# WEYCO GROUP INC (WEYS) FY 2021 MD&A

Verbatim Item 7 Management's Discussion and Analysis from WEYCO GROUP INC's 10-K for fiscal year 2021.

SEC filing source: https://www.sec.gov/Archives/edgar/data/106532/000141057822000345/weys-20211231x10k.htm
Accession: 0001410578-22-000345
Filing date: 2022-03-11
Report date: 2021-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

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

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

GENERAL

The Company designs and markets quality and innovative footwear principally for men, but also for women and children, under a portfolio of well-recognized brand names, including: Florsheim, Nunn Bush, Stacy Adams, BOGS, Rafters, and Forsake.  Inventory is purchased from third-party overseas manufacturers.  The majority of foreign-sourced purchases are denominated in U.S. dollars. The Company has two reportable segments, North American wholesale operations (“Wholesale”) and North American retail operations (“Retail”). In the wholesale segment, the Company’s products are sold to leading footwear, department, and specialty stores, as well as e-commerce retailers, primarily in the United States and Canada. The Company also has licensing agreements with third parties who sell its branded apparel, accessories and specialty footwear in the United States, as well as its footwear in Mexico and certain markets overseas.  Licensing revenues are included in the Company’s wholesale segment. The Company’s retail segment consisted of e-commerce businesses and four brick and mortar retail stores in the United States as of December 31, 2021.  Retail sales are made directly to consumers on the Company’s websites, or by Company employees.  The Company’s “other” operations include the Company’s wholesale and retail businesses in Australia, South Africa, Asia Pacific (collectively, “Florsheim Australia”), and Europe (“Florsheim Europe”).  The majority of the Company’s operations are in the United States, and its results are primarily affected by the economic conditions and the retail environment in the United States.

This discussion summarizes the significant factors affecting the consolidated operating results, financial position and liquidity of the Company for the two-year period ended December 31, 2021. This discussion should be read in conjunction with Item 8, “Financial Statements and Supplementary Data” below.

EXECUTIVE OVERVIEW

The Company’s 2021 results were mixed. Business recovery was sluggish in early 2021 with the first quarter still being significantly impacted by the pandemic, but operations improved after Covid vaccinations were rolled out in the second quarter. Demand accelerated in the third quarter, although at wholesale, supply chain delays hindered the Company’s ability to fulfill orders timely. The Company ended the year strong, with record fourth quarter wholesale shipments and strong performances across all of its brands. The positive fourth quarter results reflected two underlying trends. First, the slow unwinding of the supply chain bottleneck, as the Company started to receive significant quantities of footwear in the final months of the year. The incoming shipments allowed the Company to fill a portion of the demand pipeline, as the Company is still in the process of getting retailers back to their natural inventory models. Second, the Company is seeing strong consumer response to its product offerings in both its outdoor and legacy brands.

The BOGS outdoor brand has been solid throughout the pandemic, and ended 2021 with a record fourth quarter. BOGS’ classic weather boot styles experienced elevated demand in multiple distribution channels, ranging from department stores in cities, to farm and agricultural stores in rural communities. In addition, BOGS greatly expanded sales of its casual and lifestyle footwear from a wholesale and direct-to-consumer perspective. Relative to 2019, BOGS’ e-commerce business in North America was up over 100% for both the fourth quarter and for all of 2021.

In June 2021, the Company acquired the Forsake brand, which joined BOGS as part of the Company’s outdoor division. Over the past few months, management has been working with Forsake’s founders to onboard the brand and determine opportunities to expand Forsake’s reach both in the wholesale and direct-to-consumer channels. Along with the Company’s other brands, Forsake faced certain supply chain constraints and delays during 2021, but management believes good progress is being made to put the right structure in place for future growth.

