# LANDS' END, INC. (LE) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from LANDS' END, INC.'s 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/799288/000156459022011688/le-10k_20220128.htm
Accession: 0001564590-22-011688
Filing date: 2022-03-24
Report date: 2022-01-28
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/LE/
All MD&A years: /company/LE/mda/
Next year: /company/LE/mda/fy2023/ (FY 2023)

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion in conjunction with the Consolidated Financial Statements and accompanying notes included elsewhere in this Annual Report on Form 10-K. Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements. The matters discussed in these forward-looking statements are subject to risks, uncertainties, and other factors that could cause actual results to differ materially from those made, projected or implied in the forward-looking statements. See “Cautionary Statements Concerning Forward-Looking Statements” below and Item 1A, Risk Factors, in this Annual Report on Form 10-K for a discussion of the uncertainties, risks and assumptions associated with these statements.

This section discusses our results of operations for the year ended January 28, 2022 as compared to the year ended January 29, 2021. For a discussion and analysis of the year ended January 29, 2021 compared to January 31, 2020, please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Item 7 of our Annual Report on Form 10-K for the year ended January 29, 2021, filed with the SEC on March 25, 2021.

As used in this Annual Report on Form 10-K, references to the “Company”, “Lands’ End”, “we”, “us”, “our” and similar terms refer to Lands’ End, Inc. and its subsidiaries. Our fiscal year ends on the Friday preceding the Saturday closest to January 31.

Executive Overview

Description of the Company

Lands’ End is a leading uni-channel retailer of casual clothing, accessories, footwear and home products. Operating out of America’s heartland, we believe our vision and values make a strong connection with our core customers. We offer products online at www.landsend.com, through our own Company Operated stores and through third-party distribution channels. We are a classic American lifestyle brand with a passion for quality, legendary service and real value. We seek to deliver timeless style for women, men, kids and the home.

Lands’ End was founded in 1963 by Gary Comer and his partners to sell sailboat hardware and equipment by catalog. While our product focus has shifted significantly over the years, we have continued to adhere to our founder’s motto as one of our guiding principles: “Take care of the customer, take care of the employee and the rest will take care of itself.”

We seek to provide a common customer experience regardless of whether our customers are interacting with us on our company websites, at Company Operated stores or through third-party distribution channels.  

We have one external reportable segment and identify our operating segments according to how our business activities are managed and evaluated. Our operating segments consist of: U.S. eCommerce, Europe eCommerce, Japan eCommerce, Outfitters, Third Party, and Retail. We have determined that each of our operating segments share similar economic and other qualitative characteristics, and therefore, the results of our operating segments are aggregated into one external reportable segment.

Distribution Channels

We identify five separate distribution channels for revenue reporting purposes:

[[GREPCENT_TABLE]]
[["","\u2022","U.S. eCommerce offers products through our eCommerce website."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","International offers products primarily to consumers located in Europe and Japan through our eCommerce international websites and third-party affiliates."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","Outfitters sells uniform and logo apparel to businesses and their employees, as well as to student households through school relationships, located primarily in the U.S."]]
[[/GREPCENT_TABLE]]

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[[GREPCENT_TABLE]]
[["","\u2022","Third Party sells the same products as U.S. eCommerce direct to consumers through third-party marketplace websites and through domestic wholesale customers."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","Retail sells products through Company Operated stores."]]
[[/GREPCENT_TABLE]]

Impact of the COVID Pandemic

COVID surfaced in late 2019 and in March 2020, the World Health Organization declared COVID a pandemic. The onset of the COVID pandemic had a disruptive impact on our business operations and an unfavorable impact on our results of operations during the first half of Fiscal 2020. During the Second Quarter 2020, we began a recovery that continued to build on the momentum experienced before the COVID pandemic. Our strong foundation and ongoing enhancements across our four strategic pillars of product, digital, uni-channel distribution and infrastructure and business processes have supported us during the COVID pandemic and continue to support our financial performance and encouraging customer metrics. The ultimate timing and impact of customer demand levels across all distribution channels will depend on the duration and scope of the COVID pandemic, overall economic conditions and consumer preferences.

Health and Safety of Employees and Consumers

From the beginning of the COVID pandemic, our priority has been the safety of employees and customers. On March 16, 2020, we temporarily closed our Company Operated stores. These stores reopened during Second Quarter 2020. Since the onset of the COVID pandemic, we have taken extra precautions in our offices, distribution centers and Company Operated stores, which have varied from time to time based on the then current guidance from global, federal and state health authorities. These measures have included retail guidelines, work-from-home policies, social distancing, masking, thermal scanning and partitions in facilities. With the emergence of COVID variants and periodic increases in the number of reported cases affecting different regions, we have been required to keep these measures in place longer than anticipated.

Supply Chain

As with all industries, we experienced global supply chain challenges and we continually monitor our supply chain for manufacturing and transportation delays caused or exacerbated by the COVID pandemic. During Fiscal 2021, the COVID pandemic impacted our distribution process, third-party manufacturing partners and logistics partners, including shipping delays due to port congestion, and closure of certain third-party manufacturing facilities and production lines. These global supply chain challenges caused manufacturing, transport and receipt of inbound product delays, and resulted, at times, in lower inventory positions and higher than normal back orders. In addition, due to the global supply chain challenges we experienced increased transportation and distribution costs during the second half of Fiscal 2021.

