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PERY > SEC Filings for PERY > Form 10-K on 16-Apr-2013All Recent SEC Filings

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Form 10-K for PERRY ELLIS INTERNATIONAL INC


16-Apr-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

We began operations in 1967 as Supreme International Corporation with a focus on marketing guayabera shirts, and other men's apparel products targeted at the Hispanic market in Florida and Puerto Rico. Over time we expanded our product line to offer a variety of men's sport shirts. In 1988, we added the Natural Issue brand and completed our initial public offering in 1993. In 1996, we began an expansion strategy through the acquisition of brands including the Munsingwear family of brands in 1996, the John Henry and Manhattan brands from Perry Ellis Menswear in 1999 and the Perry Ellis brand in 1999. Following the Perry Ellis acquisition, we changed our name from Supreme International Corporation to Perry Ellis International, Inc. to better reflect the name recognition that the brand provided. In 2002, we acquired the Jantzen brand and in June 2003 we acquired Perry Ellis Menswear, our largest licensee, giving us greater control of the Perry Ellis brand, as well as adding other brands owned by Perry Ellis Menswear. In February 2005, we completed an acquisition of certain assets of Tropical Sportswear International Corporation, making us one of the largest suppliers of bottoms in the United States. In January 2006, we completed the acquisition of primarily all of the worldwide intellectual property of the leading California lifestyle company Gotcha International, including the Gotcha, Girl Star and MCD logo trademarks and the intellectual property license agreements. In February 2008, we completed the acquisition of the Laundry by Shelli Segal and C&C California brands giving us a stronger product line in dresses and women's sportswear. In January 2011, we completed the acquisition of the Rafaella brand further increasing our product line in women's sportswear. In February 2012, we completed the acquisition of Ben Hogan and further strengthened our golf product line.

We are one of the leading apparel companies in the United States. We manage a portfolio of major brands, some of which were established over 100 years ago. We design, source, market and license our products nationally and internationally at multiple price points and across all major levels of retail distribution in approximately 15,000 selling doors. Our portfolio of highly recognized brands include: Anchor Blue ®, Axist®, Ben Hogan®, C&C California®, Cubavera®, Farah®, Gotcha ®, Grand Slam®, Jantzen®, John Henry ®, Laundry by Shelli Segal®, Manhattan®, Munsingwear ®, Original Penguin® by Munsingwear®("Original Penguin"), Perry Ellis®, Rafaella® and Savane®. We also (i) license the Callaway Golf® brand and the PGA Tour® brand, including the Champions Tour® brand, for golf apparel, (ii) license the Jag® brand for men's and women's swimwear and cover-ups, and (iii) license the Nike® brand for swimwear and swimwear accessories.

We distribute our products primarily to wholesale customers that represent all major levels of retail distribution including department stores, national and regional chain stores, mass merchants, specialty stores, sporting goods stores, the corporate wear market, e-commerce, as well as clubs and independent retailers in the United States, Canada, Mexico, the United Kingdom and Europe. Our largest customers include Kohl's, Macy's, Sam's, The Marmaxx Group, and Dillard's. As of March 5, 2013, we operated 40 Perry Ellis, five Original Penguin and two multi-brand retail outlet stores located primarily in upscale retail outlet malls across the United States, United Kingdom and Puerto Rico, and three Perry Ellis, two Cubavera and 17 Original Penguin full price retail stores located in upscale demographic markets in the United States and United Kingdom. In addition, we leverage our design, sourcing and logistics expertise by offering a limited number of private label programs to retailers. In order to maximize the worldwide exposure of our brands and generate high margin royalty income, we license our brands through three worldwide, 59 domestic, and 86 international license agreements covering over 100 countries.

In fiscal 2013, our Men's Sportswear and Swim segment, which is comprised of men's sportswear, swimwear and swimwear accessories, accounted for 73% of our total revenues, our Women's Sportswear segment accounted for 15% of our total revenues, our Direct-to-Consumer segment, which is comprised of retail and e-commerce, accounted for 9% of our total revenues and our Licensing segment accounted for approximately 3% of our total revenues. Finally, our U.S. based business represented approximately 92% of total revenues, while our foreign operations represented 8% of total revenue for fiscal 2013.