The Company’s legacy brands, Florsheim, Stacy Adams, and Nunn Bush, had a robust fourth quarter. Over the course of the year, these brands were impacted by fluctuating consumer demand for dress and dress-casual footwear, from very low demand early in the year, to strong interest a few months later, with that trend continuing through the end of 2021. The falloff in the refined footwear category early in the pandemic followed a long period where the category had already been under pressure due to the increased importance of athletic and athleisure-casual footwear in today’s lifestyle. As a result, at the onset of the pandemic, many competitors pulled back or exited from the dress-shoe business, which put the Company in a strong position to pick up market share when the business bounced back. While the Company remains committed to diversifying its legacy product mix, it also recognizes that it has a tremendous opportunity to be the leader in a still sizeable category in the footwear world.

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The legacy brands also experienced success in introducing new casual and athleisure footwear. For example, the number two collection in Florsheim’s e-commerce business in 2021 was a sneaker program, and four of the top fifteen shoes were true casuals. The Company had similar success with Nunn Bush, as its number two wholesale package in 2021 was a sneaker collection. Looking back over the last two years, management is pleased with how the Company has gained market share in its traditional business, while at the same time, has pushed into new categories and positioned itself for additional opportunities.

In the retail segment, the Company posted its highest ever quarterly sales in the fourth quarter of 2021, driven by a 52% increase in e-commerce sales. Online transactions account for the vast majority of the Company’s retail sales. The Company’s online businesses are trending well above industry e-commerce growth numbers, which speaks to both the strength of its brands as well as its execution in this space. The Company continues to invest resources in marketing and analytical tools to build its e-commerce platform.

Overseas, the Company experienced an increase in fourth quarter sales and profitability at Florsheim Australia, which includes the markets of New Zealand, South Africa and the Pacific Rim. Australia reopened retail in October 2021 after months of lockdowns, which put the Company in the position to end the year on a stronger note. Overall, 2021 was a turnaround year for the Company’s overseas businesses. The Company exited its European Florsheim business and signed a long-term licensing deal for the brand in that region. Management also reset its Australian business with more favorable retail leases, increased its wholesale sales for BOGS and Florsheim, and experienced solid growth in its e-commerce business.

The Company is continuing to see strong demand for its brands across the board, and expects that both pipeline fill and strong consumer demand will drive its business in 2022. Management expects first quarter 2022’s volume to be significantly better than 2021, not only because demand is up, but also because the first quarter of 2021 was still somewhat impacted by the pandemic. As of March 1, 2022, the Company’s North American wholesale backlog was the highest in the Company’s history. The Company has bought aggressively, especially on its core product, to ensure that it can fulfill this demand as well as build its “in stock” inventory back to normal levels.

Sales and Earnings Highlights

Consolidated net sales totaled $267.6 million in 2021 compared to $195.4 million in 2020.  Consolidated gross earnings as a percent of net sales were 40.1% and 40.2% in 2021 and 2020, respectively, Operating earnings rose to $25.7 million, up from operating losses of $7.6 million last year.  Net earnings were $20.6 million, or $2.12 per diluted share, in 2021, compared to net losses of $8.5 million, or $0.87 per diluted share, in 2020.

The Company’s 2020 results were significantly impacted by the pandemic, due to most brick-and-mortar retailers being closed for a majority of the second quarter and an overall decrease in consumer demand. Additionally, last year’s operating results included non-recurring charges totaling $11.9 million. As such, comparisons of 2021 financial performance to 2020 may have limited utility. Therefore, selected comparisons to 2019 are included as appropriate. Consolidated net sales for the year-ended December 31, 2021 recovered to 88% of 2019 levels and operating earnings reached 95% of 2019 levels.

Financial Position Highlights

At December 31, 2021, cash, short-term investments, and marketable securities totaled $38.0 million and there were no amounts outstanding on the Company’s line of credit. During 2021, the Company generated $6.4 million of cash from operations. The Company used funds to pay $9.3 million in dividends and repurchase $2.5 million of company stock. The Company also spent $2.6 million to acquire the Forsake brand and had $1.0 million of capital expenditures.

