Item 1. Business
Overview
We are one of the leading apparel companies in the United States. We control a portfolio of major men’s and women’s brands, some of which were established over 100 years ago. We design, source, market and license our products nationally and internationally at multiple price points and across all major levels of retail distribution at more than 20,000 doors. Our portfolio of highly recognized brands includes Perry Ellis® and Perry Ellis America®, which we believe together generate over $1 billion in annual retail sales, Axis®, Tricots St. Raphael®, Jantzen®, John Henry®, Cubavera®, the Havanera Co.™, Natural Issue®, Munsingwear®, Grand Slam®, Original Penguin®, and Manhattan®. We also (i) license the Nike® and Tommy Hilfiger® brands for swimwear and swimwear accessories, (ii) are the worldwide master licensee for PING® golf apparel, (iii) license the Ocean Pacific® brand for certain men’s sportswear categories and (iv) license the NAUTICA® brand for our corporate wear business.
We distribute our products primarily to wholesale customers that represent all major levels of retail distribution including department stores, national and regional chain stores, mass merchants, specialty stores, sporting goods stores, green grass golf shops, the corporate incentive market, as well as clubs and independent retailers in the United States and Canada. Our largest customers include Federated Department Stores, Inc., Dillard’s Inc., The May Department Stores Company, Wal-Mart Stores, Inc., J. C. Penney Company, Kohl’s Corporation, and Sears, Roebuck & Co. We also operate 38 retail stores located primarily in upscale retail outlet malls across the United States. In addition, we leverage our design, sourcing and logistics expertise by offering a limited number of private label programs to retailers. In order to maximize the worldwide exposure of our brands and generate high margin royalty income, we license our brands through approximately 56 domestic and approximately 79 international license agreements.
Our wholesale business, which is comprised of men’s sportswear and women’s and men’s swimwear and swimwear accessories, accounted for 96% of our total revenues in fiscal 2004, and our licensing business accounted for 4% of our total revenues in fiscal 2004. We have traditionally focused on the men’s sportswear market, which represented approximately 86.7% of our total wholesale revenues in fiscal 2004, while our women’s and men’s swimwear market represented approximately 13.3% of our total wholesale revenues in fiscal 2004.
Our licensing business is a significant contributor to our operating income. We license the brands we own to third parties for the manufacturing and marketing of various products in distribution channels in which we do not distribute those brands, including men’s and women’s footwear, men’s suits, underwear, loungewear, outerwear, fragrances, eyewear and accessories. In addition, we license our brands internationally for the manufacturing and marketing of products that we offer domestically such as Jantzen sportswear. These licensing arrangements raise the overall awareness of our brands without requiring us to make capital investments or incur additional operating expenses.
In June 2003, we acquired Salant, a leading designer, marketer and distributor of brand name and private label menswear products and the largest licensee of the Perry Ellis brand. With the Salant acquisition we have consolidated control of the Perry Ellis brand, added significant revenues and earnings, solidified our balance sheet, further diversified our product offerings and customer base, and added to our portfolio of brands. As a result of this acquisition, we also assumed operation of 39 retail outlet stores, of which four have since been closed closed.
We employ a three-dimensional strategy in the design, sourcing, marketing and licensing of our products that focuses on diversity of brands, products and distribution channels. Through this strategy, we provide our products to a broad range of customers, which reduces our reliance on any single distribution channel, customer, or demographic group and minimizes competition among our brands.
Diversity of Brands. We maintain a portfolio of 18 highly recognized brands that we either own or license. We are focused on brands that appeal to fashion conscious consumers across all income levels. We design, source, market and license most of our products on a brand-by-brand basis targeting distinct consumer demographic and lifestyle profiles. We also market the Natural Issue, John Henry and the Havanera Co. brands, which appeal to the middle-income consumer. In addition, we market brands that appeal to women through our Jantzen family of swimwear products.
Diversity of Product Categories. We design and market apparel in a broad range of men’s product categories and a few women’s product categories, which increases the stability of our business. Our menswear offerings include casual sportswear, dress shirts and pants, jeans wear, golf apparel, sweaters, sports apparel, swimwear and swim accessories, activewear, and leather accessories. Our womenswear offerings include swimwear, sportswear and accessories. We believe that our product diversity decreases our dependence on any one product or fashion trend and has contributed substantially to our growth.
Diversity of Distribution Channels. We market our products through all major levels of retail distribution, which allows us to reach a broad range of consumers in the United States and Canada. We distribute through department stores, national and regional chain stores, mass merchants, specialty stores, sporting goods stores, green grass golf shops, the corporate incentive market, as well as clubs and other independent retailers in the United States and Canada. We entered the corporate wear market in 2001, where we provide corporate clients with high quality customized products. Our products are distributed through more than 20,000 doors at some of the nation’s leading retailers, including Federated, Dillard’s, May Department Stores, Wal-Mart, J. C. Penney, Kohl’s, Sears, and Nordstrom.
The following table illustrates the diversity of the brands and products we produce and market and their respective distribution channels:
Product Category
Distribution
Channels
Casual
Dress Casual
Jeans Wear
Golf
Active Sports
Swimwear
Youth Lifestyle
Upscale Department Stores
Tricots St.
Raphael
Original Penguin
Axis
Mondo di Marco
PING
Collection
Redsand
Original
Penguin
Department Stores
Cubavera
Grand Slam
Perry Ellis Axis
Perry
Ellis
America
Grand Slam
Jantzen Tommy
Hilfiger Nike
Redsand
National and Regional Chain Stores
Natural Issue
the Havanera
Co.
Munsingwear
Ocean Pacific
Jantzen
John Henry
Axist
Natural
Issue
Penguin
Sport
Munsingwear
Pro
Player
Jantzen Nike
Southpoint
Mass Merchants
Private Label
Manhattan
Private
Label
Green Grass (1)
Munsingwear
Perry Ellis
PING
Collection
Corporate
NAUTICA
Cubavera
Perry Ellis
PING
Collection
Specialty Stores
Tricots St.
Raphael
Axis
Jantzen
Tommy Hilfiger
Nike
Redsand
(1) This channel includes high-end and specialty golf shops and resorts.
We were incorporated in Florida in April 1967 and changed our name from Supreme International Corporation to Perry Ellis International, Inc. on June 18, 1999. Our principal executive offices are located at 3000 N.W. 107th Avenue, Miami, Florida 33172, and our telephone number is (305) 592-2830.
Our Competitive Strengths
We believe that our competitive strengths position us to capitalize on several trends that have affected the apparel industry in recent years. These trends include:
• the consolidation of the department and chain store distribution channels into a smaller number of larger retailers,
• the increased dependence of retailers on reliable domestic suppliers who have design expertise, advanced systems and technology, and the ability to quickly meet changing consumer tastes,
• the increased importance of mass merchants in apparel sales, and
• the continued importance of strong brands as a source of product differentiation.
We believe that we have the following competitive strengths in our industry:
Portfolio of nationally and internationally recognized brands. We currently own or license a portfolio of 18 brands, which enjoy high recognition within their respective consumer segments. We believe that these brands have built a loyal following of fashion-conscious consumers and retailers who desire high quality, well-designed products. We license the Nike, Tommy Hilfiger, PING, NAUTICA and Ocean Pacific brands, which we believe are highly recognizable brands within their various product categories. We also license 14 of our brands to third parties for products in distribution channels in which we do not market those brands. We believe that brand recognition is critical in the apparel industry, where strong brand names help define consumer preferences and drive selling space at retailers.
Diversified product offering and distribution model. We market a diverse array of products under our numerous brands at multiple price points and across multiple levels of retail distribution. Our menswear offerings include casual sportswear, dress shirts and pants, jeans wear, golf apparel, sweaters, sports apparel, swimwear and swim accessories, activewear and leather accessories. Our womenswear offerings include swimwear, sportswear and swim accessories. Our products are distributed through more than 20,000 doors at department stores, national and regional chain stores, mass merchants, specialty stores, sporting goods stores, green grass golf shops, the corporate incentive market and independent retailers in the United States and Canada. Our diversified product offerings and distribution model reduce our reliance on any one product, demographic group, merchandise preference or distribution channel and minimizes competition among our brands.
Strong relationships with our retailers. We believe that our established relationships with retailers allow us to maximize the selling space dedicated to our products, monitor our brand presentation and merchandising selection, and introduce new brands and products. Because of our quality brands and products, dedication to customer service, design expertise and sourcing capabilities, we have developed and maintained long-standing relationships with our largest customers, including Dillard’s (more than 25 years), May Department Stores (more than 25 years), J.C. Penney (more than 25 years), Sears (25 years), Federated (16 years), Wal-Mart (14 years), and Kohl’s (10 years).
Strong licensing capabilities and relationships. We license many of the brands we own, and, as a result, have gained experience in identifying potential licensing opportunities. We have established relationships with many licensees and believe these relationships provide opportunities to grow our revenues and earnings. Our brands are solidly positioned in retail outlets at all major levels of retail distribution and have increased our exposure nationally and internationally. We believe that our broad portfolio of brands also appeals to licensees because it gives licensees the opportunity to sell their products into many different distribution channels. For example, a manufacturer of men’s accessories might license the Cubavera brand to enter the department store channel or license the Munsingwear brand to target the national and regional chain stores. By licensing our owned brands, we offer consumers a complete product assortment by brand. We also coordinate our marketing efforts with licensees, thereby maximizing exposure for our brands and our return on investment.
Sophisticated global low-cost sourcing capabilities. We have sourced our products globally for more than 36 years and employ sophisticated logistics and supply chain management systems to maintain maximum flexibility. Our network of worldwide sourcing partners enables us to meet our customers’ needs in an efficient and high quality manner without relying on any one vendor, factory, or country. In fiscal 2004, based on the total dollar value, we sourced our products from Asia (72%), Central and South America (14%), the Middle East (6%) and other areas of the world (8%). We maintain a staff of experienced sourcing professionals in five offices in China (including Hong Kong), as well as in the United States, South Korea and Taiwan. Our sourcing offices closely monitor our suppliers and provide strict quality assurance analyses that allow us to consistently maintain our high quality standards for our customers. We have a compliance department that works closely with our quality assurance staff to ensure that our sourcing partners comply with Company-mandated and country-specific labor and employment regulations. We believe that sourcing our products overseas allows us to manage our inventories more effectively and avoid incurring the costs of maintaining and operating production facilities. Because of our sourcing experience, capabilities and relationships, we believe that we are well positioned to take advantage of the 2005 elimination of all textile and apparel quotas for member countries of the World Trade Organization.
Design expertise and advanced technology. We maintain a staff of 93 designers, merchandisers and artists who are supported by a staff of 41 design professionals, including assistant designers, technical designers, graphic artists and production assistants. Our in-house design staff designs substantially all of our products using advanced computer-aided design technology that minimizes the time-intensive and costly production of sewn prototypes prior to customer approval. In addition, this technology provides our customers with products that have been custom designed for their specific needs and meet current fashion trends. We employ advanced fabric and design technologies to ensure a proper fit and outstanding performance when we create our women’s and men’s swimwear. We regularly upgrade our computer technology to enhance our design capabilities, facilitate communication with our global suppliers and customers on a real-time basis, react faster to new product developments by competitors and meet changes in customer needs.
We recently launched PerrySolutions, a software system that enables our sales planners to manage our retail customers’ inventory at the SKU level. This system helps maximize sales of our products thereby increasing inventory turns for retailers, which in turn reduces our product returns and markdowns, and increases our profitability. We also use PerrySolutions during the assortment planning process to allocate the correct quantities for the initial rollout of product at retail.
Proven ability to integrate acquisitions. Since 1993, we have been successful in selectively acquiring, managing, developing and positioning 18 highly recognized brands within our business, including Munsingwear (1996), Perry Ellis (1999), John Henry (1999), Manhattan (1999) and Jantzen (2002). We believe our experience has prepared us for the integration of the Salant business.
As part of an extensive integration process for each brand, we have:
• improved the responsiveness to market trends by applying our design and sourcing expertise,
• communicated new positioning of our brands through various wide-ranging marketing programs,
• begun or continued licensing operations immediately upon acquisition,
• solidified our management team to design, market and license brands,
• repositioned the brands into different distribution channels to address the needs in those channels,
• renegotiated existing licensing agreements and developed new licensing agreements in new segments and markets, and
• extended our sourcing and distribution capabilities to the products.
Experienced management team. Our senior management team averages more than 26 years in the apparel industry and has extensive experience in growing and rejuvenating brands, structuring licensing agreements, and building strong relationships with global suppliers and retailers. In addition, George Feldenkreis, our chairman and chief executive officer, and Oscar Feldenkreis, our president and chief operating officer, have expressed their commitment to us by maintaining a significant ownership stake in our company.
Our Business Strategy
Our strategy is to continue to pursue our three-dimensional approach by developing and enhancing our portfolio of brands, increasing the scope of our product offerings and expanding distribution for our brands, while continuing our focus on growth and profitability through the execution of the following strategies:
Continue to strengthen the competitive position and recognition of our brands. We intend to continue enhancing the recognition of our brands by aggressively marketing our brands to both consumers and retailers. We have made a strategic decision to focus on branded apparel and to reduce our private label business. As a result of this shift in our business strategy and our acquisition and development of certain brands, our branded apparel business has increased as a percentage of net sales from 75% for fiscal 2003 to 91% for fiscal 2004. We manage each brand individually, developing a distinct brand and marketing strategy for every product category and distribution channel. We will continue to participate in cooperative advertising in print and broadcast media, as well as market directly to consumers through billboards, event sponsorships, celebrity sponsorships, special event advertisements and advertisements in selected periodicals. In addition, we will continue to have a strong presence at trade shows, such as “M.A.G.I.C.” in Las Vegas, Market Week in New York, and golf and swim shows and events throughout the country. Licensing our brands to third parties also enhances brand recognition by providing increased customer exposure domestically and internationally, as well as opportunities for future product extensions.
Continue to diversify our product line. We intend to continue to expand the range of our product lines, thereby capitalizing on the name recognition, popularity, and discrete target customer segmentation of our major brands. For example, we are introducing a line of women’s beachwear and sportswear under the Jantzen brand. We intend to pursue expansion opportunities in young men’s sportswear, whether through licensing or direct marketing opportunities. The Salant acquisition takes us into the men’s better market and collection market for sportswear, dress shirts, bottoms and leather accessories and, through the Axis and Tricots St. Raphael brands, the better sportswear market. We intend to use Axis and Tricots St. Raphael, as well as the expertise of Salant’s sales and marketing personnel, to expand our sweater business. In addition, we will continue to seek licensing opportunities that will expand our collection of products.
Increase penetration in each channel. We will continue to selectively pursue new ways to increase our penetration of existing channels of distribution for our products, focusing on maintaining the integrity of our products and reinforcing our image at existing retail stores, as well as introducing our products to geographic areas and consumer sectors that are presently less familiar with our products. We will also seek to expand our business with our existing customers by offering them products that are compelling and different from those in the marketplace and by capitalizing on our relationships with them by offering them more of our products. As a result of the Salant acquisition, we have increased the number of retailers that carry our brands and entered certain upscale department stores, such as Nordstrom, which carry the Axis and Tricots St. Raphael brands.
Adapt to our continually changing marketplace. We will continue to make the necessary investments and implement strategies to meet the growing needs of our customers on a timely basis in the ever-changing apparel industry. We have a history of successfully adapting our business to meet the challenges of our industry. Some examples include:
• Our acquisition of Jantzen in fiscal 2002 marked our entry into the women’s and men’s swimwear markets and formed the basis for our planned entry into the women’s sportswear market. We believe that our design and sourcing expertise positions us to grow our revenues from these product categories substantially in the future. We intend to position Jantzen as a premiere casual resort lifestyle brand for women and men.
• From our initial efforts to market guayabera shirts to the Hispanic market 36 years ago, we have focused on Hispanics, the largest minority group in the United States. We developed the Cubavera and the Havanera Co. brands in fiscal 2000 and 2002, respectively, to specifically target the Hispanic market and consumers that embrace the Hispanic lifestyle brands.
• The Salant acquisition provided us with the upscale Axis and Tricots St. Raphael brands, as well as greater control of designing and marketing the Perry Ellis line of men’s sportswear, dress shirts, bottoms and leather accessories. With this acquisition, we expect to leverage Salant’s relationships to sell more of our products through these upscale retailers.
Expand our licensing opportunities. Since our acquisition of Munsingwear in 1996, we have significantly expanded the licensing of our brands to third parties for various product categories. We intend to continue to license our brands to existing and new licensees as profitable opportunities arise. We will also use our brand portfolio to expand our licensing activities in womenswear and sportswear. At the international level, we will continue to explore licensing opportunities where we see opportunities for growth, such as Latin America, Europe and Asia. We will continue to provide our licensing partners with strong brands, design expertise and innovative marketing strategies. In addition to the revenues and brand awareness that licensing provides us, we also believe that licensing our brands benefits us by reducing the volatility of our operating income.
Pursue strategic acquisitions and opportunities. We intend to continue our strategy of making selective acquisitions to expand our portfolio of brands and add new product lines as our industry continues to follow the consolidation trend of our retailers. We will continue to internally develop new brands and logical extensions of existing brands as opportunities in the marketplace arise. We intend to pursue acquisition opportunities in a disciplined manner as they become available and focus on products or categories that have high consumer awareness and are difficult to duplicate from a technical or logistical standpoint. Since our initial public offering in 1993, we have acquired, or obtained licenses for, several brands, including Munsingwear, Perry Ellis, John Henry, Manhattan, Jantzen, PING, Tommy Hilfiger, Nike, NAUTICA, Mondo di Marco, Ocean Pacific, Axis, Tricots St. Raphael and Redsand. We believe that our history of selectively acquiring under-marketed or under-performing brands and incorporating them into our efficient infrastructure generates a superior return on investment for our investors.
