# Designer Brands Inc. (DBI) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Designer Brands Inc.'s 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1319947/000131994722000010/dsw-20220129.htm
Accession: 0001319947-22-000010
Filing date: 2022-03-21
Report date: 2022-01-29
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

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

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

This management's discussion and analysis of financial condition and results of operations contains forward-looking statements that involve various risks and uncertainties. See Cautionary Statement Regarding Forward-Looking Information for Purposes of the "Safe Harbor" Provisions of the Private Securities Litigation Reform Act of 1995 on page ii for a discussion of the uncertainties, risks, and assumptions associated with these statements. This discussion is best read in conjunction with our Consolidated Financial Statements, including the notes thereto, set forth in Item 8. Financial Statements and Supplementary Data of this Form 10-K. The results of operations for the periods reflected herein are not necessarily indicative of results that may be expected for future periods, and our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including but not limited to those listed under Item 1A. Risk Factors of this Form 10-K and included elsewhere in this Form 10-K.

The following discussion includes a comparison of our results of operations and liquidity and capital resources for 2021 and 2020. Except where it may be useful in understanding 2021 results, we have omitted discussion of results for 2019, which may be found in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended January 30, 2021, filed with the SEC on March 22, 2021.

20

EXECUTIVE OVERVIEW AND TRENDS IN OUR BUSINESS

Despite the continuing challenges of the volatile market conditions and supply chain disruptions, our strong results for 2021 demonstrated our ability to be nimble and quickly adapt our business model. Our operating profit in 2021 surpassed pre-COVID-19 levels with a 61% growth when compared to 2019 and we continued to make progress by:

•Growing our market share in historically underpenetrated categories, including athletic, men’s and kids’;

•Maintaining our leading position in the seasonal and dress categories; and

•Leaning further into our in-house design and sourcing capabilities as we move towards our goal of becoming a builder of brands.

As we look ahead to our strategic growth, we have organized our efforts around three pillars - Customer, Brand, and Speed:

•Customer- More than ever, our customers have a great desire for products and experiences, and we are adding resources to our digital, information technology ("IT") and analytics teams to understand precisely what they want and what can be improved to provide the best possible experience. Undertaking these actions will enable us to better understand our customers, provide improved service, and target new demographics in ways that we have never deployed before. We are also developing new ideas for how we can provide more value to our VIP rewards members, who we believe continue to be the lifeblood of our business and our largest competitive differentiator.

•Brand- Controlling our own brand destiny is critical for our growth. As we continue to design some of the best brands in the industry, Vince Camuto, Jessica Simpson, Lucky Brand and JLO Jennifer Lopez, we are combining that with our strong direct-to-consumer distribution through our physical footprint in North America and digital infrastructure. We are also partnering with some of the top national brands in the industry to offer one of the largest and broadest assortments. We remain focused on investing in our top 50 brands and will continue to prioritize growing our own brands.

•Speed- Moving quickly is of the utmost importance to consumers. We are developing processes to deliver products more quickly. Fulfillment of digital customer orders currently takes five to seven business days and we are working to improve that to two to three calendar days while simultaneously finding efficiencies to contain costs. We are optimizing our current infrastructure and expanding our delivery partnerships. We are also working to improve collaboration through technology and processes across our organization and to gain additional efficiencies in our overall development cycle.

IMPACT OF THE COVID-19 PANDEMIC ON OUR RESULTS OF OPERATIONS

As we continue to closely monitor the ongoing COVID-19 pandemic, our top priority remains protecting the health and safety of our customers and associates. As this continues to be an unprecedented period of uncertainty, we have made adjustments and may continue to adjust our operational plans, inventory controls, and liquidity management, as well as make changes to our expense and capital expenditure plans. While trends improved during 2021 as compared to 2020, we cannot reasonably estimate the extent to which our business will continue to be affected by the COVID-19 pandemic and to what extent the recent improved trends will continue. For instance, we have continued to experience reduced customer in-store traffic and net sales when compared to pre-COVID-19 periods, and it is unclear when customer behavior will return to pre-COVID-19 patterns, if at all. The ongoing and prolonged nature of the COVID-19 pandemic may lead to further adjustments to our operations. As such, the ultimate impacts of the COVID-19 pandemic on our businesses will depend on future developments, including the availability of labor, global supply chain disruptions, new variants of COVID-19 and the severity thereof, and the global availability and use of vaccines or palliatives, all of which are highly uncertain and cannot be predicted. As a result, we may have future write-downs or adjustments to inventories, receivables, long-lived assets, intangibles, goodwill, and the valuation allowance on deferred tax assets.

