SKECHERS U.S.A., INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this annual report on Form 10-K. This section of this Form 10-K generally discusses 2019 and 2018 items and year-to-year comparisons between 2019 and 2018. Discussions of 2017 items and year-to-year comparisons that are not included in this Form 10-K can be found in "Part II-Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Results of Operations" and "-Liquidity and Capital Resources" in our annual report on Form 10-K for the fiscal year endedDecember 31, 2018 filed with theSEC onMarch 1, 2019 . GENERAL We design, market and sell lifestyle and performance footwear for men, women and children under the Skechers brand. Our footwear is sold through a wide range of department stores and leading specialty retail stores, mid-tier retailers, boutiques, our own direct-to-consumer stores and e-commerce sites, and distributor and licensee-owned international retail stores. Our objective is to design and market quality footwear that is comfortable, stylish and innovative, leverage our brand name and profitably grow our business across all channels of distribution. Our operations are organized along our distribution channels, and we have the following three reportable sales segments: domestic wholesale sales, international wholesale sales, which include international direct subsidiary sales and international distributor sales, and direct-to-consumer sales, which includes our company-owned retail stores and direct-to-consumer websites. We evaluate segment performance based primarily on sales and gross margins. See detailed segment information in Note 20 - Segment and Geographic Reporting in our Consolidated Financial Statements included under Part II, Item 8 of this annual report. FINANCIAL OVERVIEW Our sales for 2019 increased$578.0 million , or 12.5%, to$5,220.1 million , compared to sales of$4,642.1 million in 2018. The increase in sales primarily came from our international subsidiaries and retail businesses. Our international wholesale and international retail businesses represented 57.9% of our sales during 2019. During 2019, earnings from operations increased$80.6 million , or 18.4%, to$518.4 million compared to$437.8 million in 2018. Net earnings attributable toSkechers U.S.A., Inc. were$346.6 million for 2019, an increase of$45.6 million , or 15.1%, compared to net earnings of$301.0 million in 2018. Diluted earnings per share for 2019 were$2.25 , which reflected a 17.2% increase from the$1.92 diluted earnings per share reported in the prior year. Our working capital was$1,581.4 million atDecember 31, 2019 , which was a decrease of$40.5 million from working capital of$1,621.9 million atDecember 31, 2018 . Our cash and cash equivalents decreased$47.3 million to$824.9 million atDecember 31, 2019 from$872.2 million atDecember 31, 2018 . The decrease in cash and cash equivalents was primarily the result of the purchase of the minority interest of ourIndia joint venture for$82.9 million and our investment of$100.7 million for the acquisition of ourMexico joint venture, which were partially offset by our increased net earnings and increased accounts payable. 2019 OVERVIEW In 2019, we focused on developing comfortable product that is reflective of our expansive audience and changing trends, growing our position in our domestic wholesale accounts, growing our international market share, opening retail stores in key locations worldwide, continuing to develop our global infrastructure, and balance sheet and expense management. New product design and delivery. Our success depends on our ability to design and deliver comfortable, stylish, affordable products to consumers across a broad range of demographics. In 2019, we focused on fresh updates to our core and existing styles as well as broadening our reach through collaborations, limited edition collections, and new innovations such as Arch Fit and Hyper Burst. Grow our domestic business. In 2019, we delivered updates to our core and existing styles, launched collaborations with partners, including Atmos and Opening Ceremony, as well as with well-known properties including Scooby Doo, Doug the Pug andGrumpy Cat , and introduced the award-winning Hyper Burst technology in our Skechers Performance line. In addition, we updated our successful Skechers GO Walk collection by launching Skechers GO Walk Smart and Skechers GO Walk 5. In 2019, we remained a leading source for walking, work, casual lifestyle, sandals, and casual athletic footwear. 32 -------------------------------------------------------------------------------- Further develop our international businesses. During 2019, we continued to focus on growing our international sales by expanding the products we deliver to our international markets and growing our presence with wholesale partners with solutions like shop-in-shops and focal walls. We also purchased the outstanding minority interest of ourIndia joint venture and completed an investment into a new joint venture inMexico . Expand Skechers global direct-to-consumer base. Believing that Skechers retail stores are effective and profitable brand building tools, we continued to open Skechers stores around the world, both company and third-party owned. We also continued to enhance our e-commerce solutions by investing in people and technology to drive growth in the on-line channel. Develop our global infrastructure. In 2019, we continued constructing a newChina distribution center to support our operations in the region, and we expect it to be completed in 2020. We also added additional capacity in our European Distribution Center and commenced planning to expand ourRancho Belago distribution center to support the growth of our domestic wholesale and direct-to-consumer business. Balance sheet and expense management. During 2019, we continued to focus on managing our balance sheet and bringing our marketing expenses and general and administrative expenses in line with expected sales. During 2019, we returned$30.0 million to stockholders by repurchasing 1.0 million shares of our Class A Common Stock. We also expanded and extended our existing credit facility during 2019 to provided additional liquidity to support our global growth.