Recent Acquisitions

On June 7, 2021, the Company acquired substantially all of the operating assets and certain liabilities of Forsake, a distributor of outdoor footwear, under the brand name “Forsake.” The principal assets acquired were inventory, accounts receivable, and intellectual property, including the Forsake brand name. The aggregate purchase price was approximately $2.6 million, plus contingent payments to be paid annually over a period of five years, depending on Forsake achieving certain performance measures. The Company’s estimate of the discounted fair value of the contingent payments was approximately $1.3 million in total. The $2.6 million purchase price was funded with the Company’s available cash.

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SEGMENT ANALYSIS

Net sales and earnings (loss) from operations for the Company’s segments, as well as its “other” operations, in the years ended December 31, 2021 and 2020, were as follows:

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*NM = Not Meaningful

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North American Wholesale Segment

Wholesale Net Sales

Net sales in the Company’s North American wholesale segment for the years ended December 31, 2021 and 2020, were as follows:

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As discussed above in “Executive Overview,” 2021 net sales were up across all of the Company’s legacy brands (Stacy Adams, Nunn Bush, and Florsheim). Last year’s sales of the legacy brands were lower than normal because the pandemic significantly impacted sales of dress and dress-casual footwear.  Sales of the BOGS outdoor brand, which were less affected by the pandemic in 2020, rose 17% for the year, with sales up across most distribution categories. Wholesale sales in 2021 recovered to 85% of 2019 levels.

Licensing revenues consist of royalties earned on sales of branded apparel, accessories and specialty footwear in the United States and on branded footwear in Mexico and certain overseas markets. Licensing revenues increased in 2021, compared to 2020, in line with increased licensees’ sales of branded products.

Wholesale Earnings from Operations

Wholesale gross earnings as a percent of net sales were 33.8% in 2021 versus 35.5% in 2020. The decrease in gross margins in 2021 was largely due to higher inbound freight costs, as the Company paid premium rates during the year. Management believes that gross margins will improve in mid to late 2022 as the supply chain stabilizes and as negotiated price increases with customers go into effect.

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Selling and administrative expenses for the wholesale segment consist primarily of distribution costs, salaries and commissions, advertising costs, employee benefit costs, and depreciation. Wholesale selling and administrative expenses were $49.9 million, or 24% of net sales, in 2021, versus $53.1 million, or 35% of net sales, in 2020. 2021 expenses included income of $5.5 million in wage subsidies received from the U.S. and Canadian governments, and expense of $1.1 million to write-off certain assets related to the closing of Florsheim Europe. 2020 expenses included the write-off of $4.3 million (net) in receivables related to the bankruptcy filings of two large customers, $2.0 million in employee costs related to restructuring and temporary closures, and $0.2 million in other related charges, partially offset by $1.7 million in wage subsidies received from the U.S. and Canadian governments.

Wholesale operating earnings rose to $19.5 million in 2021 from $975,000 in 2020, due mainly to higher sales. Wholesale operating earnings in 2021 reached 70% of 2019 levels.

The Company’s cost of sales does not include distribution costs (e.g., receiving, inspection, warehousing, shipping, and handling costs, which are included in selling and administrative expenses). Wholesale distribution costs were $10.8 million and $11.7 million for the years ended December 31, 2021 and 2020, respectively. 2021 and 2020 distribution costs were reduced by $1.5 million and $418,000, respectively, as a result of government wage subsidies. The Company’s gross earnings may not be comparable to other companies, as some companies may include distribution costs in cost of sales.

North American Retail Segment

Retail Net Sales

Net sales were $31.6 million in 2021, up 47% from $21.5 million in 2020. Same store sales rose 53% for the year, due to a 43% increase in e-commerce sales (with sales up on all brands’ websites) and higher brick-and-mortar same store sales. Last year’s brick-and-mortar sales were down significantly as a result of the pandemic. The Company closed three unprofitable retail stores in the third quarter of 2020 and one in the first quarter of 2021, and currently has just four active brick-and-mortar locations in North America. Retail sales in 2021 surpassed 2019 levels by 25%, due primarily to growth in e-commerce.