21

FINANCIAL SUMMARY AND OTHER KEY METRICS

•Net sales increased to $3.2 billion for 2021 from $2.2 billion for 2020.

•Gross profit as a percentage of net sales was 33.4% for 2021, as compared to 13.9% for 2020 and higher than the pre-COVID-19 rate, which was 28.6% for 2019.

•Net income for 2021 was $154.5 million, or $2.00 per diluted share, which included net after-tax benefits of $23.2 million, or $0.30 per diluted share, primarily related to the change in valuation allowance on deferred tax assets, restructuring charges, and target acquisition costs. Net loss for 2020 was $488.7 million, or a loss of $6.77 per diluted share, which included net after-tax charges of $207.1 million, or $2.87 per diluted share, primarily related to impairment and restructuring charges, a settlement gain with a vendor, and the valuation allowance established against deferred tax assets.

Comparable Sales Performance Metric- The following table presents the percent change in comparable sales for each segment and in total:

[[GREPCENT_TABLE]]
[["","2021","","2020"],["Change in comparable sales:"],["U.S. Retail segment","55.0","%","","(34.9)","%"],["Canada Retail segment","20.1","%","","(26.0)","%"],["Brand Portfolio segment - direct-to-consumer channel","30.9","%","","38.2","%"],["Other","NA","","(50.4)","%"],["Total","51.6","%","","(34.2)","%"]]
[[/GREPCENT_TABLE]]

NA - Not applicable

We consider the percent change in comparable sales from the same previous year period, a primary metric commonly used throughout the retail industry, to be an important measurement for management and investors of the performance of our direct-to-consumer businesses. We include in our comparable sales metric sales from stores in operation for at least 14 months at the beginning of the applicable year. Stores are added to the comparable base at the beginning of the year and are dropped for comparative purposes in the quarter in which they are closed. Comparable sales include stores temporarily closed as a result of the COVID-19 pandemic as management believes that this metric is meaningful to monitor our performance. Comparable sales also include e-commerce sales. Comparable sales for the Canada Retail segment exclude the impact of foreign currency translation and are calculated by translating current period results at the foreign currency exchange rate used in the comparable period of the prior year. Comparable sales for the Brand Portfolio segment include the direct-to-consumer e-commerce site www.vincecamuto.com. Beginning with the third quarter of 2020, comparable sales do not include the Other segment due to no longer having activity in the Other segment. The calculation of comparable sales varies across the retail industry and, as a result, the calculations of other retail companies may not be consistent with our calculation.

Number of Stores- As of the end of 2021 and 2020, we had the following number of stores:

[[GREPCENT_TABLE]]
[["","January 29, 2022","","January 30, 2021"],["U.S. Retail segment - DSW stores","508","","","519"],["Canada Retail segment:"],["The Shoe Company stores","115","","","117"],["DSW stores","25","","","27"],["","140","","","144"],["Total number of stores","648","","","663"]]
[[/GREPCENT_TABLE]]

22

RESULTS OF OPERATIONS

The following table presents our consolidated results of operations with associated percentages of net sales:

[[GREPCENT_TABLE]]
[["(amounts in thousands, except per share amounts)","2021","","2020","","Change"],["","Amount","","% of Net Sales","","Amount","","% of Net Sales","","Amount","","%"],["Net sales","$","3,196,583","","","100.0","%","","$","2,234,719","","","100.0","%","","$","961,864","","","43.0","%"],["Cost of sales","(2,127,946)","","","(66.6)","","","(1,923,478)","","","(86.1)","","","(204,468)","","","10.6","%"],["Gross profit","1,068,637","","","33.4","","","311,241","","","13.9","","","757,396","","","243.3","%"],["Operating expenses","(870,682)","","","(27.2)","","","(753,278)","","","(33.7)","","","(117,404)","","","15.6","%"],["Income from equity investment","8,986","","","0.3","","","9,329","","","0.5","","","(343)","","","(3.7)","%"],["Impairment charges","(1,720)","","","(0.1)","","","(153,606)","","","(6.9)","","","151,886","","","(98.9)","%"],["Operating profit (loss)","205,221","","","6.4","","","(586,314)","","","(26.2)","","","791,535","","","NM"],["Interest expense, net","(32,129)","","","(1.0)","","","(23,694)","","","(1.1)","","","(8,435)","","","35.6","%"],["Non-operating income (expenses), net","(67)","","","(0.0)","","","1,361","","","0.1","","","(1,428)","","","NM"],["Income (loss) before income taxes","173,025","","","5.4","","","(608,647)","","","(27.2)","","","781,672","","","NM"],["Income tax benefit (provision)","(18,544)","","","(0.6)","","","119,928","","","5.3","","","(138,472)","","","NM"],["Net income (loss)","$","154,481","","","4.8","%","","$","(488,719)","","","(21.9)","%","","$","643,200","","","NM"],["Basic and diluted earnings (loss) per share:"],["Basic earnings (loss) per share","$","2.12","","","","","$","(6.77)","","","","","$","8.89","","","NM"],["Diluted earnings (loss) per share","$","2.00","","","","","$","(6.77)","","","","","$","8.77","","","NM"],["Weighted average shares used in per share calculations:"],["Basic shares","73,024","","","","","72,198","","","","","826","","","1.1","%"],["Diluted shares","77,268","","","","","72,198","","","","","5,070","","","7.0","%"]]
[[/GREPCENT_TABLE]]

NM - Not meaningful

NET SALES

The following table summarizes net sales by segment:

[[GREPCENT_TABLE]]
[["(dollars in thousands)","2021","","2020","","Change"],["","Amount","","% of Total Segment Net Sales","","Amount","","% of Total Segment Net Sales","","Amount","","%","","Comparable Sales %"],["Segment net sales:"],["U.S. Retail","$","2,769,706","","","84.2","%","","$","1,800,323","","","78.5","%","","$","969,383","","","53.8","%","","55.0%"],["Canada Retail","234,809","","","7.1","%","","182,659","","","8.0","%","","52,150","","","28.6","%","","20.1%"],["Brand Portfolio","286,024","","","8.7","%","","248,646","","","10.8","%","","37,378","","","15.0","%","","30.9%"],["Other","\u2014","","","\u2014","%","","62,909","","","2.7","%","","(62,909)","","","NM","","NA"],["Total segment net sales","3,290,539","","","100.0","%","","2,294,537","","","100.0","%","","996,002","","","43.4","%","","51.6%"],["Elimination of intersegment net sales","(93,956)","","","","","(59,818)","","","","","(34,138)","","","57.1","%"],["Consolidated net sales","$","3,196,583","","","","","$","2,234,719","","","","","$","961,864","","","43.0","%"]]
[[/GREPCENT_TABLE]]

NA - Not applicable

NM - Not meaningful

23

The improvement in sales, including increases in comparable sales and total consolidated net sales, during 2021 over 2020 was a result of the temporary closure of stores in 2020 during our peak spring selling season in response to the COVID-19 pandemic and significantly reduced customer in-store traffic since re-opening. During 2021, sales significantly recovered from 2020 levels, although we have continued to experience reduced customer in-store traffic and consolidated net sales remain lower when compared to pre-COVID-19 periods. During a portion of 2021, the Canada Retail segment was impacted by further temporary closures and restrictions in certain key markets. In addition, net sales were impacted by permanent store closures, including those serviced in the Other segment. The Brand Portfolio segment net sales were higher in 2021 than 2020 due to increased orders as our retailer customers also recover, but net sales were still below pre-COVID-19 levels.

