J.Jill, Inc. (JILL) FY 2023 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes thereto included elsewhere in this Annual Report. The following discussion contains forward-looking statements that reflect our plans, estimates and assumptions. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause such differences are discussed in the sections of this Annual Report titled “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements.”
We operate on a 52- or 53-week fiscal year that ends on the Saturday that is closest to January 31. Each fiscal year generally is comprised of four 13-week fiscal quarters, although in the years with 53 weeks, the fourth quarter represents a 14-week period. The fiscal year ended January 28, 2023 (“Fiscal Year 2022”), fiscal year ended January 29, 2022 (“Fiscal Year 2021”) and fiscal year ended January 30, 2021 (“Fiscal Year 2020”) are all comprised of 52 weeks.
The discussion that follows includes a comparison of our results of operations and liquidity and capital resources for Fiscal Years 2022 and 2021. For the discussion comparing the Fiscal Years 2021 and 2020, refer to Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Fiscal Year 2021 Form 10-K, which was filed with the United States Securities and Exchange Commission on April 13, 2022.
Overview
J.Jill is a national lifestyle brand that provides apparel, footwear and accessories designed to help its customers move through a full life with ease. The brand represents an easy, thoughtful, and inspired style that celebrates the totality of all women and designs its products with its core brand ethos in mind: keep it simple and make it matter. J.Jill offers a high touch customer experience through over 200 stores nationwide and a robust ecommerce platform. J.Jill is headquartered outside Boston.
How We Assess the Performance of Our Business
In assessing the performance of our business, we consider a variety of financial and operating metrics, including accounting principles generally accepted in the United States of America (“GAAP”) and non-GAAP measures, such as:
Net sales consist primarily of revenues, net of merchandise returns and discounts, generated from the sale of apparel and accessory merchandise through our Retail and Direct channels. Net sales also include shipping and handling fees collected from customers, and royalty revenues and marketing reimbursements related to our private label credit card agreement. Retail revenue is recognized at the time of sale and Direct revenue is recognized upon shipment of merchandise to the customer.
Net sales are impacted by the size of our active customer base, product assortment and availability, marketing and promotional activities and the spending habits of our customers. Net sales are also impacted by the migration of single-channel customers to omnichannel customers who, on average, spend three times more than single-channel customers.
Total company comparable sales include net sales from our retail stores that have been open for more than 52 weeks and from our Direct channel. This measure highlights the performance of existing stores open during the period, while excluding the impact of new store openings and closures. When a store in the total company comparable store base is temporarily closed for four or more days within a fiscal week, the store is excluded from the comparable store base; if it is temporarily closed for three or fewer days within a fiscal week, the store is included within the comparable store base. Certain of our competitors and other retailers may calculate total company comparable sales differently than we do. As a result, the reporting of our total company comparable sales may not be comparable to sales data made available by other companies.
Number of stores reflects all stores open at the end of a reporting period. In connection with opening new stores, we incur pre-opening costs. Pre-opening costs include expenses incurred prior to opening a new store and primarily consist of payroll, travel, training, marketing, initial opening supplies and costs of transporting initial inventory and fixtures to retail stores, as well as occupancy costs incurred from the time of possession of a store site to the opening of that store. In connection with closing stores, we incur store-closing costs. Store-closing costs primarily consist of lease termination penalties and costs of transporting inventory and fixtures to other store locations. These pre-opening and store-closing costs are included in selling, general and administrative expenses and are generally incurred and expensed within 30 days of opening a new store or closing a store.
Gross profit is equal to our net sales less costs of goods sold. Gross profit as a percentage of our net sales is referred to as gross margin.
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Costs of goods sold (“COGS”) includes the direct costs of sold merchandise, inventory shrinkage, and adjustments and reserves for excess, aged and obsolete inventory. We review our inventory levels on an ongoing basis to identify slow-moving merchandise and use markdowns to liquidate these products. Changes in the assortment of our products may also impact our gross profit. The timing and level of markdowns are driven by customer acceptance of our merchandise. The Company’s COGS, and consequently gross profit, may not be comparable to those of other retailers, as inclusion of certain costs vary across the industry.
The variability in COGS is due to raw materials, transportation and freight costs. These costs fluctuate based on certain factors beyond our control, including labor conditions, inbound transportation or freight costs, energy prices, currency fluctuations and commodity prices. We place orders with merchandise suppliers in U.S. dollars and, as a result, are not exposed to significant foreign currency exchange risk.
Selling, general and administrative expenses include all operating costs not included in COGS. These expenses include all payroll and related expenses, occupancy costs, information systems costs and other operating expenses related to our stores and to our operations at our headquarters, including utilities, depreciation and amortization. These expenses also include marketing expense, including catalog production and mailing costs, warehousing, distribution and outbound shipping costs, customer service operations, consulting and software services, professional services and other administrative costs. Additionally, our outbound shipping costs may fluctuate due to surcharges from shipping vendors based on demand for shipping services.