Retail Earnings (Loss) from Operations

Retail gross earnings as a percent of net sales were 66.4% in 2021 and 64.8% in 2020, with gross margins up at active brick-and-mortar locations and in e-commerce. Selling and administrative expenses for the retail segment consist primarily of freight, advertising expense, employee costs, and rent and occupancy costs. Retail selling and administrative expenses were $14.3 million in 2021 and $15.0 million in 2020.  As a percent of net sales, retail selling and administrative expenses were 45% in 2021 and 70% in 2020. 2020 expenses included $1.5 million in early lease termination charges, $1.0 million for the impairment of retail store fixed assets, and $0.3 million in employee costs related to restructuring and temporary closures, partially offset by $0.2 million of income from government wage subsidies.

The retail segment had operating earnings of $6.7 million in 2021 compared to operating losses of $1.1 million in 2020. The improvement in 2021 was due to the benefit of closing unprofitable stores, higher e-commerce earnings, and improved performance at active brick-and-mortar locations. Retail operating earnings in 2021 exceeded 2019 levels by 138%.

Other

The Company’s other businesses include its wholesale and retail operations of Florsheim Australia and Florsheim Europe. Net sales of the Company’s other businesses were $30.7 million in 2021, up 41% from $21.7 million in 2020. The increase was at Florsheim Australia, with sales up in both its retail and wholesale businesses. For the year, other net sales amounted to 84% of 2019 levels, with Florsheim Australia reaching 93% of 2019 levels, offset by lower sales at Florsheim Europe, which is being wound down.

Gross earnings in the Company’s other businesses were 55.8% of net sales in 2021 versus 48.8% of net sales in 2020. Collectively, Florsheim Australia and Florsheim Europe had operating losses totaling $404,000 in 2021 compared to operating losses of $7.5 million last year. Despite the lockdowns that existed throughout much of 2021, Florsheim Australia had operating earnings of $118,000 in 2021, resulting from improved gross margins and cost reductions. Last year’s losses included $3.6 million in employee costs related to restructuring and temporary closures, $2.1 million for the impairment of retail store fixed assets and operating lease right-of-use assets, $2.0 million in reserves for obsolete and slow moving inventory due to COVID-19-related impacts, and $0.3 million in related charges, partially offset by $3.5 million of income from government wage and rent subsidies. The improvement in 2021 was primarily due to the stronger results at Florsheim Australia.

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OTHER INCOME AND EXPENSE AND TAXES

The majority of the Company’s interest income is generated by investments in marketable securities and highly liquid fixed income funds. Interest income totaled $641,000 and $527,000 in 2021 and 2020, respectively. The increase in 2021 was primarily due to investment earnings on the new fixed income funds this year.  Interest expense was $81,000 in 2021 and $79,000 in 2020. Other income totaled $1.1 million in 2021 versus $96,000 in 2020. The increase in 2021 was primarily due to a decrease in the non-service cost components of pension expense, resulting from lower interest expense and higher expected return on plan assets, and unrealized gains on foreign exchange contracts entered into by Florsheim Australia.

The Company’s effective tax rate was 24.8% in 2021 versus (20.3%) in 2020. The current tax rate differs from the U.S. federal statutory rate of 21% due to the impact of state income taxes. The Company’s 2020 tax rate was impacted by the write-off of $2.0 million in deferred tax assets of its foreign subsidiaries. Additionally, last year the Company did not record an income tax benefit on foreign losses, and, in the U.S., it carried back losses to a tax year when the U.S. federal statutory tax rate was 35%.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s primary sources of liquidity are its cash, short-term investments, and short-term marketable securities, which aggregated to $28.1 million and $34.7 million at December 31, 2021 and 2020, respectively, and its revolving line of credit.  The Company generated $6.4 million and $40.0 million of cash from operations in 2021 and 2020, respectively. Fluctuations in net cash from operating activities mainly resulted from changes in net earnings (loss) and operating assets and liabilities, most significantly, the year-end accounts receivable and inventory balances. The Company’s inventory levels increased to $71.0 million at December 31, 2021 from $59.0 million at December 31, 2020. These figures include inventory that was both in-transit to the Company’s distribution facility and on-hand inventory. Before the supply chain issues experienced in 2021, typically about 10% to 20% of the Company’s inventory was in-transit.  As of December 31, 2021, approximately 59% of the $71.0 million was in-transit, with the remaining 41% on-hand. In early 2022, the Company has continued to receive a much higher number of containers on a daily basis than normal, which has allowed it to maintain strong shipments to customers and start building back higher inventory levels on core product that is needed for at-once business.