GROSS PROFIT

The following table summarizes gross profit by segment:

[[GREPCENT_TABLE]]
[["(dollars in thousands)","2021","","2020","","Change"],["","Amount","","% of Segment Net Sales","","Amount","","% of Segment Net Sales","","Amount","","%","","Basis Points"],["Segment gross profit:"],["U.S. Retail","$","933,555","","","33.7","%","","$","242,786","","","13.5","%","","$","690,769","","","284.5","%","","2,020"],["Canada Retail","76,728","","","32.7","%","","28,651","","","15.7","%","","48,077","","","167.8","%","","1,700"],["Brand Portfolio","66,774","","","23.3","%","","36,393","","","14.6","%","","30,381","","","83.5","%","","870"],["Other","\u2014","","","\u2014","%","","962","","","1.5","%","","(962)","","","NM","","NM"],["Total segment gross profit","1,077,057","","","32.7","%","","308,792","","","13.5","%","","768,265","","","248.8","%","","1,920"],["Elimination of intersegment gross loss (profit)","(8,420)","","","","","2,449","","","","","(10,869)"],["Consolidated gross profit","$","1,068,637","","","33.4","%","","$","311,241","","","13.9","%","","$","757,396","","","243.3","%","","1,950"]]
[[/GREPCENT_TABLE]]

NM - Not meaningful

The improvement in gross profit was primarily driven by increased sales during 2021 as compared to 2020. We addressed the temporary closure of stores in 2020, and the subsequent reduction in customer in-store traffic upon store re-openings, with aggressive promotional activity. These actions resulted in higher inventory reserves, increased shipping costs associated with higher digital penetration, and deleveraged distribution and fulfillment, store occupancy, and royalty expenses on lower sales volume during 2020. During 2021, tight inventory positions resulted in fewer promotions. Accordingly, gross profit as a percentage of net sales for 2021 was higher by 480 basis points than the pre-COVID-19 rate, which was 28.6% for 2019. The Brand Portfolio segment's gross profit as a percentage of net sales significantly improved during 2021 compared to 2020 but remained below pre-COVID-19 levels when compared to 2019 due to the deleverage impacts of lower net sales.

Elimination of intersegment gross loss (profit) consisted of the following:

[[GREPCENT_TABLE]]
[["(dollars in thousands)","2021","","2020"],["Elimination of intersegment activity:"],["Net sales recognized by Brand Portfolio segment","$","(93,956)","","","$","(59,818)"],["Cost of sales:"],["Cost of sales recognized by Brand Portfolio segment","62,039","","","42,028"],["Recognition of intersegment gross profit for inventory previously purchased that was subsequently sold to external customers during the current period","23,497","","","20,239"],["","$","(8,420)","","","$","2,449"]]
[[/GREPCENT_TABLE]]

24

OPERATING EXPENSES

Operating expenses increased by $117.4 million during 2021 as compared to 2020, primarily driven by the implementation of temporary leaves of absence without pay for a significant number of our employees and reducing pay for nearly all employees not placed on temporary leave in response to the COVID-19 pandemic for most of the first half of 2020. During the second half of 2020, we re-opened our stores, discontinued the furlough program, and restored pay for our associates that had taken pay reductions, but made reductions to our workforce. During 2021, we had an increase in store payroll costs in line with the increase in net sales and higher incentive compensation expense. Operating expenses as a percentage of sales improved to 27.2% in 2021 compared to 33.7% in 2020, but was still higher than the pre-COVID-19 rate, which was 25.1% as a percentage of sales in 2019, primarily due to higher direct marketing expense and incentive compensation on lower sales.