Our historical revenue growth has been accompanied by increased selling, general and administrative expenses. The most significant increases were in marketing and payroll investments.
Adjusted earnings before interest, taxes, depreciation and amortization (“Adjusted EBITDA”) and Adjusted EBITDA Margin. Adjusted EBITDA, represents net income (loss) plus net interest expense, provision (benefit) for income taxes, depreciation and amortization, equity-based compensation expense, goodwill and indefinite-lived intangible assets impairment, write-off of property and equipment, fair value adjustments, and other non-recurring expenses, primarily consisting of outside legal and professional fees associated with certain non-recurring transactions and events. We present Adjusted EBITDA on a consolidated basis because management uses it as a supplemental measure in assessing our operating performance, and we believe that it is helpful to investors, securities analysts and other interested parties as a measure of our comparative operating performance from period to period. We also use Adjusted EBITDA as one of the primary methods for planning and forecasting overall expected performance of our business and for evaluating on a quarterly and annual basis actual results against such expectations. Further, we recognize Adjusted EBITDA as a commonly used measure in determining business value and as such, use it internally to report results. Adjusted EBITDA margin represents, for any period, Adjusted EBITDA as a percentage of net sales.
While we believe that Adjusted EBITDA is useful in evaluating our business, Adjusted EBITDA is a non-GAAP financial measure that has limitations as an analytical tool. Adjusted EBITDA should not be considered an alternative to, or substitute for, net income (loss), which is calculated in accordance with GAAP. In addition, other companies, including companies in our industry, may calculate Adjusted EBITDA differently or not at all, which reduces the usefulness of Adjusted EBITDA as a tool for comparison. We recommend that you review the reconciliation of Adjusted EBITDA to net income, the most directly comparable GAAP financial measure, and the calculation of the resultant Adjusted EBITDA margin below and not rely solely on Adjusted EBITDA or any single financial measure to evaluate our business.
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Reconciliation of Net Income (Loss) to Adjusted EBITDA and Calculation of Adjusted EBITDA Margin
The following table provides a reconciliation of net income (loss) to Adjusted EBITDA and the calculation of Adjusted EBITDA margin for the periods presented:
| For the Fiscal Year Ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in thousands) | January 28, 2023 | January 29, 2022 | January 30, 2021 | |||||||||
| Statements of Operations Data: | ||||||||||||
| Net income (loss) | $ | 42,175 | $ | (28,143 | ) | $ | (139,404 | ) | ||||
| Fair value adjustment of derivative | — | 2,775 | 1,005 | |||||||||
| Fair value adjustment of warrants - related party (a) | — | 56,984 | 4,214 | |||||||||
| Interest expense, net | 15,946 | 17,057 | 17,695 | |||||||||
| Interest expense, net - related party | 4,114 | 2,029 | 534 | |||||||||
| Income tax provision (benefit) | 16,499 | 8,018 | (48,162 | ) | ||||||||
| Depreciation and amortization | 25,761 | 29,258 | 33,696 | |||||||||
| Equity-based compensation expense (b) | 3,505 | 2,610 | 2,160 | |||||||||
| Write-off of property and equipment (c) | 267 | 940 | 969 | |||||||||
| Impairment of goodwill and intangible assets | — | — | 32,520 | |||||||||
| Adjustment for exited retail stores (d) | (250 | ) | (1,755 | ) | (1,444 | ) | ||||||
| Impairment of long-lived assets (e) | 1,413 | — | 33,777 | |||||||||
| Transaction costs (f) | — | — | 21,914 | |||||||||
| Other non-recurring items (g) | 7 | 2,013 | 2,820 | |||||||||
| Adjusted EBITDA | $ | 109,437 | $ | 91,786 | $ | (37,706 | ) | |||||
| Net sales | $ | 615,268 | $ | 585,206 | $ | 426,730 | ||||||
| Adjusted EBITDA margin | 17.8 | % | 15.7 | % | (8.8 | )% |
(a)
The fair value adjustment of warrants increased due to the increase in J.Jill’s stock price since January 30, 2021.
(b)
Represents expenses associated with equity incentive instruments granted to our management and board of directors. Incentive instruments are accounted for as equity-classified awards with the related compensation expense recognized based on fair value at the date of the grant.
(c)
Represents the net gain or loss on the disposal of fixed assets.
(d)
Represents non-cash gains associated with exiting store leases earlier than anticipated.
(e)
Represents impairment of long-lived assets related primarily to the right-of-use assets and leasehold improvements.
(f)
Represents items management believes are not indicative of ongoing operating performance. In Fiscal Year 2020, these expenses are primarily composed of legal and advisory costs.
(g)
Represents items management believes are not indicative of ongoing operating performance. In Fiscal Years 2021 and 2020, these expenses are primarily composed of incremental one-time costs related to COVID-19.
