy. As we expand our product lines, product mix shifts into styles that may utilize more expensive materials such as textile fabric and leather compared to the traditional clog. In addition, we experienced sales volume difficulty in our China market leading to decreased gross margins as average margins in China are typically higher than the global average and a $1.5 million write-down of obsolete inventory. Impact on Gross Profit due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates used to translate revenues and costs of sales from our functional currencies to our reporting currency during the three months ended September 30, 2014 decreased our gross profit by $0.4 million compared to the same period in 2013. Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $8.0 million, or 5.9%, during the three months ended September 30, 2014 compared to the same period in 2013. As a percentage of revenue, selling, general and administrative expenses increased 50 basis points from 47.0% to 47.5% during the three months ended September 30, 2014 compared to the same period in 2013. This increase in selling, general and administrative expenses is predominately due to an increase of $5.2 million in bad debt expense primarily related to delayed payments from distributors in China and Southeast Asia. In addition to this fluctuation, we have identified certain selling, general and administrative expenses that affect the comparability or underlying business trends in our condensed consolidated financial statements. The following table summarizes these expenses as well as details the additional drivers of the increase in selling, general and administrative expenses discussed above by reconciling our GAAP selling, general and administrative expenses to non-GAAP selling, general and administrative expenses: Three Months Ended September 30, Selling, general and administrative expenses reconciliation: 2014 2013 GAAP selling, general and administrative expenses $ 143,719 $ 135,674 New ERP implementation (1) (4,094 ) (3,089 ) Reorganization charges (2) (1,125 ) - Legal settlement (3) (487 ) - Non-GAAP selling, general and administrative expenses $ 138,013 $ 132,585 -------------------------------------------------------------------------------- (1) This represents operating expenses related to the implementation of our new ERP system and the add-back of accelerated depreciation and amortization on tangible and intangible items related to our current ERP system and supporting platforms that will no longer be utilized once the implementation of a new ERP is complete. (2) This relates to bonuses, consulting fees and other expenses related to recent reorganizational activities and our investment agreement with Blackstone. (3) This represents legal settlement expenses. 29 -------------------------------------------------------------------------------- Table of Contents Impact on Selling, General, and Administrative Expenses due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates used to translate expenses from our functional currencies to our reporting currency during the three months ended September 30, 2014, decreased selling, general and administrative expenses by approximately $0.4 million compared to the same period in 2013. Restructuring Charges. We recorded $8.2 million in restructuring charges during the three months ended September 30, 2014. These restructuring charges arose primarily as a result of our strategic plans for long-term improvement and growth of the business. Restructuring charges for the three months ended September 30, 2014 consisted of: † $5.4 million in severance costs, of which $3.6 million was related to the termination announced on July 21, 2014; † $1.8 million in other restructuring costs primarily related to the write-off of long-lived assets associated with the exiting of retail locations and obsolete inventory; and † $1.0 million in contract termination costs primarily related to the early termination of operating leases and sponsorship agreements. Asset Impairment Charges. We recorded $2.6 million in asset impairment charges during the three months ended September 30, 2014 related to certain underperforming retail locations in our Americas, Europe and Asia Pacific segments that were unlikely to generate sufficient cash flows to fully recover the carrying value of the stores' assets over their remaining economic life. Foreign Currency Transaction Losses. The line item entitled foreign currency transaction losses, net is comprised of foreign currency gains and losses from the re-measurement and settlement of monetary assets and liabilities denominated in non-functional currencies and the impact of certain foreign currency derivative instruments. During the three months ended September 30, 2014, losses on foreign currency transactions increased $0.2 million, or 23.7%, compared to the same period in 2013. Income tax (benefit) expense. During the three months ended September 30, 2014, income tax (benefit) expense decreased $20.3 million compared to the same period in 2013. Our effective tax rate decreased primarily due to the release of certain unrecognized tax benefits as the result of settling the Company's audit with the Internal Revenue Service. Our effective tax rate for the three months ended September 30, 2014 differs from the federal U.S. statutory rate primarily because of the release of certain unrecognized tax benefits as well as differences between income tax rates between U.S. and foreign jurisdictions. 30 -------------------------------------------------------------------------------- Table of Contents Comparison of the Nine Months Ended September 30, 2014 and 2013 Nine Months Ended September 30, Change ($ thousands, except per share data and average footwear selling price) 2014 2013 $ % Revenues $ 991,750 $ 964,007 $ 27,743 2.9 % Cost of sales 475,323 443,710 31,613 7.1 Restructuring charges 2,612 - 2,612 * Gross profit 513,815 520,297 (6,482 ) (1.2 ) Selling, general and administrative expenses 434,244 414,119 20,125 4.9 Restructuring charges 13,895 - 13,895 * Asset impairment charges 5,830 202 5,628 2,786.1 Income from operations 59,846 105,976 (46,130 ) (43.5 ) Foreign currency transaction losses, net 4,278 4,457 (179 ) (4.0 ) Interest income (1,304 ) (1,676 ) 372 (22.2 ) Interest expense 685 519 166 32.0 Other (income) expense, net (388 ) 180 (568 ) (315.6 ) Income before income taxes 56,575 102,496 (45,921 ) (44.8 ) Income tax expense 8,407 25,143 (16,736 ) (66.6 ) Net income $ 48,168 $ 77,353 $ (29,185 ) (37.7 )% Dividends on Series A convertible preferred shares 8,233 - 8,233 * Dividend equivalents on Series A convertible preferred shares related to redemption value accretion and beneficial conversion feature 2,030 - 2,030 * Net income attributable to common stockholders $ 37,905 $ 77,353 $ (39,448 ) (51.0 )% Net income per common share: Basic $ 0.38 $ 0.88 $ (0.50 ) (57.1 )% Diluted $ 0.37 $ 0.87 $ (0.50 ) (57.2 )% Gross margin 51.8 % 54.0 % (220 )bps (4.1 )% Operating margin 6.0 % 11.0 % (500 )bps (45.5 )% Footwear unit sales 45,145 43,589 1,556 3.6 % Average footwear selling price $ 21.40 $ 21.44 $ (0.04 ) (0.2 )% --------------------------------------------------------------------------------* Percentage change is not relevant as prior year amounts were zero. 31 -------------------------------------------------------------------------------- Table of Contents Revenues. During the nine months ended September 30, 2014, revenues increased $27.7 million, or 2.9%, compared to the same period in 2013 primarily due to an increase of 1.6 million, or 3.6%, in global footwear unit sales primarily driven by improved year-over-year performance in our wholesale and retail channels partially offset by a decrease of $0.04 per unit, or 0.2%, in average footwear selling price. For the nine months ended September 30, 2014, revenues from our wholesale channel