IMPAIRMENT CHARGES

During 2021, we recorded impairment charges of $1.7 million for abandoned equipment we are replacing and for the sublease of an abandoned leased space. As a result of the material reduction in net sales and cash flows due to the temporary closure of all of our stores during 2020, we performed an impairment analysis at the store level. In addition, we evaluated other long-lived assets based on our intent to use such assets going forward. During 2020, we recorded impairment charges of $127.1 million for under-performing stores. Also during 2020, we recorded an impairment charge of $6.5 million for the Brand Portfolio segment customer relationship intangible asset resulting in a full impairment due to the lack of projected cash flows over the remaining useful life. Further, as a result of the material reduction in net sales and cash flows and the decrease in the Company's market capitalization due to the impact of the COVID-19 pandemic on macroeconomic conditions, we performed an impairment analysis for goodwill and other indefinite-lived intangible assets. Our analysis concluded that the fair value of the First Cost reporting unit within the Brand Portfolio segment did not exceed its carrying value. Accordingly, during 2020, we recorded an impairment charge of $20.0 million for the First Cost reporting unit in the Brand Portfolio segment, resulting in a full impairment.

INCOME TAXES

The effective tax rate changed to 10.7% for 2021 from 19.7% for 2020. The rate for 2021 is the result of maintaining a full valuation allowance on deferred tax assets while also recording net discrete tax benefits, primarily as a result of adjustments to our estimated 2020 return reflecting implemented tax strategies. The rate for 2020 is the result of recording an additional valuation allowance of $87.6 million partially offset by the ability to carry back current year losses to a tax year where the U.S. federal statutory tax rate was 35%.

LIQUIDITY AND CAPITAL RESOURCES

OVERVIEW

Our primary ongoing operating cash flow requirements are for inventory purchases, payments on lease obligations and licensing royalty commitments, other working capital needs, and capital expenditures. Our working capital and inventory levels fluctuate seasonally. The following table summarizes our material undiscounted cash requirements for 2022 and future fiscal years thereafter, and provides reference for each item to the relevant note of the Consolidated Financial Statements of this Form 10-K:

[[GREPCENT_TABLE]]
[["(in thousands)","Note Reference","","2022","","Future Fiscal Years Thereafter","","Total"],["Debt maturities","Note 11","","$","\u2014","","","231,250","","","$","231,250"],["Fixed minimum lease payments","Note 12","","$","229,051","","","654,618","","","$","883,669"],["Noncancelable purchase obligations","Note 13","","$","9,101","","","12,285","","","$","21,386"],["Guaranteed minimum royalty payments","Note 13","","$","34,659","","","222,029","","","$","256,688"]]
[[/GREPCENT_TABLE]]

On February 8, 2022, we settled in full the $231.3 million principal amount outstanding under our senior secured term loan ("Term Loan"). In connection with this settlement, we incurred a $12.7 million loss on extinguishment of debt, comprised of a $6.9 million prepayment premium and a $5.7 million write-off of unamortized debt issuance costs, which will be recorded in the first quarter of 2022. The settlement of the Term Loan was made using proceeds from borrowings under the ABL Revolver.

25

We are committed to a cash management strategy that maintains liquidity to adequately support the operation of the business and withstand unanticipated business volatility, including the impacts of the COVID-19 pandemic. We believe that cash generated from our operations, together with our current levels of cash and availability under our ABL Revolver, are sufficient to maintain our ongoing operations and fund capital expenditures over the next 12 months and beyond.

The following table presents the key categories of our consolidated statements of cash flows:

[[GREPCENT_TABLE]]
[["(in thousands)","2021","","2020","","Change"],["Net cash provided by (used in) operating activities","$","171,429","","","$","(153,793)","","","$","325,222"],["Net cash provided by (used in) investing activities","(35,028)","","","2,631","","","(37,659)"],["Net cash provided by (used in) financing activities","(121,490)","","","122,954","","","(244,444)"],["Effect of exchange rate changes on cash balances","(33)","","","1,225","","","(1,258)"],["Net increase (decrease) in cash, cash equivalents, and restricted cash","$","14,878","","","$","(26,983)","","","$","41,861"]]
[[/GREPCENT_TABLE]]

OPERATING CASH FLOWS

The change in net cash provided by (used in) operations was driven by the net income recognized during 2021 versus a net loss incurred during 2020 as a result of the impacts of the COVID-19 pandemic, after adjusting for non-cash activity including impairment charges and the change in deferred taxes. This was partially offset by higher spend on working capital as our business recovered from the impacts of the COVID-19 pandemic and the measures we implemented in 2020 to manage our working capital to preserve liquidity, including delaying vendor and landlord payments while we renegotiated terms, reducing inventory orders, and significantly cutting costs.