Items Affecting the Comparability of our Results of Operations
Impairment losses. Our Fiscal Year 2022 and 2020 results include impairment charges of $1.4 million for long-lived assets (operating lease right-of-use asset, leasehold improvements and furniture, fixtures and equipment) and $66.3 million for long-lived assets (operating lease right-of-use asset and leasehold improvements), goodwill and intangible assets, respectively. See Note 6. Goodwill and Other Intangible Assets and Note 7. Property and Equipment, in the notes to the financial statements included elsewhere in this Annual Report, for additional information on these impairment losses.
Fair value adjustments. Fair value adjustments consist of the mark-to-market of warrants and derivative liabilities related to the debt restructuring consummated on September 30, 2020. These fair value adjustments were due to the increase in J.Jill’s stock price from January 30, 2021 through May 31, 2021. Effective May 31, 2021, these liabilities were reclassified to equity because from that date they can only be settled by exercise of the warrants into common stock. Our Fiscal Year 2021 results include fair value adjustments totaling $59.8 million. Our Fiscal Year 2020 results include fair value adjustments totaling $5.2 million. See Note 14. Net Income (Loss) Per Share, in the notes to the financial statements included elsewhere in this Annual Report, for additional information on these fair value adjustments.
COVID-19 impact. Our first and second quarter of Fiscal Year 2020 financial results were significantly impacted by COVID-19 as our stores were temporarily closed beginning in mid-March 2020 through most of the second quarter of Fiscal Year 2020 in efforts to stop the spread of the virus. Although the stores were temporarily closed and the Company lost revenues as a result, we continued to incur certain expenses, such as payroll and rent; therefore, ratios and other items may not be comparable to our Fiscal Year 2022 and 2021 financial results.
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Results of Operations
Fiscal Year Ended January 28, 2023 compared to Fiscal Year Ended January 29, 2022
The following table summarizes our consolidated results of operations for the periods indicated:
| For the Fiscal Year Ended | Change from Year Ended January 29, 2022 to the Year | |||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in thousands) | January 28, 2023 | January 29, 2022 | Ended January 28, 2023 | |||||||||||||||||||||
| Dollars | % of Net Sales | Dollars | % of Net Sales | $ Change | % Change | |||||||||||||||||||
| Net sales | $ | 615,268 | 100.0 | % | $ | 585,206 | 100.0 | % | $ | 30,062 | 5.1 | % | ||||||||||||
| Costs of goods sold | 193,218 | 31.4 | % | 190,770 | 32.6 | % | 2,448 | 1.3 | % | |||||||||||||||
| Gross profit | 422,050 | 68.6 | % | 394,436 | 67.4 | % | 27,614 | 7.0 | % | |||||||||||||||
| Selling, general and administrative expenses | 341,903 | 55.6 | % | 335,716 | 57.4 | % | 6,187 | 1.8 | % | |||||||||||||||
| Impairment of long-lived assets | 1,413 | 0 | % | — | — | 1,413 | 100.0 | % | ||||||||||||||||
| Operating income | 78,734 | 12.8 | % | 58,720 | 10.0 | % | 20,014 | 34.1 | % | |||||||||||||||
| Fair value adjustment of derivative | — | — | 2,775 | 0.5 | % | (2,775 | ) | (100.0 | )% | |||||||||||||||
| Fair value adjustment of warrants - related party | — | — | 56,984 | 9.7 | % | (56,984 | ) | (100.0 | )% | |||||||||||||||
| Interest expense, net | 15,946 | 2.6 | % | 17,057 | 2.9 | % | (1,111 | ) | (6.5 | )% | ||||||||||||||
| Interest expense, net - related party | 4,114 | 0.7 | % | 2,029 | 0.3 | % | 2,085 | 102.8 | % | |||||||||||||||
| Income (loss) before provision for income taxes | 58,674 | 9.5 | % | (20,125 | ) | (3.4 | )% | 78,799 | 391.5 | % | ||||||||||||||
| Income tax provision | 16,499 | 2.7 | % | 8,018 | 1.4 | % | 8,481 | 105.8 | % | |||||||||||||||
| Net income (loss) | $ | 42,175 | 6.9 | % | $ | (28,143 | ) | (4.8 | )% | $ | 70,318 | 249.9 | % |
Net Sales
Net sales for Fiscal Year 2022 increased $30.1 million or 5.1%, to $615.3 million from $585.2 million for Fiscal Year 2021. The increase in net sales was due to total company comparable sales increase of 6.5%. Net sales benefited from higher full-price sales as compared to Fiscal Year 2021.
Our Direct channel was responsible for 46.8% of our net sales in Fiscal Year 2022 compared to 49.8% in Fiscal Year 2021. Our Retail channel was responsible for 53.2% of our net sales in Fiscal Year 2022 and 50.2% in Fiscal Year 2021. We operated 243 and 253 retail stores at the end of these same periods, respectively.