We expect these global supply chain challenges and increases in transportation costs to continue throughout Fiscal 2022. These shipping delays and additional costs may continue to impact our future net sales, gross margin and net earnings depending upon the ultimate timing of delivery and availability of product.

Labor Shortage

We have and may continue to experience a U.S. labor shortage affecting our ability to staff and operate our U.S. distribution centers. Due to the seasonal nature of our business, we rely heavily on flexible part-time employees to staff our distribution centers in support of our peak seasons, including the back-to-school shopping season and fourth fiscal quarter holiday shopping season.

Expense Reduction

In First Quarter 2020, we took aggressive actions to reduce overall expenses as a response to decreased customer demand due to the COVID pandemic. We reduced our operating expenses and structural costs by enacting employee furloughs and temporary tiered salary reductions for the executive team and corporate staff. In addition, other discretionary operating expenses and planned capital expenditures for Fiscal 2020 were significantly reduced.

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As the COVID pandemic continues and new variants emerge, we will continue to monitor the impact of the COVID pandemic to manage overall expenses.

Basis of Presentation

The Consolidated Financial Statements have been prepared in accordance with GAAP and include the accounts of Lands’ End, Inc. and its subsidiaries. All intercompany transactions and balances have been eliminated.

Seasonality

We experience seasonal fluctuations in our net revenue and operating results and historically have realized a significant portion of our yearly net revenue and earnings during our fourth fiscal quarter. We generated 33.9% and 37.7% of our yearly net revenue in the fourth quarter of Fiscal 2021 and Fiscal 2020 respectively. The Fiscal 2021 percentage decrease of net revenue in the fourth quarter was primarily attributed to the global supply chain challenges. Thus, lower than expected fourth quarter net revenue has had and may continue to have an adverse impact on our annual operating results.

Working capital requirements typically increase during the second and third quarters of the fiscal year as inventory builds to support peak shipping/selling periods and typically decrease during the fourth quarter of the fiscal year as inventory is shipped/sold. Cash provided by operating activities is typically higher in the fourth quarter of the fiscal year due to reduced working capital requirements during that period.

Results of Operations

Fiscal Year. Our fiscal year end is on the Friday preceding the Saturday closest to January 31 each year. The fiscal periods in this report are presented as follows, unless the context otherwise requires:

[[GREPCENT_TABLE]]
[["Fiscal Year","","Ended","","Weeks"],["2021","","January 28, 2022","","52"],["2020","","January 29, 2021","","52"]]
[[/GREPCENT_TABLE]]

The following table sets forth, for the periods indicated, selected income statement data:

[[GREPCENT_TABLE]]
[["","","Fiscal 2021","","","Fiscal 2020"],["(in thousands)","","$\u2019s","","","% of Net Revenue","","","$\u2019s","","","% of Net Revenue"],["Net revenue","","$","1,636,624","","","","100.0","%","","$","1,427,448","","","","100.0","%"],["Cost of sales (excluding depreciation and amortization)","","","945,164","","","","57.8","%","","","821,595","","","","57.6","%"],["Gross profit","","","691,460","","","","42.2","%","","","605,853","","","","42.4","%"],["Selling and administrative","","","571,767","","","","34.9","%","","","518,897","","","","36.4","%"],["Depreciation and amortization","","","39,166","","","","2.4","%","","","37,343","","","","2.6","%"],["Other operating expense, net","","","741","","","","0.0","%","","","8,471","","","","0.6","%"],["Operating income","","","79,786","","","","4.9","%","","","41,142","","","","2.9","%"],["Interest expense","","","34,445","","","","2.1","%","","","27,754","","","","1.9","%"],["Other (income) expense, net","","","(628",")","","","(0.0",")%","","","796","","","","0.1","%"],["Income before income taxes","","","45,969","","","","2.8","%","","","12,592","","","","0.9","%"],["Income tax expense","","","12,600","","","","0.8","%","","","1,756","","","","0.1","%"],["Net income","","$","33,369","","","","2.0","%","","$","10,836","","","","0.8","%"]]
[[/GREPCENT_TABLE]]

Depreciation and amortization are not included in our cost of sales because we are a reseller of inventory and do not believe that including depreciation and amortization is meaningful. As a result, gross profit may not be comparable to other entities that include depreciation and amortization related to the sale of their product in their gross profit measure.

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Net Income and Adjusted EBITDA

We recorded Net income of $33.4 million and $10.8 million for Fiscal 2021 and Fiscal 2020, respectively. In addition to our Net income determined in accordance with GAAP, for purposes of evaluating operating performance, we use an Adjusted EBITDA measurement. Adjusted EBITDA is computed as Net income appearing on the Consolidated Statements of Operations net of Income tax expense, Interest expense, Depreciation and amortization and certain significant items set forth below. Our management uses Adjusted EBITDA to evaluate the operating performance of our business for comparable periods and as the basis for an executive compensation metric. The methods we use to calculate our non-GAAP financial measures may differ significantly from methods other companies use to compute similar measures. As a result, any non-GAAP financial measures presented herein may not be comparable to similar measures provided by other companies. Adjusted EBITDA should not be used by investors or other third parties as the sole basis for formulating investment decisions as it excludes a number of important cash and non-cash recurring items.

