# WEYCO GROUP INC (WEYS) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from WEYCO GROUP INC's 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/106532/000155837024003196/weys-20231231x10k.htm
Accession: 0001558370-24-003196
Filing date: 2024-03-14
Report date: 2023-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/WEYS/
All MD&A years: /company/WEYS/mda/
Previous year: /company/WEYS/mda/fy2022/ (FY 2022)
Next year: /company/WEYS/mda/fy2024/ (FY 2024)

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

GENERAL

We design, market, and distribute quality and innovative footwear principally for men, but also for women and children, under a portfolio of well-recognized brand names including: Florsheim, Nunn Bush, Stacy Adams, BOGS, Rafters, and Forsake.  Inventory is purchased from third-party overseas manufacturers.  Almost all of these foreign-sourced purchases are denominated in U.S. dollars. We have two reportable segments, North American wholesale operations (“Wholesale”) and North American retail operations (“Retail”). In the Wholesale segment, our products are sold to leading footwear, department, and specialty stores, as well as e-commerce retailers, primarily in the United States and Canada. We also have licensing agreements with third parties who sell our branded apparel, accessories, and specialty footwear in the United States, as well as our footwear in Mexico and certain markets overseas.  Licensing revenues are included in our Wholesale segment. Our Retail segment consists of e-commerce businesses and four brick-and-mortar retail stores in the United States.  Retail sales are made directly to consumers on our websites, or by our employees in our stores.  Our “other” operations include our wholesale and retail businesses in Australia, South Africa, and Asia Pacific (collectively, “Florsheim Australia”). However, we ceased operations in the Asia Pacific region in 2023, and are in the final stages of winding down this business. The majority of our operations are in the United States, and our results are primarily affected by the economic conditions and the retail environment in the United States.  

This discussion summarizes the significant factors affecting the consolidated operating results, financial position, and liquidity of our company for the two-year period ended December 31, 2023. This discussion should be read in conjunction with Item 8, “Financial Statements and Supplementary Data” below.

KNOWN TRENDS IMPACTING OUR BUSINESS

Macroeconomic pressures in the U.S. and the global economy have created a tepid retail environment. Following a period of unprecedented supply chain disruptions, retailers are being cautious with their inventory levels, which reduces wholesale customer orders.  Additionally, consumers are currently spending more of their discretionary income on experiences and services and less on footwear and apparel. Looking ahead, we expect to face continued headwinds as a result of the challenging retail environment in the first half of 2024, but we continue to focus on building our backlogs and are optimistic that demand will improve in the back half of the year.

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Post-pandemic disruptions in the supply chain in 2021 and the first half of 2022 affected the flow of our inventory into the U.S. over the past few years.  In 2022, we brought in much of our inventory for the Spring 2023 selling season early based on the expectation that extended inventory transit times would last throughout much of 2022.  As a result, our inventory was at peak levels at December 31, 2022.  By the end of 2022, inventory transit times had improved and supply chain issues had subsided.  In 2023, we managed our inventory down to more normalized levels.  

EXECUTIVE OVERVIEW

We experienced a slowdown in sales in 2023, mainly as a result of lower wholesale shipments compared to record sales in 2022.  Though sales were down, we achieved record operating and net earnings in 2023 by maintaining our pricing integrity while taking a disciplined approach to our expenses.

In our Wholesale segment, net sales of our BOGS brand were down 31% in 2023, compared to the prior year. Mild weather throughout the Fall and early Winter, in combination with an inventory glut in the outdoor market, led to the sales decline. We believe the outdoor boot market will remain challenging throughout 2024 as retailers continue to right size their inventories.  With BOGS, we are focused on moving the business forward through product innovation with an emphasis on our BOGS seamless rubber boot construction. BOGS seamless construction is 30% lighter than comparable vulcanized rubber boots and over twice as durable as measured by the number of flexes our seamless boots can withstand without any sign of cracking. This year, we are expanding the number of seamless boots in our line across numerous price points. In addition to the expansion of our seamless collection, we are also introducing new non-insulated and lightly insulated footwear so the BOGS brand is less dependent on inclement weather.