OUTLOOK FOR 2020
During 2020, we will continue to innovate our lifestyle and performance product lines by developing new styles and expanding into new categories. This includes building on our fit offerings with the addition of Stretch Knit and Arch Fit; our Performance offering with new versions of GO Walk and the addition of Hyper Burst and Max Cushioning; and our heritage collection with Street Cleats, Skechers D'Lites, Skechers Stamina, and Skechers Energy, among others. The global footwear market is competitive, but we believe global demand for the brand will remain strong due to our strategy of delivering style, comfort, innovation and quality that is affordably priced. We believe appeal for our product is broad and our marketing is effective and impactful. We will continue to use local and global brand ambassadors-including sports iconsClayton Kershaw ,Tony Romo , andHowie Long for men;Brooke Burke for women; elite athletes Meb Kelfezighi,Lionel Sanders and Edward Cheserek; and professional golfersMatt Kuchar ,Brooke Henderson , andColin Montgomerie . We expect to continue to increase our shelf space, and to open another 115 to 125 company-owned retail locations worldwide and to make investments in our direct-to-consumer technology infrastructure. In addition, we expect to complete the construction of our new distribution center inChina , begin the expansion of our distribution center inthe United States , and continue the construction of our corporate headquarters. DEFINITIONS Net sales
Reference in this annual report to "Sales" refers to Skechers' net sales
reported under generally accepted accounting principles in
Comparable sales
As part of our discussion of our results of operations, we disclose comparable
store sales, for which we typically include the impact of direct-to-consumer
sales on our company-owned websites. With respect to any reporting period, we
define comparable store sales as sales for stores that are owned and operated
for at least thirteen full calendar months as of the last day of any calendar
month within the current reporting period, and include only those sales for each
of the comparable full calendar months that the store is open within each
period. When a store closes at the end of a lease during a reporting period, we
include in comparable store sales the sales for the number of comparable full
calendar months that the store was open within the reporting period. We include
new stores in comparable store sales commencing with the fourteenth month of
operations because we believe it provides a more meaningful comparison of
operating results of months with stabilized operations, and excludes a new
store's first full calendar month of operations when operating results may not
be representative for a variety of reasons.
Definitions and calculations of comparable store sales differ among companies in
the retail industry, and therefore comparable store sales disclosed by us may
not be comparable to the metrics disclosed by other companies.
33
--------------------------------------------------------------------------------Cost of sales or Gross margins
Our cost of sales includes the cost of footwear purchased from our manufacturers, duties, tariffs, quota costs, inbound freight (including ocean, air and freight from the dock to our distribution centers), broker fees and storage costs. Because we include expenses related to our distribution network in general and administrative expenses, while some of our competitors may include expenses of this type in cost of sales, our gross margins may not be comparable and we may report higher gross margins than some of our competitors in part for this reason. Selling expenses Selling expenses consist primarily of the following: sales representative sample costs, sales commissions, trade shows, advertising and promotional costs, which may include television and ad production costs, and point-of-purchase costs.
General and administrative expenses
General and administrative expenses consist primarily of the following: salaries, wages and related taxes, various overhead costs associated with our corporate staff, stock-based compensation, domestic and international retail operations, non-selling related costs of our international operations, costs and expenses related to our distribution network for ourRancho Belago , European and other foreign distribution centers, professional fees related to both legal and accounting services, insurance, depreciation and amortization, asset impairment and legal settlements, among other expenses. Our distribution network-related costs are included in general and administrative expenses and are not allocated to specific segments.
YEAR ENDED
Sales
Sales for 2019 were$5,220.1 million , which was an increase of$578.0 million , or 12.5%, compared to sales of$4,642.1 million for 2018. The increase in sales primarily came from our international wholesale and retail businesses. Our domestic wholesale sales decreased$12.0 million , or 1.0%, to$1,247.6 million for 2019 compared to$1,259.6 million for 2018. The decrease in our domestic wholesale segment's sales was the result of a 1.9% unit sales volume decrease, to 57.0 million pairs in 2019 from 58.1 million pairs in 2018, which was partially offset by an increase in average selling price per pair of 1.9%, to$21.67 per pair for 2019 from$21.26 in 2018. This sales decrease was attributable to lower sales in our Women's and Men's Go, Kids and YOU divisions during 2019. The average selling price per pair increase within the domestic wholesale segment was primarily the result of product sales mix. Our international wholesale segment sales increased$407.8 million , or 19.8%, to$2,462.6 million for 2019 compared to sales of$2,054.8 million for 2018. Our international wholesale sales consist of wholesale sales by our foreign subsidiaries, sales from ourChina joint venture and sales to our distributors, who in turn sell to retailers in various international regions where we do not sell directly. Direct sales by our foreign subsidiaries, including our joint ventures, increased$325.8 million , or 18.9%, to$2,047.3 million for 2019 compared to sales of$1,721.5 million for 2018. The largest sales increases during the year came from our subsidiaries in theUnited Kingdom ,Germany ,India andSpain , and our joint ventures inChina ,Korea andMexico . The increases are primarily attributable to sales of our Men's and Women's Sport, Go, BOBS, and Men'sU.S.A. , lines. Our distributor sales increased$82.0 million , or 24.6%, to$415.3 million for 2019, compared to sales of$333.3 million for 2018. This was primarily attributable to increased sales to our distributors inRussia ,Indonesia andUnited Arab Emirates . Our retail segment sales increased$182.2 million to$1,509.9 million for the year endedDecember 31, 2019 , a 13.7% increase over sales of$1,327.7 million for 2018. The increase in retail sales was primarily attributable to increased comparable sales of 5.4%, which included increased sales within our Men's and Women's Sport, Men'sU.S.A. and Work divisions and a net increase of 27 domestic and 20 international stores compared to 2018. For the year endedDecember 31, 2019 , our domestic retail sales, increased 9.4% compared to 2018, which was primarily attributable to increased domestic store count and to positive comparable domestic store sales of 4.8%, and our international retail store sales increased 22.0% compared to 2018, which was attributable to increased international store count and positive comparable international store sales of 7.0%. We believe that we have established our presence in most major domestic retail markets. We had 497 domestic stores and 302 international retail stores as ofFebruary 1, 2020 , and we currently plan to open approximately 115 to 125 stores in 2020. During 2019, we opened one domestic factory outlet store, 32 domestic warehouse outlet stores, 15 international concept stores, 11 international factory outlet stores. During 2019, we closed five domestic concept stores, one domestic outlet store and six international concept stores. We periodically review all of our stores for impairment. During 2019 and 2018, we did not record an impairment charge related to our retail stores. 34 --------------------------------------------------------------------------------
Gross profit
Gross profit for 2019 increased$267.6 million , or 12.0%, to$2,491.1 million from$2,223.5 million for 2018. Gross profit, as a percentage of sales, or gross margin, decreased slightly to 47.7% in 2019 from 47.9% for 2018. Our domestic wholesale segment gross profit decreased$10.4 million , or 2.2%, to$457.9 million for 2019 from$468.3 million for 2018, which was primarily attributable due to lower sales. Domestic wholesale gross margins decreased to 36.7% for 2019 from 37.2% for 2018 primarily due to increased tariffs. Gross profit for our international wholesale segment increased$156.9 million , or 16.1%, to$1,133.6 million for 2019 compared to$976.7 million for 2018. Gross margins for the international wholesale segment were 46.0% for 2019 compared to 47.5% for 2018. Gross margins for our international direct subsidiary sales, including our joint ventures, were 50.1% for 2019 as compared to 51.7% for 2018. The decrease was primarily attributable to promotional efforts to clear seasonal inventory in select markets. Gross margins for our international distributor sales were 25.8% for 2019 as compared to 25.9% for 2018. Gross profit for our direct-to-consumer segment increased$121.1 million , or 15.6%, to$899.6 million for 2019 as compared to$778.5 million for 2018. Gross margins for all stores were 59.6% for 2019 compared to 58.6% for 2018. Gross margins for our domestic direct-to-consumer sales were 62.5% for 2019 as compared to 61.3% for 2018 primarily due to higher average selling prices. Gross margins for our international direct-to-consumer sales were 54.6% for 2019 as compared to 53.6% for 2018 primarily due to favorable product mix. The increase in our domestic retail margins was primarily attributable to higher average selling prices and lower average product costs.