increased $15.1 million, or 2.7%, compared to the same period in 2013, which was primarily driven by an increase in our Europe and Asia Pacific segments as a result of product volume expansion through new wholesale doors and continued support from existing customers partially offset by decreased wholesale channel revenues in our Americas and Japan segments. For the nine months ended September 30, 2014, revenues from our retail channel increased $10.3 million, or 3.1%, compared to the same period in 2013, which was primarily driven by our global retail expansion as we opened 11 company-operated stores (net of store closures) since September 30, 2013 partially offset by a 4.1% decrease in comparable store sales. Although we slightly expanded our global retail presence since 2013, we have begun to and plan on continuing to moderate the pace of our retail expansion in 2014 with a focus on outlet and kiosk locations and consolidating and enhancing the profitability of existing locations. For the nine months ended September 30, 2014, revenues from our internet channel increased $2.4 million, or 3.2%, compared to the same period in 2013, which was primarily driven by increased internet sales in our Asia Pacific segment partially offset by a decrease in internet sales in our Americas segment. Our internet sales totaled approximately 7.7% of our consolidated net sales during the nine months ended September 30, 2014 and 2013. We continue to benefit from our online presence through webstores worldwide enabling us to have increased access to our customers in a low cost, attractive manner and providing an opportunity to educate them about our products and brand. However, we intend to consolidate global company-operated e-commerce sites from 21 to 11 in order to focus our internet strategy in our principal geographical locations. Impact on Revenues due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates used to translate revenues from our functional currencies to our reporting currency during the nine months ended September 30, 2014 decreased our revenues by $5.3 million compared to the same period in 2013. 32 -------------------------------------------------------------------------------- Table of Contents The following table summarizes our total revenue by channel for the nine months ended September 30, 2014 and 2013: Nine Months Ended September 30, Change Constant Currency Change(1) ($ thousands) 2014 2013 $ % $ % Channel revenues: Wholesale: Americas $ 188,987 $ 195,827 $ (6,840 ) (3.5 )% $ (4,766 ) (2.4 )% Asia Pacific 192,108 180,205 11,903 6.6 12,545 7.0 Japan 69,353 78,116 (8,763 ) (11.2 ) (4,618 ) (5.9 ) Europe 126,047 107,689 18,358 17.0 15,639 14.5 Other businesses 607 200 407 203.5 375 187.5 Total Wholesale 577,102 562,037 15,065 2.7 19,175 3.4 Consumer-direct: Retail: Americas 158,924 156,784 2,140 1.4 3,270 2.1 Asia Pacific 99,500 93,937 5,563 5.9 3,972 4.2 Japan 30,112 30,625 (513 ) (1.7 ) 1,139 3.7 Europe 49,844 46,734 3,110 6.7 2,908 6.2 Total Retail 338,380 328,080 10,300 3.1 11,289 3.4 Internet: Americas 38,252 39,267 (1,015 ) (2.6 ) (780 ) (2.0 ) Asia Pacific 10,070 7,553 2,517 33.3 2,626 34.8 Japan 6,299 6,074 225 3.7 625 10.3 Europe 21,647 20,996 651 3.1 134 0.6 Total Internet 76,268 73,890 2,378 3.2 2,605 3.5 Total revenues: $ 991,750 $ 964,007 $ 27,743 2.9 % $ 33,069 3.4 % -------------------------------------------------------------------------------- (1) Reflects quarter over quarter change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Use of Non-GAAP Financial Measures" above for more information. The table below sets forth our comparable store sales by reportable operating segment for the nine months ended September 30, 2014 as compared to 2013: Constant Currency Constant Currency Nine Months Ended Nine Months Ended Comparable store sales (1) September 30, 2014 (2) September 30, 2013 (2) Americas (4.7 )% (5.1 )% Asia Pacific (4.9 ) 7.2 Japan (5.9 ) (16.1 ) Europe 0.6 3.1 Global (4.1 )% (2.4 )% -------------------------------------------------------------------------------- (1) Comparable store sales is determined on a monthly basis. Comparable store sales begin in the thirteenth month of a store's operation. Stores in which selling square footage has changed more than 15% as a result of a remodel, expansion or reduction are excluded until the thirteenth month in which they have comparable prior year sales. Temporarily closed stores are excluded from the comparable store sales calculation during the month of closure. Location closures in excess of three months are excluded until the thirteenth month post re-opening. Comparable store sales growth is calculated on a currency neutral basis using historical annual average currency rates. (2) Reflects quarter over quarter change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Use of Non-GAAP Financial Measures" above for more information. Gross profit. During the nine months ended September 30, 2014, gross profit decreased $6.5 million, or 1.2%, compared to the same period in 2013, which was primarily attributable to a $31.6 million, or 7.1%, increase in cost of sales partially offset by a 2.9% increase in revenue. Gross margin percentage decreased 220 basis points compared to the same period in 2013. The decline in gross margin percentage is primarily driven by the evolution of our product assortment and is consistent with our product strategy. As we expand our product lines, product mix shifts into styles that may utilize more expensive materials such as textile fabric and leather compared to the traditional clog. In addition, we experienced sales volume difficulty in our China market leading to decreased gross 33 -------------------------------------------------------------------------------- Table of Contents margins as average margins in China are typically higher than the global average, increased shipping costs globally and a $3.5 million write-down of obsolete inventory. Impact on Gross Profit due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates used to translate revenues and costs of sales from our functional currencies to our reporting currency during the nine months ended September 30, 2014 decreased our gross profit by $1.3 million compared to the same period in 2013. Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $20.1 million, or 4.9%, during the nine months ended September 30, 2014 compared to the same period in 2013. As a percentage of revenue, selling, general and administrative expenses increased 80 basis points from 43.0% to 43.8% during the nine months ended September 30, 2014 compared to the same period in 2013. This increase was predominately due to an increase of $7.7 million in bad debt expense primarily related to delayed payments from distributors in China and Southeast Asia and an increase of $8.6 million related to retail building expenses such as rent and maintenance expenses associated with the addition of 95 company-operated locations between September 30, 2013 and September 30, 2014. We have since begun to halt the expansion of our retail channel in order to focus on the long-term profitability of existing locations and have closed 84 company-operated locations between September 30, 2013 and September 30, 2014. These increases were partially offset by a decrease of approximately $2.0 million related to cost saving initiatives. In addition to these fluctuations, we have identified certain selling, general and administrative expenses that affect the comparability or underlying business trends in our condensed consolidated financial statements. The following table summarizes these expenses as well as details the additional drivers of the increase above by reconciling our GAAP selling, general and administrative expenses to non-GAAP selling, general and administrative expenses: Nine Months Ended September 30, Selling, general and administrative expenses