Brands
In fiscal 2004, approximately 91% of our net sales were from branded products as compared to fiscal 2003 when 75% of our net sales were from branded products. We currently own 13 and license five nationally recognized brands whose products we source and sell through all major levels of retail distribution. Our owned brands include Perry Ellis, Perry Ellis America, Axis, Tricots St. Raphael, Jantzen, John Henry, Cubavera, the Havanera Co., Natural Issue, Munsingwear, Grand Slam, Original Penguin and Manhattan. We have developed over 42 sub-brands from these brands, including Perry Ellis Portfolio, Southpoint, Penguin Sport and Axist. We also distribute the PING, Nike, Tommy Hilfiger, NAUTICA and Ocean Pacific brands under license arrangements.
We license the Perry Ellis brand, our premier brand, as well as the Jantzen, John Henry, Natural Issue, Munsingwear and Manhattan brands, for products in distribution channels in which we do not market directly to retailers. In addition, we license our brands internationally for products we distribute domestically. Our depth of brand selection enables us to target consumers across a wide range of ages, incomes and lifestyles, reduces our reliance on any single distribution channel, customer or demographic group, and minimizes competition among brands.
Perry Ellis. In fiscal 2000, we acquired the Perry Ellis and Perry Ellis America brands, which we believe together generate over $1 billion in annual retail sales and are associated with elegance, quality, value, comfort and innovative designs. The Perry Ellis brand appeals primarily to higher-income, status conscious, professional 25-40 year-old men. As a result of the Salant acquisition, we are now designing and marketing Perry Ellis branded sportswear, dress shirts, dress pants and leather accessories for the men’s better market and collection market. We also license the Perry Ellis brand to third parties for a wide variety of apparel and non-apparel products.
Axis. We acquired the Axis brand when we acquired Salant. This brand is associated with a casual lifestyle that affords quality, value, comfort and innovative designs. The Axis brand appeals primarily to higher-income, status conscious, professional 30-50 year-old men. We sell sportswear and activewear under the Axis brand, which are sold primarily at upscale department and specialty stores.
Tricots St. Raphael. We acquired the Tricots St. Raphael brand when we acquired Salant. This brand is associated with a sophisticated dress casual lifestyle featuring quality, unique designs and fabrics. The Tricots St. Raphael brand appeals primarily to higher-income, status conscious, professional 40-60 year-old men. We sell sportswear and sweaters under the Tricots St. Raphael brand, which are sold primarily at upscale department and specialty stores.
Jantzen and Southpoint. We acquired the Jantzen and Southpoint brands as part of the Jantzen acquisition in fiscal 2003. The Jantzen brand has a history of over 90 years, and its products are sold in upscale department stores, national and regional chain stores, and specialty stores. We sell men’s and women’s swimwear under the Jantzen brand, as well as women’s swimwear under the Southpoint brand. We also recently introduced men’s and women’s sportswear under the Jantzen brand to capitalize on its rich history and reputation for quality.
John Henry. The John Henry brand, which we originally licensed from Salant, and subsequently acquired in fiscal 2000, appeals to middle-income 25-45 year-old men. The brand is well known, is associated with quality and value, and is primarily sold in national and regional chain stores. Our John Henry product offerings form a “dress casual collection” as John Henry is considered a designer brand at national and regional chain stores.
Cubavera and the Havanera Co. We introduced the Cubavera brand in fiscal 2000 and followed with the introduction of the Havanera Co. brand in fiscal 2002. These brands appeal to Hispanic males between the ages of 25-45 and consumers who embrace Hispanic lifestyle brands. Cubavera is currently sold in major department stores as well as specialty stores around the country, while the Havanera Co. brand is sold in national chain stores.
Natural Issue. We developed the Natural Issue brand in fiscal 1988 to appeal to middle-income 25-55 year-old men. Natural Issue’s products include dress casual shirts, sweaters and pants. We have expanded our pants products to include the Natural Issue Executive Khaki pants line with cotton fabric, as well as twill and corduroy fabrics. Natural Issue is primarily sold in national and regional chain stores.
Munsingwear. We purchased the Munsingwear family of brands along with its associated sub-brands in fiscal 1997 to appeal to middle-income 30-50 year-old men who prefer classic American casual sportswear. Munsingwear and its sub-brands have over 100 years of history. Munsingwear apparel categories include sportswear, sweaters, activewear and casual pants, and are primarily sold in national and regional chain stores. The sub-brands are also sold primarily to national and regional chain stores.
Grand Slam and Penguin Sport. We purchased the Grand Slam and Penguin Sport brands as part of the Munsingwear acquisition in fiscal 1997. Grand Slam is an American heritage brand with its signature penguin icon logo and appeals to middle-income 30-60 year-old men who prefer classic casual gold apparel. The Grand Slam brand is primarily sold in department stores.
The Penguin Sport brand offers functional sportswear with a golf edge. It is associated with easy care fabrication, and its lightweight fabric makes for a comfortable fit. It offers fashionable styling at a moderate price and is sold in the national and regional chain, specialty and sporting goods stores.
Original Penguin. We re-introduced the Original Penguin brand in fiscal 2003, which is a lifestyle product for the Generation X and Y males who are suburban upper-middle class, ages 18 to 35. The line offers vintage inspired sportswear that its targeted consumers’ fathers used to wear. The product line is primarily sold at upscale department and upper tier specialty stores and includes apparel, shoes and accessory items.
PING. We have a worldwide apparel master license for the prestigious PING golf brand, which appeals to golfers and high-income, status conscious 25-50 year-old men. The license expires in December 2004, but renews automatically based on performance levels. The brand is a well-known golf brand, which we positioned to be associated with the highest standard of quality in the golf business. Products under this brand include golf shirts, sweaters, shorts and outerwear. The brand is sold primarily in golf shops and top-tier specialty and department stores.
Nike. We signed a license agreement with Nike to design and market men’s, women’s, junior’s, boy’s and girl’s swimwear, men’s and junior’s competitive swimwear, and swimwear apparel and accessories as part of the Jantzen acquisition. Swim products are sold through sporting good stores, specialty stores, team dealers and department store distribution. The license agreement expires on May 31, 2006.
Tommy Hilfiger. We acquired the license for the Tommy Hilfiger brand women’s and junior’s fashion swimwear as part of the Jantzen acquisition. These products are sold in upscale department and specialty stores. The license agreement expires on December 31, 2005.
Ocean Pacific. We acquired the license for the Ocean Pacific brand men’s casual sportswear as part of the Salant acquisition. These products are sold in national and regional chain stores. The license agreement expires on December 31, 2005.
Other Brands. We also own the Manhattan, Mondo di Marco, Pro Player and Redsand brands and license the NAUTICA brand. The Manhattan and Mondo di Marco brands are associated with dress casual apparel sold primarily at mass merchants and upscale department stores, respectively. The Redsand brand is associated with a youth lifestyle and is sold primarily at specialty stores. The NAUTICA brand is licensed for our corporate wear business.
Other Markets
Private Label. In addition to our sales of branded products, we sell products to retailers for marketing as private label for their own store lines. In fiscal 2004, we sold private label products to Saks, Inc., Dillard’s, J.C. Penney, Goody’s, Casual Male, Kmart, Wal-Mart and Meijer. Private label sales generally yield lower gross margins than sales of comparable branded products. Private label sales accounted for approximately 9%, 25%, and 37% of net sales during fiscal 2004, 2003, and 2002, respectively. The decrease in the private label business as a percentage of our net sales is a result of the additional net sales of apparel under the brands acquired in the Jantzen acquisition, the subsequent license agreements with Nike and Tommy Hilfiger and our decision to focus our efforts on selling branded products.
Corporate wear. We entered into the corporate wear business at the end of fiscal 2001. We recognized a change in the current business environment and have successfully provided a variety of corporations with high quality designer products. In fiscal 2004, our corporate wear business accounted for 3.3% of net sales. We currently offer the PING, NAUTICA, Cubavera and Perry Ellis brands in this market and sell primarily to corporate wear distributors.
Products and Product Design
We offer a broad line of high quality men’s casual sportswear, dress shirts and pants, jeans wear, golf apparel, sweaters, sports apparel, swimwear and swim accessories, activewear and leather accessories. Our womenswear offerings include swimwear, sportswear and swim accessories. Substantially all of our products are designed by our in-house staff utilizing our advanced computer-aided design technology. This technology enables us to produce computer-generated simulated samples that display how a particular style will look in a given color and fabric before it is actually produced. These samples can be printed on paper or directly onto fabric to accurately present the colors and patterns to a potential customer. In addition, we can quickly alter the simulated sample in response to our customers’ comments, such as change of color, print layout, collar style and trimming, pocket details and/or placket treatments. The use of computer-aided design technology minimizes the time-consuming and costly need to produce actual sewn samples prior to retailer approval, allows us to create custom-designed products meeting the specific needs of customers and reduces a product’s time to market, from conception to the delivery of the product to customers.
In designing our apparel products, we seek to promote consumer appeal by combining functional, colorful and high quality fabrics with creative designs and graphics. Styles, color schemes and fabrics are also selected to encourage consumers to coordinate outfits and form collections, thereby encouraging multiple purchases. Our designers stay abreast of the latest design trends, fabrics, colors, styles and consumer preferences by attending trade shows, periodically conducting market research in Europe and the United States and using outside consultants. Our purchasing department also seeks to improve the quality of our fabrics by staying informed about the latest trends in fabric all over the world. In addition, we actively monitor the retail sales of our products to determine changes in consumer trends.
In accordance with standard industry practices for licensed products, we have the right to approve the concepts and designs of all products produced and distributed by our licensees.
Our products include:
Shirts. We offer a broad line of sport shirts, which includes cotton and cotton-blend printed, yarn-dyed and solid knit shirts, cotton woven shirts, silk, cotton and rayon printed button front sport shirts, linen sport shirts, golf shirts, and embroidered knits and woven shirts. Our shirt line also includes dress shirts, dress casual shirts, brushed twill shirts, jacquard knits and yarn-dyed flannels. Additionally, we are one of the leading distributors of guayabera-style shirts in the United States. We market shirts under a number of our own brands as well as the private labels of our retail customers. Our shirts are produced in a wide range of men’s sizes, including sizes for the big and tall men’s market. Sales of shirts accounted for approximately 57%, 65%, and 74% of our net sales during fiscal 2004, 2003, and 2002, respectively. The decrease of shirts as a percentage of net sales reflects the addition of swimwear, as a result of the Jantzen acquisition, and our increased focus on our other products.
Bottoms. Our bottoms line include a variety of styles of wool, wool-blend, linen and polyester/rayon dress pants, casual pants in cotton and polyester/cotton and linen/cotton walking shorts. We market our bottoms as single items or as a collection to complement our shirt lines. Sales of bottoms accounted for approximately 21%, 21%, and 20% of our net sales during fiscal 2004, 2003, and 2002, respectively.
Swimwear. With the Jantzen acquisition, and upon the successful addition of both the Nike and Tommy Hilfiger licenses, we entered the women’s, men’s and junior’s swimwear and accessories market. Sales of swimwear and accessories accounted for approximately 13% and 8% of net sales during fiscal 2004 and 2003, respectively.
Other Products. We also offer sweaters, vests, jackets, pullovers and leather accessories under our existing brands, as well as private label. The majority of the other products we sell are sweaters and leather accessories. Other products accounted for approximately 9%, 6%, and 6% of net sales during each of fiscal 2004, 2003 and 2002.
Licensing Operations
For the past eight years, we have been licensing the brands we own, and sublicensing the brands we license, to third parties for various product categories. Licensing enhances the images of our brands by widening the range, product offerings and distribution of products sold under our brands without requiring us to make capital investments or incur additional operating expenses. As a result of this strategy, we have gained experience in identifying potential licensing opportunities and have established relationships with many licensees. Our licensing operation is also a significant contributor to our operating income.
As of April 6, 2004, we were the licensor in approximately 135 license agreements, 56 domestic and 79 international, with 100 licensees, 40 domestic and 60 international, for various products including footwear, sportswear, dress shirts and bottoms, underwear, loungewear, outerwear, activewear, neckwear, fragrances, eyewear and accessories. Wholesale sales of licensed products by our licensees (including Salant) were approximately $434.0 million, $576.0 million, and $534.0 million in fiscal 2004, 2003, and 2002, respectively. We received royalties from these sales of approximately $21.7 million, $28.8 million, and $26.7 million in fiscal 2004, 2003, and 2002, respectively. While our royalties declined as a result of the Salant acquisition, we believe that our long-term licensing opportunities will continue to grow domestically and internationally. See our audited Consolidated Financial Statements and the related notes in this report.
Although the Perry Ellis brand has international recognition, we still perceive the brand to be under-penetrated in international markets such as Europe and Asia. We are actively attempting to obtain licenses for various products bearing the Perry Ellis brand in these under-performing international markets. We believe that our brand and licensing experience will enable us to capitalize on these international opportunities and that the Salant acquisition will assist us in this endeavor. In addition, we believe that the Jantzen brand’s history of over 90 years will allow us to take advantage of many domestic and international licensing opportunities.
To maintain a brand’s image, we closely monitor our licensees and approve all licensed products. In evaluating a prospective licensee, we consider the candidate’s experience, financial stability, manufacturing performance and marketing ability. We also evaluate the marketability and compatibility of the proposed products with our other products. We regularly monitor product design, development, merchandising and marketing of licensees, and schedule meetings throughout the year with licensees to ensure quality, uniformity and consistency with our products. We also give our licensees a view of our products and fashion collections and our expectations of where its products should be positioned in the marketplace. In addition to approving, in advance, all of our licensees’ products, we also approve their advertising, promotional and packaging materials.
As part of our licensing strategy, we work with our licensees to further enhance the development, image, and sales of their products. We offer licensees marketing support, and our relationships with retailers help the licensees generate higher revenues.
Our license agreements generally extend for a period of three to five years with options to renew prior to expiration for an additional multi-year period based upon a licensee meeting certain performance criteria. The typical agreement requires that the licensee pay us the greater of a royalty based on a percentage of the licensee’s net sales of the licensed products or a guaranteed minimum royalty that typically increases over the term of the agreement. Generally, licensees are required to contribute to us additional monies for advertising and promotion of the licensed products in their covered territory.
Marketing, Distribution and Customers
We market our apparel products to customers principally through the direct efforts of our in-house sales staff, independent commissioned sales representatives who work exclusively for us, and other non-exclusive independent commissioned sales representatives who generally market other product lines as well as ours. We also attend major industry trade shows in the fashion, golf, and corporate sales areas.
We own a chain of 38 retail outlet stores, 35 of which were acquired as part of the Salant acquisition, through which we sell Perry Ellis products directly to the public. These retail stores are generally located in upscale retail outlet malls.
We believe that customer service is a key factor in successfully marketing our apparel products. We coordinate efforts with customers to develop products meeting their specific needs using our design expertise and computer-aided design technology. Utilizing our sourcing capabilities, we strive to produce and deliver products to our customers on a timely basis.
Our in-house sales staff is responsible for customer follow-up and support, including monitoring prompt order fulfillment and timely delivery. We utilize an Electronic Data Interchange, or EDI, system for certain customers in order to provide advance-shipping notices, process orders and conduct billing operations. In addition, certain customers use the EDI system to communicate their weekly inventory requirements per store to us. We then fill these orders either by shipping directly to the individual stores or by sending shipments, individually packaged and bar coded by store, to a centralized customer distribution center.
We recently launched PerrySolutions, a software system that enables our sales planners to manage our retail customers’ inventory at the SKU level. This system helps maximize the sales of our products thereby increasing inventory turns for the retailer, which in turn reduces our product returns and markdowns and increases our profitability. By using software that provides demographic mapping data, we can develop specific micro-market plans for our customers that provide them with enhanced returns on our various product lines.
We sell merchandise to a broad spectrum of retailers, including national and regional chain, upscale department, mass merchants and specialty stores. Our largest customers include Federated, May Department Stores, Dillard’s, Wal-Mart, J.C. Penney, Kohl’s, and Sears. We have developed and maintained long-standing relationships with these customers, including Dillard’s (more than 25 years), May Department Stores (more than 25 years), J.C. Penney (more than 25 years), Sears (25 years), Federated (16 years), Wal-Mart (14 years) and Kohl’s (10 years).
Net sales to our five largest customers accounted for approximately 39%, 40%, and 47% of net sales in fiscal 2004, 2003, and 2002, respectively. For fiscal 2004, net sales to Kohl’s accounted for approximately 10% of our net sales. For fiscal 2003, net sales to Wal-Mart accounted for approximately 11% of net sales. For fiscal 2002, net sales to Target accounted for approximately 12% of net sales, while net sales to J. C. Penney and Wal-Mart each accounted for approximately 11% of net sales. No other single customer accounted for more than 10% of net sales during such fiscal years.
Advertising and Promotions
We advertise to customers through print advertisements in a variety of consumer and trade magazines and newspapers and through outdoor advertising such as billboards strategically placed to be viewed by consumers. For example, we are continuing Jantzen’s emphasis on print advertisements for our swimwear products in influential magazines such as Sports Illustrated, In Style, Glamour and Vogue and intend to sponsor selected athletes and celebrities in the future. In order to promote our men’s sportswear at the retail level, we participate in cooperative advertising in print and broadcast media, which features our products in our customers’ advertisements. The cost of this cooperative advertising is shared with our customers. We also conduct various in-store marketing activities with our customers, such as retail events and promotions, the costs of which are shared by our customers. These events and promotions are in great part orchestrated to coincide with high volume shopping times such as holidays (Christmas and Thanksgiving) and Father’s Day. In addition to event promotion, we place perennial displays and signs of our products in retail establishments.