Gross Profit and Cost of Goods Sold
Gross profit for Fiscal Year 2022 increased $27.6 million, or 7.0%, to $422.1 million from $394.4 million for Fiscal Year 2021. The gross margin for Fiscal Year 2022 was 68.6% compared to 67.4% for Fiscal Year 2021, largely driven by favorable promotional rates and the increase in Retail channel sales accompanied by strong full price sales in the same channel.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for Fiscal Year 2022 increased $6.2 million, or 1.8%, to $341.9 million from $335.7 million for Fiscal Year 2021. The increase is driven by a $4.2 million increase in marketing costs, $3.1 million increase in compensation and benefits, a $1.4 million increase in shipping costs, and a $0.9 million increase in equity-based compensation expense, offset by a $3.5 million decrease in depreciation and amortization. The increase in marketing costs was primarily due to a $2.2 million increase in print media and catalog costs, and $2.0 million increase in paid search and digital media expenses. The increase in compensation and benefits was primarily due to a $2.2 million increase in hourly and part-time wages and salaries expense, and a $0.8 million increase in benefits expense.
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Fair Value Adjustments
Fair value adjustments consist of the mark-to-market of warrants and derivative liabilities related to the debt restructuring consummated on September 30, 2020.
Interest Expense, net
Interest expense, net consists of interest expense on the Credit Facilities, partially offset by interest earned on cash. Interest expense for Fiscal Year 2022 increased by $1.0 million, or 5.2%, to $20.1 million from $19.1 million for Fiscal Year 2021. The increase was driven by higher interest rates.
Income Tax Provision
The income tax provision for Fiscal Year 2022 was $16.5 million compared to $8.0 million for Fiscal Year 2021. Our effective tax rates were 28.1% and (39.8)%, respectively. The effective tax rate during Fiscal Year 2022 differs from the federal statutory rate of 21.0% due primarily to the impacts of (i) state and local income taxes, (ii) executive compensation limitations, (iii) valuation allowance changes, and(iv) tax return to provision adjustments. The Company paid $19.7 million in cash for income taxes during Fiscal Year 2022 and received a tax refund of approximately $10.3 million relating to prior years.
The effective tax rate for Fiscal Year 2021 differs from the federal statutory rate of 21.0% due primarily to the impacts of (i) nondeductible fair value adjustments of the warrants and derivative, (ii) state and local income taxes, (iii) executive compensation limitations, and (iv) valuation allowance adjustments related to state and local income taxes. Refer to Note 13. Income Taxes to the consolidated financial statements for additional income tax information. The Company paid $9.3 million in cash for income taxes during Fiscal Year 2021 and received a tax refund of approximately $17.5 million relating to prior years.
Liquidity and Capital Resources
General
Our primary sources of liquidity and capital resources are cash and cash equivalents generated from operating activities and availability under our ABL Facility. On April 15, 2022, we entered into an Amendment No. 5 to our ABL Credit Agreement (the “ABL Amendment”), by and among the Company, Jill Acquisition LLC, J.Jill Gift Card Solutions, Inc., Jill Intermediate LLC, the other guarantors party thereto, the other lenders party thereto and CIT Finance LLC, as the administrative agent and collateral agent. The ABL Amendment (i) extended the maturity date of the ABL Facility from May 8, 2023 to May 8, 2024, provided that if by November 4, 2023, the Priming Facility maturity date has not been appropriately extended to a date that is at least November 4, 2024, then the ABL Facility maturity date will automatically be deemed to be November 4, 2023, and (ii) changed the benchmark interest rate applicable to the loans under the ABL Facility from LIBOR to SOFR. As of January 28, 2023, we had $87.1 million in cash and cash equivalents and $30.0 million of total availability under our $40.0 million ABL Facility.
Also, in Fiscal Year 2021, we received $17.5 million of a total expected federal income tax refund of approximately $26.7 million related to Fiscal Year 2020. In Fiscal Year 2022, the Company received the remaining expected refund of $9.2 million, bringing the total refund proceeds to $26.7 million. The tax refund amount benefited from the provisions under the CARES Act enacted in March 2020 most significantly from the provision that allows for net operating losses in Fiscal Year 2020 to be carried back to earlier tax years with higher tax rates than the current year.
The Credit Agreements include customary negative covenants, including covenants limiting the ability of the Company to, among other things, incur additional indebtedness, create liens on assets, make investments, loans or advances, engage in mergers, consolidations, sales of assets and purchases, pay dividends and distributions, enter into transactions with affiliates, and make payments in respect of junior indebtedness. Each of the Priming Credit Agreement, the Subordinated Term Loan Credit Agreement and the ABL Credit Agreement also has certain financial covenants (see Note 9. Debt to the audited consolidated financial statements included in this Annual Report). As of January 28, 2023, the Company is in compliance with all such covenants.