Selling expenses
Selling expenses increased by$19.5 million , or 5.6%, to$369.9 million for 2019 from$350.4 million for 2018. As a percentage of sales, selling expenses were 7.1% and 7.5% for 2019 and 2018, respectively. The increase in selling expenses was primarily the result of higher advertising expense of$20.3 million .
General and administrative expenses
General and administrative expenses increased by$169.3 million , or 11.6%, to$1,625.3 million for 2019 from$1,456.0 million for 2018. As a percentage of sales, general and administrative expenses were 31.1% and 31.4% for 2019 and 2018, respectively. The increase in general and administrative expenses was primarily attributable to$61.1 million related to supporting our growing international operations, particularly inChina andMexico , increased store operating costs of$78.4 million primarily attributable to an additional net 47 stores, and increased domestic wholesale general and administrative expenses of$29.8 million primarily due to increased distribution costs of$26.8 million as a result of increased direct-to-consumer sales.
Other income (expense)
Interest income was$11.8 million for 2019 compared to$10.1 million for 2018. The increase in interest income was primarily due to higher average cash and investment balances and higher effective interest rates. Interest expense for 2019 increased$1.7 million to$7.5 million compared to$5.8 million in 2018. Interest expense increased primarily due to increased interest owed to our foreign manufacturers. Loss on foreign currency transactions for 2019 was$5.7 million compared to a$9.2 million loss in 2018. This decreased foreign currency exchange loss was primarily attributable to the impact of a strongerU.S. dollar on our intercompany balances in our foreign subsidiaries.
Income taxes
Our provision for income tax expense and our effective income tax rate are significantly impacted by the mix of our domestic and foreign earnings (loss) before income taxes. In the non-U.S. jurisdictions in which we have operations, the applicable statutory rates are generally significantly lower than in theU.S. , ranging from 0% to 34.6%. Our provision for income tax expense was calculated using the applicable statutory income tax rate for each jurisdiction applied to our pre-tax earnings (loss) in each jurisdiction, while our effective tax rate is calculated by dividing income tax expense by earnings (loss) before income taxes. 35
--------------------------------------------------------------------------------
Our earnings (loss) before income taxes and income tax expense for 2019, 2018 and 2017 are as follows (in thousands):
Years Ended December 31,
2019 2018 2017
Earnings (loss) Earnings (loss) Income tax Earnings (loss)
before income Income tax before income expense before income Income tax Income tax jurisdiction
taxes expense taxes (benefit) taxes expense
United States (1) $ 4,999 $ 24,887 $ 16,597
121,702 30,320 89,429 19,595 95,668 12,971
Hong Kong 50,131 4,303 48,352 8,106 17,778 5,030
Jersey (2) 245,561 - 213,327 - 198,048 -
Non-benefited loss operations (3) (7,685 ) 1,184 (11,422 ) (3,387 ) (17,350 ) 3,306
Other jurisdictions (4) 101,297 28,059 75,601 24,797 64,488 14,242
Earnings before income taxes $ 516,005
$ 431,884$ 60,611 $ 384,260$ 149,156 Effective tax rate (5) 17.2% 14.0% 38.8%
(1)
22, 2017.
(2) Jersey does not assess income tax on corporate net earnings.
(3) Consists of entities in the following tax jurisdictions where no tax benefit
is recognized in the period being reported because of the provision of
offsetting valuation allowances:
(4) Consists of entities in the following tax jurisdictions, each of which
comprises not more than 5% of consolidated earnings (loss) before taxes in
the period being reported:
(5) The effective tax rate is calculated by dividing income tax expense by
earnings before income taxes.