INVESTING CASH FLOWS

For 2021, the net cash used in investing activities was primarily due to capital expenditures relating to infrastructure and IT projects, new stores, and store improvements. For 2020, the net cash provided by investing activities was due to the liquidation of our available-for-sale securities and the proceeds from a settlement with a vendor, partially offset by capital expenditures.

FINANCING CASH FLOWS

During 2021, the net cash used in financing activities was due to net payments of $100.0 million on the ABL Revolver and payments of $12.5 million on the Term Loan. During 2020, the net cash provided by financing activities was due to net proceeds from borrowings from our ABL Revolver and Term Loan of $343.7 million offset by the settlement of borrowings under our senior unsecured revolving credit agreement (the "Credit Facility") of $190.0 million and the payment of debt issuance costs of $21.4 million associated with the changes we made to our debt structure.

DEBT

ABL Revolver- On August 7, 2020, we replaced the Credit Facility with the ABL Revolver, which provides a revolving line of credit of up to $400.0 million. Our ABL Revolver matures in August 2025 and is secured by substantially all of our personal property assets, including a first priority lien on credit card receivables and inventory. The amount of credit available is limited to a borrowing base based on, among other things, a percentage of the book value of eligible inventory and credit card receivables, as reduced by certain reserves. As of January 29, 2022, the ABL Revolver had a borrowing base of $400.0 million, with no outstanding borrowings and $4.9 million in letters of credit issued, resulting in $395.1 million available for borrowings.

Term Loan- On August 7, 2020, we also entered into a $250.0 million Term Loan. The Term Loan was collateralized by a first priority lien on substantially all of our personal and real property (subject to certain exceptions), including investment property and intellectual property, and by a second priority lien on certain other personal property, primarily credit card receivables, and inventory, that constitute first priority collateral for the ABL Revolver.

26

Termination of Term Loan- As discussed above, on February 8, 2022, we voluntarily terminated our Term Loan and settled in full the $231.3 million principal amount then outstanding. In connection with this settlement, we incurred a $12.7 million loss on extinguishment of debt, comprised of a $6.9 million prepayment premium and a $5.7 million write-off of unamortized debt issuance costs, which will be recorded in the first quarter of 2022. The settlement of the Term Loan was made using proceeds from borrowings under the ABL Revolver. As of January 29, 2022, the total borrowings under the Term Loan were classified as long-term debt since we had the ability and intent to refinance the Term Loan using borrowings from our ABL Revolver, which we classify as long-term debt. Following the termination of the Term Loan, we had $235.0 million of outstanding borrowings, resulting in $160.1 million remaining available for borrowings, under the ABL Revolver.

Debt Covenants- The ABL Revolver contains a minimum availability covenant where an event of default shall occur if availability is less than the greater of $30.0 million or 10.0% of the maximum credit amount. In addition, the ABL Revolver contains customary covenants restricting our activities, including limitations on the ability to sell assets, engage in acquisitions, enter into transactions involving related parties, incur additional debt, grant liens on assets, pay dividends or repurchase stock, and make certain other changes. There are specific exceptions to these covenants including, in some cases, upon satisfying specified payment conditions. As of January 29, 2022, we were in compliance with all financial covenants.

Refer to Note 11, Debt, of the Consolidated Financial Statements of this Form 10-K for further information about our debt arrangements.

CAPITAL EXPENDITURE PLANS

We expect to spend approximately $70.0 million to $80.0 million for capital expenditures in 2022. Our future investments will depend primarily on the number of stores we open and remodel, infrastructure and IT projects that we undertake and the timing of these expenditures.