Our licensing business is a significant contributor to our operating income. We license the brands we own to third parties for the manufacturing and marketing of various products in distribution channels and countries in which we do not distribute those brands, including men's and women's apparel and footwear, men's suits, underwear, loungewear, outerwear, fragrances, eyewear and accessories. These licensing arrangements heighten


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the overall awareness of our brands without requiring us to make capital investments or incur additional operating expenses. We employ a three-dimensional strategy in the design, sourcing, marketing and licensing of our products that focuses on diversity of brands, products and distribution channels. Through this strategy, we provide our products to a broad range of customers, which reduces our reliance on any single distribution channel, customer, or demographic group and minimizes competition among our brands.

Our products have historically been geared towards lighter weight apparel generally worn during the spring and summer months. We believe that this seasonality has been reduced with the strengthening of our fall, winter, and holiday merchandise. Our swimwear business, however, is highly seasonal in nature, with the significant majority of our sales occurring in our first and fourth quarters. Seasonality can be affected by a variety of factors, including the mix of advance and fill-in orders, the amount of sales to different distribution channels, and overall product mix among traditional merchandise, fashion merchandise and swimwear. Our higher-priced products generally tend to be less sensitive to economic and weather conditions. Revenues for our second quarter will typically be lower than our other quarters due to the impact of seasonal sales.

We believe that our future growth will come as a result of organic growth from our continued emphasis on our existing brands; new and expanded product lines; domestic and international licensing opportunities; international, direct retail and e-commerce opportunities and selective acquisitions and opportunities that fit strategically with our business model. Our future results may be impacted by risks and trends set forth in "Item 1A. Risk Factors" and elsewhere in this report.

Recent Accounting Pronouncements

See Footnotes to the Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data" for recent accounting pronouncements.

Critical Accounting Policies

Included in the footnotes to the consolidated financial statements in this report is a summary of all significant accounting policies used in the preparation of our consolidated financial statements. We follow the accounting methods and practices as required by accounting principles generally accepted in the United States of America ("GAAP"). In particular, our critical accounting policies and areas in which we use judgment are revenue recognition, the estimated collectability of accounts receivable, the recoverability of obsolete or overstocked inventory, the impairment of long-lived assets that are our trademarks and goodwill, and the measurement of retirement related benefits.

Revenue Recognition. Sales are recognized at the time legal title to the product passes to the customer, generally FOB Perry Ellis' distribution facilities, net of trade allowances, discounts, estimated returns and other allowances, considering historical and anticipated trends. Revenues are recorded net of corresponding sales taxes. Retail store revenue is recognized net of estimated returns and corresponding sales tax at the time of sale to consumers. Royalty income is recognized when earned on the basis of the terms specified in the underlying contractual agreements.

Accounts Receivable. We maintain an allowance for doubtful accounts receivable and an allowance for estimated trade discounts, co-op advertising, allowances provided to retail customers to flow goods through the retail channel, and losses resulting from the inability of our retail customers to make required payments considering historical and anticipated trends. Management reviews these allowances and considers the aging of account balances, historical experience, changes in customer creditworthiness, current economic and product trends, customer payment activity and other relevant factors. A small portion of our accounts receivable are insured for collections. Should any of these factors change, the estimates made by management may also change, which could affect the level of future provisions.

Inventories. Our inventories are valued at the lower of cost or market value. Estimates and judgment are required in determining what items to stock and at what levels, and what items to discontinue and how to value them. We evaluate all of our inventory style-size-color stock keeping units, or SKUs, to determine excess or slow-moving SKUs based on orders on hand and projections of future demand and market conditions. For those units in inventory that are so identified, we estimate their market value or net sales value based on current realization trends. If the projected net sales value is less than cost, on an individual SKU basis, we write down inventory to reflect the lower value. This methodology recognizes projected inventory losses at the time such losses are evident rather than at the time goods are actually sold.