reconciliation: 2014 2013 GAAP selling, general and administrative expenses $ 434,244 $ 414,119 New ERP implementation (1) (11,122 ) (6,833 ) Reorganization charges (2) (5,576 ) - Legal settlement (3) (2,333 ) - Brazil tax credits (4) - (6,094 ) Non-GAAP selling, general and administrative expenses $ 415,213 $ 401,192 -------------------------------------------------------------------------------- (1) This represents operating expenses related to the implementation of our new ERP system and the add-back of accelerated depreciation and amortization on tangible and intangible items related to our current ERP system and supporting platforms that will no longer be utilized once the implementation of a new ERP is complete. (2) This relates to bonuses, consulting fees and other expenses related to recent reorganizational activities and our investment agreement with Blackstone. (3) This represents legal settlement expenses. (4) This represents a net expense related to the resolution of a statutory tax audit in Brazil. Impact on Selling, General, and Administrative Expenses due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates used to translate expenses from our functional currencies to our reporting currency during the nine months ended September 30, 2014, decreased selling, general and administrative expenses by approximately $1.5 million compared to the same period in 2013. Restructuring Charges. We recorded $16.5 million in restructuring charges during the nine months ended September 30, 2014. These restructuring charges arose primarily as a result of our strategic plans for long-term improvement and growth of the business. Restructuring charges for the nine months ended September 30, 2014 consisted of: † $9.8 million in severance costs, of which $4.5 million was related to the termination of executive management and $3.6 million was related to the termination announced on July 21, 2014; † $4.5 million in other restructuring costs primarily related to the write-off of long-lived assets associated with the exiting of retail locations and obsolete inventory; and † $2.2 million in contract termination costs primarily related to the early termination of operating leases and sponsorship agreements. Asset Impairment Charges. We recorded $5.8 million in asset impairment charges during the nine months ended September 30, 2014 related to certain underperforming retail locations in our Americas, Europe and Asia Pacific segments that were unlikely to generate sufficient cash flows to fully recover the carrying value of the stores' assets over their remaining economic life. 34 -------------------------------------------------------------------------------- Table of Contents Foreign Currency Transaction Losses. The line item entitled foreign currency transaction losses, net is comprised of foreign currency gains and losses from the re-measurement and settlement of monetary assets and liabilities denominated in non-functional currencies and the impact of certain foreign currency derivative instruments. During the nine months ended September 30, 2014, losses on foreign currency transactions decreased $0.2 million, or 4.0%, compared to the same period in 2013. Income tax expense. During the nine months ended September 30, 2014, income tax expense decreased $16.7 million compared to the same period in 2013. Our effective tax rate decreased primarily due to the release of certain unrecognized tax benefits as the result of settling the Company's audits with the Canada Revenue Agency and the Internal Revenue Service. Our effective tax rate for the nine months ended September 30, 2014 differs from the federal U.S. statutory rate primarily because of the release of certain unrecognized tax benefits as well as differences between income tax rates between U.S. and foreign jurisdictions. 35 -------------------------------------------------------------------------------- Table of Contents Presentation of Reportable Segments We have four reportable operating segments based on the geographic nature of our operations: Americas, Asia Pacific, Japan and Europe. We also have an "Other businesses" category which aggregates insignificant operating segments that do not meet the reportable threshold and represent manufacturing operations located in Mexico, Italy and Asia. The composition of our reportable operating segments is consistent with that used by our Chief Operating Decision Maker ("CODM") to evaluate performance and allocate resources. Each of our reportable operating segments derives its revenues from the sale of footwear, apparel and accessories to external customers as well as intersegment sales. Revenues of the "Other businesses" category are primarily made up of intersegment sales. The remaining revenues for the "Other businesses" represent non-footwear product sales to external customers. Intersegment sales are not included in the measurement of segment operating income or regularly reviewed by the CODM and are eliminated when deriving total consolidated revenues. The primary financial measure utilized by the CODM to evaluate performance and allocate resources is segment operating income. Segment performance evaluation is based primarily on segment results without allocating corporate expenses, or indirect general, administrative and other expenses. Segment profits or losses of our reportable operating segments include adjustments to eliminate intersegment profit or losses on intersegment sales. As such, reconciling items for segment operating income represent unallocated corporate and other expenses as well as intersegment eliminations. Segment assets consist of cash and cash equivalents, accounts receivable and inventory as these balances are regularly reviewed by the CODM. Comparison of the Three Months Ended September 30, 2014 and 2013 by Segment The following table sets forth information related to our reportable operating business segments for the three months ended September 30, 2014 and 2013: Three Months Ended September 30, Change Constant Currency Change (4) ($ thousands) 2014 2013 $ % $ % Revenues: Americas $ 127,475 $ 116,194 $ 11,281 9.7 % $ 11,815 10.2 % Asia Pacific 78,327 79,406 (1,079 ) (1.4 ) (2,137 ) (2.7 ) Japan 35,519 38,984 (3,465 ) (8.9 ) (1,803 ) (4.6 ) Europe 60,645 53,903 6,742 12.5 7,204 13.4 Total segment revenues 301,966 288,487 13,479 4.7 15,079 5.2 Other businesses 435 37 398 1075.7 393 1062.2 Total consolidated revenues $ 302,401 $ 288,524 $ 13,877 4.8 % $ 15,472 5.4 % Operating income (loss): Americas $ 15,094 $ 17,969 $ (2,875 ) (16.0 )% $ (2,800 ) (15.6 )% Asia Pacific 4,384 13,690 (9,306 ) (68.0 ) (9,106 ) (66.5 ) Japan 9,091 11,656 (2,565 ) (22.0 ) (2,414 ) (20.7 ) Europe 9,689 6,860 2,829 41.2 2,821 41.1 Total segment operating income 38,258 50,175 (11,917 ) (23.8 ) (11,499 ) (22.9 ) Other businesses(1) (5,405 ) (5,495 ) 90 (1.6 ) 78 (1.4 ) Intersegment eliminations 15 15 - - - - Unallocated corporate and other(2) (31,755 ) (26,788 ) (4,967 ) 18.5 (5,758 ) 21.5 Total consolidated operating income(3) $ 1,113 $ 17,907 $ (16,794 ) (93.8 )% $ (17,179 ) (95.9 )% Foreign currency transaction losses, net 1,290 1,043 247 23.7 Interest income (424 ) (853 ) 429 (50.3 ) Interest expense 366 44 322 731.8 Other (income) expense, net (217 ) 13 (230 ) (1769.2 ) Income before income taxes $ 98 $ 17,660 $ (17,562 ) (99.4 )% 36 -------------------------------------------------------------------------------- Table of Contents -------------------------------------------------------------------------------- (1) During the three months ended September 30, 2014, operating losses of Other businesses slightly decreased $0.1 million compared to the same period in 2013, primarily due to a $0.2 million decrease in selling, general and administrative expenses partially offset by $0.1 million decrease in gross margin. (2) Includes a corporate component consisting primarily of corporate