While Adjusted EBITDA is a non-GAAP measurement, management believes that it is an important indicator of operating performance, and useful to investors, because:

[[GREPCENT_TABLE]]
[["","\u2022","EBITDA excludes the effects of financings, investing activities and tax structure by eliminating the effects of interest, depreciation and income tax."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","Other significant items, while periodically affecting our results, may vary significantly from period to period and have a disproportionate effect in a given period, which affects comparability of results. We have adjusted our results for these items to make our statements more comparable and therefore more useful to investors as the items are not representative of our ongoing operations."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25aa","Corporate restructuring \u2013 severance costs associated with the reduction in corporate positions in Fiscal 2020."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25aa","Goodwill and long-lived asset impairment \u2013 charges associated with the non-cash write-down of goodwill and certain long-lived assets in Fiscal 2020."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25aa","Other \u2013 amortization of transaction related costs associated with our Third Party distribution channel in Fiscal 2021 and Fiscal 2020."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25aa","Loss on disposal of property and equipment \u2013 management considers the net gain or loss on asset valuation to result from investing decisions rather than ongoing operations in Fiscal 2021 and Fiscal 2020."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","","Fiscal 2021","","","Fiscal 2020"],["(in thousands)","","$\u2019s","","","% of Net Revenue","","","$\u2019s","","","% of Net Revenue"],["Net income","","$","33,369","","","","2.0","%","","$","10,836","","","","0.8","%"],["Income tax expense","","","12,600","","","","0.8","%","","","1,756","","","","0.1","%"],["Other (income) expense, net","","","(628",")","","","(0.0",")%","","","796","","","","0.1","%"],["Interest expense","","","34,445","","","","2.1","%","","","27,754","","","","1.9","%"],["Operating income","","","79,786","","","","4.9","%","","","41,142","","","","2.9","%"],["Depreciation and amortization","","","39,166","","","","2.4","%","","","37,343","","","","2.6","%"],["Corporate restructuring","","","\u2014","","","","\u2014","%","","","2,941","","","","0.2","%"],["Goodwill and long-lived asset impairment","","","\u2014","","","","\u2014","%","","","3,844","","","","0.3","%"],["Other","","","1,189","","","","0.1","%","","","383","","","","0.0","%"],["Loss on disposal of property and equipment","","","741","","","","0.0","%","","","1,303","","","","0.1","%"],["Adjusted EBITDA","","$","120,882","","","","7.4","%","","$","86,956","","","","6.1","%"]]
[[/GREPCENT_TABLE]]

In assessing the operational performance of our business, we consider a variety of financial measures. We operate in five separate distribution channels for revenue reporting purposes: U.S. eCommerce, International, Outfitters, Third Party and Retail. A key measure in the evaluation of our business is revenue performance by

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distribution channel. We also consider Gross profit and Selling and administrative expenses in evaluating the performance of our business.

We use Net revenue to evaluate revenue performance for the U.S. eCommerce, International, Outfitters and Third Party distribution channels. For our Retail distribution channel, we use Company Operated stores Same Store Sales as a key measure to evaluate performance. A store is included in Same Store Sales calculations when it has been open for at least 14 months and selling square footage has not changed by 15% or more within the past year. Online sales and sales generated through our in-store web portal are considered revenue in our U.S. eCommerce and International distribution channels and are excluded from Same Store Sales. Starting with First Quarter 2020, due to the COVID pandemic, we temporarily ceased using Same Store Sales as a key measure in evaluating performance and instead evaluated our Company Operated stores on sales productivity which was a metric measuring sales traffic and customer conversion. Beginning with Third Quarter 2021, we reverted back to Same Store Sales as we believe there is now greater comparability of year-on-year store and economic dynamics.

Discussion and Analysis

Fiscal 2021 Compared to Fiscal 2020

Net revenue

Total Net revenue for Fiscal 2021 was $1.64 billion, an increase of $209.2 million or 14.7% from Fiscal 2020.  U.S. eCommerce saw increased demand as customers reacted positively to the continued enhancements in our seasonal product assortments and digital capabilities. Outfitters saw stronger demand within our travel-related national accounts and school uniform households recovered to historical back-to-school shopping patterns. Third Party saw an increase with a full year of Kohl’s revenue as well as the impact of expanding our broader store assortment, during Third Quarter 2021, into an additional 150 Kohl’s retail locations, for a total of 300 retail locations.