Under the Priming Credit Agreement, the Company had certain payment obligations during Fiscal Year 2021. On May 31, 2021, the Company had the choice to either (i) repay $4.9 million in aggregate principal amount of the loans under the Priming Credit Agreement, together with accrued and unpaid interest thereon or (ii) issue additional shares of Common Stock to the lenders party to the Priming Credit Agreement in an amount as defined in the Agreement. On May 31, 2021, the Company chose to issue 272,097 shares to the Priming Lenders, with a value of approximately $5.2 million (based on the value of those shares as of close on that date), rather than repaying the $4.9 million since the minimum liquidity covenant would have increased to $25.0 million from $15.0 million if the Company had chosen to repay the $4.9 million of principal.
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In addition, the Priming Credit Agreement provided for a principal paydown of at least $25.0 million by August 30, 2021. The principal payment of $25.0 million, which was generated by operating cash flows, was made on August 27, 2021, avoiding additional PIK interest and fees.
Cash Flow Analysis
The following table shows our cash flows information for the periods presented:
| For the Fiscal Year Ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in thousands) | January 28, 2023 | January 29, 2022 | January 30, 2021 | |||||||||
| Net cash provided by (used in) operating activities | $ | 74,425 | $ | 74,999 | $ | (34,811 | ) | |||||
| Net cash used in investing activities | (15,067 | ) | (5,474 | ) | (3,805 | ) | ||||||
| Net cash (used in) provided by financing activities | (8,262 | ) | (37,975 | ) | 21,496 |
Net Cash provided by Operating Activities
Net cash provided by operating activities during Fiscal Year 2022 decreased $0.6 million as compared to Fiscal Year 2021. Higher net income for Fiscal Year 2022 was offset by the increase in cash used for working capital of $14.9 million compared with Fiscal Year 2021. Working capital cash uses consisted of lower cash inflows relating to prepaid expenses and other current assets of $8.3 million driven primarily by the lower collection of income tax receivables in the current year, and accrued expenses and other current liabilities of $4.4 million due mainly to the impact of product returns, partially offset by the timing of other accruals, and accounts payable of $4.4 million and accounts receivable of $3.2 million due to the timing of payments. These net cash uses were partially offset by higher cash inflows from inventories of $3.4 million due to decreased inventory levels and the net change in operating lease assets and liabilities of $2.1 million.
Net cash provided by operating activities during Fiscal Year 2022 was $74.4 million. Key elements of cash provided by operating activities were (i) net income of $42.2 million, (ii) adjustments to reconcile net income to net cash provided by operating activities of $35.4 million, primarily driven by $25.8 million of depreciation and amortization, and (iii) the use of cash from net operating assets and liabilities of $3.1 million, primarily driven by accounts payable and operating lease assets and liabilities, partially offset by changes in merchandise inventory and prepaid expenses and other current assets.
Net cash provided by operating activities during Fiscal Year 2021 was $75.0 million. Key elements of cash provided by operating activities were (i) net loss of $28.1 million, (ii) adjustments to reconcile net income to net cash provided by operating activities of $91.3 million, primarily driven by the noncash change in fair value of warrants, depreciation and amortization, and (iii) a source of cash from net operating assets and liabilities of $11.8 million, primarily driven by the receipt of the income tax refund, partially offset by payments for merchandise inventory and rents for retail stores that were deferred into Fiscal Year 2021 from Fiscal Year 2020.
Net Cash used in Investing Activities
Net cash used in investing activities during Fiscal Year 2022 was $15.1 million, an increase of $9.6 million as compared to Fiscal Year 2021, representing purchases of property and equipment related investments in stores and information systems.
Net Cash used in Financing Activities
Net cash used in financing activities during Fiscal Year 2022 decreased as compared to the prior year due to a voluntary principal payment on the Priming Facility and net repayments on the ABL Facility in Fiscal Year 2021.
Net cash used in financing activities during Fiscal Year 2022 was $8.3 million, which was driven by the $5.0 million repayment of the Existing Term Loan and $2.1 million principal payment on the Priming Facility.
Net cash used in financing activities during Fiscal Year 2021 was $38.0 million, which was driven by the $25.0 million voluntary principal payment on the Priming Facility, which was made to avoid increased PIK interest and fees, and net payments of $11.1 million on the ABL Facility.
Dividends
The payment of cash dividends in the future, if any, will be at the discretion of our board of directors and will depend upon such factors as earnings levels, capital requirements, restrictions imposed by applicable law, our overall financial condition, restrictions in our debt agreements and any other factors deemed relevant by our board of directors. As a holding company, our ability to pay dividends depends on our receipt of cash dividends from our operating subsidiaries, which may
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further restrict our ability to pay dividends as a result of restrictions on their ability to pay dividends to us under our debt agreements and under future indebtedness that we or they may incur.
Capitalization
At January 28, 2023, long-term debt consisted of the following:
| Carrying Value of Debt | ||||
|---|---|---|---|---|
| January 28, 2023 | ||||
| Priming Facility (principal of $201,349) | 198,941 | |||
| Subordinated Term Loan Facility (principal and paid-in kind interest of $20,548) | 9,719 | |||
| Less: Current portion | (3,424 | ) | ||
| Net long-term debt | $ | 205,236 |
The Company had no short-term borrowings under the Company’s ABL Facility as of January 28, 2023. The Company had outstanding letters of credit in the amount of $7.0 million and had a maximum additional borrowing capacity of $30.0 million as of January 28, 2023. The Company was in compliance with all debt covenants as of January 28, 2023.