support and administrative functions, costs associated with share-based compensation, research and development, brand marketing, legal, depreciation on corporate and other assets not allocated to operating segments and costs of the same nature of certain corporate holding companies. For the three months ended September 30, 2014, Unallocated corporate and other operating losses increased $5.0 million compared to the same period in 2013 primarily due to $2.5 million in restructuring charges related to the termination of certain employees and executives and $2.1 million increase in selling, general and administrative expenses. (3) Please refer to our Results of Operations to reconcile total consolidated operating income to net income as segment information does not have an effect on values below total consolidated operating income. (4) Reflects quarter over quarter change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Use of Non-GAAP Financial Measures" above for more information. Americas Operating Segment. During the three months ended September 30, 2014, revenues from our Americas segment increased $11.3 million, or 9.7%, compared to the same period in 2013 primarily due to a 17.2% increase in footwear units sold partially offset by a 4.7% decrease in average footwear unit selling price and a $0.5 million unfavorable impact from foreign currency fluctuations driven by the weakening of the Brazilian Real against the U.S. Dollar. During the three months ended September 30, 2014, revenue increases for the region were realized primarily in the wholesale channel, which increased $8.0 million, or 17.6%, compared to 2013. The increase in wholesale channel revenue was predominately driven by increased volume in the United States, partially offset by decreased volume in South America. In addition to the wholesale channel, revenue increases for the region were also realized in the retail channel which increased $1.9 million, or 3.1%, and the internet channel which increased $1.4 million, or 12.8%, compared to 2013. The increase in retail channel revenue was driven by increased volume partially offset by a 3.1% decrease in comparable store sales and lower average footwear unit selling prices. The increase in internet channel revenue was due to increased traffic and conversion. During the three months ended September 30, 2014, segment operating income decreased $2.9 million, or 16.0%, compared to the same period in 2013.This decrease was predominately driven by $2.1 million in restructuring charges related to severance costs in the United States and an inventory write-down related to an exited business line, $2.0 million in retail asset impairment charges related to the long-lived assets in ten company-operated stores and a $1.6 million, or 3.5%, increase in selling, general and administrative expenses primarily due to variable compensation and building costs. Partially offsetting these decreases was the revenue increase noted above. Asia Pacific Operating Segment. During the three months ended September 30, 2014, revenues from our Asia Pacific segment decreased $1.1 million, or 1.4%, compared to the same period in 2013 primarily due to a 1.0% increase footwear units sold and a $1.1 million favorable impact from foreign currency fluctuations partially offset by a 2.0% decrease in average footwear unit selling price. During the three months ended September 30, 2014, we realized revenue declines in our wholesale and direct-to-consumer channels compared to 2013. Our wholesale channel revenue decreased $0.9 million, or 2.1%, primarily due to decreased performance in our China business as a result of distributor inventory levels and sell through. Our direct-to-consumer channel revenues decreased $0.2 million primarily due to a 9.2% decrease in comparable store sales influenced primarily by declines in China, Korea and Hong Kong partially offset by increased average footwear unit selling price. During the three months ended September 30, 2014, segment operating income decreased $9.3 million, or 68.0%, compared to the same period in 2013. This decrease was predominately driven by a $5.2 million, or 16.1%, increase in selling, general and administrative expenses due to an increase in reserves for doubtful accounts as a result of delayed payments from distributors in China and Southeast Asia, $3.2 million in restructuring charges related to severance and store closure costs, $0.4 million in retail asset impairment charges related to the long-lived assets in two company-operated stores and the revenue decrease noted above. Partially offsetting these decreases was a $0.5 million favorable impact from foreign currency fluctuations. Japan Operating Segment. During the three months ended September 30, 2014, revenues from our Japan segment decreased $3.5 million, or 8.9%, compared to the same period in 2013 primarily due to a 9.2% decrease in average footwear selling price and a $1.7 million unfavorable impact from foreign currency fluctuations partially offset by a 0.6% increase in footwear units sold. During the three months ended September 30, 2014, we realized revenue declines in our wholesale and direct-to-consumer channels compared to 2013. Our wholesale channel decreased $2.9 million, or 11.9% primarily due to lower at-once demand, slow sell-through of inventory as a result of macroeconomic declines leading to lower average footwear selling prices and a $1.0 million unfavorable impact from foreign currency fluctuations. Our direct-to-consumer channel revenues decreased $0.5 million, or 3.7%, primarily due to an 8.0% decrease in comparable store sales and a $0.7 million unfavorable impact from foreign currency fluctuations partially offset by the addition of three retail locations (net of store closures) since September 30, 2013. During the three months ended September 30, 2014, segment operating income decreased $2.6 million, or 22.0%, compared to the same period in 2013. This decrease was driven predominately by the revenue decrease noted above coupled with a gross margin decrease of 370 basis points as a result of product costs being tied to the U.S. Dollar and a $0.2 million unfavorable impact from foreign currency fluctuations. Partially offsetting these decreases was a $0.7 million, or 6.8%, decrease in selling, general and administrative expenses compared to 2013. Europe Operating Segment. During the three months ended September 30, 2014, revenues from our Europe segment increased $6.7 million, or 12.5%, compared to the same period in 2013 primarily due to a 14.4% increase in footwear units sold partially offset by a 37 -------------------------------------------------------------------------------- Table of Contents 1.2% decrease in average footwear unit selling price and a $0.5 million unfavorable impact from foreign currency fluctuations. During the three months ended September 30, 2014, we realized revenue growth in the region in our wholesale and retail channels compared to 2013. Our wholesale channel revenue increased $6.3 million, or 22.9%, primarily due to the expansion in our number of wholesale doors and strong sales performance through existing wholesale customers. Our retail channel revenue increased $0.5 million, or 2.6%, primarily due to the addition of four company-operated stores (net of store closures) since September 30, 2013 coupled with a 0.1% increase in comparable store sales. Our internet channel revenue remained relatively flat on a year-over-year basis. During the three months ended September 30, 2014, segment operating income increased $2.8 million, or 41.2%, compared to the same period in 2013. This increase was predominately due to the revenue increase noted above and a $0.8 million, or 3.4%, decrease in selling, general and administrative expenses. Partially offsetting these increases was $0.4 million in restructuring charges related to store closure costs and $0.2 million in retail asset impairment charges related to the long-lived assets in eight company-operated stores. 