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Intangible Assets. We review our intangible assets with indefinite useful lives for possible impairments at least annually and perform impairment testing during the fourth quarter of each year by among other things, obtaining independent third party valuations. We evaluate the "fair value" of our identifiable intangible assets for purposes of recognition and measurement of impairment losses. Evaluating indefinite useful life assets for impairment involves certain judgments and estimates, including the interpretation of current economic indicators and market valuations, and our strategic plans with regard to our operations, historical and anticipated performance of our operations and other factors. If we incorrectly anticipate these trends or unexpected events occur, our results of operations could be materially affected. We estimate the fair value of the trademarks based on an income approach using the relief-from-royalty method. This methodology assumes that, in lieu of ownership, a third party would be willing to pay a royalty in order to exploit the related benefits of trademark assets. The cash flow models we use to estimate the fair values of our trademarks involve several assumptions. Changes in these assumptions could materially impact our fair value estimates. Assumptions critical to the fair value estimates are: (i) discount rates used to derive the present value factors used in determining the fair value of the trademarks;
(ii) royalty rates used in the trademark valuations; (iii) projected revenue and expense growth rates; and (iv) projected long-term growth rates used in the derivation of terminal year values. These and other assumptions are impacted by economic conditions and expectations of management and could change in the future based on period-specific facts and circumstances. We base our fair value estimates on assumptions we believe to be reasonable, but which are unpredictable and inherently uncertain.

Goodwill. Goodwill represents the excess of the purchase price over the value assigned to tangible and identifiable intangible assets of businesses acquired and accounted for under the acquisition method. We review goodwill at least annually for possible impairment during the fourth quarter of each year using a discounted cash flow analysis that requires that certain assumptions and estimates be made regarding industry economic factors and future profitability and cash flows. Evaluating goodwill for impairment involves certain judgments and estimates, including the interpretation of current economic indicators and market valuations, and our strategic plans with regard to our operations, historical and anticipated performance of our operations and other factors. If we incorrectly anticipate these trends or unexpected events occur, our results of operations could be materially affected. Assumptions critical to the fair value estimates are: (i) discount rates used to derive the present value factors used in determining the fair value of each reporting unit; (ii) projected revenue and expense growth rates; and (iii) projected long-term growth rates used in the derivation of terminal year values. The goodwill impairment test is a two-step process that requires us to make decisions in determining appropriate assumptions to use in the calculation. The first step consists of estimating the fair value of each reporting unit and comparing those estimated fair values with the carrying values, which include the allocated goodwill. If the estimated fair value is less than the carrying value, a second step is performed to compute the amount of the impairment, if any, by determining an "implied fair value" of goodwill. The determination of each reporting unit's implied fair value of goodwill requires us to allocate the estimated fair value of the reporting unit to its assets and liabilities. Any unallocated fair value represents the implied fair value of goodwill which is compared to its corresponding carrying amount.

Retirement-Related Benefits. The pension obligations related to our defined benefit pension plans are developed from actuarial valuations. Inherent in these valuations are key assumptions, including the discount rate, expected return of plan assets, future compensation increases, and other factors, which are updated on an annual basis. Management is required to consider current market conditions, including changes in interest rates, in making these assumptions. Actual results that differ from the assumptions are accumulated and amortized over future periods, and therefore, generally affect the recognized pension expense or benefit and our pension obligation in future periods. The fair value of plan assets is based on the performance of the financial markets, particularly the equity markets. Therefore, the market value of the plan assets can change dramatically in a relatively short period of time. Additionally, the measurement of the plan's benefit obligation is highly sensitive to changes in interest rates. As a result, if the equity market declines and/or interest rates decrease, the plan's estimated accumulated benefit obligation could exceed the fair value of the plan assets and therefore, we would be required to establish an additional minimum liability, which would result in a reduction in shareholders' equity for the amount of the shortfall.


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Our Results of Operations for Fiscal 2013

The following table sets forth, for the periods indicated selected items in our consolidated statements of income expressed as a percentage of total revenues:

                                             February 2,           January 28,           January 29,
Fiscal Years Ended                              2013                  2012                  2011
Net sales                                            97.2 %                97.4 %                96.7 %
Royalty income                                        2.8 %                 2.6 %                 3.3 %

Total revenues                                      100.0 %               100.0 %               100.0 %
Cost of sales                                        67.3 %                67.0 %                64.3 %

Gross profit                                         32.7 %                33.0 %                35.7 %
Selling, general and administrative
expenses                                             27.2 %                25.4 %                27.8 %
Depreciation and amortization                         1.4 %                 1.4 %                 1.5 %
Impairment on long-lived assets                       0.4 %                 0.6 %                 0.0 %