RECENT ACCOUNTING PRONOUNCEMENTS

There are no recent accounting pronouncements that are expected to have a material impact to our consolidated financial statements when adopted.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

As discussed in Note 1, Description of Business and Significant Accounting Policies, of the Consolidated Financial Statements included in this Form 10-K, the preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, and disclosure of commitments and contingencies at the date of the consolidated financial statements and reported amounts of revenue and expenses during the reporting period. We base these estimates and judgments on factors we believe to be relevant, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The process of determining significant estimates is fact-specific and takes into account factors such as historical experience, current and expected economic conditions, product mix, and in some cases, actuarial and valuation techniques. We constantly re-evaluate these significant factors and make adjustments where facts and circumstances dictate. While we believe that the factors considered provide a meaningful basis for the accounting policies applied in the preparation of the consolidated financial statements, we cannot guarantee that our estimates and assumptions will be accurate. As the determination of these estimates requires the exercise of judgment, actual results may differ from those estimates, and such differences may be material to our consolidated financial statements.

27

We believe the following represent the most significant accounting policies, critical estimates and assumptions, among others, used in the preparation of our consolidated financial statements:

[[GREPCENT_TABLE]]
[["Policy","Judgments and Estimates","Effect if Actual Results Differ from Assumptions"],["Inventories- The U.S. Retail segment inventory is accounted for using the retail inventory method and is stated at the lower of cost or market. Under the retail inventory method, the valuation of inventories at cost and the resulting gross profits are determined by applying a calculated cost-to-retail ratio to the retail value of inventories. The cost basis of inventories reflected on the balance sheet is decreased by charges to cost of sales at the time that the retail value of the inventory is lowered by markdowns. The Canada Retail and Brand Portfolio segments account for inventory using the moving average cost method and is stated at the lower of cost or net realizable value. For all inventories, we also monitor excess and obsolete inventories that may need to be liquidated at amounts below cost. We perform physical inventory counts or cycle counts on all inventory on hand throughout the year and adjust the recorded balance to reflect the results. We record estimated shrink between physical inventory counts, based on historical experience and recent results, less amounts realized.","Inherent in the calculation of inventories are certain significant judgments and estimates, including setting the original merchandise retail value, markdowns, shrink, and liquidation values. The shrink reserve is calculated as a percentage of sales from the last physical inventory date, based on both historical experience and recent physical inventory results, less amounts realized. Aged inventory may be written down using estimated liquidation values and cost of disposal based on historical experience.","If the reduction to inventories for markdowns, shrink, and aged inventories were to increase by 10%, cost of sales would increase by approximately $3.9 million."],["Asset Impairment of Long-Lived Assets- We periodically evaluate the carrying amount of our long-lived assets, primarily property and equipment and operating lease assets, when events and circumstances warrant such a review to ascertain if any assets have been impaired. The carrying amount of a long-lived asset or asset group is considered impaired when the carrying value of the asset or asset group exceeds the expected future cash flows from the asset or asset group. The impairment loss recognized is the excess of the carrying value of the asset or asset group over its fair value.","Our reviews are conducted at the lowest identifiable level, which typically is at the store level for the majority of our long-lived assets. Fair value at the store level is typically based on projected discounted cash flows over the remaining lease term. We also review construction in progress projects, including internal-use software under development, for recoverability when we have a strategic shift in our plans.","A 10% change in our projected cash flows for our store fleet would not result in a material amount of additional impairment charges. To the extent that these future projections or our strategies change, the conclusion regarding impairment may differ from our current estimates."]]
[[/GREPCENT_TABLE]]