We use direct consumer advertising in selected markets featuring the Perry Ellis, Cubavera, the Havanera Co., John Henry, Natural Issue, Munsingwear and Grand Slam brand names through the placement of highly visible billboards, sponsorships and special event advertising. We also maintain informational websites featuring our brands. We create and implement editorial and public relations strategies designed to heighten the visibility of our brands. All of these activities are coordinated around each brand in an integrated marketing approach.
Seasonality and Backlog
Our products have historically been geared towards lighter weight apparel generally worn during the spring and summer months. We believe that this seasonality has been reduced with our introduction of fall, winter and holiday merchandise. The swimwear business, however, is highly seasonal in nature, with the vast majority of our sales occurring in our first and fourth quarter.
We generally receive orders from our retailers approximately five to seven months prior to shipment. For approximately 80% of our sales, we have orders from our retailers before we place orders with our suppliers. A summary of the order and delivery cycle for our four primary selling seasons, excluding swimwear, is illustrated below:
Merchandise Season
Advance Order Period
Delivery Period to Retailers
Spring
July to September
January to March
Summer
October to December
April and May
Fall
January to March
June to September
Holiday
April to June
October and November
Sales and receivables are recorded when inventory is shipped. Our backlog of orders includes confirmed and unconfirmed orders, which we believe, based on industry practice and past experience, will be confirmed. As of April 1, 2004, the backlog for orders of our products, all of which are expected to be shipped during fiscal 2005, was approximately $221.7 million, as compared to approximately $129.7 million as of March 2, 2003, which was prior to the Salant acquisition.
The amount of unfilled orders at a point in time is affected by a number of factors, including the mix of product, the timing of the receipt and processing of customer orders and the scheduling of the sourcing and shipping of the product, which in most cases depends on the desires of the customer. Backlog is also affected by on-going trends among customers to reduce the lead-time on their orders. Since the fall of 2001, our customers have been more cautious of their inventory levels and have delayed placing orders and re-orders compared to our previous experience. Due to these factors a comparison of unfilled orders from period to period is not necessarily meaningful and may not be indicative of eventual actual shipments.
Supply of Products and Quality Control
We currently use independent contract manufacturers to supply the substantial majority of the products we sell. Of the total dollar value of sourced products in fiscal 2004, 72%, 14%, 6% and 8% were sourced from suppliers in Asia, South and Central America, the Middle East and other areas of the world, respectively. We believe that the use of numerous independent contract manufacturers allows us to maximize production flexibility, while avoiding significant capital expenditures, work-in-process inventory build-ups and the costs of maintaining and operating production facilities. We have had relationships with some suppliers for as long as 30 years, however, none of these relationships are formal or require either party to purchase or supply any fixed quantity of product.
The vast majority of our non-swimwear products are purchased as “full packages,” where we place an order with the supplier and the supplier purchases all the raw materials, assembles the garments and ships them to our distribution facilities or third party facilities. For some of our swimwear business, which includes the Jantzen, Southpoint, Nike and Tommy Hilfiger brands, we purchase fabric from domestic and international suppliers. The purchased fabric is primarily cut in the United States. The cut fabric is matched with various trim components and shipped to off-shore sewing contractors located primarily in Mexico and the Caribbean Basin enabling us to utilize exemptions under “807” customs regulations, which provide that certain articles assembled abroad from United States components are exempt from United States duties on the value of those components. This process is generally referred to as CMT (cut, make and trim) and differs from “full package” sourcing in that we, not the supplier, purchase and own the fabric and trim components. We are, however, shifting the production of our swimwear business to the “full package” sourcing model and anticipate that in the future the vast majority of our purchases will be “full packages.” Finished goods are generally shipped to either our distribution facilities or to third-party warehouses in California for repackaging and distribution to customers.
We maintain a staff of experienced sourcing professionals in five offices in China (including Hong Kong), as well as the United States, South Korea and Taiwan. This staff sources our products worldwide, monitors our suppliers’ purchases of raw material, and monitors production at contract manufacturing facilities in order to ensure quality control and timely delivery. We also operate through independent agents in Asia and the Middle East. Our personnel based in our Miami, Florida office perform similar functions with respect to our suppliers in Central America. We conduct inspections of samples of each product prior to cutting by contractors during the manufacturing process and prior to shipment. We also have full-time quality assurance inspectors in Latin America and the Caribbean and in each of our overseas offices.
We also generally facilitate and aid our foreign contractors in obtaining raw materials. Otherwise, the foreign contractors
purchase the raw material in accordance with our specifications. Raw materials, which are in most instances made and/or colored especially for us, consist principally of piece goods and yarn and are specified by us from a number of foreign and domestic textile mills and converters.
We are committed to ethical sourcing standards and require our independent contractors to comply with our code of conduct. We monitor compliance by our foreign contract manufacturers with applicable laws and regulations relating to, for example, the payment of wages, working conditions and the environment. As part of our compliance program, we routinely perform audits of our contract manufacturers and require corrective action when appropriate.
Our relationship with our foreign suppliers subjects us to the risks of doing business abroad. As a result of our suppliers, in some instances, being at great geographic distances from us, our transportation costs are increased and longer lead times are required, which reduces our flexibility. Our finished goods are also subject to import duties, quotas and other restrictions. The countries that we source our products from may, from time to time, impose new quotas, duties, tariffs, or other restrictions or adjust prevailing quota, duty or tariff levels, which could affect our ability to import products at the current or increased levels. Other risks in doing business with foreign suppliers include political or economic instability, any significant fluctuations in the value of the dollar against foreign currencies, terrorist activities, and restrictions on the transfer of funds. Although we have not been affected in a material way by any of the foregoing factors, we cannot predict the likelihood or frequency of any such events occurring and any material disruption may have an adverse affect on our business.
In order to assist with the timely delivery of finished goods, we function as our own customs broker for a majority of our deliveries. We prepare our own customs documentation and arrange for any inspections or other clearance procedures with the United States Customs Service. We are a member of the United States Customs Automated Interface program. This membership permits us to clear our goods through United States Customs electronically and generally reduces the necessary clearance time to a matter of hours rather than days.
Import and Import Restrictions
Our import operations are subject to constraints imposed by bilateral textile agreements between the United States and a number of foreign countries including China, Indonesia and Korea. These agreements impose quotas on the amount and type of goods that can be imported into the United States from these countries. Such agreements also allow the United States to impose, at any time, restraints on the importation of categories of products that, under the terms of the agreements, are not subject to specified limits. Most of our imported products are also subject to United States customs duties and other charges.
We monitor duty, tariff, and quota-related developments and continually seek to minimize our potential exposure to quota-related risks through, among other measures, geographical diversification of our contract manufacturers, the maintenance of overseas offices, allocation of overseas production to product categories where more quota is available and shifts of production among countries and manufacturers.
Under the terms of the World Trade Organization Agreement on Textiles and Clothing, WTO members have agreed to remove all quotas by January 1, 2005. Because of our sourcing experience, capabilities and relationships, we believe we are well-positioned to take advantage of the elimination of quotas by 2005.
Competition
The retail apparel industry is highly competitive and fragmented. Our competitors include numerous apparel designers, manufacturers, importers, licensors, and our own customers’ private label programs, many of which are larger and have greater financial and marketing resources than we have available to us. We believe that the principal competitive factors in the industry are: (1) brand name and brand identity, (2) timeliness, reliability and quality of services provided, (3) market share and visibility, (4) price, and (5) the ability to anticipate customer and consumer demands and maintain appeal of products to customers.
We strive to focus on these points and have proven our ability to anticipate and respond quickly to customer demands with our brands, range of products and our ability to operate within the industry’s production and delivery constraints. We believe that our continued dedication to customer service, product assortment and quality control, as well as our aggressive pursuit of licensing and acquisition opportunities, directly addresses the competitive factors in all market segments. Our established brands and relationships with retailers have resulted in a loyal following of customers.
We understand that the level of competition and the nature of our competitors vary by product segment. In particular, in the mass market channel, manufacturers constitute our main competitors in this less expensive segment of the market, while high profile domestic and foreign designers and licensors account for our main competitors in the more upscale segment of the market. Although we have been able to compete successfully to date, there can be no assurance that significant new competitors will not develop in the future.
Trademarks
Our material trademarks are registered with the United States Patent and Trademark Office and in other countries. We regard our trademarks and other proprietary rights as valuable assets that are critical in the marketing of our products, and, therefore, we vigorously protect our trademarks against infringements.
Employees
As of April 6, 2004, we had approximately 1,398 employees compared to approximately 576 employees as of April 6, 2003. Other than some of our employees at our Winnsboro, South Carolina distribution facility, none of our employees are subject to collective bargaining agreements. In fiscal 2003, however, a labor organization attempted to organize certain employees of one of our subsidiaries at our Miami, Florida facility. A National Labor Relations Board-supervised election was held on September 9, 2002. A majority of the employees at our Miami distribution center who voted cast their ballots against unionization. The labor organization filed objections to the election, and, after a lengthy review process, the National Labor Relations Board ordered another election be held on May 30, 2003. At the May 30, 2003 election, a majority of the employees who voted cast their ballots against unionization. The labor organization filed objections to this second election, which objections are pending before the National Labor Relations Board. We consider our employee relations to be satisfactory.
Certain Risks
Our business faces certain risks. The risks described below may not be the only risks we face. Additional risks that we do not yet know of or that we currently think are immaterial may also impair our business. If any of the events or circumstances described as risks below actually occurs, our business, results of operations or financial condition could be materially and adversely affected.
We rely on a few key customers, and the loss of any one key customer would substantially reduce our revenues.
We derive a significant amount of our revenues from a few major customers. A significant decrease in business from or loss of any of our major customers could harm our financial condition by causing a significant decline in revenues attributable to such customers.
Net sales to our five largest customers totaled approximately 39%, 40%, and 47% of net sales during fiscal 2004, fiscal 2003, and fiscal 2002, respectively. Our five largest customers are J. C. Penney, Kohl’s, Federated, May, and Sears. For fiscal 2004, Kohl’s represented 10% of our net sales. Net sales to Wal-Mart accounted for approximately 11% of net sales during fiscal 2003. Net sales to Target Corporation, Wal-Mart, and J. C. Penney accounted for approximately 12%, 11% and 11% of net sales during fiscal 2002, respectively. No other single customer accounted for more than 10% of our net sales during these fiscal years.
Although we have long-standing relationships with many of our customers, we do not have long-term contracts with any of them and purchases generally occur on an order-by-order basis. We believe that purchasing decisions are generally made independently by individual department stores within a company controlled group. There has been a trend, however, toward more centralized purchasing decisions. As such decisions become more centralized, the risk to us of such concentration increases. If our customers were to curtail or cease their purchase orders with us, our revenues could significantly decrease and our financial condition could be significantly harmed.
We may not be able to anticipate consumer preferences and fashion trends, which could negatively affect acceptance of our products by retailers and consumers and result in a significant decrease in net sales.
Our failure to anticipate, identify and respond effectively to changing consumer demands and fashion trends could adversely affect acceptance of our products by retailers and consumers and may result in a significant decrease in net sales or leave us with a substantial amount of unsold inventory. We believe that our success depends on our ability to anticipate, identify and respond to changing fashion trends in a timely manner. Our products must appeal to a broad range of consumers whose preferences cannot be predicted with certainty and are subject to rapid change. We may not be able to continue to develop appealing styles or successfully meet constantly changing consumer demands in the future. In addition, any new products or brands that we introduce may not be
successfully received by retailers and consumers. Due to the fact that we began marketing women’s apparel with the acquisition of the Jantzen swimwear business in fiscal 2003, we may be more subject to additional changes in fashion trends as women’s fashion trends have historically changed more rapidly than men’s. If our products are not successfully received by retailers and consumers and we are left with a substantial amount of unsold inventory, we may be forced to rely on markdowns or promotional sales to dispose of excess, slow-moving inventory. If this occurs, our business, financial condition, results of operations and prospects may be harmed.
Our business could be negatively impacted by the financial instability of our customers.
During the past several years, various retailers, including some of our customers, have experienced significant difficulties, including bankruptcies, liquidations, consolidation of ownership, and increased centralization of buying decisions. For example, Kmart Corporation and Casual Male Corp. filed for protection from creditors under Chapter 11 of the U.S. Bankruptcy Code. These and other financial problems of some of our customers increase the risk of extending credit to these retailers. Consistent with industry practices, we sell products primarily on open account after completing an appropriate credit review. A significant adverse change in a customer or its financial position could cause us to limit or discontinue business with that customer, require us to assume more credit risk relating to that customer’s receivables or limit our ability to collect amounts related to previous purchases by that customer, all of which could harm our business, financial condition and results of operation by causing a significant decline in revenues attributable to such customers.
We are dependent upon the revenues generated by our licensing alliances and the loss or inability to renew certain licenses could reduce our royalty income or net sales and consequently reduce our net income.
A portion of our net income is derived from licensing income received from our licensing partners. The interruption of the business of several of our licensing partners at any one time could adversely affect our royalty income and net income. Licensing income accounted for $21.7 million or 4.3% of total revenues for fiscal 2004.
We currently license the PING, Nike, Tommy Hilfiger, NAUTICA and Ocean Pacific brands from third parties. These licenses vary in length of term, renewal conditions and royalty obligations. The average term of these licenses is three to five years with automatic renewals depending upon whether we achieve certain targeted sales goals. We may not be able to renew or extend any of these licenses, on favorable terms, if at all. If we are unable to renew or extend any of these licenses, we could experience a decrease in net sales.
We may face challenges integrating Salant, which may negatively impact our business.
We will need to integrate Salant’s business into our operations in order to achieve the anticipated benefits of the Salant acquisition. We may face challenges in consolidating functions and integrating management procedures, personnel and operations in an efficient and effective manner which may negatively impact our business. Some of these challenges include increased demands on management related to the significant increase in the size and diversity of our business after the Salant acquisition, the diversion of management’s attention to implement our strategies for the Salant business, the retention and integration of key Salant employees, analyzing aspects of Salant’s business that are to be kept separate and distinct from our other businesses, and difficulties in assimilating Salant’s corporate culture and practices into ours.
We may not have uncovered all the risks associated with the Salant acquisition or any future acquisitions and a significant liability may arise after closing.
There may be additional risks that we failed to discover in the course of performing our due diligence investigations related to the Salant acquisition and any future acquisitions which could result in significant liabilities arising after the consummation of such transactions. In connection with the Salant acquisition, we assumed all of Salant’s liabilities, whether pre-existing or contingent, as a matter of law. Moreover, as in the Salant acquisition, to the extent we acquire all of the capital stock of potential future sellers, we will assume all of the seller’s liabilities as a matter of law. As is customary in transactions similar to the Salant acquisition, the merger agreement did not provide for our indemnification against any of Salant’s liabilities should they arise or become known to us after the closing. Such liabilities could include those arising from the trademarks, employee benefits and pension contribution obligations of a prior owner, accounting and financial reporting matters, tax matters and noncompliance with applicable federal, state or local environmental requirements by prior owners for which we, as a successor owner, may potentially be responsible. While we tried to minimize these risks by conducting such due diligence, including trademark, employee benefits and environmental reviews, that we deemed appropriate under the circumstances, we may not have identified all existing or potential risks. Any significant liability that may arise may harm our business, financial condition, results of operations and prospects by requiring us to expend significant funds to satisfy such liability.
We need significant working capital to fund our operations, a substantial portion of which is financed, and our inability to continue to finance such working capital could affect our marketing and sales efforts because our ability to purchase inventory would be curtailed.
We need significant working capital to purchase inventory and are often required to post letters of credit when placing an order with one of our foreign manufacturers. We meet our working capital needs through our operating cash flow, our senior credit facility and letter of credit facilities. If we are unable to extend or renew either our senior credit facility or letter of credit facilities on satisfactory terms or in the event borrowings thereunder were unavailable to us as a result of any noncompliance with any covenants contained therein, our ability to purchase inventory would be curtailed or eliminated, which would significantly affect our marketing and sales efforts, thus harming our business.
We have a significant amount of debt, which could have important negative consequences to us, including making it difficult for us to satisfy all of our obligations in the event we experience financial difficulties.
We have a significant amount of debt. As of March 31, 2004, we had $265.7 million of debt outstanding (excluding amounts outstanding under our letter of credit facilities).
Our substantial indebtedness could have important consequences to you, including:
• making it more difficult for us to satisfy our obligations with respect to our senior secured notes and our senior subordinated notes, including our ability to repurchase such notes upon the occurrence of a change of control,
• increasing our vulnerability to adverse general economic and industry conditions and adverse changes in governmental regulations,
• limiting our ability to obtain additional financing to fund capital expenditures, acquisitions and other general corporate requirements,
• requiring us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund capital expenditures, acquisitions or other general corporate purposes,
• limiting the rights of our holders of senior subordinated notes to receive payments if holders of our secured debt have not been paid,
• limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate, and
• placing us at a competitive disadvantage compared to our less leveraged competitors.
Our ability to pay interest on our indebtedness and to satisfy our other debt obligations will depend upon, among other things, our future operating performance and our ability to refinance indebtedness when necessary. Each of these factors is, to a large extent, dependent on economic, financial, competitive and other factors beyond our control. If, in the future, we cannot generate sufficient cash from operations to make scheduled payments on our indebtedness or to meet our other obligations, we will need to refinance our existing debt, obtain additional financing or sell assets. We cannot assure you that our business will generate cash flow, or that we will be able to obtain funding, sufficient to satisfy our debt service requirements.