Operating income                                      3.7 %                 5.6 %                 6.3 %
Costs on early extinguishment of debt                 0.0 %                 0.1 %                 0.1 %
Interest expense                                      1.5 %                 1.6 %                 1.7 %

Net income before income taxes                        2.2 %                 3.9 %                 4.5 %
Income tax provision                                  0.7 %                 1.3 %                 1.4 %

Net income                                            1.5 %                 2.6 %                 3.1 %
Net income attributable to
noncontrolling interest                               0.0 %                 0.0 %                 0.1 %

Net income attributable to Perry Ellis
International, Inc.                                   1.5 %                 2.6 %                 3.1 %


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The following table sets forth, for the periods indicated, selected financial data expressed by segments and includes a reconciliation of EBITDA to operating income by segment, the most directly comparable GAAP financial measure:

                                February 2,         January 28,         January 29,
                                   2013                2012                2011
                                                  (in thousands)
   Revenues by segment:
   Men's Sportswear and Swim   $     708,202       $     718,721       $     677,481
   Women's Sportswear                149,084             164,298              26,119
   Direct-to-Consumer                 85,165              72,530              60,284
   Licensing                          27,102              25,043              26,404

   Total revenues              $     969,553       $     980,592       $     790,288

                                            February 2,           January 28,           January 29,
                                               2013                  2012                  2011
                                                                (in thousands)
Reconciliation of operating income to
EBITDA
Operating income (loss) by segment:
Men's Sportswear and Swim                  $      24,366         $      38,276         $      36,089
Women's Sportswear                                (4,028 )               5,848                (4,582 )
Direct-to-Consumer                                (6,640 )              (5,273 )              (4,188 )
Licensing                                         22,647                16,534                22,519

Total operating income                     $      36,345         $      55,385         $      49,838

Add:
Depreciation and amortization
Men's Sportswear and Swim                  $       8,573         $       9,028         $       9,779
Women's Sportswear                                 1,902                 1,412                   222
Direct-to-Consumer                                 3,054                 2,719                 1,813
Licensing                                            367                   514                   397

Total depreciation and amortization        $      13,896         $      13,673         $      12,211


EBITDA by segment:
Men's Sportswear and Swim                  $      32,939         $      47,304         $      45,868
Women's Sportswear                                (2,126 )               7,260                (4,360 )
Direct-to-Consumer                                (3,586 )              (2,554 )              (2,375 )
Licensing                                         23,014                17,048                22,916

Total EBITDA                               $      50,241         $      69,058         $      62,049

EBITDA margin by segment
Men's Sportswear and Swim                            4.7 %                 6.6 %                 6.8 %
Women's Sportswear                                  (1.4 %)                4.4 %               (16.7 %)
Direct-to-Consumer                                  (4.2 %)               (3.5 %)               (3.9 %)
Licensing                                           84.9 %                68.1 %                86.8 %
Total EBITDA margin                                  5.2 %                 7.0 %                 7.9 %

EBITDA consists of earnings before interest, cost on early extinguishment of debt, depreciation and amortization, noncontrolling interest and income taxes. EBITDA is not a measurement of financial performance under accounting principles generally accepted in the United States of America, and does not represent cash flow from operations. The most directly comparable GAAP financial measure, presented above, is operating income by segment. EBITDA and EBITDA margin by segment are presented solely as a supplemental disclosure because management believes that they are a common measure of operating performance in the apparel industry.

The following is a discussion of our results of operations for the fiscal year ended February 2, 2013 ("fiscal 2013") as compared with the fiscal year ended January 28, 2012 ("fiscal 2012") and fiscal 2012 compared with the fiscal year ended January 29, 2011 ("fiscal 2011").


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Our fiscal 2013 results as compared to our fiscal 2012 results

Net sales. Men's Sportswear and Swim net sales in fiscal 2013 were $708.2 million, a decrease of $10.5 million, or 1.5%, from $718.7 million in fiscal 2012. The net sales decrease was attributable to our expected decrease in Perry Ellis sportswear and private label bottoms programs, partially offset by increases in our golf and international businesses.

Women's Sportswear net sales in fiscal 2013 were $149.1 million, a decrease of $15.2 million, or 9.3%, from $164.3 million in fiscal 2012. Net sales decreased, as anticipated, primarily due to our Rafaella sportswear business, partially offset by increases in our contemporary Laundry by Shelli Segal dresses and C&C California businesses. We expect improved performance in our Rafaella sportswear collection business as we transition into the spring season.