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Net sales of our legacy businesses (comprised of the Florsheim, Nunn Bush and Stacy Adams brands) were collectively down 5% for the year. At the brand level, Florsheim, Nunn Bush and Stacy Adams were down 4%, 2%, and 10%, respectively, for the year. The decline in sales of all three brands reflects a general slowdown in the market for dress and dress casual footwear. In addition, many of our retail partners have shifted to more of a “chase” strategy in order to maintain greater inventory flexibility.   We see the decrease in our legacy shipments as part of a return to a normal business cycle after a period of heightened demand and supply chain delays. We anticipate this trend will continue through the first half of 2024. Our sell-throughs at retail remain solid, and we continue to diversify our product mix across all three brands to expand our casual and hybrid offerings.

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In our Retail segment, sales were up 4% for the year, driven by growth in our e-commerce businesses.  Overall, we believe we had strong direct consumer performance for the year, with a solid sales increase in 2023 as well as record retail operating earnings. We view our direct-to-consumer business as a growth opportunity and continue to invest in our online platform.

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Florsheim Australia’s net sales in local currency were down 3% for the year. The loss of a significant wholesale account as well as soft consumer demand presented challenges in the Australian market. We anticipate headwinds through the first half of 2024 and are focused on reducing expenses while we assess opportunities to rekindle our growth. As previously disclosed, we closed our Asia Pacific operations in 2023. Going forward, certain significant wholesale accounts that were previously served by our Asia Pacific team will be picked up by Australian wholesale division.

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Sales and Earnings Highlights

Consolidated net sales for 2023 were $318.0 million, down 10% compared to $351.7 million in 2022.  Consolidated gross earnings as a percent of net sales were 44.9% and 41.1% in 2023 and 2022, respectively. Operating earnings were a record $41.0 million, up 2% over our previous record of $40.4 million, despite lower sales.  Net earnings were a record $30.2 million, or $3.17 per diluted share, in 2023, up 2% compared to $29.5 million, or $3.07 per diluted share, in 2022.

Financial Position Highlights

At December 31, 2023, our cash and marketable securities totaled $75.9 million and we had no debt outstanding on our $40.0 million revolving line of credit. During 2023, we generated $98.6 million of cash from operations, due mainly to net earnings and reductions in inventory levels. We used funds to pay $9.3 million in dividends and to repurchase $4.3 million of our stock during 2023. We also had $3.3 million of capital expenditures.

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SEGMENT ANALYSIS

Net sales and earnings from operations for our segments, as well as our “other” operations, in the years ended December 31, 2023 and 2022, were as follows:

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North American Wholesale Segment

Wholesale Net Sales

Net sales in our Wholesale segment for the years ended December 31, 2023 and 2022, were as follows:

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Wholesale net sales were collectively down in 2023 due to lower demand following record growth in 2022.  Sales across all our brands in 2022 were positively impacted by a combination of post-pandemic retailer pipeline fill and strong consumer demand. Our BOGS brand experienced the largest decrease for the year, compared to record sales for the brand in 2022, as orders were down amid the current saturation of product in the outdoor market, and due to the mild weather in the final months of 2023.  Licensing revenues consist of royalties earned on sales of branded apparel, accessories, and specialty footwear in the United States and on branded footwear in Mexico and certain overseas markets. Licensing revenues increased in 2023, compared to 2022, in line with increased licensees’ sales of branded products.

Wholesale Earnings from Operations

Wholesale gross earnings as a percent of net sales were 39.7% in 2023 versus 35.6% in 2022. Gross margins improved as a result of increased selling prices and lower inventory costs, primarily inbound freight. Selling and administrative expenses for the wholesale segment consist primarily of distribution costs, salaries and commissions, advertising costs, employee benefit costs, and depreciation. Wholesale selling and administrative expenses were $66.0 million and $68.2 million in 2023 and 2022, respectively. The decrease in 2023 was primarily due to lower employee costs, mainly commission-based compensation. As a percent of net sales, wholesale selling and administrative expenses were 26% in 2023 and 24% in 2022.  Wholesale operating earnings reached a record $33.3 million in 2023, up 2% over our previous record of $32.6 million in 2022, due to higher gross margins and lower selling and administrative expenses.

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Our cost of sales does not include distribution costs (e.g., receiving, inspection, warehousing, shipping, and handling costs) which are included in selling and administrative expenses. Wholesale distribution costs were $15.5 million and $16.0 million for the years ended

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December 31, 2023 and 2022, respectively. Our gross earnings may not be comparable to other companies, as some companies may include distribution costs in cost of sales.

North American Retail Segment

Retail Net Sales

Retail net sales were a record $38.0 million in 2023, up 4% over our previous record of $36.7 million in 2022. The increase was primarily due to higher sales on our legacy brands’ websites, partially offset by lower sales on the BOGS’ website. Sales at our four domestic brick and mortar stores were down 4% for the year.