To service our existing and future debt, we will require a significant amount of cash, which may not be available to us.
Our ability to make payments on or refinance our debt will depend largely upon our future operating performance and cash flow. Our future operating performance and cash flow are subject to many factors, including general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control.
We cannot assure you that our business will generate cash flow from operations in an amount sufficient to enable us to pay the interest and principal on our debt or to fund our other liquidity needs. If we are unable to generate cash to meet our debt service requirements, we may have to renegotiate or refinance the terms of our debt. We cannot assure you that we will be able to renegotiate or refinance any of our debt on commercially reasonable terms or at all. In addition, prior to the repayment of our senior subordinated notes, we will be required to repay or refinance our senior credit facility and, perhaps, any other debt we incur. Any new debt we incur may have a shorter maturity than our existing debt. Payment of such debt will reduce the amount of funds available to us to make payments on our existing debt.
If we are unable to refinance our debt or obtain new financing under these circumstances, we would have to consider other options, such as selling certain assets to meet our debt service obligations or using cash, if available, that would have been used for other business purposes.
These options may not be feasible or may be inadequate, and may also adversely affect our operations or the implementation of our business plan. Our senior credit facility and the indentures governing our senior secured notes and the senior subordinated notes may restrict, or market or business conditions may limit, our ability to do some of these things. Non-payment or other non-compliance with our senior credit facility, the indentures governing our senior secured notes and senior subordinated notes or the instruments governing our other debt could result in an event of default under our other instruments governing our debt.
Our swimwear business has not been profitable.
We acquired the Jantzen swimwear business in March 2002, which business has not yet been profitable. Our future results may be adversely impacted if this business remains unprofitable.
Our swimwear business is highly seasonal in nature and revenue and profitability can be adversely affected by climate and other factors.
The vast majority of swimwear shipments to our customers occur in our first and fourth quarters. Adverse weather, temporary disruptions in the supply chain and other factors that result in reduced or delayed shipments to customers could impact the profitability of the swimwear business, which in turn may negatively impact our consolidated net income.
We operate in a highly competitive and fragmented industry and our failure to successfully compete could result in a loss of one or more significant customers.
The retail apparel industry is highly competitive and fragmented. Our competitors include numerous apparel designers, manufacturers, importers and licensors, many of which have greater financial and marketing resources than us. We believe that the principal competitive factors in the apparel industry are:
• brand name and brand identity,
• timeliness, reliability and quality of services provided,
• market share and visibility,
• price, and
• the ability to anticipate customer and consumer demands and maintain appeal of products to customers.
The level of competition and the nature of our competitors varies by product segment with low-margin, mass-market manufacturers being our main competitors in the less expensive segment of the market and U.S. and foreign designers and licensors competing with us in the more upscale segment of the market. If we do not maintain our brand names and identities and continue to provide high quality and reliable services on a timely basis at competitive prices, we may not be able to continue to compete in our industry. If we are unable to compete successfully, we could lose one or more of our significant customers which, if not replaced, could negatively impact our sales and financial performance.
We depend on certain key personnel the loss of which could negatively impact our ability to manage our business.
Our future success depends to a significant extent on retaining the services of certain executive officers and directors, in particular George Feldenkreis, our chairman of the board and chief executive officer, and Oscar Feldenkreis, our president and chief operating officer. They are each party to an employment agreement, which was renewed in December 2002 for an additional two-year period expiring in May 2005. The loss of the services of either George Feldenkreis or Oscar Feldenkreis, or any other key member of management, could have a material adverse effect on our ability to manage our business. Our continued success is dependent upon our ability to attract and retain qualified management, administrative and sales personnel to support our future growth. Our inability to do so may have a significant negative impact on our ability to manage our business.
Item 2.
Item 2. Properties
We own our principal executive and administrative office, warehouse and distribution facility, which is located in a 230,000 square foot facility in Miami, Florida. This facility is encumbered by an $11.6 million mortgage. For purposes of potential future expansion, we own approximately three acres of land adjacent to this facility.
We lease three facilities in Miami, totaling approximately 103,000 square feet, which house distribution and administrative functions. These facilities are leased on a month-to-month basis from our chairman and chief executive officer.
We own a 345,000 square foot distribution center in Seneca, South Carolina, and in Winnsboro, South Carolina, we own a 380,000 square foot distribution facility.
We lease several locations in New York City, totaling approximately 97,000 square feet, with leases expiring from August 2005 to December 2012. These locations are used for office, design, and showroom space.
We lease 45,200 square feet for office space used by our swimwear business in Portland, Oregon, pursuant to a lease expiring in December 2004.
In order to monitor production of our products in the Far East, we maintain offices in South Korea and China (including Hong Kong) and also lease offices jointly with GFX, Inc., a company controlled by George Feldenkreis, our chairman and chief executive officer, in Beijing, China and Taipei, Taiwan.
We also operate 38 retail outlet stores, comprising approximately 94,500 square feet of selling space, all of which are leased.
Item 3.
Item 3. Legal Proceedings
Perry Ellis is subject to claims and suits against it, and is the initiator of claims and suits against others in the ordinary course of business, including claims arising from the use of its trademarks. Perry Ellis does not believe that the resolution of any pending claims will have a material adverse affect on its business, financial condition or results of operations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity and Related Shareholder Matters
(a) Market Information
Our common stock has been listed for trading on the Nasdaq National Market under the symbol “PERY” since June 1999. Prior to that date, our trading symbol was “SUPI” based upon our former name, Supreme International Corporation. The following table sets forth, for the periods indicated, the range of high and low per share bids of our common stock as reported by the Nasdaq National Market. Such quotations represent inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
(b) Holders
As of April 6, 2004, there were approximately 276 shareholders of record of our common stock. We believe the number of beneficial owners of our common stock is in excess of 1,100.
(c) Dividends
We have not paid any cash dividends since our inception and do not contemplate doing so in the near future. Payment of cash dividends is prohibited under our senior credit facility and indentures governing our senior secured notes and senior subordinated notes. See Notes 14 through 17 to the consolidated financial statements of Perry Ellis included in Item 8 of this Report. Any future decision regarding payment of cash dividends will depend on our earnings and financial position and such other factors, as our board of directors deems relevant.
(d) Securities Authorized for Issuance under Equity Compensation Plans
The section under the heading “Executive Compensation” entitled “Equity Compensation Plan Information for Fiscal 2004” in the Company’s proxy statement for the 2004 annual meeting of shareholders is incorporated herein by reference.
For additional information concerning the Company’s capitalization please see Note 23, “Stock Options and Warrants” of the Notes to the Consolidated Financial Statements included in Item 8.
Item 6.
Item 6. Selected Financial Data
Summary Historical Financial Information
(Dollars in thousands, except for per share data)
The following selected financial data is qualified by reference to, and should be read in conjunction with, the Consolidated Financial Statements of Perry Ellis and related Notes thereto included in Item 8 of this Report and “Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
We began operations in 1967 as Supreme International Corporation and initially focused our efforts on marketing guayabera shirts, and other men’s apparel products targeted at the Hispanic market in Florida and Puerto Rico. Over time we expanded our product line to offer a variety of men’s sport shirts. In 1988, we developed the Natural Issue brand and completed our initial public offering in 1993. In 1996, we began an expansion strategy through the acquisition of brands including the Munsingwear family of brands in 1996, the John Henry and Manhattan brands from Salant in 1999 and the Perry Ellis brand in 1999. Following the Perry Ellis acquisition, we changed our name from Supreme International Corporation to Perry Ellis International, Inc. to better reflect the name recognition that the brand provided. In 2002, we acquired the Jantzen brand and in June 2003 we acquired Salant, our largest licensee, giving us greater control of the Perry Ellis brand, as well as adding other brands owned by Salant.
We believe we are one of the leading apparel companies in the United States. We control a portfolio of major men’s and women’s brands, some of which were established over 100 years ago. We design, source, market and license our products nationally and internationally at multiple price points and across all major levels of retail distribution at more than 20,000 doors. The levels of retail distribution include department stores, national and regional chain stores, mass merchants, specialty stores, sporting goods stores, green grass golf shops, the corporate incentive market and independent retailers in the United States and Canada. Our largest customers include Federated, Dillard’s, May Department Stores, Wal-Mart, J.C. Penney, Kohl’s, and Sears. We also operate 38 retail stores located primarily in upscale retail outlet malls across the United States. In addition, we leverage our design, sourcing and logistics expertise by offering a limited number of private label programs to retailers. In order to maximize the worldwide exposure of our brands and generate high margin royalty income, we license our brands through approximately 56 domestic and approximately 79 international license agreements. Our licensing business is a significant contributor to our operating income.
In fiscal 2004, we experienced a 65.4% increase in total revenue and a 21.8% increase in net income. These increases were primarily due to our acquisition of Salant and organic growth offset by a decrease in royalty income. The record net income results we realized in fiscal 2004 came despite the fact that our swimwear business performed at levels below our expectations.
Our wholesale business, which is comprised of men’s sportswear and women’s and men’s swimwear and swimwear accessories, accounted for 96% of our total revenues in fiscal 2004, and our licensing business accounted for 4% of our total revenues in fiscal 2004. We have traditionally focused on the men’s sportswear market, which represented approximately 86.7% of our total wholesale revenues in fiscal 2004, while the women’s and men’s swimwear market represented approximately 13.3% of our total wholesale revenues in fiscal 2004.
In June 2003, we acquired Salant, a leading designer, marketer and distributor of brand name and private label menswear products and the largest licensee of the Perry Ellis brand. With the Salant acquisition we have consolidated control of the Perry Ellis brand, added significant revenues and earnings, solidified our balance sheet, further diversified our product offerings and customer base, and added to our portfolio of brands. As a result of this acquisition, we also assumed operation of 39 retail outlet stores, of which we have since closed four. The Salant business represented approximately $165 million of the $200 million in total revenue growth we experienced in fiscal 2004.
Our products have historically been geared towards lighter weight apparel generally worn during the spring and summer months. We believe that this seasonality has been reduced with our introduction of fall, winter, and holiday merchandise. Our swimwear business, however, is highly seasonal in nature, with the significant majority of its sales occurring in our first and fourth quarters. Our higher-priced products generally tend to be less sensitive to either economic or weather conditions. Seasonality can be affected by a variety of factors, including the mix of advance and fill-in orders, the amount of sales to different distribution channels, and overall product mix among traditional merchandise, fashion merchandise and swimwear. We expect that revenues for our second quarter will typically be lower than our other quarters due to the impact of seasonal sales.
We believe that our future growth will come as a result of our continued emphasis on our existing brands; new and expanded product lines; increases in our sales of bottoms, sweaters, swimwear and accessories; domestic and international licensing; multi-brand development for the fast-growing Hispanic market; and selective acquisitions and opportunities that fit strategically with our business model. Our expected future growth in these areas may be offset somewhat by a decreased focus on private label business.
In the past few years, the general decline in the U.S. economy has resulted in lower consumer spending. Retailers have responded to the general sense of economic weakness by delaying the placement of orders, reducing orders, and implementing aggressive price discounting and promotional activities. Many retailers, including some of our customers, have prioritized their own private label products or have instituted competitive internet-based global bidding processes for their private label business that, in some cases, are designed to effectively reduce margins to a level that are no longer attractive to us. In addition, during the past several years various retailers, including some of our customers, have experienced significant difficulties including bankruptcies, liquidations and reorganizations. All of these factors have materially adversely affected the apparel industry. Furthermore, the geopolitical situation has adversely affected the U.S. economy and consequently the apparel industry. We believe, however, that the current U.S. economy has improved in recent months. This improvement has led to the improved results of our customers. We believe that the improved economy and the resulting increase in demand for apparel should benefit us for the foreseeable future.
Recent Accounting Pronouncements
See Notes to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” for recent accounting pronouncements.
Critical Accounting Policies
Included in the footnotes to the consolidated financial statements in this report is a summary of all significant accounting policies used in the preparation of our consolidated financial statements. We follow the accounting methods and practices as required by Accounting Principles Generally Accepted in the United States of America (“GAAP”). In particular, our critical accounting policies and areas we use judgment in are the areas of revenue recognition, the estimated collectability of accounts receivable, the recoverability of obsolete or overstocked inventory, the impairment of long-lived assets that are our trademarks, the recoverability of deferred tax assets and the measurement of retirement related benefits.
Revenue Recognition. Sales are recognized at the time legal title to the product passes to the customer, generally FOB Perry Ellis’ distribution facilities, net of trade allowances and a provision for estimated returns and other allowances. Royalty income is recognized when earned on the basis of the terms specified in the underlying contractual agreements. We believe that our revenue recognition policies conform to Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements.
Accounts Receivable. We maintain an allowance for doubtful accounts receivables for estimated trade discounts, co-op advertising, allowances provided to retail customers to flow goods through the retail channel, and losses resulting from the inability of our retail customers to make required payments considering historical and anticipated trends. Judgment is critical because some retail customers are currently operating in bankruptcy or have experienced financial difficulties. Additional allowances might be required if their financial condition were to worsen.
Inventories. Our inventories are valued at the lower of cost or market value. We evaluate all of our inventory style-size-color stock keeping units, or SKUs, to determine excess or slow-moving SKUs based on orders on hand and projections of future demand and market conditions. For those units in inventory that are so identified, we estimate their market value or net sales value based on current realization trends. If the projected net sales value is less than cost, on an individual SKU basis, we provide an allowance to reflect the lower value of that inventory. This methodology recognizes projected inventory losses at the time such losses are evident rather than at the time goods are actually sold.
Intangible Assets. We have, at the present time, only one class of indefinite lived assets, trademarks. We review our intangible assets with indefinite useful lives for possible impairments on an annual basis in accordance with SFAS No. 142 and perform impairment testing as of February 1st of each year. We evaluate the “fair value” of our identifiable intangible assets for
purposes of recognition and measurement of impairment losses. Evaluating indefinite useful life assets for impairment involves certain judgments and estimates, including the interpretation of current economic indicators and market valuations, and our strategic plans with regard to our operations, historical and anticipated performance of our operations and other factors. If we incorrectly anticipate these trends or unexpected events occur, our results of operations could be materially affected.
Deferred Taxes. We account for income taxes under the liability method. Deferred tax assets and liabilities are recognized based on the differences between financial statement and tax basis of assets and liabilities using presently enacted tax rates. A valuation allowance is recorded to reduce deferred tax assets to that portion which is expected to more likely than not be realized. The ultimate realization of the deferred tax asset is dependent upon the generation of future taxable income during the periods prior to the expiration of the related net operating losses. If our estimates and assumptions about future taxable income are not appropriate, the value of our deferred tax asset may not be recoverable.
Retirement-Related Benefits. The pension obligations related to our defined benefit pension plans are developed from actuarial valuations. Inherent in these valuations are key assumptions, including the discount rate, expected return of plan assets, future compensation increases, and other factors, which are updated on an annual basis. Management is required to consider current market conditions, including changes in interest rates, in making these assumptions. Actual results that differ from the assumptions are accumulated and amortized over future periods, and therefore, generally affect the recognized pension expense or benefit and our pension obligation in future periods. The fair value of plan assets is based on the performance of the financial markets, particularly the equity markets. The equity markets can be, and recently have been, very volatile. Therefore, the market value of the plan assets can change dramatically in a relatively short period of time. Additionally, the measurement of the plan’s benefit obligation is highly sensitive to changes in interest rates. As a result, if the equity market declines and/or interest rates decrease, the plan’s estimated accumulated benefit obligation could exceed the fair value of the plan assets and therefore, we would be required to establish an additional minimum liability, which would result in a reduction in shareholder’s equity for the amount of the shortfall. For fiscal 2004, we did not record an additional minimum pension liability calculated under the provisions of SFAS No. 87.
Items Affecting Comparability of Fiscal Periods
Adoption of SFAS No. 142. As disclosed in Note 2 to the Consolidated Financial Statements, we adopted SFAS No. 142, “Goodwill and Other Intangible Assets,” as of February 1, 2002. Under the provisions of SFAS No. 142, certain intangibles are no longer amortized after the date of adoption. Intangible assets as of the date of adoption are evaluated to determine if they have finite or indefinite useful lives. Intangible assets determined to have finite lives are amortized over those lives and intangible assets that have indefinite useful lives are not amortized. SFAS No. 142 does not permit the restatement of previously issued financial statements, but does require the disclosure of prior years results adjusted to exclude amortization expense related to goodwill and intangible assets which are no longer being amortized.
Adoption of EITF Issue No. 01-09. As disclosed in Note 2 to the Consolidated Financial Statements, we adopted EITF Issue No. 01-09, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products),” as of February 1, 2002. The provisions of EITF No. 01-09, relate to the measurement, recognition and presentation of certain sales incentives offered to the company’s customers. These new accounting rules apply to certain sales incentives such as discounts, coupons, rebates and certain payments made to retailers for shelf space or reimbursement of advertising costs. These accounting rules generally require these incentives to be reflected as a reduction in revenues on the income statement rather than selling, general and administrative expense. Upon adoption of these rules at the beginning of fiscal 2003, all prior financial statement results have been restated to reflect the impact of the change. The adoption of this new accounting standard had no impact on our income before minority interest and income taxes, net income or financial position.
Acquistions. We completed the Salant acquisition on June 2003, which contributed $164.8 million to our revenue growth
Our Results of Operations for Fiscal 2004
The following table sets forth, for the periods indicated, selected items in our consolidated statements of income expressed as a percentage of total revenues:
The following is a discussion of the results of operations for the fiscal year ended January 31, 2004 (“fiscal 2004”) as compared with the fiscal year ended January 31, 2003 (“fiscal 2003”).