For 2019, the effective tax rate was lower than theU.S. federal and state combined statutory rate of approximately 25%, primarily because of earnings from foreign operations in jurisdictions imposing either lower tax rates on corporate earnings or no corporate income tax. During 2019, as reflected in the table above, earnings (loss) before income taxes in theU.S. were$5.0 million , with income tax expense of$24.9 million , which is an average rate of 498%. This rate is higher than the 25%U.S. statutory rate primarily due to the taxation on global intangible low-taxed income ("GILTI"), in theU.S. Earnings (loss) before income taxes in non-U.S. jurisdictions were$511.0 million , with an aggregate income tax expense of$63.9 million , which is an average rate of 12.5%. Combined, this results in consolidated earnings before income taxes for the period of$516.0 million , and consolidated income tax expense for the period of$88.8 million , resulting in an effective tax rate of 17.2%. For 2019, of our$511.0 million in earnings before income tax earned outside theU.S. ,$245.6 million was earned in Jersey, which does not impose a tax on corporate earnings. In Jersey, earnings before income taxes increased by$32.3 million to$245.6 million in 2019 from$213.3 million in 2018. This increase was primarily attributable to an increase in international sales, which resulted in an increase in earnings before income taxes in Jersey from royalties and commissions under the terms of our inter-subsidiary agreements. In addition, there were foreign losses of$7.6 million for which no tax benefit was recognized during the year endedDecember 31, 2019 because of the provision of offsetting valuation allowances. Individually, none of the other foreign jurisdictions included in "Other jurisdictions" in the table above had earnings greater than 5% of our consolidated earnings (loss) before taxes in any of the years shown. As ofDecember 31, 2019 , we had approximately$824.9 million in cash and cash equivalents, of which$566.4 million , or 68.7%, was outside theU.S. Of the$566.4 million held by our non-U.S. subsidiaries, approximately$220.3 million is available for repatriation to theU.S. without incurringU.S. income taxes and applicable non-U.S. income and withholding taxes in excess of the amounts accrued in our consolidated financial statements as ofDecember 31, 2019 . We believe our cash and cash equivalents and investments held in theU.S. and cash provided from operations are sufficient to meet our liquidity needs in theU.S. for the next twelve months, and we do not expect to repatriate any of the funds presently designated as indefinitely reinvested outside theU.S. We have provided for the tax impact of expected distributions from our joint venture inChina as well as from our subsidiary inChile to our intermediate parent company inSwitzerland . Otherwise, because of the need for cash for operating capital and continued overseas expansion, we do not foresee the need for any of our other foreign subsidiaries to distribute funds up to an intermediate foreign parent company in any form of taxable dividend. Under current applicable tax laws, if we chose to repatriate some or all of the funds we have designated as indefinitely reinvested outside theU.S. , the amount repatriated would not be subject toU.S. income taxes but may be subject to applicable non-U.S. income and withholding taxes, and to certain state income taxes. 36 --------------------------------------------------------------------------------
Non-controlling interest in net income and loss of consolidated subsidiaries
Net earnings attributable to non-controlling interest for 2019 increased$10.5 million to$80.7 million as compared to$70.2 million for 2018 due to increased profitability of our joint ventures. Non-controlling interest represents the share of net earnings or loss that is attributable to our joint venture partners.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
Our working capital atDecember 31, 2019 was$1,581.4 million , a decrease of$40.5 million from working capital of$1,621.9 million atDecember 31, 2018 . Our cash and cash equivalents atDecember 31, 2019 was$824.9 million compared to$872.2 million atDecember 31, 2018 . This decrease in cash and cash equivalents of$47.3 million , after consideration of the effect of exchange rates, was the result of capital expenditures of$236.1 million , increased receivables of$118.4 million and acquisitions of$100.7 million , which was partially offset by our net earnings of$427.3 million , and increased accounts payable of$154.5 million . Our primary sources of operating cash are collections from customers on wholesale and retail sales. Our primary uses of cash are inventory purchases, selling, general and administrative expenses and capital expenditures.
Operating Activities
Net cash provided by operating activities was$426.6 million for 2019 and$568.6 million for 2018. On a comparative yeartoyear basis, the$142.0 million decrease in cash flows from operating activities in 2019 primarily resulted from increased inventories of$171.9 million .
Investing Activities
Net cash used in investing activities was$344.1 million for 2019 as compared to$319.4 million in 2018. The increase in cash used in investing activities in 2019 as compared to 2018 was due to net cash used in the acquisition of an interest in ourMexico joint venture of$100.7 million and increased capital expenditures of$93.1 million , offset by a net decrease in investment purchases of$163.5 million . Capital expenditures for 2019 were approximately$236.1 million , which primarily consisted of$51.9 million for new store openings and remodels,$53.0 million for the construction for ourChina distribution center,$33.8 million to support our international wholesale operations,$19.6 million for the upgrades to our domestic distribution center, and$15.6 million for new retail locations in ourChina joint venture. This compares to capital expenditures of$143.0 million in the prior year, which primarily consisted of$50.0 million for new store openings and remodels,$28.8 million for land for ourChina distribution center,$20.6 million to support our international wholesale operations,$10.5 million for new retail locations in ourChina joint venture, and$17.6 million for the upgrades to our domestic distribution center. We expect our ongoing capital expenditures for 2020 to be between$325.0 million and$350.0 million , which includes completing the construction of ourChina distribution center; the expansion of ourU.S. distribution facility; opening 115 to 125 new company-owned Skechers stores and 20 to 30 store remodels, expansions and relocations; the expansion of our corporate headquarters; and technology investments, primarily in our direct-to-consumer business. We believe our current cash, investments, operating cash flows, available lines of credit and current financing arrangements should be adequate to fund these capital expenditures, although we may seek additional funding for all or a portion of these expenditures. Financing Activities Net cash used in financing activities was$132.0 million during 2019 compared to$119.7 million during 2018. The increase in cash used by financing activities was primarily attributable to the purchases of the non-controlling interest of ourIndia joint venture of$82.9 million , partially offset by a decrease of$70.0 million in repurchases of shares of our Class A Common Stock.
Capital Resources and Prospective Capital Requirements
Share Repurchase Program
OnFebruary 6, 2018 , our Board of Directors authorized the Share Repurchase Program, pursuant to which we may, from time to time, purchase shares of our Class A Common Stock for an aggregate repurchase price not to exceed$150.0 million . The Share Repurchase Program expires onFebruary 6, 2021 . Share repurchases may be executed through various means, including, without limitation, open market transactions, privately negotiated transactions or pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Exchange Act, subject to market conditions, applicable legal requirements and other relevant factors. The Share Repurchase Program does not obligate us to acquire any particular amount of shares of Class A Common Stock and the program may be suspended or discontinued at any time. As ofDecember 31, 2019 , there was$20.0 million available under the Share Repurchase Program. 37 --------------------------------------------------------------------------------
Acquisitions
In the first quarter of 2019, we purchased the minority interest in ourIndia joint venture for$82.9 million , which made ourIndia joint venture entity a wholly-owned subsidiary. In the second quarter of 2019, we purchased a 60% interest in Manhattan SKMX, deR.L. de C.V. ("Skechers Mexico") for a total cash consideration of$100.7 million , net of cash acquired. Skechers Mexico is a joint venture that operates and generates sales inMexico . As a result of this purchase, Skechers Mexico became a majority-owned subsidiary and the results are consolidated in our consolidated financial statements from the date of acquisition. The formation of the joint venture provides significant merchandising, supply chain and retail operations inMexico . We are in the final process of completing the purchase price allocation, which will be completed byApril 1, 2020 . However, the finalization may result in changes in the assets acquired and tax-related items. Pro forma results of operations have not been presented because the effects of the acquisitions, individually and in the aggregate, were not material to our consolidated financial statements.