Net revenue is presented by distribution channel in the following table:

[[GREPCENT_TABLE]]
[["(in thousands)","","Fiscal 2021","","% of Net Revenue","","","Fiscal 2020","","% of Net Revenue"],["U.S. eCommerce","","$","1,027,138","","62.8%","","","$","961,911","","67.4%"],["International","","","220,997","","13.5%","","","","222,878","","15.6%"],["Outfitters","","","254,191","","15.5%","","","","174,260","","12.2%"],["Third Party","","","86,517","","5.3%","","","","39,945","","2.8%"],["Retail","","","47,781","","2.9%","","","","28,454","","2.0%"],["Total Net revenue","","$","1,636,624","","","","","","$","1,427,448"]]
[[/GREPCENT_TABLE]]

U.S. eCommerce Net revenue was $1.03 billion in Fiscal 2021, an increase of $65.2 million or 6.8% from Fiscal 2020. The increase in U.S. eCommerce was primarily driven by stronger website traffic and a higher average order value as customers continued to react positively to the product assortments and digital capabilities, which drove a year over year increase in our new customers acquired and overall customer file, partially offset by the delayed inventory receipts due to global supply chain challenges in the second half of fiscal 2021.

International Net revenue was $221.0 million in Fiscal 2021, a decrease of $1.9 million or 0.8% from $222.9 million in Fiscal 2020. The decrease in International was due to softer demand in the second half of Fiscal 2021 primarily related to the delayed inventory receipts due to global supply chain challenges. The second half decrease was partially offset by the first half of Fiscal 2021 which was driven by implementing U.S. eCommerce initiatives in Europe eCommerce which resulted in stronger demand as customers reacted positively to the product assortments and digital capabilities.

Outfitters Net revenue was $254.2 million in Fiscal 2021, an increase of 45.9% from $174.3 million in Fiscal 2020. The increase was primarily attributed to stronger demand within our travel-related national accounts and

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school uniforms as households recovered to historical back-to-school shopping patterns offset by a slower recovery in our small and medium-sized business customers.

Third Party Net revenue was $86.5 million in Fiscal 2021, an increase of $46.6 million or 116.6% from $39.9 million in Fiscal 2020. The increase was primarily attributed to a full year of revenue with the full product assortment online on Kohls.com as well as the impact of expanding our broader store assortment, during Third Quarter 2021, into an additional 150 Kohl’s retail locations for a total of 300 retail locations.

Retail Net revenue was $47.8 million in Fiscal 2021, an increase of $19.3 million or 67.9% from $28.5 million in Fiscal 2020. Our U.S. Company Operated Stores experienced an increase of 32.4% in Same Store Sales as compared to the Fourth Quarter 2020. On January 28, 2022, there were 30 U.S. Company Operated stores compared to 31 U.S. Company Operated stores on January 29, 2021.  

Gross Profit

In Fiscal 2021, total Gross profit increased 14.1% to $691.5 million compared with $605.9 million for Fiscal 2020. Gross margin decreased 10 basis points to 42.3% of total Net revenue in Fiscal 2021 from 42.4% of total Net revenue in Fiscal 2020. The decrease was driven by increased shipping costs attributed to the global supply chain challenges during the second half of Fiscal 2021 and higher mix of sales from the lower-margin Third Party distribution channel, mostly offset by improved promotional strategies.

Selling and Administrative Expenses

Selling and administrative expenses were $571.8 million, or 35.0% of total Net revenue in Fiscal 2021 compared with $518.9 million, or 36.4% of total Net revenue in Fiscal 2020. The approximately 140 basis points decrease was driven by leverage on higher sales and continued expense controls slightly offset by increased digital marketing expenses, higher distribution center labor costs and non-recurring expense reductions taken at the onset of the COVID pandemic.

Depreciation and Amortization

Depreciation and amortization were $39.2 million in Fiscal 2021, an increase of $1.9 million or 4.9%, compared with $37.3 million in Fiscal 2020. The increase in Depreciation and amortization was primarily attributable to the continued investment in our digital information technology infrastructure.

Other Operating Expense, Net

Other operating expense, net was $0.7 million in Fiscal 2021 compared to $8.5 million in Fiscal 2020. The decrease of $7.8 million was primarily related to the $3.3 million impairment charge of goodwill allocated to our Japan eCommerce reporting unit and $2.9 million of corporate restructuring costs in Fiscal 2020.

Operating Income

Operating income was $79.8 million in Fiscal 2021, compared with $41.1 million in Fiscal 2020. The increase of $38.7 million was driven by the increase in Gross profit from the increased revenue partially offset by higher shipping costs attributed to the global supply chain challenges and higher Selling and administrative expenses.

Interest Expense

Interest expense was $34.4 million in Fiscal 2021, compared with $27.8 million in Fiscal 2020. The increase of $6.6 million in Interest expense was driven by higher interest rates associated with the Term Loan Facility.

Other (Income) Expense

Other income was $0.6 million in Fiscal 2021 compared to Other expense of $0.8 million in Fiscal 2020. The decrease in Other expense was attributed to a final payment in Second Quarter 2020 associated with the transitioning of a sourcing office.  

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Income Tax Expense

Income tax expense of $12.6 million was recorded for Fiscal 2021 which resulted in an effective tax rate of 27.4%. This compared to Income tax expense of $1.8 million in Fiscal 2020 which resulted in an effective tax rate of 13.9%. The Fiscal 2020 tax rate was lower than Fiscal 2021 due to a $3.1 million benefit as a result of the CARES Act.