Retail Earnings from Operations

Retail gross earnings as a percent of net sales were 65.9% in 2023 and 65.7% in 2022. Selling and administrative expenses for the retail segment consist primarily of freight, advertising expense, employee costs, rent and occupancy costs. Retail selling and administrative expenses totaled $18.3 million in 2023, or 48% of net sales, for the year compared to $18.1 million, or 49% of net sales, in 2022. The Retail segment achieved record operating earnings of $6.8 million in 2023, up 11% over $6.1 million in 2022, due mainly to the increase in web sales.

Other

Our other operations consist of our retail and wholesale businesses in Australia, South Africa, and Asia Pacific (collectively, “Florsheim Australia”). However, we ceased operations in the Asia Pacific region in 2023, and are in the final stages of winding down this business. The winddown of our Asia-Pacific operations did not have a material impact on our full year 2023 consolidated results.  

Other net sales totaled $29.6 million in 2023 down 7% from $31.8 million in 2022. In local currency, Florsheim Australia’s net sales were down 3% for the year, due mainly to the mid-year loss of a sizeable wholesale customer in Australia, partially offset by higher sales across Florsheim Australia’s retail businesses.   Other gross earnings were 62.5% of net sales in 2023 versus 61.1% of net sales in 2022. Other operating earnings totaled $1.0 million in 2023 and $1.7 million in 2022, down mainly as a result of lower sales in Australia this year.

OTHER INCOME AND EXPENSE AND TAXES

Most of our interest and dividend income is generated by investments in marketable securities and money market mutual funds. Interest and dividend income totaled $1.1 million and $361,000 in 2023 and 2022, respectively. The increase in 2023 was due to more earnings on the higher cash balances this year.  Interest expense was $529,000 in 2023 and $710,000 in 2022. The decrease in 2023 was due to less interest incurred as we paid off our debt during the year. Other expense, net, totaled $738,000 in 2023 and $277,000 in 2022. Other expense was up in 2023 due largely to an increase in the non-service cost components of pension expense, primarily interest cost, as a result of the higher interest rates this year. Last year’s other expense included a $894,000 pension settlement charge recorded in connection with a lump-sum benefit payment to a former executive of the Company.

Our effective tax rate was 26.1% in 2023 versus 25.7% in 2022. The current tax rate differs from the U.S. federal statutory rate of 21% due mainly to the impact of state income taxes.

LIQUIDITY AND CAPITAL RESOURCES

Our primary sources of liquidity are cash, short-term investments, and short-term marketable securities, which aggregated $69.5 million and $18.4 million at December 31, 2023 and 2022, respectively, and our revolving line of credit.  We generated $98.6 million of cash from operations in 2023, and used $29.9 million of cash in operations in 2022. Fluctuations in net cash from (used for) operating activities mainly resulted from changes in net earnings and operating assets and liabilities, most significantly, our inventory. Our inventory balance was $74.9 million at December 31, 2023, down from $128.0 million at December 31, 2022. We brought our inventories down in 2023 to a level that balances availability for in-season orders with better inventory turn.

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Our capital expenditures were $3.3 million and $2.3 million in 2023 and 2022, respectively. This year’s capital expenditures included costs related to equipment installed in our Glendale warehouse that automates the packing and labeling process of single pair orders. With the growth of our e-commerce and drop-ship businesses, gaining efficiency in this area allows us to give faster service with significant labor savings. Looking ahead, we expect capital expenditures will be between $2.0 million and $4.0 million in 2024.

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We paid aggregate cash dividends of $9.3 million and $7.0 million in 2023 and 2022, respectively.  The increase in 2023 was due to a timing difference in our quarterly dividend payment schedule; 2023 included four quarterly dividend payments, as our fourth quarter 2022 dividend was paid in early January 2023. 2022 included only three quarterly dividend payments, as our fourth quarter 2021 dividend was paid in late December 2021.

In December 2022, in accordance with the terms of our supplemental pension plan, we made a lump-sum benefit payment of $4.3 million to a former executive of the Company.

We repurchase our common stock under our share repurchase program when we believe market conditions are favorable. In 2023, we purchased 170,422 shares at a total cost of $4.3 million through our share repurchase program. In 2022, we purchased 171,397 shares at a total cost of $4.2 million through our share repurchase program.  As of December 31, 2023, there were 868,757 authorized shares remaining under the program.