Financing Arrangements
OnNovember 21, 2019 , we entered into a$500.0 million senior unsecured revolving credit facility, which matures onNovember 21, 2024 (the "2019 Credit Agreement"), withBank of America, N.A ., as administrative agent and joint lead arranger,HSBC Bank USA, N.A. andJPMorgan Chase Bank, N.A ., as joint lead arrangers, and other lenders. The 2019 Credit Agreement replaced our then existing$250.0 million loan and security agreement datedJune 30, 2015 withBank of America, N.A .,MUFG Union Bank, N.A. andHSBC Bank USA, National Association that was set to expire onJune 30, 2020 . The 2019 Credit Agreement may be increased by up to$250.0 million under certain conditions and provides for the issuance of letters of credit up to a maximum of$100.0 million and swingline loans up to a maximum of$25.0 million . We may use the proceeds from the 2019 Credit Agreement for working capital and other lawful corporate purposes. At our option, any loan (other than swingline loans) will bear interest at a rate equal to (a) LIBOR plus an applicable margin between 1.125% and 1.625% based upon our Total Adjusted Net Leverage Ratio (as defined in the 2019 Credit Agreement) or (b) a base rate (defined as the highest of (i) the Federal Funds Rate plus 0.50%, (ii) theBank of America prime rate and (iii) LIBOR plus 1.00%) plus an applicable margin between 0.125% and 0.625% based upon our Total Adjusted Net Leverage Ratio. Any swingline loan will bear interest at the base rate. We will pay a variable commitment fee of between 0.125% and 0.25% of the actual daily unused amount of each lender's commitment, and will also pay a variable letter of credit fee of between 1.125% and 1.625% on the maximum amount available to be drawn under each issued and outstanding letter of credit, both of which are based upon our Total Adjusted Net Leverage Ratio. The 2019 Credit Agreement contains customary affirmative and negative covenants for credit facilities of this type, including covenants that limit the ability of our company and our subsidiaries to, among other things, incur debt, grant liens, make certain acquisitions, dispose of assets, effect a change of control of our company, make certain restricted payments including certain dividends and stock redemptions, make certain investments or loans, enter into certain transactions with affiliates and certain prohibited uses of proceeds. The 2019 Credit Agreement also requires that the total adjusted net leverage ratio not exceed 3.75, except in the event of an acquisition in which case the ratio may be increased at our election to 4.25 for the quarter in which such acquisition occurs and for the next three quarters thereafter. The 2019 Credit Agreement provides for customary events of default including payment defaults, breaches of representations or warranties or covenants, cross defaults with certain other indebtedness to third parties, certain judgments/awards/orders, a change of control, bankruptcy and insolvency events, inability to pay debts, ERISA defaults, and invalidity or impairment of the 2019 Credit Agreement or any loan documentation related thereto, with, in certain circumstances, cure periods. Certain of the lenders party to the 2019 Credit Agreement, and their respective affiliates, have performed, and may in the future perform for us and our subsidiaries, various commercial banking, investment banking, underwriting and other financial advisory services, for which they have received, and will receive, customary fees and expenses. We paid origination, arrangement and legal fees of$1.6 million on the 2019 Credit Agreement, which are being amortized to interest expense over the five-year life of the 2019 Credit Agreement. As ofDecember 31, 2019 , there was no outstanding amount under the 2019 Credit Agreement. OnSeptember 29, 2018 , through a Taicang subsidiary, we entered into a700 million yuan loan agreement with China Construction Bank Corporation (the "China DC Loan Agreement"). The proceeds from the China DC Loan Agreement are being used to finance the construction of our distribution center inChina . Interest is paid quarterly. The interest rate was 4.275% atDecember 31, 2019 , which floats and is calculated from a reference rate provided by thePeople's Bank of China . The interest rate may increase or decrease over the life of the loan and will be evaluated every 12 months. The principal of the loan will be repaid in semi-annual installments, beginning in 2021, of variable amounts as specified in the China DC Loan Agreement. The China DC Loan Agreement contains customary affirmative and negative covenants for secured credit facilities of this type, including covenants that limit the ability of the joint venture to, among other things, allow external investment to be added, pledge assets, issue debt with priority over the China DC Loan Agreement, and adjust the capital stock structure of the TC Subsidiary. The China DC Loan Agreement matures onSeptember 28, 2023 . The obligations of the TC Subsidiary under the China DC Loan Agreement are jointly and severally guaranteed by our Chinese joint venture. As ofDecember 31, 2019 , there was$48.8 million outstanding under this credit facility, which is classified as long-term borrowings in our consolidated balance sheets. OnApril 30, 2010 , HF Logistics-SKX,LLC (the "JV"), throughHF Logistics-SKX T1, LLC , aDelaware limited liability company and a wholly-owned subsidiary of the JV ("HF-T1"), entered into a construction loan agreement withBank of America , 38 -------------------------------------------------------------------------------- N.A., as administrative agent and as a lender, andRaymond James Bank , FSB, as a lender (collectively, the "Construction Loan Agreement"), pursuant to which the JV obtained a loan of up to$55.0 million used for construction of the project on the property (the "Original Loan"). OnNovember 16, 2012 , HF-T1 executed a modification to the Construction Loan Agreement (the "Modification"), which addedOneWest Bank , FSB as a lender, increased the borrowings under the Original Loan to$80.0 million and extended the maturity date of the Original Loan toOctober 30, 2015 . OnAugust 11, 2015 , the JV through HF-T1 entered into an amended and restated loan agreement withBank of America, N.A ., as administrative agent and as a lender, andCIT Bank, N.A . (formerly known asOneWest Bank , FSB) andRaymond James Bank, N.A. , as lenders (collectively, the "Amended Loan Agreement"), which amends and restates in its entirety the Construction Loan Agreement and the Modification. As of the date of the Amended Loan Agreement, the outstanding