The maturity date of the Priming Credit Agreement is May 8, 2024. The Company intends to refinance this debt and, in connection with a refinancing, use cash on hand to reduce the amount borrowed.
The loans under the Priming Credit Agreement bear interest at the Company’s election at: (1) Base Rate (as defined in the Priming Credit Agreement) plus 4.00% or (2) LIBOR plus 5.00%, with a minimum LIBOR per annum of 1.00%, with the interest payable on a quarterly basis. The Priming Credit Agreement required a principal paydown of at least $25.0 million by August 30, 2021; otherwise, there would be a Paid-in-Kind (“PIK”) interest rate increase and a PIK fee. On August 27, 2021, the Company made the principal paydown of $25.0 million to avoid additional PIK and interest fees.
On May 31, 2021, the Company had the choice (the “May 31, 2021 Option”) to either (i) repay $4.9 million in aggregate principal amount of the loans under the Priming Credit Agreement, together with accrued and unpaid interest thereon or (ii) issue additional shares of Common Stock to the Priming Lenders in an amount as defined in the Priming Credit Agreement. On May 31, 2021, and within the terms of the Priming Facility, the Company chose to issue 272,097 additional shares of Common Stock to the lenders party to the Priming Credit Agreement with a value of approximately $5.2 million (based on the value of those shares as of close on that date).
The maturity date of the Subordinated Term Loan Facility is November 8, 2024. Loans under the Subordinated Term Loan Facility bear interest at the Borrower’s election at (1) Base Rate (as defined in the Subordinated Term Loan Facility) plus 11.00% or (2) LIBOR plus 12.00%, with a minimum LIBOR per annum of 1.00%.
On April 15, 2022, the Company entered into an Amendment No. 5 to its ABL Credit Agreement, the ABL Amendment (i) extended the maturity date of the ABL Facility from May 8, 2023 to May 8, 2024, provided that if by November 4, 2023, the Priming Facility maturity date has not been appropriately extended to a date that is at least November 4, 2024, then the ABL Facility maturity date will automatically be deemed to be November 4, 2023, and (ii) changed the benchmark interest rate applicable to the loans under the ABL Facility from LIBOR to SOFR. The ABL Facility allows us to elect, at our own option, the applicable interest rate for borrowings under the ABL Facility using a SOFR or Base Rate variable interest rate plus an applicable margin. SOFR loans under the ABL Facility accrue interest at a rate equal to SOFR plus a spread ranging from 2.25% to 2.50%, subject to availability. Base Rate loans under the ABL Facility accrue interest at a rate equal to (i) the highest of (a) the prime rate, (b) the overnight Federal Funds Effective Rate plus 0.50%, (c) most recently available Adjusted SOFR (as adjusted by any Floor) plus 1% (ii) a spread ranging from 1.25% to 1.50%, subject to availability. Principal is payable upon maturity of the ABL Facility on its termination date. The ABL Facility also requires the payment of monthly fees based on the average quarterly unused portion of the commitment, as well as a fee on the balance of the outstanding letters of credit.
Future Cash Requirements
We enter into contractual obligations in the ordinary course of business that may require future cash payments. Such obligations include merchandise inventories, marketing, including catalog production and distribution, payroll, store occupancy costs and capital expenditures associated with opening new stores, remodeling existing stores and upgrading information systems. The notes to the financial statements included elsewhere in this Annual Report provide additional information.
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We believe our sources of liquidity, namely operating cash flows and credit facility capacity will continue to be adequate to meet our contractual obligations, working capital and capital expenditure requirements, finance anticipated expansion and strategic initiatives, and fund debt maturities for the foreseeable future. We expect capital expenditures in the next twelve months to support opening of new stores, store design/ remodels, and system upgrades and maintenance projects.
Off Balance Sheet Arrangements
We are not a party to any off balance sheet arrangements.
Critical Accounting Policies and Significant Estimates
Our discussion of results of operations and financial condition is based upon the consolidated financial statements included elsewhere in this Annual Report, which have been prepared in accordance with GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and certain assumptions about future events that affect the classification and amounts reported in our consolidated financial statements and accompanying notes, including revenue and expenses, assets and liabilities, and the disclosure of contingent assets and liabilities. These estimates and assumptions are based on our historical results as well as management’s judgment. Although management believes the judgment applied in preparing estimates is reasonable based on circumstances and information known at the time, actual results could vary materially from estimates based on assumptions used in the preparation of our consolidated financial statements.