38 -------------------------------------------------------------------------------- Table of Contents Comparison of the Nine Months Ended September 30, 2014 and 2013 by Segment The following table sets forth information related to our reportable operating business segments for the nine months ended September 30, 2014 and 2013: Nine Months Ended September 30, Change Constant Currency Change (4) ($ thousands) 2014 2013 $ % $ % Revenues: Americas $ 386,163 $ 391,878 $ (5,715 ) (1.5 )% $ (2,276 ) (0.6 )% Asia Pacific 301,678 281,695 19,983 7.1 19,143 6.8 Japan 105,764 114,815 (9,051 ) (7.9 ) (2,854 ) (2.5 ) Europe 197,538 175,419 22,119 12.6 18,681 10.6 Total segment revenues 991,143 963,807 27,336 2.8 32,694 3.4 Other businesses 607 200 407 203.5 375 187.5 Total consolidated revenues $ 991,750 $ 964,007 $ 27,743 2.9 % $ 33,069 3.4 % Operating income (loss): Americas $ 53,451 $ 61,787 $ (8,336 ) (13.5 )% $ (8,410 ) (13.6 )% Asia Pacific 65,962 76,478 (10,516 ) (13.8 ) (10,503 ) (13.7 ) Japan 29,421 36,679 (7,258 ) (19.8 ) (6,065 ) (16.5 ) Europe 29,254 31,188 (1,934 ) (6.2 ) (2,527 ) (8.1 ) Total segment operating income 178,088 206,132 (28,044 ) (13.6 ) (27,505 ) (13.3 ) Other businesses(1) (13,750 ) (14,907 ) 1,157 (7.8 ) 1,098 (7.4 ) Intersegment eliminations 45 45 - 0.0 - - Unallocated corporate and other(2) (104,537 ) (85,294 ) (19,243 ) 22.6 (19,977 ) 23.4 Total consolidated operating income(3) $ 59,846 $ 105,976 $ (46,130 ) (43.5 )% $ (46,384 ) (43.8 )% Foreign currency transaction losses, net 4,278 4,457 (179 ) (4.0 ) Interest income (1,304 ) (1,676 ) 372 (22.2 ) Interest expense 685 519 166 32.0 Other (income) expense, net (388 ) 180 (568 ) (315.6 ) Income before income taxes $ 56,575 $ 102,496 $ (45,921 ) (44.8 )% -------------------------------------------------------------------------------- (1) During the nine months ended September 30, 2014, operating losses of Other businesses decreased $1.2 million compared to 2013, primarily due to a $0.8 million increase in gross margin and a $0.4 million decrease in selling, general and administrative expenses. (2) Includes a corporate component consisting primarily of corporate support and administrative functions, costs associated with share-based compensation, research and development, brand marketing, legal, depreciation on corporate and other assets not allocated to operating segments and costs of the same nature of certain corporate holding companies. For the nine months ended September 30, 2014, Unallocated corporate and other operating losses increased $19.2 million compared to the same period in 2013, primarily due to $8.3 million restructuring charges related to the termination of certain employees and executives and a write-off of obsolete inventory related to an exited business line and an $8.6 million increase in selling, general and administrative expenses primarily related to the implementation of our ERP system and our investment agreement with Blackstone partially offset by cost savings in variable compensation. (3) Please refer to our Results of Operations to reconcile total consolidated operating income to net income as segment information does not have an effect on values below total consolidated operating income. (4) Reflects quarter over quarter change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Use of Non-GAAP Financial Measures" above for more information. Americas Operating Segment. During the nine months ended September 30, 2014, revenues from our Americas segment decreased $5.7 million, or 1.5%, compared to 2013 primarily due to a 3.7% decrease in footwear units sold and a $3.4 million unfavorable impact from foreign currency fluctuations driven by weakening of the Brazilian Real against the U.S. Dollar. This decrease was partially offset by a 3.3% increase in average footwear unit selling price. During the nine months ended September 30, 2014, revenue declines for the region were realized primarily in the wholesale channel which decreased $6.8 million, or 3.5%, and in the internet channel which decreased $1.0 million, or 2.6%, compared to 2013. The decrease in wholesale channel revenue was predominately driven by a mix of lower than anticipated at-once orders as a result of accounts remaining lean on inventory in the first half of the year and a decline in activity in our Latin and South America markets partially offset by an increase in activity in the United States. The decrease in internet channel revenue was predominately driven by a decrease in average footwear selling price partially offset by an increase in footwear unit sales and increased conversion and traffic. Partially offsetting this decrease was a $2.1 million, or 1.4%, 39 -------------------------------------------------------------------------------- Table of Contents increase in retail channel revenues, which is primarily the result of the addition of 24 company-operated stores since September 30, 2013 partially offset by a 4.7% decrease in comparable store sales and the closure of 21 company-operated stores since September 30, 2013. During the nine months ended September 30, 2014, segment operating income decreased $8.3 million, or 13.5%, compared to 2013 driven predominately by the revenue decreases noted above, $3.3 million in restructuring charges related to the reorganization of our business in Brazil, severance costs in the United States and an inventory write-down related to an exited business line and a $3.0 million increase in retail asset impairment charges related to the long-lived assets in 26 company-operated stores. Partially offsetting these decreases was a $6.1 million, or 4.4%, decrease in selling, general and administrative expenses due to a non-recurring charge of $6.1 million during the same period in 2013 related to the resolution of a statutory tax audit in Brazil and a decrease in marketing spend partially offset by building cost increases as a result of retail expansion. Asia Pacific Operating Segment. During the nine months ended September 30, 2014, revenues from our Asia Pacific segment increased $20.0 million, or 7.1%, compared to 2013 primarily due to a 5.3% increase in average footwear selling price, a 2.0% increase in footwear units sold and a $0.8 million favorable impact from foreign currency fluctuations. During the nine months ended September 30, 2014, we realized revenue growth in the region in all three channels compared to 2013. Our wholesale channel revenue increased $11.9 million, or 6.6%, primarily due to the expansion of our wholesale doors and continued support from existing customers partially offset by a decrease in third quarter performance in our China business as a result of distributor inventory levels and sell through. Our direct-to-consumer channel revenues increased $8.1 million, or 8.0%, primarily due to increased traffic during the year and the addition of 52 company-operated stores since September 30, 2013 as we focus on high-traffic, outlet locations partially offset by a 4.9% decrease in comparable store sales and the closure of 51 company-operated stores since September 30, 2013. During the nine months ended September 30, 2014, segment operating income decreased $10.5 million, or 13.8%, compared to 2013. This decrease was predominately driven by a $13.5 million, or 14.2%, increase in selling, general and administrative expenses due to the expansion of our retail channel and an increase in reserves for doubtful accounts as a result of delayed payments from distributors in China and Southeast Asia, a $3.6 million in restructuring charges related to severance and store closure costs and $0.8 million in retail asset impairment charges related to the long-lived assets in 14 company-operated stores. Partially offsetting these decreases was the