principal balance of the Original Loan was$77.3 million . In connection with this refinancing of the Original Loan, the JV, our company and HF agreed that we would make an additional capital contribution of$38.7 million to the JV for the JV through HF-T1 to use to make a payment on the Original Loan. The payment equaled our 50% share of the outstanding principal balance of the Original Loan. Under the Amended Loan Agreement, the parties agreed that the lenders would loan$70.0 million to HF-T1 (the "New Loan"). The New Loan is being used by the JV through HF-T1 to (i) refinance all amounts owed on the Original Loan after taking into account the payment described above, (ii) pay$0.9 million in accrued interest, loan fees and other closing costs associated with the New Loan and (iii) make a distribution of$31.3 million less the amounts described in clause (ii) to HF. Pursuant to the Amended Loan Agreement, the interest rate on the New Loan is the LIBOR Daily Floating Rate (as defined in the Amended Loan Agreement) plus a margin of 2%. The maturity date of the New Loan isAugust 12, 2020 , which HF-T1 has one option to extend by an additional 24 months, or untilAugust 12, 2022 , upon payment of a fee and satisfaction of certain customary conditions. OnAugust 11, 2015 ,HF-T1 andBank of America, N.A . entered into an ISDA master agreement (together with the schedule related thereto, the "Swap Agreement") to govern derivative and/or hedging transactions that HF-T1 concurrently entered into withBank of America, N.A . Pursuant to the Swap Agreement, onAugust 14, 2015 , HF-T1 entered into a confirmation of swap transactions (the "Interest Rate Swap") withBank of America, N.A . The Interest Rate Swap has an effective date ofAugust 12, 2015 and a maturity date ofAugust 12, 2022 , subject to early termination at the option of HF-T1, commencing onAugust 1, 2020 . The Interest Rate Swap fixes the effective interest rate on the New Loan at 4.08% per annum. Pursuant to the terms of the JV, HF Logistics is responsible for the related interest expense on the New Loan, and any amounts related to the Swap Agreement. The full amount of interest expense related to the New Loan has been included in our consolidated statements of equity within non-controlling interests. The Amended Loan Agreement and the Swap Agreement are subject to customary covenants and events of default.Bank of America, N.A . also acts as a lender and syndication agent under our credit agreement datedJune 30, 2015 . We had$63.7 million outstanding under the Amended Loan Agreement, which is included in short-term borrowings as ofDecember 31, 2019 . As ofDecember 31, 2019 , outstanding short-term and long-term borrowings were$121.2 million , of which$115.4 million relates to loans for our domestic andChina distribution center. Our long-term debt obligations contain both financial and non-financial covenants, including cross-default provisions. We were in compliance with all debt covenants related to our short-term and long-term borrowings as of the date of this annual report. We believe that anticipated cash flows from operations, available borrowings under our credit agreement, existing cash and investments balances and current financing arrangements will be sufficient to provide us with the liquidity necessary to fund our anticipated working capital and capital requirements at least throughMarch 31, 2021 . Our future capital requirements will depend on many factors, including, but not limited to, the global economy and the outlook for and pace of sustainable growth in our markets, the levels at which we maintain inventory, sale of excess inventory at discounted prices, the market acceptance of our footwear, the number and timing of new store openings, the success of our international operations, costs associated with constructing ourChina distribution center and distribution center equipment, the costs of upgrading our domestic and European distribution centers, the amount and timing of share repurchases, the levels of advertising and marketing required to promote our footwear, the extent to which we invest in new product design and improvements to our existing product design, costs associated with constructing new corporate offices, and any potential acquisitions of other brands or companies. To the extent that available funds are insufficient to fund our future activities, we may need to raise additional funds through public or private financing of debt or equity. We have been successful in the past in raising additional funds through financing activities; however, we cannot be assured that additional financing will be available to us or that, if available, it can be obtained on past terms which have been favorable to our stockholders and us. Failure to obtain such financing could delay or prevent our current business plans, which could adversely affect our business, financial condition, results of operations and cash flows. In addition, if additional capital is raised through the sale of additional equity or convertible securities, dilution to our stockholders could occur. 39 --------------------------------------------------------------------------------
Disclosure about Contractual Obligations and Commercial Commitments
The following table summarizes our material contractual obligations and
commercial commitments as of
Less than One to Three to More Than
One Three Five Five
Total Year Years Years Years
Short-term borrowings $ 5,789 $ 5,789 $ - $ - $ -
Long-term borrowings (1) 117,138 65,413 51,725 - -Operating lease obligations (2) 1,387,959 236,604 394,299 317,290 439,766 Purchase obligations (3)
1,290,431 1,290,431 - - -
Warehouse and equipment (4) 302,940 127,940 175,000 - -
Corporate construction contracts
(5) 152,450 85,162 67,288 - -
Minimum payments related to other
arrangements 51,120 22,266 28,854 - -
Total (6) $ 3,307,827 $ 1,833,605 $ 717,166 $ 317,290 $ 439,766 (1) Amounts include anticipated interest payments based on interest rates
currently in effect.
(2) Operating lease obligations consists primarily of real properly leases for
our retail stores, corporate offices, European and other international
distribution centers. These leases frequently include options that permit us
to extend beyond the terms of the initial fixed term. We currently expect to
fund these commitments with cash flows from operations and existing cash and
investment balances.
(3) Purchase obligations include the following: (i) accounts payable balances for
the purchase of footwear of
credit of
manufacturers for
commitments with cash flows from operations and existing cash and investment
balances.