Net Income

As a result of the above factors, Net income was $33.4 million, or $0.99 per diluted share in Fiscal 2021 compared to $10.8 million, or $0.33 per diluted share in Fiscal 2020.

Adjusted EBITDA

As a result of the above factors, Adjusted EBITDA increased 39.0% to $120.9 million in Fiscal 2021, compared to Adjusted EBITDA of $87.0 million in Fiscal 2020.

Liquidity and Capital Resources

Our primary need for liquidity is to fund working capital requirements of our business, capital expenditures, debt service and for general corporate purposes. Our cash and cash equivalents and the ABL Facility serve as sources of liquidity for short-term working capital needs and general corporate purposes. There was no balance outstanding for the revolving ABL Facility on January 28, 2022 other than for letters of credit. Cash generated from our net revenue and profitability, and somewhat to a lesser extent our changes in working capital, are driven by the seasonality of our business, with a significant amount of net revenue and operating cash flows generally occurring in the fourth fiscal quarter of each year. We expect that our cash on hand and cash flows from operations, along with borrowings on the ABL Facility, will be adequate to meet our capital requirements and operational needs for at least the next 12 months.

Description of Material Indebtedness

Debt Arrangements

Our $275.0 million revolving ABL Facility includes a $70.0 million sublimit for letters of credit and is available for working capital and other general corporate liquidity needs. There was no balance outstanding on January 28, 2022 and $25.0 million outstanding on January 29, 2021. The balance of outstanding letters of credit was $23.5 million and $27.1 million on January 28, 2022 and January 29, 2021, respectively.

During Fiscal 2020, we exercised the “accordion” feature under the ABL Facility increasing the maximum borrowings available under the facility from $175.0 million to $275.0 million, subject to a borrowing base (the “Loan Cap”). This was completed in two separate transactions. The first was a $25.0 million increase effective March 19, 2020 and the second was a $75.0 million increase effective September 9, 2020. The latter was completed through the Second Amendment to the ABL Facility executed on August 12, 2020.

On July 29, 2021, we executed the Third Amendment to the ABL Facility resulting in favorable financial terms compared to the Second Amendment to the ABL Facility and extension of the maturity date of the ABL Facility, as discussed below.

On September 9, 2020, we entered into the Term Loan Facility which provided borrowings of $275.0 million. Origination costs, including an Original Issue Discount (OID) of 3% and $5.1 million in debt origination fees were paid in connection with entering into the Term Loan Facility.

Interest; Fees

The Third Amendment to the ABL Facility lowered the interest rates applicable to borrowings under the ABL Facility.  For LIBOR loans, commencing July 31, 2021 the borrowing margin is, where the average daily total loans outstanding for the previous quarter are (i) less than $95.0 million, 1.25%, (ii) equal to or greater than $95.0 million but less than $180.0 million, 1.50%, and (iii) greater than or equal to $180.0 million, 1.75%. For Base Rate loans,

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the borrowing margin is, where the average daily total loans outstanding for the previous quarter are (i) less than $95.0 million, 0.50%, (ii) equal to or greater than $95.0 million but less than $180.0 million, 0.75%, and (iii) greater than or equal to $180.0 million, 1.00%. The Third Amendment to the ABL Facility replaced the 0.75% LIBOR floor with a 0.0% LIBOR floor.

The interest rates per annum applicable to the loans under the Term Loan Facility are based on a fluctuating rate of interest measured by reference to, at the borrower’s election, either (1) an adjusted LIBOR (with a minimum rate of 1.00%) plus 9.75% or (2) an alternative base rate (which is the greater of (i) the prime rate published in the Wall Street Journal, (ii) the federal funds rate, which shall be no lower than 0.00% plus ½ of 1.00%, or (iii) the one month LIBOR rate plus 1.00% per annum) plus 8.75%.  

Effective with the Third Amendment to the ABL Facility, the ABL Facility fees include (i) commitment fees of 0.25% based upon the average daily unused commitment (aggregate commitment less loans and letter of credit outstanding) under the ABL Facility for the preceding fiscal quarter and (ii) customary letter of credit fees.

Customary agency fees are payable in respect of the Debt Facilities.

Maturity; Amortization and Prepayments

The Third Amendment to the ABL Facility extended the maturity from November 16, 2022 to the earlier of (a) July 29, 2026 and (b) June 9, 2025 if, on or prior to such date, the Term Loan Facility has not been refinanced, extended or repaid in full in accordance with the terms thereof and not replaced with other indebtedness.

The Term Loan Facility matures on September 9, 2025 and amortizes at a rate equal to 1.25% per quarter. It is subject to mandatory prepayments in an amount equal to a percentage of the borrower’s excess cash flows in each fiscal year, ranging from 0% to 75% depending on our total leverage ratio, and with the proceeds of certain asset sales, casualty events and extraordinary receipts. Based upon Fiscal 2021 results, in accordance with the Term Loan Facility, there is no prepayment required. The loan may not be voluntarily prepaid during the first two years of its term, without significant penalties. After the initial two-year period, a prepayment premium of 3% applies to voluntary prepayments and certain mandatory prepayments made after September 9, 2022 and on or prior to September 9, 2023, 1% for such prepayments made after September 9, 2023 and on or prior to September 9, 2024, and no premium on such prepayments thereafter.