28

[[GREPCENT_TABLE]]
[["Policy","Judgments and Estimates","Effect if Actual Results Differ from Assumptions"],["Impairment of Goodwill and Other Indefinite Lived Intangible Assets- We evaluate goodwill and other indefinite lived intangible assets for impairment annually during our fourth quarter, or more frequently if an event occurs or circumstances change, such as material deterioration in performance or a significant and sustained decline in our stock price, that would indicate that impairment may exist. When evaluating for impairment, we may first perform a qualitative assessment to determine whether it is more likely than not that there is an impairment. If we do not perform a qualitative assessment, or if we determine that it is more likely than not that the carrying value exceeds its fair value, we will calculate the estimated fair value. Fair value is the price a willing buyer would pay and is typically calculated using a discounted cash flow analysis. Where deemed appropriate, we may also utilize a market approach for estimating fair value. Impairment charges are calculated as the amount by which the carrying amount exceeds its fair value, but not to exceed the carrying value for goodwill.","When assessing goodwill and other indefinite lived intangible assets for impairment, our decision to perform a qualitative impairment assessment is influenced by a number of factors, including the significance of the excess of the estimated fair value over carrying value at the last assessment date and the amount of time since the last quantitative fair value assessments. Our quantitative impairment calculations contain uncertainties as we are required to make assumptions and to apply judgment when estimating future cash flows, including projected revenue and operating results, as well as selecting appropriate discount rates and an assumed royalty rate. Estimates of revenue and operating results are based on internal projections considering past performance and forecasted changes, strategic initiatives, and the business environment impacting performance. Discount rates and a royalty rate are selected based on market participant assumptions. These estimates are highly subjective, and our ability to realize the future cash flows used in our fair value calculations is affected by factors such as the success of strategic initiatives, changes in economic conditions, changes in our operating performance and changes in our business strategies.","As of January 29, 2022, we had $93.7 million of goodwill within the U.S. Retail segment, which is also the reporting unit, and $15.5 million in indefinite-lived trademarks and tradenames within the Canada Retail segment. We performed a qualitative impairment assessment for goodwill. In addition, we determined the fair values of the indefinite-lived intangibles were in excess of their carrying values and a 10% decrease in fair values would not result in a material impairment charge. As we periodically reassess estimated future cash flows and asset fair values, changes in our estimates and assumptions may cause us to realize material impairment charges in the future."],["Leases- We recognize lease liabilities based on the present value of the future fixed lease commitments over the lease term with corresponding lease assets. The majority of our real estate leases provide for renewal options, which are typically not included in the lease term used for measuring the lease assets and lease liabilities as it is not reasonably certain we will exercise options.","We determine the discount rate for each lease by estimating the rate that we would be required to pay on a secured borrowing for an amount equal to the lease payments over the lease term.","As of January 29, 2022, a change in our discount rate of 100 basis points would have changed the recorded operating lease assets and liabilities by approximately $19.7 million."]]
[[/GREPCENT_TABLE]]

29

[[GREPCENT_TABLE]]
[["Policy","Judgments and Estimates","Effect if Actual Results Differ from Assumptions"],["Income Taxes- We determine the aggregate amount of income tax provision or benefit to accrue and the amount that will be currently receivable or payable based upon tax statutes of each jurisdiction in which we do business. Deferred tax assets and liabilities, as a result of these timing differences, are reflected on our balance sheet for temporary differences that are expected to reverse in subsequent years. A valuation allowance is established against deferred tax assets when it is more likely than not that some or all of the deferred tax assets will not be realized. We review and update our tax positions as necessary to add any new uncertain tax positions taken, or to remove previously identified uncertain positions that have been adequately resolved. Additionally, uncertain positions may be remeasured as warranted by changes in facts or law.","Our ability to recover deferred tax assets depends on several factors, including the amount of net operating losses we can carry back and our ability to project future taxable income. In evaluating future taxable income, significant weight is given to positive and negative evidence that is objectively verifiable. In addition, tax laws, regulations, and policies in various jurisdictions may be subject to significant change due to economic, political and other conditions, and significant judgment is required in estimating amounts for income taxes. There may be transactions that occur during the ordinary course of business for which the ultimate tax determination is uncertain. The U.S. Treasury Department, the U.S. Internal Revenue Service, and other standard-setting bodies could interpret or issue guidance on how provisions of tax laws, regulations, and policies will be applied or otherwise administered that is different from our interpretation. In addition, state, local or foreign jurisdictions may enact tax laws that could result in further changes to taxation and materially affect our financial position and results of operations.","As of January 29, 2022, our deferred tax assets were reserved with a valuation allowance of $70.8 million. We also had gross unrecognized tax benefits of $11.1 million. However, we may have material adjustments in the future that may impact our income tax amounts based on additional information, additional guidance or revised interpretations."]]
[[/GREPCENT_TABLE]]