The most significant accounting estimates involve a high degree of judgment or complexity. Management believes the estimates and judgments most critical to the preparation of our consolidated financial statements and to the understanding of our reported financial results include those made in connection with revenue recognition, including accounting for outstanding gift cards that will ultimately not be redeemed (“gift card breakage”) and estimated merchandise returns; estimating the value of inventory; and impairment assessments for goodwill and other indefinite-lived intangible assets, and long-lived assets. Management evaluates its policies and assumptions on an ongoing basis. Our significant accounting policies related to these accounts in the preparation of our consolidated financial statements are described below (see Note 2. Summary of Significant Accounting Policies to our audited consolidated financial statements presented elsewhere in this Annual Report for additional information regarding our critical accounting policies).
Revenue Recognition
Revenue is primarily derived from the sale of apparel and accessory merchandise through our Retail and Direct channels, which includes website and catalog phone orders. Revenue also includes shipping and handling fees collected from customers. The Company recognizes revenue when its single performance obligation is met at the time when the control of the promised goods or services are transferred to customers at an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. Revenue from our Retail channel is recognized at the time of sale and revenue from our Direct channel is recognized upon shipment of merchandise to the customer.
The Company has a return policy where merchandise returns will be accepted within 90 days of the original purchase date. At the time of sale, the Company records an estimated sales reserve for merchandise returns based on historical prior returns experience and expected future returns. The estimated sales reserve is recorded as a return asset (and corresponding adjustment to cost of goods sold) for the cost of inventory and a return liability for the amount to settle the return with a customer (and a corresponding adjustment to revenue). The return asset and return liability are recorded in Prepaid expenses and other current assets, and Accrued expenses and other current liabilities, respectively, in the consolidated balance sheets. The Company collects and remits sales and use taxes in all states in which retail and direct sales occur and taxes are applicable. These taxes are reported on a net basis and are thereby excluded from revenue.
The Company sells gift cards without expiration dates to customers. The Company does not charge administrative fees on unused gift cards. Proceeds from the sale of gift cards are recorded as a contract liability until the customer redeems the gift card or when the likelihood of redemption is remote. Based on historical experience, the Company estimates the value of gift card breakage and will not be escheated under statutory unclaimed property laws. This gift card breakage is recognized as revenue over the time period established by the Company’s historical gift card redemption pattern.
The Company recognizes revenues from shipments to customers when the shipping and handling activities occur and will accrue those related costs. Shipping and handling costs are recorded in selling, general and administrative expenses.
Merchandise Inventory
Inventory consists of finished goods merchandise held for sale to our customers. Inventory is stated at the lower of cost or net realizable value. Cost is calculated using the weighted average method of accounting, and includes the cost to purchase merchandise from our manufacturers, duties, tariffs, inbound freight and commissions.
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In the normal course of business, we record inventory reserves by applying estimates, based on past and projected sales performance, to the inventory on hand. The carrying value of inventory is reduced to estimated net realizable value when factors indicate that merchandise will not be sold on terms sufficient to recover its cost.
We monitor inventory levels, sales trends and sales forecasts to estimate and record reserves for excess, slow-moving and obsolete inventory. We utilize internal channels, including sales catalogs, the internet, and price reductions in retail and outlet stores to liquidate excess inventory. In some cases, external channels such as inventory liquidators are utilized. The prices obtained through these off-price selling methods vary based on many factors. Accordingly, estimates of future sales prices require management judgment based on historical experience, assessment of current conditions and assumptions about future transactions. We have not made significant changes to our assumptions during the periods presented in our consolidated financial statements included elsewhere in this Annual Report, and estimates have not varied significantly from historically recorded amounts.
Asset Impairment Assessments
Goodwill
We evaluate goodwill annually at year end to determine whether the carrying value reflected on the balance sheet is recoverable, and more frequently if events or circumstances indicate that the fair value of a reporting unit is less than its carrying value. Our two reporting units applicable to goodwill impairment assessments are defined as our Direct and Retail sales channels. Examples of impairment indicators that would trigger an impairment assessment of goodwill between annual evaluations include, among others, macro-economic conditions, competitive environment, industry conditions, changes in our profitability and cash flows, and changes in sales trends or customer demand.
We may assess our goodwill for impairment initially using a qualitative approach to determine whether conditions exist to indicate that it is more likely than not that the fair value of a reporting unit is less than its carrying value. If management concludes, based on assessment of relevant events, facts and circumstances, that it is more likely than not that a reporting unit’s fair value is greater than its carrying value, no further impairment testing is required.
If management’s assessment of qualitative factors indicates that it is more likely than not that the fair value of a reporting unit is less than its carrying value, then a quantitative assessment is performed. We also have the option to bypass the qualitative assessment described above and proceed directly to the quantitative assessment. The quantitative assessment requires comparing the fair value of a reporting unit to its carrying value, including goodwill. We estimate the fair value of reporting units using the income approach. The income approach uses a discounted cash flow analysis, which involves significant estimates and assumptions, including preparation of revenue and profitability growth forecasts, selection of the discount rate and the terminal year multiple.