Guarantees; Security

All obligations under the Debt Facilities are unconditionally guaranteed by Lands’ End, Inc. and, subject to certain exceptions, each of its existing and future direct and indirect subsidiaries. The ABL Facility is secured by a first priority security interest in certain working capital of the borrowers and guarantors consisting primarily of accounts receivable and inventory. The Term Loan Facility is secured by a second priority security interest in the same collateral, with certain exceptions.

The Term Loan Facility is secured by a first priority security interest in certain property and assets of the borrowers and guarantors, including certain fixed assets such as real estate, stock of the subsidiaries and intellectual property, in each case, subject to certain exceptions. The ABL Facility is secured by a second priority interest in the same collateral, with certain exceptions.

Representations and Warranties; Covenants

Subject to specified exceptions, the Debt Facilities contain various representations and warranties and restrictive covenants that, among other things, restrict Lands’ End, Inc.’s and its subsidiaries’ ability to incur indebtedness (including guarantees), grant liens, make investments, make dividends or distributions with respect to capital stock, make prepayments on other indebtedness, engage in mergers or change the nature of their business.

The Term Loan Facility contains certain financial covenants, including a quarterly maximum total leverage ratio test, a weekly minimum liquidity test and an annual maximum capital expenditure amount.

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Under the ABL Facility, if excess availability falls below the greater of 10% of the Loan Cap amount or $15.0 million, we will be required to comply with a minimum fixed charge coverage ratio of 1.0 to 1.0.

The Debt Facilities contain certain affirmative covenants, including reporting requirements such as delivery of financial statements, certificates and notices of certain events, maintaining insurance and providing additional guarantees and collateral in certain circumstances.

As of January 28, 2022, we were in compliance with all of our covenants in the Debt Facilities.

Events of Default

The Debt Facilities include customary events of default including non-payment of principal, interest or fees, violation of covenants, inaccuracy of representations or warranties, cross defaults related to certain other material indebtedness, bankruptcy and insolvency events, invalidity or impairment of guarantees or security interests and material judgments and change of control.

Cash Flows from Operating Activities

Operating activities generated net cash of $70.6 million and $91.6 million in Fiscal 2021 and Fiscal 2020, respectively. Our primary source of operating cash flows is the sale of merchandise goods and services to customers, while the primary use of cash in operations is the purchase of merchandise inventories.

In Fiscal 2021, net cash provided by operating activities decreased $21.0 million compared to Fiscal 2020.  The increase in net income was offset by changes in working capital.

Cash Flows from Investing Activities

Net cash used in investing activities was $25.2 million and $30.1 million for Fiscal 2021 and Fiscal 2020, respectively. Cash used in investing activities for both years was primarily used for investments to update our digital information technology infrastructure.

For Fiscal 2022, we plan to invest approximately $37.0 million in capital expenditures for strategic investments and infrastructure, primarily in technology and general corporate needs.

Cash Flows from Financing Activities

Net cash used in financing activities was $45.1 million and $103.1 million for Fiscal 2021 and Fiscal 2020, respectively. The financing activities in Fiscal 2021 consisted of required principal payments of $13.8 million on the Term Loan Facility and net payments of $25.0 million on the ABL Facility. The financing activities in Fiscal 2020 consisted primarily of the refinancing of the Term Loan Facility.

Contractual Obligations and Off-Balance-Sheet Arrangements

We have no material off-balance-sheet arrangements other than the guarantees and contractual obligations that are discussed below.

Information concerning our obligations and commitments to make future payments under contracts such as lease agreements and other contingent commitments, as of January 28, 2022, is aggregated in the following table:

[[GREPCENT_TABLE]]
[["","","Payments Due by Period"],["(in thousands)","","Total","","","1 Year or less","","","2-3 Years","","","3-4 Years","","","After 5 years"],["Operating leases (1)","","$","48,063","","","$","9,240","","","$","13,880","","","$","10,843","","","$","14,100"],["Principal payments on long-term debt","","","257,813","","","","13,750","","","","27,500","","","","216,563","","","","\u2014"],["Interest on long-term debt and ABL Facility fees","","","102,450","","","","30,566","","","","56,218","","","","15,666","","","","\u2014"],["Purchase obligations (2)","","","423,956","","","","423,956","","","","\u2014","","","","\u2014","","","","\u2014"],["Total contractual obligations","","$","832,282","","","$","477,512","","","$","97,598","","","$","243,072","","","$","14,100"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(1)","Operating lease obligations consist primarily of future minimum lease commitments related to our operating leases (refer to Note 4, Leases, of the Consolidated Financial Statements for further details)."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(2)","Purchase obligations primarily represent open purchase orders for inventory."]]
[[/GREPCENT_TABLE]]

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Financial Instruments with Off-Balance-Sheet Risk

The $275.0 million ABL Facility includes a $70.0 million sublimit for letters of credit and the Third Amendment to the ABL Facility extended the maturity from November 16, 2022 to the earlier of (a) July 29, 2026 and (b) June 9, 2025 if, on or prior to such date, the Term Loan Facility has not been refinanced, extended or repaid in full in accordance with the terms thereof and not replaced with other indebtedness. The ABL Facility is available for working capital and other general corporate liquidity needs. There was no balance outstanding on January 28, 2022 and $25.0 million outstanding on January 29, 2021. The balance of outstanding letters of credit was $23.5 million and $27.1 million on January 28, 2022 and January 29, 2021, respectively.