On September 28, 2023, we amended our line of credit agreement. The amendment (“Amended Credit Agreement”) extended the maturity of our credit facility to September 28, 2024 and has a maximum available borrowing limit of $40.0 million. Under the terms of the Amended Credit Agreement, amounts outstanding bear interest at the one-month term secured overnight financing rate (“SOFR”) plus 125 basis points. The Amended Credit Agreement is secured by a security interest in our general business assets, and contains customary representations, warranties, and covenants (including a minimum tangible net worth financial covenant) for a facility of this type. At December 31, 2023, there were no outstanding borrowings on the line of credit, and we were in compliance with all financial covenants. At December 31, 2022, outstanding borrowings on the line of credit were approximately $31.1 million at an interest rate of 5.77%.

As of December 31, 2023, approximately $5.9 million of cash and cash equivalents was held by our foreign subsidiaries.

We continue to evaluate the best uses for our available liquidity, including, among other uses, capital expenditures, continued stock repurchases and acquisitions. We believe that available cash, marketable securities, cash provided by operations, and available borrowing facilities will provide adequate support for the cash needs of the business for at least one year, although there can be no assurances.

Off-Balance Sheet Arrangements

We do not utilize any special purpose entities or other off-balance sheet arrangements.

Critical Accounting Estimates

Our accounting policies are more fully described in Note 2 of the Notes to Consolidated Financial Statements.  As disclosed in Note 2, the preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions about future events that affect the amounts reported in the consolidated financial statements and accompanying notes.  Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the consolidated financial statements. The following policies are considered by management to be the most critical in understanding the significant accounting estimates inherent in the preparation of our consolidated financial statements and the uncertainties that could impact our results of operations, financial position and cash flows.

Sales Returns, Sales Allowances and Doubtful Accounts

We record reserves and allowances (“reserves”) for sales returns, sales allowances and discounts, cooperative advertising, and accounts receivable balances that we believe will ultimately not be collected. The reserves are based on such factors as specific customer situations, historical experience, a review of the current aging status of customer receivables and current and expected economic conditions. The reserve for doubtful accounts includes a specific reserve for accounts identified as potentially uncollectible, plus an additional reserve for the balance of accounts, determined based on historical trends. We evaluate the reserves and the estimation process and adjust when appropriate.  Apart from unprecedented write-offs that occurred during the COVID-19 pandemic, our historical write-offs against the reserves have been within our expectations. Future changes in reserves may be required if actual returns, discounts and bad debt activity varies from the original estimates.  These changes could impact our results of operations, financial position, and cash flows.

Pension Plan Accounting

Our pension expense and corresponding obligation are determined on an actuarial basis and require certain actuarial assumptions.  We believe the two most critical of these assumptions are the discount rate and the expected rate of return on plan assets.  We evaluate actuarial assumptions annually on the measurement date (December 31) and make modifications based on such factors as market interest rates and historical asset performance.  Changes in these assumptions can result in different expense and liability amounts, and future actual experience can differ from these assumptions.

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Discount Rate – Pension expense and projected benefit obligations both increase as the discount rate is reduced.  See Note 12 of the Notes to Consolidated Financial Statements for discount rates used in determining pension expense for the years ended December 31, 2023 and 2022, and the funded status of the plans at December 31, 2023 and 2022.  We use the spot-rate approach to determine the service and interest cost components of pension expense. Under the spot-rate approach, the service and interest costs were calculated by applying specific spot rates along the yield curve to the relevant projected cash flows, to provide a better estimate of future service and interest costs. A 0.5% decrease in the discount rate would have a nominal impact on annual pension expense, and would increase the projected benefit obligation by approximately $2.7 million.  

Expected Rate of Return – Pension expense increases as the expected rate of return on pension plan assets decreases.  In estimating the expected return on plan assets, we consider the historical returns on plan assets and future expectations of asset returns.  We utilized an expected rate of return on plan assets of 6.75% for both 2023 and 2022, respectively. This rate was based on our Company’s long-term investment policy of equity securities: 20% - 80%; fixed income securities: 20% - 80%; and other, principally cash:  0% - 20%.  A 0.5% decrease in the expected return on plan assets would increase annual pension expense by approximately $182,000.

Our unfunded benefit obligation was $14.0 million and $16.1 million at December 31, 2023 and 2022, respectively.

Recent Accounting Pronouncements

See Note 2 of the Notes to Consolidated Financial Statements.

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