revenue increase noted above and a $0.8 million favorable impact from foreign currency fluctuations. Japan Operating Segment. During the nine months ended September 30, 2014, revenues from our Japan segment decreased $9.1 million, or 7.9%, compared to 2013 primarily due to a 10.2% decrease in average footwear selling price and a $6.2 million unfavorable impact from foreign currency fluctuations partially offset by a 2.9% increase in footwear units sold. During the nine months ended September 30, 2014, we realized revenue declines primarily in the wholesale channel which decreased $8.8 million, or 11.2%, compared to 2013. This decrease was mainly due to a soft wholesale market and slow sell-through of inventory as a result of macroeconomic declines leading to lower average footwear selling prices. In addition, our direct-to-consumer channel revenues slightly decreased $0.3 million, or 0.8%, compared to 2013 primarily due to a 5.9% decrease in comparable stores sales partially offset by the addition of three retail locations (net of store closures) since September 30, 2013. During the nine months ended September 30, 2014, segment operating income decreased $7.3 million, or 19.8%, compared to the same period in 2013. This decrease was driven predominately by the revenue decrease noted above coupled with a gross margin decrease of 310 basis points as a result of product costs being tied to the U.S. Dollar and a $1.2 million unfavorable impact from foreign currency fluctuations. Partially offsetting these decreases was a $1.2 million, or 4.1%, decrease in selling, general and administrative expenses. Europe Operating Segment. During the nine months ended September 30, 2014, revenues from our Europe segment increased $22.1 million, or 12.6%, compared to 2013 primarily due to a 22.7% increase in footwear units sold partially offset by a 8.1% decrease in average footwear unit selling price. This contrasting increase in average footwear units sold and decrease in average footwear unit selling price is primarily related to discounting on certain products during the first half of the year in our wholesale channel. In addition to sales metrics, our Europe segment realized a $3.4 million favorable impact from foreign currency fluctuations driven by the strengthening of the Euro and British Pound Sterling against the U.S. Dollar partially offset by the weakening of the Russian Ruble against the U.S. Dollar throughout the first half of the year. During the nine months ended September 30, 2014, we realized revenue growth in the region in all three channels compared to 2013. Our wholesale channel revenue increased $18.4 million, or 17.0%, primarily due to the expansion in our number of wholesale doors and strong sales performance throughout the region. Our direct-to-consumer channel revenues increased $3.8 million, or 5.6%, primarily due to the addition of four company-operated stores (net of store closures) since September 30, 2013 coupled with a 0.6% increase in comparable store sales. During the nine months ended September 30, 2014, segment operating income decreased $1.9 million, or 6.2%, compared to 2013. This decrease was predominately due to a $5.9 million, or 9.2%, increase in selling, general and administrative expenses compared to 2013 due to an increase in variable compensation and outside services and legal settlement fees of approximately $1.8 million, $1.8 million in retail asset impairment charges related to the long-lived assets in 17 company-operated stores, $1.4 million in restructuring charges related to store closure costs and a gross margin decrease of 250 basis points as a result of product costs being tied to the U.S. Dollar. Partially offsetting these decreases was the revenue increase noted above. 40 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources Cash Flows During the nine months ended September 30, 2014, cash and cash equivalents increased $33.2 million, or 10.5%, to $350.4 million compared to $317.1 million at December 31, 2013. The primary driver of this increase is the $182.2 million in net cash proceeds from our investment agreement with Blackstone. This increase was partially offset by the repurchase of $90.1 million of our common stock associated with board authorized repurchases including related commission charges under our publicly-announced repurchase plan, strategic reinvestments into the business including $43.3 million in capital spend primarily related to our ERP system implementation, dividend payments of $5.2 million associated with our investment agreement with Blackstone and debt payments of $3.9 million related to long-term bank borrowings. We anticipate that cash flows from operations will be sufficient to meet the ongoing needs of our business for the next twelve months. In order to provide additional liquidity in the future and to help support our strategic goals, we have a revolving credit facility with a syndicate of lenders, including PNC Bank, National Association ("PNC") as lead lender, which currently provides us with up to $100.0 million in borrowing capacity and matures in December 2017 (see Revolving Credit Facility below). Additional future financing may be necessary and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all. Sale of Preferred Stock On January 27, 2014, we received approximately $182.2 million of proceeds for the sale of 200,000 shares of Series A preferred stock to Blackstone and its permitted transferees. The Series A preferred stock has an aggregate stated value of $200.0 million, or $1,000.0 per share. The Series A preferred stock ranks senior to our common stock with respect to dividend rights and rights on liquidation, winding-up and dissolution. Holders of Series A preferred stock are entitled to cumulative dividends payable quarterly in cash at a rate of 6% per annum as well as any dividends declared or paid on common stock and are entitled to vote together with the holders of common stock on an as-converted basis. As of September 30, 2014, accrued dividends amounted to $3.1 million, which were paid to Blackstone on October 1, 2014. The Series A preferred stock has several conversion features as well as redemption rights. The conversion rate is subject to customary anti-dilution and other adjustments subject to certain share caps and other restrictions. As of September 30, 2014, the Blackstone investment, on an as converted to common stock basis, represented approximately 14.3% of the outstanding common stock of the Company. Stock Repurchase Plan Authorizations We continue to evaluate options to maximize the returns on our cash and maintain an appropriate capital structure, including, among other alternatives, repurchases of our common stock. Subject to certain restrictions on repurchases under our revolving credit facility, we are authorized to repurchase up to $350.0 million of our common stock. The number, price, structure and timing of the repurchases, if any, will be at our sole discretion and future repurchases will be evaluated by us depending on market conditions, liquidity needs and other factors. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not oblige us to acquire any particular amount of our common stock. The board of directors may suspend, modify or terminate the repurchase program at any time without prior notice. During the three months ended September 30, 2014, we repurchased approximately 2.9 million shares at a weighted average price of $14.74 per share for an aggregate price of approximately $43.0 million excluding related commission charges under our publicly-announced repurchase plan. During the nine months ended September 30, 2014, we repurchased approximately 6.1 million shares at a weighted average price of $14.76 per share for an aggregate price of approximately $89.9 million excluding related commission charges under our publicly-announced repurchase plan. Since September 30, 2014, we have repurchased approximately 0.5 million shares at a weighted average price of $12.15 per share for an aggregate price of approximately $5.7 million excluding related commission charges under our publicly-announced repurchase plan. Revolving Credit Facility On December 16, 2011, we entered into an Amended and Restated Credit Agreement, (as amended, the "Credit Agreement") with the lenders named therein and PNC Bank, National Association, as a lender and administrative agent for the lenders. 