Application of Critical Accounting Policies and Estimates

Our Consolidated Financial Statements have been prepared in accordance with GAAP, which requires management to make estimates and judgments that affect amounts reported in the Consolidated Financial Statements and accompanying notes. While our estimates and assumptions are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from our estimates and assumptions. Our estimation processes contain uncertainties because they require management to make assumptions and apply judgment to make these estimates. Should actual results be different than our estimates, we could be exposed to gains or losses from differences that may be material.

For a summary of our significant accounting policies, please refer to Note 2, Summary of Significant Accounting Policies, of our Consolidated Financial Statements. We believe the accounting policies discussed below represent the accounting policies we apply that are the most critical to understanding our Consolidated Financial Statements.

Inventory Valuation

Our inventories consist of merchandise purchased for resale and are recorded at the lower of cost or market. The nature of our business requires that we make a significant amount of our merchandising decisions and corresponding inventory purchase commitments with vendors several months in advance of the time in which a particular merchandise item is intended to be included in the merchandise offerings. These decisions and commitments are based upon, among other possible considerations, historical sales with identical or similar merchandise, our understanding of then-prevailing trends and influences, and an assessment of likely economic conditions and various competitive factors.

For financial reporting and tax purposes, our United States inventory, primarily merchandise held for sale, is stated at last-in, first-out (“LIFO”) cost, which is adjusted to the lower of cost or market. We account for our non-United States inventory on the first-in, first-out (“FIFO”) method. The United States inventory accounted for using the LIFO method as of percentage of the total inventory was 86% at January 28, 2022 and 87% at January 29, 2021.

We continually make assessments as to whether the carrying cost of inventory exceeds its market value and, if so, by what dollar amount. Excess inventories may be disposed of through our normal course of business. Based on historical results experienced through various methods of disposition, we will write down the carrying value of inventories that are not expected to be sold at or above cost. The excess and obsolete reserve balances were $15.2 million and $22.8 million as of January 28, 2022, and January 29, 2021, respectively. The $7.6 million decrease in the excess and obsolescence reserve is primarily due to our ability to sell through returned embroidered, hemmed or damaged product compared to the prior year when the COVID pandemic limited our distribution options to sell this merchandise. For the inventory marked down to net realizable value, a one percentage point increase in our assumed recovery rates at January 28, 2022, would have had an immaterial impact on our Consolidated Financial Statements.

Goodwill and Trade Name Impairment Assessments

Goodwill and the trade name indefinite-lived intangible asset are tested separately for impairment annually, during the fourth quarter, or are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.

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Frequently our impairment loss calculations contain multiple uncertainties because the calculation requires management to make assumptions and to apply judgment to estimate future cash flows and asset fair values, including forecasting cash flows under different scenarios. We perform goodwill and indefinite-lived intangible asset impairment tests on an annual basis and update these annual impairment tests mid-year if events or circumstances occur that would more likely than not reduce the fair value of a reporting unit or indefinite-lived intangible asset below its carrying amount. If actual results fall short of our estimates and assumptions used in estimating future cash flows and asset fair values, we may be exposed to future impairment losses that could be material.

Goodwill impairment assessments

We test goodwill for impairment using a one-step quantitative test. The quantitative test compares the reporting unit’s fair value to its carrying value. An impairment is recorded for any excess carrying value above the reporting unit’s fair value, not to exceed the amount of goodwill. We estimate fair value of our reporting units using a discounted cash flow model, commonly referred to as the income approach. The income approach uses a reporting unit’s projection of estimated operating results and cash flows that is discounted using a weighted-average cost of capital that reflects current market conditions appropriate to our reporting unit. The discounted cash flow model uses projections based on management’s best estimates of economic and market conditions over the projected period using the best information available, including growth rates in revenues, costs and estimates of future expected changes in operating margins and cash expenditures. Other significant estimates and assumptions include terminal value growth rates, weighted average cost of capital and changes in future working capital requirements.

In response to the COVID pandemic, during First Quarter 2020 we tested our Outfitters and Japan eCommerce reporting units for goodwill impairment. The testing resulted in no impairment of the Outfitters reporting unit and full impairment of the $3.3 million of goodwill allocated to our Japan eCommerce reporting unit.