The Company’s capital expenditures were $1.0 million and $3.4 million in 2021 and 2020, respectively. The Company’s 2020 capital expenditures included costs related to the expansion of office space within its corporate headquarters. In 2022, the Company plans to invest in its distribution center to enable it to process and ship more efficiently the large increase in e-commerce orders experienced over the past several years. Including these costs, the Company expects capital expenditures will be between $2.0 million and $3.0 million in 2022.

The Company paid cash dividends of $9.3 million and $11.8 million in 2021 and 2020, respectively.  The decrease in 2021 was due to a shift in timing of the Company’s regular quarterly dividend payment schedule; 2021 included four dividend payments while 2020 included five dividend payments, as the Company accelerated the timing of its January 2021 dividend payment into 2020.  

The Company repurchases its common stock under its share repurchase program when it believes market conditions are favorable. In 2021, the Company purchased 125,204 shares at a total cost of $2.5 million through its share repurchase program. In 2020, the Company purchased 106,490 shares at a total cost of $2.1 million through its share repurchase program.  As of December 31, 2021, there were 210,576 authorized shares remaining under the program.

At December 31, 2021, the Company had a $40 million revolving line of credit with a bank that is secured by a lien against the Company’s general corporate assets. The line of credit bears interest at the LIBOR plus 1.35% and expires on November 4, 2022. The related credit agreement contains customary representations, warranties, and covenants (including a minimum tangible net worth financial covenant) for a facility of this type. At December 31, 2021 and 2020, there were no amounts outstanding on the Company’s line of credit and the Company was in compliance with all financial covenants. There were also no amounts outstanding on the line of credit during 2021.

As of December 31, 2021, approximately $3.5 million of cash and cash equivalents was held by the Company’s foreign subsidiaries.

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

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Off-Balance Sheet Arrangements

The Company does not utilize any special purpose entities or other off-balance sheet arrangements.

Critical Accounting Policies

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

Sales Returns, Sales Allowances and Doubtful Accounts

The Company records reserves and allowances (“reserves”) for sales returns, sales allowances and discounts, cooperative advertising, and accounts receivable balances that it believes will ultimately not be collected. The reserves are based on such factors as specific customer situations, historical experience, a review of the current aging status of customer receivables and current and expected economic conditions. The reserve for doubtful accounts includes a specific reserve for accounts identified as potentially uncollectible, plus an additional reserve for the balance of accounts, determined based on historical trends. The Company evaluates the reserves and the estimation process and makes adjustments when appropriate.  Prior to 2020, actual write-offs against the reserves had been within the Company’s expectations. However, in 2020, the Company wrote down $4.3 million (net) in receivables due to the bankruptcy filings of two large customers during the pandemic. Future changes in reserves may be required if actual returns, discounts and bad debt activity varies from the original estimates.  These changes could impact the Company’s results of operations, financial position and cash flows.

Pension Plan Accounting

The Company’s pension (benefit) expense and corresponding obligation are determined on an actuarial basis and require certain actuarial assumptions. Management believes the two most critical of these assumptions are the discount rate and the expected rate of return on plan assets. The Company evaluates its actuarial assumptions annually on the measurement date (December 31) and makes modifications based on such factors as market interest rates and historical asset performance.  Changes in these assumptions can result in different expense and liability amounts, and future actual experience can differ from these assumptions.