Our Fiscal 2004 Results as compared to our Fiscal 2003 Results
Total revenues. Total revenues consist of net sales and royalty income. Total revenues for fiscal 2004 were $505.9 million, which is an increase of $200.1, or 65.4%, from $305.8 for fiscal 2003. The increase was due mainly to an increase of approximately $164.8 million in net sales generated by the Salant business, which we acquired in the Salant acquisition in June 2003, an increase of $38.9 million in net sales generated by our swimwear business, and a $3.5 million increase in net sales in our other men’s sportswear business, which includes all of our businesses other than our Salant business and swimwear business. This increase was offset in part by a decrease in royalty income of $7.1 million described below.
Net sales. Net sales in fiscal 2004 were $484.2 million, an increase of $207.2 million, or 74.8%, from $277.0 million in fiscal 2003. The increase in net sales is primarily attributable to the increases in net sales generated by the Salant business, by our swimwear business, and other men’s sportswear business.
Royalty income. Royalty income in fiscal 2004 was $21.7 million, a decrease of $7.1 million, or 24.6%, from $28.8 million in fiscal 2003. The decrease in royalty income for fiscal 2004 was due to two reasons. First, the loss of $3.5 million in royalty income we previously received from Salant. We acquired Salant in June 2003. For the fiscal years 2001 through 2003 Salant was our largest licensee, and its results are now recognized in our net sales. Second, the decrease in royalty income was also attributable to the decreases in royalty income from certain of the licensees of the Perry Ellis and John Henry brands. Royalty income is derived from agreements entered into by us with our licensees, which average three years in length. The vast majority of our license agreements require licensees to pay us a royalty, based on net sales and require licensees to pay a guaranteed minimum royalty. Approximately 67% of our royalty income was attributable to guaranteed minimum royalties with the balance attributable to royalty income in excess of the guaranteed minimums for each of fiscal 2004 and 2003.
Cost of sales. Cost of sales in fiscal 2004 were $336.4, an increase of $131.4 million, or 64.1%, from $205.0 million in fiscal 2003. The increase is primarily due to the increase in net sales described above.
As a percentage of revenues, cost of sales decreased from 67.0% in fiscal 2003 to 66.5% in fiscal 2004. Two factors contributed to this change. First royalty income, which has virtually no cost of sales associated with it decreased, which drove the average cost of sales as a percentage of total revenues up. Second, primarily as a result of the impact high margin sales from the Salant acquisition our cost of sales as a percentage of net sales (sales excluding royalty income) in fiscal 2004 was 69.5% as compared to 74% in fiscal 2003.
Gross profit. Gross profit was $169.5 million in fiscal 2004, as compared to $100.8 million, an increase of 68.1%. The increase in gross profit in fiscal 2004 as compared to fiscal 2003 was primarily attributed to the impact of our acquisition of Salant for the 7.5-month period after June 19, 2003. Additionally, we experienced growth in gross profit dollars in our other wholesale business. These increases were offset by a $7.1 million decrease in royalty income. As a percentage of total revenue gross profit margins were
33.5% in fiscal 2004 as compared to 33.0% in fiscal 2003. The decrease in royalty income mentioned earlier adversely impacted the overall gross profit margin percent; however, that decrease was offset by an improvement in our gross margin percent in our wholesale business (that is cost of sales divided by net sales). The wholesale gross profit margin percent improved in fiscal 2004 to 30.5% as compared to 26% in fiscal 2003. This improvement came as a result of the impact of sales from the Salant acquisition and from the Company’s continued success in realigning its business to higher margin branded business as compared to private label sales. Branded sales accounted for 91% of net sales in fiscal 2004 as compared to 75% in fiscal 2003.
The gross profit percentage for branded label sales typically is 3% to 5% higher than our private label sales depending on customer and product mix. Our gross profit percentage may not be comparable to others in our industry, because our gross profit includes royalty income and others in the apparel industry may not have such income.
Selling, general and administrative expenses. Selling, general and administrative expenses in fiscal 2004 were $119.7 million, an increase of $55.8 million, or 87.4%, from $63.9 million in fiscal 2003. As a percentage of total revenues, selling, general and administrative expenses were 23.7% in fiscal 2004 as compared to 20.9% in fiscal 2003. The increase in selling, general and administrative costs is primarily attributable to the additional $37.2 million in expenses incurred by our Salant business and an additional $10.9 million from our swimwear business. The increase in these costs is also attributable to an increase in expenses we incurred supporting our organic growth, and an increase in advertising, marketing and design to support our existing brands, such as Perry Ellis, Cubavera, the Havanera Co., and Original Penguin.
Depreciation and amortization. Depreciation and amortization in fiscal 2004 was $5.0 million, an increase of $1.5 million, or 40.7%, from $3.5 million in fiscal 2003. The increase is due to the increase in property and equipment purchased in fiscal 2004 and a full year of depreciation from the purchase of the main administrative office, warehouse and distribution facility in Miami and the Seneca distribution center. As of January 31, 2004, we owned approximately $36.8 million of property, plant and equipment as compared to $31.0 million of property, plant and equipment as of January 31, 2003.
Costs on early extinguishment of debt. As a result of redeeming our $100 million in senior subordinated notes in fiscal 2004, which were scheduled to mature in April 2006, our costs on early extinguishment of debt in fiscal 2004 was $7.3 million. The costs on early extinguishment of debt include the call premium we paid and other associated redemption costs.
Interest expense. Interest expense in fiscal 2004 was $16.4 million, an increase of $.6 million, or 3.9%, from $15.8 million in fiscal 2003 The increase is mainly due to higher average debt balances, including the $150.0 million senior subordinated notes issued in September 2003, offset by the impact of certain derivative hedging transactions.
As of January 31, 2004, we had $257.1 million in long-term debt as compared to $194.4 million as of January 31, 2003. The increase in long-term debt is a direct result of the long-term debt we incurred in connection with the Salant acquisition. In addition, we had an additional $11.8 million outstanding under our senior credit facility as compared to the prior fiscal year, which resulted in higher interest expense. The interest expense on higher outstanding debt was offset in part by the impact of certain derivative hedging transactions described in “Item 3: Quantitative and Qualitative Disclosures about Market Risks.”
Income taxes. Income taxes in fiscal 2004 were $7.7 million, a $1.0 million increase as compared to $6.7 million for fiscal 2003. For fiscal 2004, our effective tax rate was 36.5% as compared to 38.2% in fiscal 2003.
Net income. Net income in fiscal 2004 was $13.1 million, an increase of $2.3 million, or 21.8%, as compared to net income of $10.8 million in fiscal 2003. The increase in net income was due to the changes described above.
Our Fiscal 2003 Results as compared to our Fiscal 2002 Results
Total revenues. Total revenues consist of net sales and royalty income. Total revenues increased $27.8 million, or 10.0%, to $305.8 million in fiscal 2003 from $278.0 million in the prior year. The increase was due predominately to an increase of $25.3 million in net sales related to the sales generated by the Jantzen swimwear business and an increase in royalty income of $2.1 million.
Net sales. Net sales increased $25.7 million, or 10.2%, to $277.0 million in fiscal 2003 from $251.3 million in the comparable period last year. The increase in net sales is primarily attributable to the net sales generated by the Jantzen swimwear business. Net sales of non-swimwear men’s apparel remained relatively unchanged for the fiscal year.
Royalty income. Royalty income was $28.8 million in fiscal 2003, a $2.1 million, or 7.9% increase over the prior year amount of $26.7 million. Royalty income is derived from agreements entered into by us with our licensees which average three years in length. The vast majority of our license agreements require licensees to pay us a royalty, based on net sales and require licensees to pay a guaranteed minimum royalty. Approximately 67% and 76% of our royalty income was attributable to guaranteed minimums
royalties with the balance attributable to royalty income in excess of the guaranteed minimums for fiscal 2003 and 2002, respectively. The increase in royalty income was mainly due to increases in royalty income in excess of guaranteed minimums for certain licensees of the Perry Ellis brand, including Salant, having strong results despite a slowdown in overall retail sales and the addition of royalty income generated from the Jantzen brands. The decrease in guaranteed minimums as a percentage of total royalty income was mainly due to increases in royalty income in excess of guaranteed minimums for certain licenses of the Perry Ellis brand, and royalty income from the Jantzen brands.
Cost of sales. Cost of sales for fiscal 2003 of $205.0 million was $13.4 million, or 7.0% higher than the prior year amount of $191.6 million due mainly to the increase in net sales as described above. As a percent of revenues, cost of sales decreased from 68.9% in fiscal 2002 to 67.0% in fiscal 2003, due primarily to a change in our sales mix between private label and branded label sales. Cost of sales includes only costs relating to sale of product and excludes costs relating to royalty income which are immaterial. Gross profit was $100.8 million in fiscal 2003, or 33.0% of revenues, as compared to $86.4 million, or 31.1% of revenues, in the prior year. We increased focus on branded label sales, which accounted for 75.0% of our net sales in fiscal 2003 compared to 70.1% in fiscal 2002, contributed to greater gross margins because branded label sales typically generate higher gross margins. Our gross margin percentage for branded label sales typically are 3% to 5% higher than our gross margin percentage for private label sales depending on customer and product mix. Our gross profit percentage may not be comparable to others in the industry, because we include royalty income in gross profit and others in the apparel industry may not.
Selling, general and administrative expenses. Selling, general and administrative expenses were $63.9 million in fiscal 2003 as compared to $55.4 million in the prior year, an increase of $8.5 million, or 15.2%. As a percent of total revenues, selling, general and administrative expenses increased from 19.9% in fiscal 2002 to 20.9% in fiscal 2003. The increase was due primarily to the additional $10.4 million in expenses incurred by the Jantzen operations, offset by a decrease of $2.0 million in expenses incurred by our European Operations while the selling, general and administrative expenses relating to our other businesses remained relatively unchanged.
Depreciation and amortization. Depreciation and amortization expense in fiscal 2003 was $3.6 million or 1.1% of revenues as compared to $6.7 million or 2.4% of revenues in fiscal 2002. The decrease is due primarily to the adoption of SFAS No. 142, “Goodwill and Other Intangible Assets,” as of February 1, 2002. Under the provisions of SFAS No. 142, goodwill is no longer amortized after the date of adoption. Intangible assets as of the date of adoption are evaluated to determine if they have finite or indefinite useful lives. Intangible assets determined to have finite lives are amortized over those lives and intangible assets that have indefinite useful lives are not amortized.
Interest expense. Interest expense in fiscal 2003 was $15.8 million as compared to $13.6 million in the prior year. The increase is primarily attributable to our senior secured notes, which we sold to finance the Jantzen acquisition, to pay down borrowings under the senior credit facility and to use as additional working capital offset by lower interest rates and the positive impact of certain derivative hedging transactions described herein.
Income taxes. Income taxes in fiscal 2003 were $6.7 million, a $2.7 million increase as compared to $4.0 million in fiscal 2002. The increase was due primarily to an increase in pretax income. The effective tax rates for fiscal years 2003 and 2002 were 38.2% and 37.9%, respectively.
Net income. Fiscal 2003 net income increased $4.2 million, or 63.4%, to $10.8 million from the prior year, primarily as a result of the increase in net sales of $25.7 million, royalty income of $2.1 million and the improvement in gross margin of $14.4 million.
Our Liquidity and Capital Resources
We rely primarily upon cash flow from operations and borrowings under our senior credit facility and letter of credit facilities to finance our operations and expansion. We believe that as a result of the growth in our business, our working capital requirements will increase. As of January 31, 2004, our total working capital was $192.9 million as compared to $119.9 million as of January 31, 2003. We believe that our cash flows from operations and borrowings under our senior credit facility and letter of credit facilities are sufficient to meet our working capital needs for the foreseeable future.
Net cash used in operating activities was $11.3 million in fiscal 2004 as compared to cash used in operating activities of $16.8 million in fiscal 2003 and $22.4 million provided by operations in fiscal 2002. The decrease of $5.5 million in the level of cash used in operating activities in fiscal 2004 as compared to fiscal 2003 is primarily attributable to an decrease in the use of cash related to accounts receivable, inventory, accounts payable and accrued expenses, and higher net income. Net cash used in operating activities was $16.8 million in fiscal 2003, as compared to $22.4 million provided by operations in fiscal 2002. The difference was due to an increase in accounts receivable of $29.4 million, and an increase in inventory of $3.7 million in fiscal 2003 offset in part by higher earnings. Accounts receivable increased due to our acquisition of Salant, organic growth and a greater concentration of shipments occuring in the last month of the fiscal year. Inventory increased by $1.9 million over the prior year due to the timing of receipts of goods at January 31, 2004 and levels of replenishment of inventory.
Net cash used in investing activities was $44.9 million in fiscal 2004, which primarily reflects the cash portion of the acquisition of Salant for $34.5 million, net of cash acquired, purchases of property and equipment of $8.7 million and the purchase of the Redsand trademark for $1.8 million.
In fiscal 2003, net cash used in investing activities was $47.3 million, principally due to the Jantzen acquisition and purchases of property and equipment. In addition, in fiscal 2003, we used $22.1 million for the purchase of property, plant and equipment, which included the $14.5 million contingent rental payment that was required by the termination of the synthetic lease and $2.5 million for the purchase of the Seneca distribution center.
Net cash provided by financing activities in fiscal 2004 was $52.4 million, which primarily reflects the net proceeds from our senior credit facility of $11.8 million, net proceeds from our offering of our 8 7/8% senior subordinated notes of $146.8 million, proceeds from the exercise of employee stock options of $2.1 million, offset by payments to redeem our 12¼% senior subordinated notes of $107.3 million, which included a redemption premium, and purchases of treasury stock of $1.0 million.
Net cash provided by financing activities in fiscal 2003 was $67.5 million, which reflects the net proceeds from our offering of senior secured notes of $55.6 million, the proceeds from the exercise of employee stock options of $1.3 million, proceeds from the real estate mortgage of $11.6 million on our main administrative office, warehouse and distribution facility, offset by net repayments under our senior credit facility of $1.2 million, and scheduled payments on our 12¼% senior subordinated notes of $2.2 million.
The Salant Acquisition
On June 19, 2003, we acquired Salant Corporation, which was our largest licensee. The aggregate merger consideration paid by us was approximately $90.9 million, comprised of approximately $51.9 million in cash, approximately $35.6 million worth of our newly issued common stock and approximately $3.4 million in merger costs. The cash portion of the merger consideration was funded from Salant’s available cash reserves and through borrowings under our senior credit facility.
Salant licensed the Perry Ellis brand from us for men’s sportswear, dress shirts, dress bottoms and accessories and derived approximately $164.3 million, or 65% of its fiscal 2002 revenues, from the sale of Perry Ellis products. Salant was our largest licensee of Perry Ellis branded apparel. The remaining $87.7 million of Salant’s fiscal 2002 revenue were made up of Salant’s owned brands such as Axis® and Tricots St. Raphael®, sales under license agreements for use of the JNCO® and Ocean Pacific® brands, as well as several private label programs.
Senior Credit Facility
Our amended senior credit facility with Congress Financial Corporation (Florida), as agent for a syndicate of lenders, provides us with a revolving credit facility of up to an aggregate amount of $110.0 million. The senior credit facility expires in September 2005 and the indebtedness thereunder ranks ahead of the 8 7/8% senior subordinated notes. On February 23, 2004, we increased our availability under the senior credit facility to $130.0 million until June 7, 2004.
The following is a description of the terms of the senior credit facility, as amended and does not purport to be complete and is subject to, and qualified in its entirety by reference to, all the provisions of the senior credit facility.
Certain Covenants. The senior credit facility contains certain covenants, which, among other things, requires us to maintain a minimum EBITDA if availability falls below a certain minimum. It may restrict our ability and the ability of our subsidiaries to, among other things, incur additional indebtedness in certain circumstances, redeem or repurchase capital stock, make certain investments, or sell assets. We are prohibited from paying cash dividends under these covenants. We believe we are currently in compliance with all of our covenants under the senior credit facility. We could be materially harmed if we violate any covenants as the lenders under the senior credit facility could declare all amounts outstanding thereunder, together with accrued interest, to be immediately due and payable. If we are unable to repay those amounts, the lenders could proceed against our assets. In addition, a violation could also constitute a cross-default under the indentures and mortgage, resulting in all of our debt obligations becoming immediately due and payable, which we may not be able to satisfy.
Borrowing Base. Borrowings under the senior credit facility are limited under its terms to a borrowing base calculation, which generally restricts the outstanding balances to the lesser of either (1) the sum of (a) 85.0% of eligible receivables plus (b) 85.0% of our eligible factored accounts receivables up to $20.0 million plus (c) the lesser of (i) the inventory loan limit, or (ii) the lesser of
(A) 65.0% of eligible finished goods inventory, or (B) 85.0% of the net recovery percentage (as defined in the senior credit facility) of eligible inventory, or (2) the loan limit; and in each case minus (x) 35.0% of the amount of outstanding letters of credit for eligible inventory, (y) the full amount of all other outstanding letters of credit issued pursuant to the senior credit facility which are not fully secured by cash collateral, and (z) licensing reserves for which we are the licensee of certain branded products.
Interest. Interest on the principal balance under the senior credit facility accrues, at our option, at either (a) our bank prime lending rate with adjustments depending upon our quarterly average excess availability plus excess cash or leverage ratio or (b) 2.00% above the rate quoted by our bank as the average Eurodollar Rate (“Eurodollar”) for 1-, 2-, 3- and 6-month Eurodollar deposits with one-quarter percentage point adjustments depending upon our quarterly average excess availability plus excess cash and leverage ratio at the time of borrowing.