(4) Amounts include warehouse and equipment upgrades for our
Belago distribution centers.
(5) During 2018, we entered into construction agreements with McCarthy
in
(6) Our consolidated balance sheet, as of
million in unrecognized tax benefits. Future payments related to these
unrecognized tax benefits have not been presented in the table above, due to
the uncertainty of the amounts, the potential timing of cash settlements with
the tax authorities, and uncertainty whether any settlement would occur. In
addition, the table above does not include payments of
next six years related to the provisional one-time tax liability recorded due
to the Tax Act.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any relationships with unconsolidated entities or financial partnerships such as entities often referred to as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance-sheet arrangements or for other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.
CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES
Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements, which have been prepared in accordance withU.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience, other available information, and on other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for judgments about the carrying values of assets and liabilities. In determining whether an estimate is critical, we consider whether the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment or the susceptibility of such matters to change, and whether the impact of the estimates and assumptions have a material impact on our financial condition or operating performance. Actual results may differ from these estimates under different assumptions or conditions. 40 --------------------------------------------------------------------------------
We believe the following critical accounting estimates are affected by significant judgments used in the preparation of our consolidated financial statements: revenue recognition, allowance for bad debts, returns, sales allowances and customer chargebacks, inventory write-downs, valuation of intangibles and long-lived assets, goodwill, litigation reserves, and tax estimates and valuation of deferred income taxes.
Revenue Recognition. We derive income from the sale of footwear and royalties earned from licensing the Skechers brand. We recognize revenue when control of the promised goods or services is transferred to its customers in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. ForNorth America , goods are shipped Free on Board ("FOB") shipping point directly from our domestic distribution center inRancho Belago ,California . For international wholesale customers, product is shipped FOB shipping point, (i) direct from our distribution center inLiege, Belgium , (ii) to third-party distribution centers inCentral America ,South America andAsia , and (iii) directly from third-party manufacturers to our other international customers. For our distributor sales, the goods are generally delivered directly from the independent factories to third-party distribution centers or to our distributors' freight forwarders on a Free Named Carrier ("FCA") basis. We recognize revenue on wholesale sales upon shipment as that is when the customer obtains control of the promised goods. Related costs paid to third-party shipping companies are recorded as cost of sales and are accounted for as a fulfillment cost and not as a separate performance obligation. We generate retail revenues primarily from the sale of footwear to customers at retail locations or through our websites. For our in-store sales, we recognize revenue at the point of sale. For sales made through our websites, we recognize revenue upon shipment to the customer which is when the customer obtains control of the promised good. Sales and value added taxes collected from direct-to-consumer or retail customers are excluded from reported revenues. We record accounts receivable at the time of shipment when our right to the consideration becomes unconditional. We typically extend credit terms to our wholesale customers based on their creditworthiness and generally we do not receive advance payments. Generally, wholesale customers do not have the right to return goods, however, we periodically decide to accept returns or provide customers with credits. Allowances for estimated returns, discounts, doubtful accounts and chargebacks are provided for when related revenue is recorded. Retail and direct-to-consumer sales generally represent amounts due from credit card companies and are generally collected within a few days of the purchase. As such, we have determined that an allowance for doubtful accounts for direct-to-consumer sales is not necessary. We earn royalty income from our licensing arrangements that qualify as symbolic licenses rather than functional licenses. Upon signing a new licensing agreement, we receive up-front fees, which are generally characterized as prepaid royalties. These fees are initially deferred and recognized as revenue is earned (i.e., as licensed sales are reported to us or on a straight-line basis over the term of the agreement). The first calculated royalty payment is based on actual sales of the licensed product or, in some cases, minimum royalty payments. We calculate and accrue estimated royalties based on the agreement terms and correspondence with the licensees regarding actual sales.
Judgments
We considered several factors in determining that control transfers to the customer upon shipment of products. These factors include that legal title transfers to the customer, we have a present right to payment, and the customer has assumed the risks and rewards of ownership at the time of shipment. We accrue a liability for product returns at the time of sale based on our historical experience. We also accrue amounts for goods expected to be returned in salable condition. As ofDecember 31, 2019 andDecember 31, 2018 , our sales returns liability totaled$86.5 million and$67.3 million , respectively, and was included in accrued expenses in the consolidated balance sheets. Allowance for bad debts, returns, sales allowances and customer chargebacks. We provide a reserve against our receivables for estimated losses that may result from our customers' inability to pay. To minimize the likelihood of uncollectibility, customers' credit-worthiness is reviewed and adjusted periodically in accordance with external credit reporting services, financial statements issued by the customer and our experience with the account. When a customer's account becomes significantly past due, we generally place a hold on the account and discontinue further shipments to that customer, minimizing further risk of loss. We determine the amount of the reserve by analyzing known uncollectible accounts, aged receivables, economic conditions in the customers' countries or industries, historical losses and our customers' credit-worthiness. Amounts later determined and specifically identified to be uncollectible are charged or written off against this reserve. Allowances for returns, sales allowances and customer chargebacks are recorded against revenue. Allowances for bad debts are recorded to general and administrative expenses. Retail and direct-to-consumer receivables represent amounts due from credit card companies and are generally collected within a few days of the purchase. As such we have determined that no allowance for doubtful accounts is necessary. We also reserve for potential disputed amounts or chargebacks from our customers. Our chargeback reserve is based on a collectability percentage based on factors such as historical trends, current economic conditions, and nature of the chargeback receivables. We also reserve for potential sales returns and allowances based on historical trends. 