If the fair value of a reporting unit exceeds its carrying amount, goodwill is not considered to be impaired and no further testing is required. If the carrying amount exceeds the reporting unit’s fair value, a goodwill impairment charge is recognized for the amount in excess, not to exceed the total amount of goodwill allocated to that reporting unit.
During Fiscal Year 2022 and 2021, we did not record any impairment to our goodwill. During Fiscal Year 2020, we performed quantitative assessments which resulted in goodwill impairment of $17.9 million. This analysis contains uncertainties because it requires us to make assumptions and to apply judgments to estimate industry economic factors and the profitability of future business strategies. If actual results are not consistent with our estimates and assumptions, we may be exposed to future impairment losses that could be material.
Indefinite-Lived Intangible Assets
Our trade name has been assigned an indefinite life as we currently anticipate that it will contribute cash flows to us indefinitely. Our trade name is reviewed at least annually to determine whether events and circumstances continue to support an indefinite, useful life.
We evaluate our trade name annually at year end for potential impairment, or whenever events or changes in circumstances indicate that its carrying value may not be recoverable. Conditions that may indicate impairment include, but are not limited to, significant loss of market share to a competitor, the identification of other impaired assets within a reporting unit, loss of key personnel that negatively and materially has an adverse effect on our operations, the disposition of a significant portion of a reporting unit or a significant adverse change in business climate or regulations.
Impairment losses are recorded to the extent that the carrying value of the indefinite-lived intangible asset exceeds its fair value. We measure the fair value of our trade name using the relief-from-royalty method, which estimates the present value of royalty income that could be hypothetically earned by licensing the brand name to a third party over the remaining useful life. The most significant estimates and assumptions inherent in this approach are the preparation of revenue forecasts, selection of the royalty and discount rates, and selection of the terminal year multiple.
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We did not record any impairment losses related to the trade name during Fiscal Year 2022 and 2021. In Fiscal Year 2020, we determined that an impairment loss of $12.0 million was required. This analysis contains uncertainties because it requires us to make assumptions and to apply judgments to estimate industry economic factors and the profitability of future business strategies. If actual results are not consistent with our estimates and assumptions, we may be exposed to future impairment losses that could be material.
Long-Lived Assets
Long-lived assets include definite-lived intangible assets (our customer list) subject to amortization, property and equipment and operating lease assets. Long-lived assets obtained in a business combination are recorded at the acquisition-date fair value, property and equipment purchased in the normal course of business is recorded at cost and operating lease assets are recorded at the present value of the lease payments.
We assess the carrying value of long-lived assets for potential impairment whenever indicators exist that the carrying value of an asset group might not be recoverable. Indicators of impairment include, among others, a significant decrease in the market price of an asset, a significant adverse change in the extent or manner in which an asset is being used or in its physical condition, and operating or cash flow performance that demonstrates continuing losses associated with an asset group.
When indicators of potential impairment exist, we compare the sum of estimated undiscounted future cash flows expected to result from the use and eventual disposition of the asset group to the carrying value of the asset group. If the carrying value of an asset group exceeds the sum of estimated undiscounted future cash flows, we record an impairment loss in the amount required to reduce carrying value of the asset group to fair value. We estimate the fair value of an asset group based on the present value of estimated future cash flows, calculated by discounting the cash flow projections used in the previous step.
We assessed the carrying value of our customer list as described above and determined that an impairment loss of $2.6 million was required during Fiscal Year 2020. The customer list impairment is recorded in impairment of intangible assets in the consolidated statement of operations and comprehensive income. We did not record any impairments of intangible assets during Fiscal Year 2022 and 2021.
During Fiscal Year 2022, we assessed the carrying values of right-of-use assets and property and equipment as described above. During Fiscal Year 2022, the Company recorded impairment charges of $0.6 million related primarily to a right-of-use asset relating to revised sublease assumptions of one floor of the corporate headquarters located in Quincy, Massachusetts that was vacated in July 2019 and $0.8 million due to the Company’s revised outlook on future cash flows at certain store locations. During Fiscal Year 2021, we did not record any impairments related to right-of-use assets and leasehold improvements. During Fiscal Year 2020, the Company recorded impairment charges of $23.0 million and $10.8 million related to right-of-use assets and leasehold improvements, respectively, associated with the assets of underperforming retail locations. Right-of-use asset and leasehold improvement impairments are recorded in impairment of long-lived assets in the consolidated statement of operations and comprehensive income.
Determining the fair value of long-lived assets requires management judgment and relies upon the use of significant estimates and assumptions, including future sales, our margins and cash flows, current and future market conditions, discount rates applied, useful lives and other factors. We believe our assumptions are reasonable based on available information. Changes in assumptions and estimates used in the impairment analysis, or future results that vary from assumptions used in the analysis, could affect the estimated fair value of long-lived intangible assets and could result in impairment charges in a future period.
Recent Accounting Pronouncements
See Note 3. Accounting Standards to our audited consolidated financial statements included elsewhere in this Annual Report for information regarding recently issued accounting pronouncements.
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