41 -------------------------------------------------------------------------------- Table of Contents The Credit Agreement enables us to borrow up to $100.0 million, with the ability to increase commitments to up to $125 million subject to certain conditions, and is currently set to mature on December 16, 2017. The Credit Agreement is available for working capital, capital expenditures, permitted acquisitions, reimbursement of drawings under letters of credit, and permitted dividends, distributions, purchases, redemptions and retirements of equity interests. Borrowings under the Credit Agreement are secured by all of our assets including all receivables, equipment, general intangibles, inventory, investment property, subsidiary stock and intellectual property. Borrowings under the Credit Agreement bear interest at a variable rate. For domestic rate loans, the interest rate is equal to the highest of (i) the daily federal funds open rate as quoted by ICAP North America, Inc. plus 0.5%, (ii) PNC's prime rate and (iii) a daily LIBOR rate plus 1.0%, in each case there is an additional margin ranging from 0.25% to 1.00% based on certain conditions. For LIBOR rate loans, the interest rate is equal to a LIBOR rate plus a margin ranging from 1.25% to 2.00% based on certain conditions. The Credit Agreement requires monthly interest payments with respect to domestic rate loans and at the end of each interest period with respect to LIBOR rate loans. The Credit Agreement further provides for a limit on the issuance of letters of credit to a maximum of $20.0 million. The Credit Agreement contains provisions requiring us to maintain compliance with certain restrictive and financial covenants. On September 26, 2014, we entered into the Fifth Amendment to Amended and Restated Credit Agreement (the "Fifth Amendment"), pursuant to which certain terms of the Credit Agreement were amended. The Fifth Amendment primarily (i) extends the minimum fixed charge coverage ratio of 1.15 to 1.00 through the second quarter of 2015 and will return to 1.25 to 1.00 at the end of each quarter thereafter, and (ii) amends certain definitions of the financial covenants to become more favorable to us. As of September 30, 2014 and December 31, 2013, we had no outstanding borrowings under the Credit Agreement. As of September 30, 2014 and December 31, 2013, we had issued and outstanding letters of credit of $8.2 million and $7.2 million, respectively, which were reserved against the borrowing base under the terms of the Credit Agreement. As of September 30, 2014, we were in compliance with all restrictive and financial covenants under the Credit Agreement. Long-term Bank Borrowings On December 10, 2012, we entered into a Master Installment Payment Agreement ("Master IPA") with PNC in which PNC finances our purchase of software and services, which may include but are not limited to third party costs to design, install and implement software systems, and associated hardware described in the schedules defined within the Master IPA. The Master IPA was entered into to finance our implementation of a new enterprise resource planning ("ERP") system, which began in October 2012 and is estimated to continue through early 2015. The terms of each note payable under the Master IPA consist of variable interest rates and payment terms based on amounts borrowed and timing of activity throughout the implementation of the ERP system. As of September 30, 2014 and December 31, 2013, we had $12.9 million and $16.8 million, respectively, of long-term debt outstanding under five separate notes payable under the Master IPA, of which $5.2 million and $5.1 million, respectively, represent current installments. As of September 30, 2014, the notes bear interest rates ranging from 2.45% to 2.79% and maturities ranging from September 2016 to September 2017. As this debt arrangement relates solely to the construction and implementation of an ERP system for use by the Company, all interest expense incurred under the arrangement has been capitalized to the condensed consolidated balance sheets until the assets are ready for intended use and will be amortized over the useful life of the software upon that date. During the three and nine months ended September 30, 2014, we capitalized $0.1 million and $0.3 million, respectively, in interest expense related to this debt arrangement to the condensed consolidated balance sheets. During the three and nine months ended September 30, 2013, we did not capitalize any interest expense related to this debt arrangement. Working Capital During the nine months ended September 30, 2014, accounts receivable increased $54.3 million, or 52.0%, to $158.7 million compared to $104.4 million at December 31, 2013, which is primarily the result of seasonality as third quarter revenues typically exceed our fourth quarter revenues partially offset by an increase in allowance for bad debt as a result of delayed payments from our partner stores in China and Southeast Asia. During the nine months ended September 30, 2014, inventories increased $40.5 million, or 24.9%, to $202.8 million compared to $162.3 million at December 31, 2013, which is primarily related to seasonality and product mix partially offset by a slight decrease in company-operated retail locations. Capital Assets During the three months and nine months ended September 30, 2014, net capital expenditures acquired, inclusive of intangible assets, were $10.7 million and $43.7 million, respectively, compared to $20.5 million and $53.0 million, respectively, during the same period 42 -------------------------------------------------------------------------------- Table of Contents in 2013 primarily due to decreased capital spend in our retail channel as we begin to close or convert locations partially offset by a slight increase in the capitalization of our ERP implementation costs. We have entered into various operating leases that require cash payments on a specified schedule. Over the next five years we are committed to make payments of approximately $257.5 million related to our operating leases. We plan to continue to enter into operating leases related to our retail stores; however, we plan to reduce our overall retail footprint in 2014. We also continue to evaluate cost reduction opportunities. Our evaluation of cost reduction opportunities will include an evaluation of contracts for sponsorships, operating lease contracts and other contracts that require future minimum payments resulting in fixed operating costs. Any changes to these contracts may require early termination fees or other charges that could result in significant cash expenditures. Repatriation of Cash As we are a global business, we have cash balances which are located in various countries and are denominated in various currencies. Fluctuations in foreign currency exchange rates impact our results of operations and cash positions. Future fluctuations in foreign currencies may have a material impact on our cash flows and capital resources. Cash balances held in foreign countries may have additional restrictions and covenants associated with them which could adversely impact our liquidity and ability to timely access and transfer cash balances between entities. We generally consider unremitted earnings of subsidiaries operating outside of the U.S. to be indefinitely reinvested; however, our board of directors recently approved a foreign cash repatriation strategy. As part of this strategy, we have repatriated approximately $90.0 million for which income taxes have already been accrued for or paid. Further cash repatriation will depend on future cash requirements in the U.S. We maintain approximately $52.0 million of foreign earnings for which tax has previously been provided, and which has not been repatriated at this time. Most of the cash balances held outside of the U.S. could be repatriated to the U.S., but under current law, would be subject to U.S. federal and state income taxes less applicable foreign tax credits. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. Certain countries have monetary laws which may limit our ability to utilize cash resources in those countries for operations in other countries. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or other countries and could adversely affect our liquidity. As of September 30, 2014, we held $262.5 million of our total $350.4 million in cash in international locations. This cash is primarily used for the ongoing operations of the business in the locations in which the cash is held. Of the $262.5 million, $1.2 million could potentially be restricted, as described above. If the remaining $261.3 million were to be immediately repatriated to the U.S., we would be required to incur approximately $47.3 million in taxes that were not previously provided for in our consolidated statement of operations. Contractual Obligations In February 2011, we renewed and amended our supply agreement with Finproject S.r.l. which provides us the exclusive right to purchase certain raw materials used to manufacture our products. The agreement also provides that we meet minimum purchase requirements to maintain exclusivity throughout the term of the agreement, which expires December 31, 2014. Historically, the minimum purchase requirements have not been onerous and we do not expect them to become onerous in the future. Depending on the material purchased, pricing is either based on contracted price or is subject to quarterly reviews and fluctuates based on order volume, currency fluctuations and raw material prices. Pursuant to the agreement, we guarantee the payment for certain third-party manufacturer purchases of these raw materials up to a maximum potential amount of €3.5 million (approximately $4.8 million as of September 30, 2014), through a letter of credit that was issued to Finproject S.r.l. The following table summarizes aggregate information about our significant contractual cash obligations as of September 30, 2014: Payments due by period Less than 1 - 3 3 - 5 More than ($ thousands) Total 1 year years years 5 years Operating lease obligations (1) $ 379,530 $ 83,583 $ 108,074 $ 65,850 $ 122,023 Inventory purchase obligations with third party manufacturers (2) 165,743 165,743 - - - Dividends payable (3) 90,833 12,067 24,000 24,000 30,766 Other contracts (4) 40,738 14,219 23,242 3,277 - Debt obligations (5) (9) 13,415 1,381 12,034 - - Minimum licensing royalties (6) 4,067 1,180 1,932 955 - Estimated liability for uncertain tax positions (7) 884 884 - - - Capital lease obligations (8) (9) 44 30 14 - - Total $ 695,254 $ 279,087 $ 169,296 $ 94,082 $ 152,789 43 -------------------------------------------------------------------------------- Table of Contents -------------------------------------------------------------------------------- (1) Our operating lease obligations consist of retail stores, offices, warehouses, vehicles, and equipment expiring at various dates through 2033. This balance represents the minimum cash commitment under contract to various third-parties for operating lease obligations including the effect of rent escalation clauses, deferred rent and minimum sublease rentals due in the future under non-cancelable subleases. This balance does not include certain contingent rent clauses that may require additional rental amounts based on sales volume, inventories, etc. as these amounts are not determinable for future periods. (2) Our inventory purchase obligations with third party manufacturers consist of open purchase orders for footwear products and includes an immaterial amount of purchase commitments with certain third-party manufacturers for yet-to-be-received finished product where title passes to us upon receipt. All purchase obligations with third party manufacturers are expected to be paid within one year. (3) Dividends payable are associated with our investment agreement with Blackstone at a rate of 6.0% the stated value of the investment. The amounts represent expected dividend payments over the eight year redemption accretion period. (4) Other contracts consist of various agreements with third-party providers. (5) We have entered into an agreement with PNC to finance the purchase of software and services related to the implementation of our new ERP system, which began in October 2012 and is expected to continue through early 2015. Our current debt obligations consist of five separate notes issued under the agreement, which bear interest rates ranging from 2.45% to 2.79% and maturities ranging from September 2016 to September 2017. (6) Our minimum licensing royalties consist of usage-based payments for the right to use various licenses, trademarks and copyrights in the production of our footwear, apparel and accessories. Royalty obligations are based on minimum guarantees under contract; however, may include additional royalty obligations based on sales volume that are not determinable for future periods. (7) Our estimated liability for uncertain tax positions are unrecognized tax benefits taken in our income tax return that would reduce our effective tax rate, if recognized. As of September 30, 2014, we had gross unrecognized tax benefits recorded in non-current liabilities of $12.2 million and an additional $2.4 million in gross interest and penalties. Of the $12.2 million, we expect approximately $0.9 million to be paid within less than a year. Of the remaining $11.3 million uncertain tax liabilities, we are unable to make a reasonable estimate of the timing of payments in individual years and therefore, such amounts are not included in the contractual obligation table above. (8) Our capital lease obligations consist of office equipment expiring at various dates through 2016. This balance represents the minimum cash commitment under contract to various third-parties for capital lease obligations. (9) Amounts include anticipated interest payments. Off-Balance Sheet Arrangements We had no material off balance sheet arrangements as of September 30, 2014. Seasonality Due to the seasonal nature of our footwear which is more heavily focused on styles suitable for warm weather, revenues generated during our first and fourth quarters are typically less than revenues generated during our second and third quarters, when the northern hemisphere is experiencing warmer weather. We continue to expand our product line to include more winter-oriented styles to mitigate some of the seasonality of our revenues. Our quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including the timing of new model introductions or general economic or consumer conditions. Accordingly, results of operations and cash flows for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any other year. Critical Accounting Policies and Estimates For a discussion of accounting policies that we consider critical to our business operations and an understanding of our results of operations and that affect the more significant judgments and estimates used in the preparation of our unaudited condensed consolidated financial statements, see Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates" contained in our Annual Report on Form 10-K for the year ended December 31, 2013 and incorporated by reference herein. |