41 -------------------------------------------------------------------------------- The likelihood of a material loss on an uncollectible account would be mainly dependent on deterioration in the overall economic conditions in a particular country or region. Reserves are fully provided for all probable losses of this nature. For receivables that are not specifically identified as high risk, we provide a reserve based upon our historical loss rate as a percentage of sales. Inventory write-downs. Inventories are stated at the lower of cost or market. We continually review our inventory for excess and slow-moving inventory. Our review is based on inventory on hand, prior sales and expected net realizable value. Our analysis includes a review of inventory quantities on hand at period-end in relation to year-to-date sales, existing orders from customers and projections for sales in the foreseeable future. The net realizable value, or market value, is determined based on our estimate of sales prices of such inventory based on historical sales experience on a style-by-style basis. A write-down of inventory is considered permanent, and creates a new cost basis for those units. The likelihood of any material inventory write-down depends primarily on our expectation of future consumer demand for our product. A misinterpretation or misunderstanding of future consumer demand for our product or of the economy, or other failure to estimate correctly, could result in inventory valuation changes, either favorably or unfavorably, compared to the requirement determined to be appropriate as of the balance sheet date. Valuation of intangibles and long-lived assets. When circumstances warrant, we test for recoverability of the asset groups' carrying value using estimates of undiscounted future cash flows based on the existing service potential of the applicable asset group in determining the fair value of each asset group. We evaluate whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount based on our assessment of the following events or changes in circumstances:
• macroeconomic conditions such as a deterioration in general economic
conditions, limitations on accessing capital, fluctuations in foreign
exchange rates, or other developments in equity and credit markets;
• industry and market considerations such as a deterioration in the
environment in which an entity operates, an increased competitive
environment, a decline in market-dependent multiples or metrics, or achange in the market for an entity's products or services, or a regulatory
or political development;
• cost factors such as increases in raw materials, labor, or other costs
that have a negative effect on earnings and cash flows;
• overall financial performance such as negative or declining cash flows, or
a decline in actual or planned revenue or earnings compared with actual
and projected results of relevant prior periods;
• other relevant entity-specific events such as changes in management, key
personnel, strategy, customers, contemplation of bankruptcy, or
litigation;
• events affecting a reporting unit such as a change in the composition or
carrying amount of its net assets, a more-likely-than-not expectation of
selling or disposing all, or a portion, of a reporting unit, the testing
for recoverability of a significant asset group within a reporting unit,
or recognition of a goodwill impairment loss in the financial statements
of a subsidiary that is a component of a reporting unit; and
• a sustained decrease in share price.
If the assets are considered to be impaired, the impairment we recognize is the
amount by which the carrying value of the assets exceeds the fair value of the
assets. We base the useful lives and related amortization or depreciation
expense on our estimate of the period that the assets will generate revenues or
otherwise be used by us. We review all of our stores for impairment annually or
more frequently if events or changes in circumstances require it. We prepare a
summary of cash flows for each of our retail stores, to assess potential
impairment of the fixed assets and leasehold improvements. Stores with negative
cash flows which have been open in excess of twenty-four months are then
reviewed in detail to determine whether impairment exists. Management reviews
both quantitative and qualitative factors to assess whether a triggering event
occurred. For the years ended December 31, 2019 , 2018 and 2017, respectively we
did not record an impairment charge.
Goodwill . We assess goodwill for impairment annually or more frequently if
events or changes in circumstances require it. First, we determine if, based on
qualitative factors, it is more likely than not that an impairment exists.
Factors considered include historical financial performance, macroeconomic and
industry conditions and the legal and regulatory environment. If the qualitative
assessment indicates that it is more likely than not that an impairment exists,
then a quantitative assessment is performed. The quantitative assessment
requires an analysis of several best estimates and assumptions, including future
sales and operating results, and other factors that could affect fair value or
otherwise indicate potential impairment. We also consider the reporting units'
projected ability to generate income from operations and positive cash flow in
future periods, as well as perceived changes in consumer demand and acceptance
of products, or factors impacting the industry generally. The fair value
assessment could change materially if different estimates and assumptions were
used.
42
-------------------------------------------------------------------------------- Litigation reserves. Estimated amounts for claims that are probable and can be reasonably estimated are recorded as liabilities in our consolidated financial statements. The likelihood of a material change in these estimated reserves would depend on additional information or new claims as they may arise as well as the favorable or unfavorable outcome of the particular litigation. Both the likelihood and amount (or range of loss) on a large portion of our remaining pending litigation is uncertain. As such, we are unable to make a reasonable estimate of the liability that could result from unfavorable outcomes in our remaining pending litigation. As additional information becomes available, we will assess the potential liability related to our pending litigation and revise our estimates. Such revisions in our estimates of potential liability could materially impact our results of operations and financial position. Tax estimates and valuation of deferred income taxes. We record a valuation allowance when necessary to reduce our deferred tax assets to the amount that is more likely than not to be realized. The likelihood of a material change in our expected realization of our deferred tax assets depends on future taxable income and the effectiveness of our tax planning strategies amongst the various domestic and international tax jurisdictions in which we operate. We evaluate our projections of taxable income to determine the recoverability of our deferred tax assets and the need for a valuation allowance.
INFLATION
We do not believe that the rates of inflation experienced inthe United States over the last three years have had a significant effect on our sales or profitability. However, we cannot accurately predict the effect of inflation on future operating results. Although higher rates of inflation have been experienced in a number of foreign countries in which our products are manufactured, we do not believe that inflation has had a material effect on our sales or profitability. While we have been able to offset our foreign product cost increases by increasing prices or changing suppliers in the past, we cannot assure you that we will be able to continue to make such increases or changes in the future. EXCHANGE RATES We receiveU.S. dollars for substantially all of our domestic and a portion of our international product sales, as well as our royalty income. Inventory purchases from offshore contract manufacturers are primarily denominated inU.S. dollars. However, purchase prices for our products may be impacted by fluctuations in the exchange rate between theU.S. dollar and the local currencies of the contract manufacturers, which may have the effect of increasing our cost of goods in the future. During 2019 and 2018, exchange rate fluctuations did not have a material impact on our inventory costs. We do not engage in hedging activities with respect to such exchange rate risk.
RECENT ACCOUNTING PRONOUNCEMENTS
Refer to Note 1 - The Company and Summary of Significant Accounting Policies in
the accompanying Notes to the Consolidated Financial Statements for recently
adopted and recently issued accounting standards.
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