Discount Rate – Pension expense and projected benefit obligation both increase as the discount rate is reduced.  See Note 12 of the Notes to Consolidated Financial Statements for discount rates used in determining pension (benefit) expense for the years ended December 31, 2021 and 2020, and the funded status of the plans at December 31, 2021 and 2020.  The Company uses the spot-rate approach to determine the service and interest cost components of pension (benefit) expense. Under the spot-rate approach, the service and interest costs were calculated by applying specific spot rates along the yield curve to the relevant projected cash flows, to provide a better estimate of future service and interest costs. A 0.5% decrease in the discount rate would have a nominal impact on annual pension (benefit) expense, and would increase the projected benefit obligation by approximately $4.7 million.

Expected Rate of Return – Pension expense increases as the expected rate of return on pension plan assets decreases.  In estimating the expected return on plan assets, the Company considers the historical returns on plan assets and future expectations of asset returns.  The Company utilized an expected rate of return on plan assets of 7.00% for both 2021 and 2020. This rate was based on the Company’s long-term investment policy of equity securities: 20% - 80%; fixed income securities: 20% - 80%; and other, principally cash:  0% - 20%.  A 0.5% decrease in the expected return on plan assets would increase annual pension expense by approximately $216,000.

The Company’s unfunded benefit obligation was $28.3 million and $34.0 million at December 31, 2021 and 2020, respectively.

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Goodwill and Trademarks

Goodwill represents the excess of the purchase price over fair value of identifiable net assets acquired from a business acquisition. Goodwill is not amortized, but is reviewed for impairment on an annual basis and between annual tests if indicators of impairment are present. The Company’s goodwill primarily resulted from the 2011 acquisition of the BOGS and Rafters brands, and, to a lesser extent, the 2021 acquisition of the Forsake brand. The applicable reporting units are the Company’s wholesale and retail segments.

The Company has the option to assess goodwill for impairment by performing either a qualitative assessment or quantitative test. The qualitative assessment is the first step and determines whether it is more likely than not that the fair values of the reporting units are less than the related carrying values. If the assessment indicates the fair values exceed the carrying values, then there is no impairment and the quantitative test is not required. However, if the assessment indicates the fair values are less than the carrying values, then the quantitative test is required. In the quantitative test, the fair value would be estimated based upon an evaluation of the reporting unit’s estimated future discounted cash flows as well as the valuation multiples for comparable companies. In 2021, the Company completed a qualitative assessment noting no indicators of impairment. In 2020, the Company performed a quantitative analysis which indicated a premium compared to the carrying value of net assets, including goodwill, at the reporting unit level.  The Company did not record goodwill impairment charges for any of its reporting units in 2021 or 2020.

In evaluating trademarks, the Company completed a qualitative assessment in 2021 noting no indicators of impairment. In 2020, a quantitative analysis was used, in which estimated fair values were determined using discounted cash flows and implied royalty rates. Based on the results of the trademark assessments, the Company concluded that the fair values of the trademarks substantially exceeded their respective carrying values. Therefore, no impairment was recorded on the Company’s trademarks in 2021 or 2020.  

The Company can make no assurances that the goodwill or trademarks will not be impaired in the future. When preparing a discounted cash flow analysis, the Company makes a number of key estimates and assumptions. The Company estimates the future cash flows based on historical and forecasted revenues and operating costs. This, in turn, involves further estimates such as estimates of future growth rates and inflation rates. The discount rate is based on the estimated weighted average cost of capital for the business and may change from year to year. Weighted average cost of capital includes certain assumptions such as market capital structures, market beta, risk-free rate of return and estimated costs of borrowing. Changes in these key estimates and assumptions, or in other assumptions used in this process, could materially affect the Company’s impairment analysis for a given year.

Recent Accounting Pronouncements

See Note 2 of the Notes to Consolidated Financial Statements.

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