Security. As security for the indebtedness under the senior credit facility, we granted the lenders a first priority security interest in substantially all of our existing and future assets other than our trademark portfolio existing as of March 2002, including, without limitation, accounts receivable, inventory deposit accounts, general intangibles, equipment and capital stock or membership interests, as the case may be, of certain subsidiaries. Lenders under the senior credit facility have a second priority security interest in our trademark portfolio as of March 2002 and a first priority lien on the rest of our trademarks.
Letter of Credit Facilities
As of January 31, 2004, we maintained four U.S. dollar letter of credit facilities totaling $90.0 million and one letter of credit facility totaling $2.8 million utilized by our Canadian joint venture. Each letter of credit is secured primarily by the consignment of merchandise in transit under that letter of credit and certain subordinated liens on our assets, including but not limited to the capital stock or membership interests, as the case may be, of certain of our subsidiaries. As of January 31, 2004, there was $30.8 million available under existing letter of credit facilities.
Senior Secured Notes
In March of 2002 we issued $57.0 million 9½% senior secured notes due March 15, 2009. The proceeds of the offering were used to finance the Jantzen acquisition, to reduce the amount of outstanding debt under the previous senior credit facility and as additional working capital. The proceeds to us were $55.6 million yielding an effective interest rate of 9.74% after deduction of discounts. We entered into certain derivative hedging transaction described in “Item 7A:
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The market risk inherent in the Company’s financial statements represents the potential changes in the fair value, earnings or cash flows arising from changes in interest rates. The Company manages this exposure through regular operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments. The Company’s policy allows the use of derivative financial instruments for identifiable market risk exposure, including interest rate. The Company does not enter into derivative financial contracts for trading or other speculative purposes except for as discussed below.
In August 2001, the Company entered into an interest rate swap, option and interest rate cap agreements (the “$40 million Swap Agreement”) for an aggregate notional amount of $40.0 million in order to minimize its debt servicing costs associated with its $100.0 million of 12¼% senior subordinated notes due April 1, 2006.
The fair value of the $40 million Swap Agreement recorded on the Company’s Consolidated Balance Sheet was $1.9 million as of January 31, 2003. In conjunction with the $40 million Swap Agreement, the Company also entered into an interest rate cap and basis swap that did not qualify for hedge accounting treatment under the SFAS No. 133, resulting in $0.2 million increase of recorded interest expense on the Consolidated Statement of Income for the fiscal year ended January 31, 2004 and $0.35 million increase of recorded interest expense for the year ended January 31, 2003.
In August 2003, the Company terminated the $40 million Swap Agreement and received approximately $1.9 million, which is included as a component of interest income.
In conjunction with the March 2002 offering of $57.0 million of 9½% senior secured notes due March 15, 2009, the Company entered into interest rate swap and option agreements (the “$57 million Swap Agreement”) for an aggregate notional amount of $57.0 million in order to minimize the debt servicing costs associated with the 9½% senior secured notes. The $57 million Swap Agreement is scheduled to terminate on March 15, 2009. Under the $57 million Swap Agreement, the Company is entitled to receive semi-annual interest payments on September 15 and March 15 at a fixed rate of 9½% and is obligated to make semi-annual interest payments on September 15 and March 15 at a floating rate based on the three-month LIBOR rate plus 369 basis points for the period from March 22, 2002 through March 15, 2009. The $57 million Swap Agreement has optional call provisions with trigger dates of March 15, 2005, March 15, 2006 and March 15, 2007, which contain premium requirements in the event the call is exercised.
The $57 million Swap Agreement is a fair value hedge as it has been designated against the 9½% senior secured notes carrying a fixed rate of interest and converts such notes to variable rate debt. The interest rate swap contracts are reflected at fair value in the Company’s consolidated balance sheet with a corresponding offset to the designated item. The fair value of the $57 million Swap Agreement recorded on the Company’s Consolidated Balance Sheet was $5.0 million and $4.4 million as of January 31, 2003 and 2004, respectively.
In December 2002, the Company entered into an interest rate floor agreement (the “$57 million Floor Agreement”) for an aggregate notional amount of $57.0 million associated with the 9½% senior secured notes. The $57 million Floor Agreement is scheduled to terminate on March 15, 2005. Under the $57 million Floor Agreement, the Company must pay the difference between the three-month LIBOR rate and 1.50% for all rate resets in which the LIBOR is below 1.50%. When the LIBOR is equal to or greater than 1.50%, the Company makes no payments under the Floor.
The $57 million Floor Agreement did not qualify for hedge accounting treatment under SFAS No. 133, resulting in $0.2 million and $0.1 million increase of recorded interest expense on the Consolidated Statement of Income for the fiscal years ended January 31, 2003 and 2004, respectively. The fair value of the $57 million Floor Agreement recorded on the Company’s Consolidated Balance Sheet was ($0.2) and ($0.1) million as of January 31, 2003 and 2004, respectively.
In April 2003, the Company entered into an interest rate cap agreement (the “$57 million Cap Agreement”) for an aggregate notional amount of $57.0 million associated with the senior secured notes. The $57 million Cap Agreement is scheduled to terminate on March 15, 2009. The $57 million Cap Agreement caps the interest rate on the senior secured notes at 10%.
The $57 million Cap Agreement did not qualify for hedge accounting treatment, resulting in $0.3 million increase of recorded interest expense on the consolidated statement of income for the fiscal year ended January 31, 2004. The fair value of the $57 million Cap Agreement recorded on the Company’s consolidated balance sheet was ($0.3) million as of January 31, 2004.
In conjunction with the Company’s September 2003 offering of $150.0 million of 8 7/8% senior subordinated notes due September 15, 2013, the Company entered into interest rate swap agreements (the “$150 million Swap Agreement”) for an aggregate notional amount of $150.0 million in order to minimize the debt servicing costs associated with the new senior subordinated notes. The $150 million Swap Agreement is scheduled to terminate on September 15, 2013. Under the $150 million Swap Agreement, the Company is entitled to receive semi-annual interest payments on September 15 and March 15 at a fixed rate of 8 7/8% and is obligated to make semi-annual interest payments on September 15 and March 15 at a floating rate based on the six-month LIBOR rate plus 394 basis points for the period from September 22, 2003 through September 15, 2013. The $150 million Swap Agreement has optional call provisions with trigger dates of September 15, 2008, September 15, 2009, September 15, 2010 and September 15, 2011, which contain premium requirements in the event the call is exercised.
The $150 million Swap Agreement is a fair value hedge as it has been designated against the 8 7/8% senior subordinated notes carrying a fixed rate of interest and converts such notes to variable rate debt. The interest rate swap contracts are reflected at fair value in our consolidated balance sheet with a corresponding offset to the designated item. The fair value of the $150 million Swap Agreement recorded on the consolidated balance sheet was $0.5 million as of January 31, 2004.
The table below provides information about the Company’s derivative financial instruments and other financial instruments that are sensitive to changes in interest rates, including interest rate swaps and debt obligations
Expected Maturity Date
Fiscal Years Ended January 31,
(In Millions)
(A) $150 million 2003 swap variable rate is based on the 6-month LIBOR rate plus 394 basis points through 9/15/13 Average variable rates for all periods are based on the rates in effect on January 31, 2004.
(B) $57 million 2002 swap variable rate is based on 3-month LIBOR rate plus 369 basis points through 3/15/09. The interest rate floor limits the pay rate on the swap to 1.50% and expires at the same time as the underlying swap. The interest rate cap limits the pay rate on the swap to 10.00% and expires at the same time as the underlying swap. Average variable rates for all periods are based on the rates in effect on January 31, 2004.
(C) Senior credit facility has a variable rate of interest of either 1) the published prime lending rate or 2) Eurodollar rate with adjustments of both rates based on meeting certain financial conditions.
(D) Fair market value as of January 31, 2004 does not include the fair value of the interest rate cap or floor.
Item 8.
Item 8. Financial Statements And Supplementary Data
See pages through appearing at the end of this report.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
As of the end of the period covered by this Annual Report, an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures was carried out by us under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures have been designed and are being operated in a manner that provides reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. A system of controls, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.
No changes in our internal controls over financial reporting occured during the quarter ended January 31, 2004 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Information regarding our directors and executive officers required by this item is included in our Proxy Statement relating to our 2004 Annual Meeting under the captions “Election of Directors” and “Management” and is incorporated herein by reference.
Information regarding our audit committee financial expert required by this item is included in our Proxy Statement relating to our 2004 Annual Meeting under the caption “Meetings and Committees of the Board of Directors” and is incorporated herein by reference.
Information regarding compliance with Section 16 of the Securities Exchange Act of 1934 is included in our 2004 Proxy Statement relating to our 2004 Annual Meeting under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” and is incorporated herein by reference.
We have adopted a Code of Ethics that applies to all of our directors, officers, and employees. The Code of Ethics is posted on our website at www.pery.com. Amendments to, and waivers granted under, our Code of Ethics, if any, will be posted to our website as well.
Item 11.
Item 11. Executive Compensation
Information required by this item is included in our 2004 Proxy Statement under the captions “Executive Compensation”, “Summary Compensation Table”, “Option Grants in Last Fiscal year”, “Stock Option Held at End of Fiscal 2003”, “Compensation of Directors”, “Employment Agreements”, and “Compensation Committee Interlocks and Insider Participation” and is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information required by this item is included in our 2004 Proxy Statement under the caption “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information for Fiscal 2004” and is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
Information required by this item is included in our 2004 Proxy Statement under the captions “Certain Relationships and Related Transactions” and is incorporated herein by reference.
Item 14.
Item 14. Principal Accounting Fees and Services
Information required by this item is included in our 2004 Proxy Statement under the caption “Principal Accountant Fees and Services” and is incorporated herein by reference.
Item 15.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Documents filed as part of this report
(1) Consolidated Financial Statements.
The following Consolidated Financial Statements of Perry Ellis International, Inc. and subsidiaries are included in Part II, Item 8:
Page
Independent Auditors’ Report
Consolidated Balance Sheets as of January 31, 2004 and 2003
Consolidated Statements of Income for each of the three years in the period ended January 31, 2004
Consolidated Statements of Changes in Stockholders’ Equity for each of the three years in the period ended January 31,
Consolidated Statements of Cash Flows for each of the three years in the period ended January 31, 2004
Notes to Consolidated Financial Statements
(2) Consolidated Financial Statement Schedule
All schedules required by applicable Securities and Exchange Commission regulations are either not required under the related instructions, are inapplicable or the required information has been included in the Consolidated Financial Statements and therefore such schedules have been omitted.
(3) Exhibits
Exhibit No
Description of Exhibit
3.1
Registrant’s Amended and Restated Articles of Incorporation (5)
3.2
Registrant’s Amended and Restated Bylaws (1)
4.1
Form of Common Stock Certificate (1)
4.2
Indenture dated April 6, 1999 between the Registrant and State Street Bank and Trust Company (“State Street”), as amended (6)
4.5
Specimen Forms of 12 1/4% Senior Subordinated Notes Due April 1, 2006 (6)
4.6
Indenture dated March 22, 2002 between the Registrant and State Street, as amended (9)
4.8
Pledge and Security Agreement dated March 22, 2002 by and among the Registrant, Jantzen Apparel Corp. and State Street (9)
4.9
Specimen Forms of 91/2% Senior Secured Notes Due March 15, 2009 (9)
4.10
Indenture dated September 22, 2003 between the Registrant and U.S. Bank Trust National Association (“U.S. Bank”)(16)
4.11
Specimen Forms of 8 7/8% Senior Subordinated Notes Due September 15, 2013 (16)
10.3
Form of Indemnification Agreement between the Registrant and each of the Registrant’s Directors and Officers (1)
10.9
1993 Stock Option Plan (1)(2)
10.10
Directors Stock Option Plan(1)(2)
10.17
Amendment to Business Lease between George Feldenkreis and the Registrant relating to office facilities (3)
10.20
Profit Sharing Plan (2)(3)
10.21
Amended and Restated Employment Agreement between the Registrant and George Feldenkreis (2)(3)
10.22
Amended and Restated Employment Agreement between the Registrant and Oscar Feldenkreis (2)(3)
10.24
Lease Agreement [Land] dated as of August 28, 1997 between SUP Joint Venture, as Lessor and the Registrant, as Lessee (4)
10.25
Lease Agreement [Building] dated as of August 28, 1997 between SUP Joint Venture, as Lessor and the Registrant, as Lessee (4)
10.34
Employment agreement between Allan Zwerner and the Registrant (2)(6)
10.36
Incentive Stock Option Plan (2)(7)
10.37
Asset Purchase Agreement dated as of March 15, 2002 by and among the Registrant, Jantzen, Inc. and VF Canada, Inc. (8)
10.38
Fifth Amendment dated March 14, 2002 to Amended and Restated Loan and Security Agreement dated March 26, 1999 (9)
10.39
Fourth Amendment to Master Agreement dated March 14, 2002, by and among the Registrant, SUP Joint Venture, SunTrust Bank and Israeli Discount Bank (9)
10.40
Loan and Security Agreement dated as of October 1, 2002 (the “Senior Credit Facility”) (11)
10.41
Agreement and Plan of Merger, dated February 3, 2003, by and among the Registrant, Connor Acquisition Corp. and Salant (12)
10.42
Letter Agreement, dated February 3, 2003, among Michael J. Setola, Salant and the Registrant (9)
10.43
Letter Agreement, dated February 3, 2003, among Awadhesh K. Sinha, Salant and the Registrant (9)
10.44
2002 Stock Option Plan (10)
10.45
Employment agreement between Alberto de Cardenas and the Registrant (2)(13)
10.57
Amendment No. 1 to the Senior Credit Facility (15)
10.58
Amendment No. 2 to the Senior Credit Facility (16)
10.59
Amendment No. 3 to the Senior Credit Facility (17)
10.60
Amendment No. 4 to the Senior Credit Facility (17)
10.61
Employment agreement between Timothy B. Page and the Registrant (2)(17)
21.1
Subsidiaries of the Registrant (17)
23.1
Consent of Deloitte & Touche LLP, independent public accountants regarding financial statements of the Registrant (17)
31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended (17)
31.2
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended (17)
32.1
Certification of Chief Executive Officer pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(17)
32.2
Certification of Chief Financial Officer pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(17)
(1) Previously filed as an Exhibit of the same number to the Registrant’s Registration Statement on Form S-1 (File No. 33-60750) and incorporated herein by reference.
(2) Management Contract or Compensation Plan.
(3) Previously filed as an Exhibit of the same number to the Registrant’s Registration Statement on Form S-1 (File No. 33-96304) and incorporated herein by reference.
(4) Previously filed as an Exhibit of the same number to the Registrant’s Annual Report on Form 10-K for the year ended January 31, 1998 and incorporated herein by reference.
(5) Previously filed as an Exhibit to the Registrant’s Proxy Statement for its 1998 Annual Meeting and incorporated herein by reference.
(6) Previously filed as an Exhibit to the Registrant’s Registration Statement on Form S-4 (File No. 33-78427) and incorporated herein by reference.
(7) Previously filed as an Exhibit to the Registrant’s Proxy Statement for its 2000 Annual Meeting and incorporated herein by reference.
(8) Previously filed as an Exhibit to the Registrant’s Current Report on Form 8-K dated March 22, 2002, as amended, and incorporated herein by reference.
(9) Previously filed as an Exhibit of the same number to the Registrant’s Annual Report on Form 10-K for the year ended January 31, 2002 and incorporated herein by reference.
(10) Previously filed as an Annex to the Registrant’s Proxy Statement for its 2002 Annual Meeting and incorporated herein by reference.
(11) Previously filed as an Exhibit of the same number to the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended October 31, 2002, as amended and incorporated herein by reference.
(12) Previously filed as an Exhibit to the Registrant’s Current Report on Form 8-K dated February 5, 2003 as amended, and incorporated herein by reference.
(13) Previously filed as an Exhibit of the same number to the Registrant’s Annual Report on Form 10-K for the year ended January 31, 2003 and incorporated herein by reference.
(14) Previously filed as an Exhibit to Salant Corporation’s Annual Report on Form 10-K for the fiscal year ended December 29, 2001 and incorporated herein by reference.
(15) Previously filed as an Exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended July 31, 2003 and incorporated herein by reference.
(16) Previously filed as filed as an Exhibit to the Registrant’s Registration Statement on Form S-4 (File No.33-110616) and incorporated herein by reference.
(17) Filed herewith.
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K, with respect to Items 7 and 12, dated November 19, 2003, during the three months ended January 31, 2004.
(c) Item 601 Exhibits
The exhibits required by Item 601 of Regulation S-K are set forth in (a)(3) above.
(d) Financial Statement Schedules
The financial statement schedules required by Regulation S-K are set forth in (a)(2) above.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PERRY ELLIS INTERNATIONAL, INC.
Dated: April 15, 2004
By:
/S/ GEORGE FELDENKREIS
George Feldenkreis
Chairman of the Board and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.
PERRY ELLIS INTERNATIONAL, INC. AND SUBSIDIARIES
INDEPENDENT AUDITORS’ REPORT
To the Board of Directors and Stockholders of Perry Ellis International, Inc.:
We have audited the consolidated balance sheets of Perry Ellis International, Inc. and subsidiaries (the “Company”) as of January 31, 2004 and 2003, and the related consolidated statements of operations, changes in stockholders’ equity and cash flows for each of the three years in the period ended January 31, 2004. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of January 31, 2004 and 2003, and the results of its operations and its cash flows for each of the three years in the period ended January 31, 2004 in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 2 to the consolidated financial statements, in the year ended January 31, 2003, the Company changed its method of accounting for intangible assets to conform to Statement of Financial Accounting Standard No. 142 “Goodwill and Other Intangible Assets.”