Direct-to-Consumer net sales in fiscal 2013 were $85.2 million, an increase of $12.7 million, or 17.5%, from $72.5 million in fiscal 2012. The increase is attributable to comparable store increases in our store base. We also realized continued store expansion and growth in our e-commerce platform.

Royalty income. Royalty income for fiscal 2013 was $27.1 million, an increase of $2.1 million, or 8.4%, from $25.0 million in fiscal 2012. Royalty income increases were attributable to Perry Ellis and Original Penguin footwear licenses, as well as fragrance licenses. Approximately 83.2% of our royalty income was attributed to guaranteed minimum royalties with the balance attributable to royalty income in excess of guaranteed minimums for fiscal 2013.

Gross profit. Gross profit was $317.2 million in fiscal 2013, a decrease of $6.5 million, or 2.0%, as compared to $323.7 million in fiscal 2012. This decrease is attributed to the reduction in net sales as described above and the factors described within the gross profit margin section below.

Gross profit margin. In fiscal 2013, gross profit margins were 32.7% as a percentage of total revenue as compared to 33.0% in fiscal 2012, a decrease of 30 basis points. This decrease is primarily associated with the impact from the write-down and liquidation of inventory related to the planned exits of brands, the closing of a sourcing office as well as increased promotional activity within our collection businesses. This decrease was partially offset by higher margins in our direct-to-consumer, golf lifestyle and licensing businesses.

Selling, general and administrative expenses. Selling, general and administrative expenses in fiscal 2013 were $263.4 million, an increase of $14.8 million, or 6.0%, from $248.6 million in fiscal 2012. The increase was in line with our expectations and was primarily attributed to the direct-to-consumer business for new stores opened during fiscal 2013. Also, we experienced costs in the amount of approximately $8.0 million related to our realignment, which primarily encompassed voluntary early retirement costs, the exit and consolidation of our west and east coast third party logistics warehouses, relocation of our New York offices and severance expense related to exited businesses. These increases were partially offset by savings realized in our strategic review, as well as, lower compensation expense.

EBITDA. Men's Sportswear and Swim EBITDA margin in fiscal 2013 decreased 190 basis points to 4.7%, from 6.6% in fiscal 2012. The EBITDA margin was negatively impacted by the reduction in gross profit margin, which was attributable to higher levels of promotional activity in our Perry Ellis sportswear collection business, partially offset by higher gross profit margins in our golf lifestyle business. We also realized reduced leverage from selling, general and administrative expenses attributable to the expected revenue reductions in this segment.

Women's Sportswear EBITDA margin in fiscal 2013 decreased 580 basis points to (1.4%), from 4.4% in fiscal 2012. In addition to the reduction of net sales, as discussed above, the margin was negatively impacted by the costs associated with the exit and consolidation of our east coast warehouse logistics providers. Margin was also negatively impacted by the loss of leverage in selling, general and administrative expenses attributable to the expected revenue reductions in this segment.

Direct-to-Consumer EBITDA margin in fiscal 2013 decreased 70 basis points to (4.2%), from (3.5%) in fiscal 2012. The decrease was primarily attributable to the impairment of certain long-lived assets (leaseholds) in the amount $1.7 million to their estimated fair value as described below. This decrease was partially offset by favorable leverage in selling, general and administrative expenses attributable to the revenue increases realized in the segment.


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Licensing EBITDA margin in fiscal 2013 increased 1,680 basis points to 84.9%, from 68.1% in fiscal 2011. During fiscal 2012, we recognized an impairment of $4.6 million on long-lived assets. No comparable impairment occurred during fiscal 2013. Additionally, this increase was further attributed to the increase in license business as discussed above.

Depreciation and amortization. Depreciation and amortization in fiscal 2013, was $13.9 million, an increase of $0.2 million, or 1.5%, from $13.7 million in fiscal 2012. This increase is attributed to our capital expenditures, primarily in the direct-to-consumer segment.

Impairment on long-lived assets. During the fourth quarter of fiscal 2013, we recorded a $3.5 million impairment charge to reduce the net carrying value of . . .

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