We completed our Fiscal 2021 and Fiscal 2020 annual goodwill impairment analysis during the fourth quarter and determined that the fair value of the U.S. eCommerce and Outfitters reporting units exceeded their carrying values by 91.2% and 65.5%, respectively in Fiscal 2021 and 61.7% and 108.8%, respectively in Fiscal 2020, and as such, we did not record a goodwill impairment charge.

Goodwill impairment charges may be recognized in future periods to the extent changes in factors or circumstances occur, including deterioration in the macroeconomic environment, retail industry or in the equity markets, deterioration in our performance or our future projections, or changes in our plans for the reporting unit.

Indefinite-lived intangible asset impairment assessments

Our indefinite-lived intangible asset is the Lands’ End trade name. We review the trade name for impairment on an annual basis during our fourth fiscal quarter or whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The fair value of the trade name indefinite-lived intangible asset is estimated using the relief from royalty valuation method. The relief from royalty method of the income approach was most appropriate for analyzing our indefinite-lived asset. This method is based on the assumption that, in lieu of ownership, a firm would be willing to pay a royalty in order to exploit the related benefits of this asset class. The relief from royalty method involves two steps: (1) estimation of reasonable royalty rates for the assets and (2) the application of these royalty rates to a forecasted net revenue stream and discounting the resulting cash flows to determine a present value. We multiplied the selected royalty rate by the forecasted net revenue stream to calculate the cost savings (relief from royalty payment) associated with the asset. The cash flows are then discounted to present value using the selected discount rate and compared to the carrying value of the asset.

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In Fiscal 2021 and Fiscal 2020 we performed the annual testing of the indefinite-lived intangible asset, the Lands’ End trade name. The fair value exceeded the carrying value by 68.9% and 61.2% in Fiscal 2021 and Fiscal 2020, respectively, and as such, no trade name impairment charges were recorded.

See Note 2, Summary of Significant Accounting Policies, and Note 8, Goodwill and Indefinite-Lived Intangible Assets, of the Notes to Consolidated Financial Statements in this Annual Report on Form 10-K for more information about these assets and the related impairment charges.

Revenue Recognition

While revenue recognition for us does not involve significant judgment, it represents an important accounting policy. For sales shipped from our distribution centers, we recognize revenue and the related cost of goods sold at the time the products are expected to be received by the customers. For sales transacted at stores, revenue is recognized when the customer receives and pays for the merchandise at the register. We record an allowance for estimated returns based on our historical return patterns and various other assumptions that management believes to be reasonable.

We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate our sales return allowance. However, if the actual rate of sales returns increases significantly, our operating results could be adversely affected. We have not made any material changes in the accounting methodology used to estimate future sales returns in the past three fiscal years.

Provision for Income taxes

We record a valuation allowance against our deferred tax assets when it is more likely than not that some portion or all of such deferred tax assets will not be realized. In determining the need for a valuation allowance, management is required to make assumptions and to apply judgment, including forecasting future income, taxable income and the mix of income or losses in the jurisdictions in which we operate. Our effective tax rate in a given financial statement period may also be materially impacted by changes in the mix and level of income or losses, changes in the expected outcome of audits, or changes in the deferred tax valuation allowance.

At any point in time, many tax years are subject to or in the process of being audited by various taxing authorities. To the extent our estimates of settlements change, or the final tax outcome of these matters is different from the amounts recorded, such differences will impact the income tax provision in the period in which such determinations are made. Our income tax expense includes changes in our estimated liability for exposures associated with our various tax filing positions. Determining the income tax expense for these potential assessments requires management to make assumptions that are subject to factors such as proposed assessments by tax authorities, changes in facts and circumstances, issuance of new regulations, and resolution of tax audits. We performed an evaluation over our deferred tax assets and determined that a valuation allowance is considered necessary. See Note 9, Income Taxes, for further details on the valuation allowance.

We believe the judgments and estimates discussed above are reasonable. However, if actual results fall short of our estimates or assumptions, we may be exposed to losses or gains that could be material.

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

This document contains forward-looking statements. Forward-looking statements reflect our current views with respect to, among other things, future events and performance. These statements may discuss, among other things, our net sales, gross margin, operating expenses, operating income, net income, cash flow, financial condition, financings, impairments, expenditures, growth, strategies, plans, achievements, dividends, capital structure, organizational structure, future store openings, market opportunities and general market and industry conditions. We generally identify forward-looking statements by words such as “anticipate,” “estimate,” “expect,” “intend,” “project,” “plan,” “predict,” “believe,” “seek,” “continue,” “outlook,” “may,” “might,” “will,” “should,” “can have,” “likely,” “targeting” or the negative version of these words or comparable words. Forward-looking statements are based on beliefs and assumptions made by management using currently available information. These statements are only predictions and are not guarantees of future performance, actions or events. Forward-looking statements are subject to risks and uncertainties. If one or more of these risks or uncertainties materialize, or if management’s underlying beliefs and assumptions prove to be incorrect, actual results may differ materially from those contemplated by a forward-looking statement. These risks and uncertainties include those set forth under Item 1A, Risk Factors, in this Annual Report on Form 10-K. Forward-looking statements speak only as of the date on which they are made. We expressly disclaim any obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by applicable securities laws and regulations.

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