/s/ DELOITTE & TOUCHE LLP
Certified Public Accountants
Miami, Florida
April 16, 2004
PERRY ELLIS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF JANUARY 31,
See notes to consolidated financial statements
PERRY ELLIS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED JANUARY 31,
See notes to consolidated financial statements
PERRY ELLIS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR EACH OF THE THREE YEARS ENDED JANUARY 31
See notes to consolidated financial statements.
PERRY ELLIS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JANUARY 31,
See notes to consolidated financial statements.
PERRY ELLIS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JANUARY 31, 2004
1. General
The Company is a leading licensor, designer and marketer of a broad line of high quality men’s sportswear, including sport and dress shirts, golf sportswear, sweaters and casual dress pants and shorts, which sells to all levels of retail distribution. The Company licenses its trademark portfolio domestically and internationally for apparel and other products that it does not sell including dress sportswear, outerwear, fragrances and accessories. The Company has built a broad portfolio of brands through selective acquisitions and the establishment of its own brands over its 35-year operating history. The Company’s distribution channels include regional, national and international upscale department stores, mid-tier department stores, chain stores, mass merchants, specialty stores and corporate wear distributors as well as various retail sales stores throughout the United States, Puerto Rico and Canada.
2. Summary of Significant Accounting Policies
The following is a summary of the Company’s significant accounting policies:
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of Perry Ellis International, Inc. and its wholly-owned and controlled subsidiaries. All intercompany transactions and balances have been eliminated in consolidation. The ownership interest in consolidated subsidiaries of non-controlling shareholders is reflected as minority interest.
USE OF ESTIMATES - 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 that affect the amounts in the consolidated financial statements and the accompanying notes. Actual results could differ from those estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS - The carrying amounts of accounts receivable, accrued payable, accrued interest payable and accounts payable approximates fair value due to their short-term nature. The carrying amount of the senior credit facility approximates fair value due to the relatively frequent resets of its floating interest rate. As of January 31, 2004, the fair value of the 8 7/8 % senior subordinated notes and the 9½% senior secured notes was approximately $159.8 million and $61.6 million, respectively, based on quoted market prices. See footnote 12 and 21 for disclosure related to fair value of other financial instruments.
INVENTORIES - Inventories are stated at the lower of cost (moving average cost) or market. Cost principally consists of the purchase price, labor, customs, duties, freight, insurance and commissions to buying agents.
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Amortization of leasehold improvements is computed using the straight-line method over the shorter of the lease term or estimated useful lives of the improvements. The useful lives are as follows:
INTANGIBLE ASSETS - Intangible assets primarily represent costs incurred in connection with the acquisition of brand names and license rights. In fiscal 2002 intangibles were amortized over their estimated useful lives. Upon adoption of Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” those assets were identified as intangible assets with an indefinite useful life and accordingly are no longer being amortized. The Company assesses the carrying value of intangible assets on an annual basis using estimated fair values.
DEFERRED DEBT ISSUE COSTS - Costs incurred in connection with financing have been capitalized and are being amortized on a straight-line basis, which approximates the interest method, over the term of the related debt instrument. Unamortized debt issue costs are included in other assets in the consolidated balance sheet.
LONG-LIVED ASSETS - Management reviews long-lived assets, primarily fixed assets, for possible impairment whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. If there is an indication of impairment, management prepares an estimate of future cash flows (undiscounted and without interest charges) expected to result from the use of the asset and its eventual disposition. If these cash flows are less than the carrying amount of the asset, an impairment loss is recognized to reduce the asset to its estimated fair value. Preparation of estimated expected future cash flows is inherently subjective and is based on management’s best estimate of assumptions concerning future conditions. There has not been any material impairment to long-lived assets in 2002, 2003 or 2004.
RETIREMENT-RELATED BENEFITS - The Company accounts for its defined benefit pension plan and its nonpension post retirement benefit plans using actuarial models required by SFAS No. 87, “Employers’ Accounting for Pensions”, and SFAS 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions”, respectively. These models use an attribution approach that generally spreads the individual events over the service lives of the employees in the plan. The principle underlying the required attribution approach is that employees render service over their service lives on a relatively smooth basis and therefore, the income statement effects of pensions or nonpension postretirement benefit plans are earned in, and should follow, the same pattern.
The principal components of the net periodic pension calculations are the expected long-term rate of return on plan assets, discount rate and the rate of compensation increases. The Company uses long-term historical actual return information, the mix of investments that comprise plan assets, and future estimates of long-term investment returns by reference to external sources to develop its expected return on plan assets. The discount rate assumptions used for pension and nonpension postretirement benefit plan accounting reflects the rates available on high-quality fixed income debt instruments at the Company’s fiscal year end. The rate of compensation increase is another significant assumption used in the actuarial model for pension accounting and is determined by the Company based upon its long-term plans for such increases.
ADVERTISING AND RELATED COSTS - The Company’s accounting policy relating to advertising and related costs is to expense these costs in the period incurred. Advertising and related costs were $7.7 million, $6.5 million and $15.6 million for the years ended January 31, 2002, 2003 and 2004, respectively, and are included in selling, general and administrative expenses.
COST OF SALES - Cost of sales includes costs to acquire and produce inventory for sale. These costs include costs of purchased products, labor, inbound freight, custom duties, buying commissions, cargo insurance, customs inspection, licensed product royalty expenses, provisions for inventory shrinkage and obsolescence and product sourcing expenses.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES - Selling expenses include costs incurred in the selling of merchandise. General and administrative expenses include costs incurred in the administration or general operations of the business. Selling, general and administrative expenses include employee and related costs, advertising, professional fees, warehouse costs, and other related selling costs.
REVENUE RECOGNITION - Sales are recognized and title transfers upon shipment. Trade allowances and a provision for estimated returns and other allowances are recorded at the time sales are made. Royalty income is recognized when earned on the basis of the terms specified in the underlying contractual agreements. A liability for unearned revenue royalty income is recognized when licensees pay contractual obligations before being earned. The Company believes that its revenue recognition policies conform to Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements as amended. The Company operates predominantly in North America, with over 90% of its sales in the domestic market. Three customers accounted for approximately 12%, 11% and 11% of net sales for fiscal year 2002, one customer accounted for approximately 11% for fiscal 2003 and one customer accounted for approximately 10% of net sales for fiscal 2004. The Company does not believe that these concentrations of sales and credit risk represent a material risk of loss with respect to its financial position as of January 31, 2004.
ADVERTISING REIMBURSEMENTS - The majority of Perry Ellis’ license agreements require licensees to pay Perry Ellis an advertising reimbursement, based on a percentage of the licensee net sales. The Company records earned advertising reimbursements received from its licensees as a reduction of the related advertising costs in selling, general and administrative expenses. For the fiscal years 2002, 2003 and 2004, the Company has reduced selling, general and administrative expenses by $5.6 million, $7.4 million and $4.9 million of licensee reimbursements, respectively. Unearned advertising reimbursements result when a licensee pays required reimbursements prior to the Company incurring the advertising expense. A current liability is recorded for these unearned advertising reimbursements.
FOREIGN CURRENCY TRANSLATION - For the Company’s international operations, local currencies are generally considered their functional currencies. The Company translates assets and liabilities to their U.S. dollar equivalents at rates in effect at the balance sheet date and revenue and expenses are translated at average monthly exchange rates. Translation adjustments resulting from this process are recorded in stockholders’ equity as a component of accumulated other comprehensive income (loss).
INCOME TAXES - Deferred income taxes result primarily from timing differences in the recognition of expenses for tax and financial reporting purposes and are accounted for in accordance with SFAS No. 109, Accounting for Income Taxes, which requires the liability method of computing deferred income taxes. Under the liability method, deferred taxes are adjusted for tax rate changes as they occur.
NET INCOME PER SHARE - Basic net income per share is computed by dividing net income by the weighted average shares of outstanding common stock. The calculation of diluted net income per share is similar to basic earnings per share except that the denominator includes potentially dilutive common stock. The potentially dilutive common stock included in the Company’s computation of diluted net income per share includes the effects of stock options and warrants as determined using the treasury stock method.
The following table sets forth the computation of basic and diluted income per share.
(1) Represents weighted average stock options to purchase shares of common stock that were not included in computing diluted earnings per share because their effects were antidilutive for the respective periods.
ACCOUNTING FOR STOCK-BASED COMPENSATION - The Company has chosen to account for stock-based compensation to employees and non-employee members of the Board using the intrinsic value method prescribed by Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees, and related interpretations. As required by SFAS No. 123, Accounting for Stock-Based Compensation, the Company has presented certain pro forma and other disclosures related to stock-based compensation plans.
SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure” requires disclosure in both interim and annual financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results as follows:
RECLASSIFICATIONS - Certain amounts in the prior years financial statements may have been reclassified to conform to the current year presentation.
RECENT ACCOUNTING PRONOUNCEMENTS - In April 2001, the Financial Accounting Standards Board (“FASB”) Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 01-09,
“Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products).” This issue addresses the recognition, measurement and income statement classification of consideration from a vendor to a customer in connection with the customer’s purchase or promotion of the vendor’s products. This consensus only impacted Perry Ellis’ revenue and expense classifications and has no effect on reported income.
In July 2001, the FASB issued SFAS No. 141, “Business Combinations.” SFAS No. 141 requires the use of the purchase method of accounting for all business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method. SFAS No. 141 also addresses the recognition and measurement of goodwill and other intangible assets acquired in a business combination. The Company applied the provisions of this pronouncement to the Salant acquisition.(See Note 10)
In July 2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets,” which changes the accounting treatment as it applies to goodwill and other identifiable intangible assets with indefinite useful lives from an amortization method to an impairment-only approach. Under SFAS No. 142, proper accounting treatment requires annual assessment for any impairment of the carrying value of the assets based upon an estimation of the fair value of the identifiable intangible asset with an indefinite useful life, or in the case of goodwill of the reporting unit to which the goodwill pertains. Under SFAS No. 142, goodwill and identifiable intangible assets with indefinite useful lives are no longer subject to amortization. Impairment losses, if any, arising from the initial application of SFAS No. 142 are to be reported as a cumulative effect of a change in accounting principle. The effective date of this statement is for fiscal years beginning after December 15, 2001. The Company adopted SFAS No. 142 for its fiscal year beginning February 1, 2002.
In accordance with SFAS No. 142, the Company obtained a valuation and estimated useful life report of all its intangible assets at adoption and annually as of February 1st. Results of this analysis indicate no material impairment in the carrying value of its intangible assets and also indicate that the intangible assets have indefinite useful lives. The following table indicates earnings per share adjusted for the effect of SFAS No. 142.
On October 3, 2001, the FASB issued SFAS No. 144. “Accounting for the Impairment or Disposal of Long-Lived Assets,” which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. While SFAS No. 144 supersedes SFAS No. 121 “Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of,” it retains many of the fundamental provisions of SFAS No. 121. SFAS No. 144 also supersedes the accounting and reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,” for the disposal of a segment of a business. The effective date of SFAS No.144 is for fiscal years beginning after December 15, 2001. The adoption of SFAS No. 144 on February 1, 2002, did not have a material effect on the financial position or the results of operations of the Company.
In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB No. 13, and Technical Corrections,” which all but eliminates the presentation in income statements of debt extinguishments as extraordinary items. SFAS No. 145 will be effective for fiscal years beginning after May 15, 2002. Perry Ellis adopted SFAS No. 145 as of February 1, 2003. While the adoption of SFAS No.145 did not have a material impact on the financial position or results of operations of the Company, it did have an impact on the presentation of the cost on early extinguishment of debt in fiscal 2004.
In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to exit or disposal plan. SFAS No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. SFAS No. 146 did not have a material impact on the financial position or results of operations of the Company.
In November 2002, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others- an Interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34” (“FIN 45”). FIN 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor’s fiscal year-end. However, the disclosure requirements in FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. FIN 45 did not have a material effect on Perry Ellis’ financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure (SFAS 148). SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS 123, Accounting for Stock-Based Compensation, to require disclosure in both interim and annual financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company adopted the disclosure provision of SFAS No. 148 effective for fiscal year ended January 31, 2003.
In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities - an Interpretation of ARB No. 51” (“FIN 46”). In December 2003, the FASB issued a revision to FIN 46. FIN 46 addresses consolidation by business enterprises of variable interest entities (formerly special purpose entities or SPEs). In general, a variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. The objective of FIN 46 is not to restrict the use of variable interest entities but to improve financial reporting by companies involved with variable interest entities. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. The Company is required to adopt the provision of FIN No. 46 immediately for variable interests in variable interest entities created after January 31, 2003, and in the quarter ending April 30, 2004 for variable interests in variable interest entities created before February 1, 2003. However, certain of the disclosure requirements apply to financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The Company does not have any variable interest entities as defined in FIN 46 and accordingly, the Company has determined that it will not be required to consolidate any variable interest entity upon the full adoption of FIN 46.
In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. The new guidance amends SFAS No. 133 for decisions (a) made as part of the Derivative Implementation Group process that effectively required amendments to SFAS No. 133, (b) in connection with other Board projects dealing with financial instruments, and (c) regarding implementation issues raised in relation to the application of the definition of a derivative, particularly regarding the meaning of “an underlying” and the characteristics of a derivative that contain financing components. The amendments set forth in SFAS No. 149 improve financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. SFAS No. 149 is generally effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The guidance is to be applied prospectively. SFAS No. 149 is not expected to have a material impact on the financial position or results of operations of the Company.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 improves the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. The new statement requires that those instruments be classified as liabilities in statements of financial position. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and otherwise shall be effective at the beginning of the first interim period beginning after June 15, 2003. In November 2003, the FASB indefinitely deferred the effective date for the classification and measurement provision of certain mandatorily redeemable non-controlling interests. For financial instruments created before May 2003 and still existing at the beginning of the interim period of adoption, transition will be accomplished by reporting the cumulative effect of a change in accounting principle. The adoption of the effective provisions of SFAS No. 150 did not have a material impact on the financial position or results of operations of the Company.
In December 2003, the FASB issued SFAS No. 132 (Revised 2003), “Employers’ Disclosures about Pension and Other Postretirement Benefits,” which enhanced the disclosure about pension plans and other postretirement benefit plans, but did not change the measurement or recognition principles for those plans. The statement requires additional disclosure about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. The Company adopted the disclosure provisions of SFAS 132 for the year ended January 31, 2004.
3. Shares Repurchase
On July 11, 2000, the Board of Directors of the Company approved a share repurchase program in which up to 500,000 shares of common stock may be purchased from time to time during the following 12 months. On July 11, 2001, the Board of Directors extended the current share repurchase program for an additional year, and on September 25, 2001 increased the number of shares authorized for repurchase to 750,000 shares. The shares may be purchased in the open market or in privately negotiated transactions.
On September 17, 2003, the Board of Directors authorized the Company to repurchase shares based on the value of the funds received from the exercise of employee stock options. For fiscal year ended January 31, 2004, the Company repurchased 35,687 shares at an average price of $26.15 per share. For the fiscal year ended January 31, 2003, the Company did not repurchase any additional shares. On March 26, 2002, the Company retired 51,400 shares held in the treasury. For the fiscal year ended January 31, 2002, the Company had repurchased 296,100 shares at an average price of $7.35 per share. On March 2, 2001 and October 29, 2001, the Company retired 160,000 and 244,600 shares held in the treasury, respectively.
4. Accounts Receivable
Accounts receivable consist of the following as of January 31:
The activity for the allowance for doubtful account is as follows:
The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of our trade customers to make required payments. We provide an allowance for specific customer accounts where collection is doubtful and also provide a general allowance for other accounts based on historical collection and write-off experience. Judgment is critical because some retail customers are currently experiencing financial difficulties. If their financial condition were to worsen, additional allowances might be required.
5. Inventories
Inventories consist of the following as of January 31:
The Company’s inventories are valued at the lower of cost (moving average cost) or market. The Company evaluates all of its inventory style-size-color stock keeping units (SKUs) to determine excess or slow moving SKUs based on orders on hand and projections of future demand and market conditions. For those units in inventory that are so identified, we estimate their market value based on current sales trends. If the projected net sales value is less than cost, on an individual SKU basis, we provide an allowance to reflect the lower value of that inventory. This methodology recognizes projected inventory losses at the time such losses are evident rather than at the time goods are actually sold.
6. Property and Equipment
Property and equipment consists of the following as of January 31:
Depreciation expense relating to property and equipment amounted to approximately $1,849,000, $2,280,000, and $3,847,000 for the fiscal years ended January 31, 2002, 2003 and 2004, respectively.
7. Intangible Assets
Intangible assets consisted of the following as of January 31:
Amortization expense relating to the intangible assets amounted to approximately $4,342,000 for the fiscal year ended January 31, 2002. As of January 31, 2003, all intangible assets are indefinite useful life assets and are not subject to amortization according to SFAS No. 142.
8. Accrued Expenses
Accrued expenses consists of the following as of January 31:
Other liabilities for fiscal 2004 are principally related to liabilities acquired with the Salant transaction.
9. Other Current Liabilities
Other current liabilities consists of the following as of January 31:
10. Salant Acquisition
On June 19, 2003, the Company acquired Salant Corporation. The aggregate merger consideration paid by the Company was approximately $90.9 million, comprised of approximately $51.9 million in cash ($34.5 million net of cash acquired), approximately $35.6 million worth of newly issued Perry Ellis common stock and approximately $3.4 million in merger costs.
Salant licensed the Perry Ellis brand from the Company for men’s sportswear, dress shirts, dress bottoms and accessories, and derived approximately $164.3 million, or 65%, of its 2002 revenues from the sale of Perry Ellis products. Salant was the Company’s largest licensee of Perry Ellis branded apparel. The remaining $87.7 million of Salant’s 2002 revenue was made up of sales of product under Salant’s owned brands such as Axis® and Tricots St. Raphael®, sales under license agreements for use of the JNCO® and Ocean Pacific® brands, as well as several private label programs.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. Purchase accounting adjustments include fair value adjustments and the allocation of the excess of fair value over purchase price as required under SFAS 141.
11. Pro Forma Financial Information (Unaudited)
The pro forma financial information presented below, gives effect to the Salant acquisition as if it occurred as of the beginning of each of the fiscal years ended January 2002, 2003 and 2004. The results of the Salant acquisition are reflected in our income statement for the period from June 19, 2003, the closing date of acquisition, through January 31, 2004.
Net income (loss) includes $0.92 million, net of tax, of non-recurring direct merger related costs recorded by Salant during the twelve months ended January 31, 2004
12. Derivatives Financial Instruments
FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS 138 requires that all derivative financial instruments such as interest rate swap contracts and foreign exchange contracts, be recognized in the financial statements and measured at fair value regardless of the purpose or intent for holding them. Changes in the fair value of derivative financial instruments are either recognized in income or shareholders’ equity (as a component of comprehensive income), depending on whether the derivative is being used to hedge changes in fair value or cash flows.
The Company has an interest rate risk management policy with the objective of managing its interest costs. To meet this objective the Company employs hedging and derivatives strategies to limit the effects of changes in interest rates on its operating income and cash flows, and to lower its overall fixed rate interest cost on its senior subordinated notes and senior secured notes.
The Company does not acquire derivative instruments for any purpose other than to manage interest rate risk. That is, the Company does not speculate using derivative instruments.
The Company believes its interest rate risk management policy is generally effective. Nonetheless, the Company’s profitability may be adversely affected during particular periods as a result of changing interest rates. In addition, hedging transactions using derivative instruments involve risks such as counter-party credit risk. The counter-parties to the Company’s arrangements are lenders of the hedged debt instruments or are major financial institutions.
In August 2001, the Company entered into an interest rate swap, option and interest rate cap agreements (the “$40 million Swap Agreement”) for an aggregate notional amount of $40.0 million in order to minimize its debt servicing costs associated with its $100.0 million of 12 1/4% senior subordinated notes due April 1, 2006.
The fair value of the $40 million Swap Agreement recorded on the Company’s Consolidated Balance Sheet was $1.9 million as of January 31, 2003. In conjunction with the $40 million Swap Agreement, the Company also entered into an interest rate cap and basis swap that did not qualify for hedge accounting treatment under the SFAS No. 133, resulting in $0.2 million increase of recorded interest expense on the Consolidated Statement of Income for the fiscal year ended January 31, 2004 and $0.35 million increase of recorded interest expense for the year ended January 31, 2003.
In August 2003, the Company terminated the $40 million Swap Agreement for approximately $1.9 million which is included as a component of interest income.
In conjunction with the March 2002 offering of $57.0 million of 9 1/2% senior secured notes due March 15, 2009, the Company entered into interest rate swap and option agreements (the “$57 million Swap Agreement”) for an aggregate notional amount of $57.0 million in order to minimize the debt servicing costs associated with the 9 1/2% senior secured notes. The $57 million Swap Agreement is scheduled to terminate on March 15, 2009. Under the $57 million Swap Agreement, the Company is entitled to receive semi-annual interest payments on September 15 and March 15 at a fixed rate of 9 1/2% and are obligated to make semi-annual interest payments on September 15 and March 15 at a floating rate based on the three-month LIBOR rate plus 369 basis points for the period from March 22, 2002 through March 15, 2009. The $57 million Swap Agreement has optional call provisions with trigger dates of March 15, 2005, March 15, 2006 and March 15, 2007, which contain premium requirements in the event the call is exercised. The $57 million Swap Agreement is a fair value hedge as it has been designated against the 9 1/2% senior secured notes carrying a fixed rate of interest and converts such notes to variable rate debt. The interest rate swap contracts are reflected at fair value in the company’s consolidated balance sheet with a corresponding offset to the designated item. The fair value of the $57 million Swap Agreement recorded on the Company’s Consolidated Balance Sheet was $5.0 million and $4.4 million as of January 31, 2003 and 2004, respectively.
In December 2002, the Company entered into an interest rate floor agreement (the “$57 million Floor Agreement”) for an aggregate notional amount of $57.0 million associated with the 9 1/2% senior secured notes. The $57 million Floor Agreement is scheduled to terminate on March 15, 2005. Under the
$57 million Floor Agreement, the Company must pay the difference between the three-month LIBOR rate and 1.50% for all rate resets in which the LIBOR is below 1.50%. When the LIBOR is equal to or greater than 1.50%, the Company makes no payments under the Floor.
The $57 million Floor Agreement did not qualify for hedge accounting treatment under SFAS No. 133, resulting in $0.2 million and $0.1 million increase of recorded interest expense on the Consolidated Statement of Income for the fiscal years ended January 31, 2003 and 2004, respectively. The fair value of the $57 million Floor Agreement recorded on the Company’s Consolidated Balance Sheet was ($0.2) and ($0.1) million as of January 31, 2003 and 2004, respectively.
In April 2003, the Company entered into an interest rate cap agreement (the “$57 million Cap Agreement”) for an aggregate notional amount of $57.0 million associated with the senior secured notes. The $57 million Cap Agreement is scheduled to terminate on March 15, 2009. The $57 million Cap Agreement caps the interest rate on the senior secured notes at 10%.
The $57 million Cap Agreement did not qualify for hedge accounting treatment, resulting in $0.3 million increase of recorded interest expense on the consolidated statement of income for the fiscal year ended January 31, 2004. The fair value of the $57 million Cap Agreement recorded on the Company’s consolidated balance sheet was ($0.3) million as of January 31, 2004.
In conjunction with the Company’s September 2003 offering of $150.0 million of 8 7/8% senior subordinated notes due September 15, 2013, the Company entered into interest rate swap agreements (the “$150 million Swap Agreement”) for an aggregate notional amount of $150.0 million in order to minimize the debt servicing costs associated with the new senior subordinated notes. The $150 million Swap Agreement is scheduled to terminate on September 15, 2013. Under the $150 million Swap Agreement, the Company is entitled to receive semi-annual interest payments on September 15 and March 15 at a fixed rate of 8 7/8% and is obligated to make semi-annual interest payments on September 15 and March 15 at a floating rate based on the six-month LIBOR rate plus 394 basis points for the period from September 22, 2003 through September 15, 2013. The $150 million Swap Agreement has optional call provisions with trigger dates of September 15, 2008, September 15, 2009, September 15, 2010 and September 15, 2011, which contain premium requirements in the event the call is exercised.
The $150 million Swap Agreement is a fair value hedge as it has been designated against the 8 7/8% senior subordinated notes carrying a fixed rate of interest and converts such notes to variable rate debt. The interest rate swap contracts are reflected at fair value in our consolidated balance sheet with a corresponding offset to the designated item. The fair value of the $150 million Swap Agreement recorded on the consolidated balance sheet was $0.5 million as of January 31, 2004.
The Company does not currently have a significant exposure to foreign exchange risk and accordingly, has not entered into any transactions to hedge against those risks. See Note 2 for policy on foreign currency translation.
13. Borrowings under Letter of Credit Facilities
As of January 31, 2004, the Company maintained three US dollar letter of credit facilities of $60.0 million, $30.0 million sublimit for letters of credit under the Company’s senior credit facility, and one letter of credit facility totaling $2.8 million utilized by the Company’s consolidated Canadian joint venture. Each letter of credit is secured primarily by the consignment of merchandise in transit under that letter of credit and certain subordinated liens on the Company’s assets. As of January 31, 2004, there was $30.8 million available under existing letter of credit facilities.
Amounts outstanding under letter of credit facilities consist of the following as of January 31:
14. Long Term Debt-Senior Credit Facility
In June 2003, the Company amended its senior credit facility with Congress Financial Corporation (Florida), as agent for a syndicate of lenders, to provide a revolving credit facility of up to an aggregate amount of $110.0 million. In February 2004, the availability under the senior credit facility was increased to $130.0 million until June 2004. The senior credit facility expires in September 2005 and the indebtedness thereunder ranks ahead of the 8 7/8% senior subordinated notes.
The following is a description of the terms of the senior credit facility, as amended and does not purport to be complete and is subject to, and qualified in its entirety by reference to, all the provisions of the senior credit facility.
Certain Covenants. The senior credit facility contains certain covenants, which, among other things, requires us to maintain a minimum EBITDA if availability falls below a certain minimum. It may restrict our ability and the ability of our subsidiaries to, among other things, incur additional indebtedness in certain circumstances, redeem or repurchase capital stock, make certain investments, or sell assets. We are prohibited from paying cash dividends under these covenants. We believe we are currently in compliance with all of our covenants under the senior credit facility. We could be materially harmed if we violate any covenants as the lenders under the senior credit facility could declare all amounts outstanding there under, together with accrued interest, to be immediately due and payable. If we are unable to repay those amounts, the lenders could proceed against our assets. In addition, a violation could also constitute a cross-default under the indentures and mortgage, resulting in all of our debt obligations becoming immediately due and payable, which we may not be able to satisfy.
Borrowing Base. Borrowings under the senior credit facility are limited under its terms to a borrowing base calculation, which generally restricts the outstanding balances to the lesser of either (1) the sum of (a) 85.0% of eligible receivables plus (b) 85.0% of our eligible factored accounts receivables up to $20.0 million plus (c) the lesser of (i) the inventory loan limit, or (ii) the lesser of (A) 65.0% of eligible finished goods inventory, or (B) 85.0% of the net recovery percentage (as defined in the senior credit facility) of eligible inventory, or (2) the loan limit; and in each case minus (x) 35.0% of the amount of outstanding letters of credit for eligible inventory, (y) the full amount of all other outstanding letters of credit issued pursuant to the senior credit facility which are not fully secured by cash collateral, and (z) licensing reserves for which we are the licensee of certain branded products.
Interest. Interest on the principal balance under the senior credit facility accrues, at our option, at either (a) our bank prime lending rate with adjustments depending upon our quarterly average excess availability plus excess cash or leverage ratio or (b) 2.00% above the rate quoted by our bank as the average Eurodollar Rate (“Eurodollar”) for 1-, 2-, 3- and 6-month Eurodollar deposits with one-quarter percentage point adjustments depending upon our quarterly average excess availability plus excess cash and leverage ratio at the time of borrowing.
Security. As security for the indebtedness under the senior credit facility, we granted the lenders a first priority security interest in substantially all of our existing and future assets other than our trademark portfolio existing as of March 2002, including, without limitation, accounts receivable, inventory deposit
accounts, general intangibles, equipment and capital stock or membership interests, as the case may be, of certain subsidiaries. Lenders under the senior credit facility have a second priority security interest in our trademark portfolio as of March 2002 and a first priority lien on the rest of our trademarks.
15. 9 1/2% Senior Secured Notes
In March 2002, the Company issued $57.0 million 9 1/2% senior secured notes due March 15, 2009. The proceeds of the offering were used to finance the Jantzen acquisition, to reduce the amount of outstanding debt under the previous senior credit facility and as additional working capital. The proceeds to Perry Ellis were $55.6 million yielding an effective interest rate of 9.74% after deduction of discounts. The Company entered into an interest rate swap and option agreement (the “$57 million Swap Agreement”) in order to minimize debt service costs on the secured senior notes. The fair values of the $57 million Swap Agreement recorded on the Company’s Consolidated Balance Sheet were $5.0 million and $4.4 million as of January 31, 2003 and 2004, respectively.
The senior secured notes are secured by a first priority security interest granted in the Company’s existing portfolio of trademarks and licenses as of the closing date of the Jantzen acquisition, including the trademarks, licenses and all income, royalties and other payments acquired in the Jantzen acquisition. The senior secured notes are senior secured obligations of the Company and rank pari passu in right of payment with all of its existing and future senior indebtedness. The senior secured notes are effectively senior to all unsecured indebtedness of the Company to the extent of the value of the assets securing the senior secured notes. The senior secured notes are guaranteed by certain subsidiaries of the Company.
Certain Covenants. The indenture governing the senior secured notes contains certain covenants which restrict the Company’s ability and the ability of its subsidiaries to, among other things, incur additional indebtedness in certain circumstances, redeem or repurchase capital stock, make certain investments, or sell assets. The Company is prohibited from paying cash dividends under these covenants. The Company believes it is currently in compliance with all of the covenants in this indenture. The Company could be materially harmed if we violate any covenants because the indenture’s trustee could declare the outstanding notes, together with accrued interest, to be immediately due and payable, which the Company may not be able to satisfy. In addition, a violation could also constitute a cross-default under the senior credit facility, letter of credit facility, mortgage and the indenture relating to the Company’s senior subordinated notes resulting in all of the Company’s debt obligations becoming immediately due and payable, which the Company may not be able to satisfy.
16. 12 1/4% Senior Subordinated Notes
The Company issued $100.0 million senior subordinated notes on April 6, 1999, the proceeds of which were used to acquire Perry Ellis, John Henry and Manhattan brands and to pay down the outstanding balance of the senior credit facility. The notes mature on April 1, 2006, and bear interest at the rate of 12 1/4% payable on April 1 and October 1 in each year. The proceeds to the Company were $98.9 million yielding an effective interest rate of 12.39% after deduction of discounts. The Company entered into an interest rate swap, option, and interest rate cap agreements (the “$40 million Swap Agreement”) for an aggregate notional of $40 million in order to minimize debt service costs on the senior subordinated notes.
In November 2002, the Company repurchased $2.2 million of the 12 1/4% senior subordinated notes. On October 15, 2003, the Company redeemed the $100 million of 12 1/4% senior subordinated notes that were scheduled to mature on April 1, 2006 for approximately $107.3 million. The redemption resulted in costs on the early extinguishment of debt of $7.3 million, principally as a result of a redemption premium.
17. 8 7/8% Senior Subordinated Notes
On September 22, 2003, the Company issued $150 million 8 7/8% senior subordinated notes, the proceeds of which were used to redeem the 12 1/4% senior subordinated notes and to pay down the outstanding balance of the senior credit facility at that time. The notes mature on September 15, 2013 and bear interest at the rate of 8 7/8%, payable semiannually on March 15 and September 15 of each year. The proceeds to the Company were $146.8 million yielding an effective interest rate of 9.1%. The Company entered into interest rate swap agreements (the “$150 million Swap Agreement”) in order to minimize debt service costs on the senior subordinated notes. The fair value of the $150 million Swap Agreement recorded on the Company’s Consolidated Balance Sheet was $0.5 million as of January 31, 2004.
Certain Covenants. The indenture governing the senior subordinated notes contains certain covenants which restrict the Company’s ability and the ability of its subsidiaries to, among other things, incur additional indebtedness in certain circumstances, redeem or repurchase capital stock, make certain investments, or sell assets. The Company believes it is currently in compliance with all of the covenants in this indenture. The Company is prohibited from paying cash dividends under these covenants. The Company could be materially harmed if it violates any covenants because the indenture’s trustee could declare the outstanding notes, together with accrued interest, to be immediately due and payable, which the Company may not be able to satisfy. In addition, a violation could also constitute a cross-default under the senior credit facility, the letter of credit facilities, mortgage and the indenture relating to the Company’s senior secured notes resulting in all of the Company’s debt obligations becoming immediately due and payable, which the Company may not be able to satisfy.
18. Real Estate Financing
The Company occupied its main administrative office, warehouse and distribution facility under a synthetic operating lease for a 240,000 square foot facility in Miami, Florida. The lease, as amended, expired on June 30, 2002, and required a final payment at termination of $14.5 million.
On June 30, 2002, the Company made the required payment under the synthetic lease and partially refinanced the acquisition of the facility with an $11.6 million mortgage. The mortgage has customary covenants and as of January 31, 2004, the Company believes it is in compliance with these covenants.
On September 13, 2002, the Company purchased a distribution center in Seneca, South Carolina for $2.5 million using our revolver. The Company exercised the option to purchase the facility as part of the March 2002 Jantzen acquisition.
19. Income Taxes
The income tax provision consists of the following for each of the years ended January 31:
The following table reconciles the statutory federal income tax rate to the Company’s effective income tax rate for each of the years ended January 31:
Deferred income taxes are provided for the temporary differences between financial reporting basis and the tax basis of the Company’s assets and liabilities under SFAS No. 109. The tax effects of temporary differences as of January 31 are as follows:
In connection with the Salant acquisition, the Company acquired a net deferred tax asset of approximately $53.5 million, net of a $20.3 million valuation allowance. Additionally, the acquisition of Salant caused an “ownership change” for federal income tax purposes. As a result, the use of any net operating losses existing at the date of the ownership change to offset future taxable income of the company is limited by Section 382 of the Internal Revenue Code of 1986, as amended (“Section 382”). As of June 19, 2003 Salant had available federal net operating losses of approximately $123 million, of which approximately $56 million will expire unutilized as a result of the annual usage limitations under Section 382. Therefore, management has determined that a valuation allowance for deferred income tax assets is necessary as the assets are not expected to be fully realized. As of January 31, 2004, approximately $18 million of the $123 million net operating losses expired. The following table reflects the expiration of the remaining net operating losses:
Deferred taxes have not been recognized on unremitted earnings of the Company’s foreign subsidiaries based on the “indefinite reversal” criteria of APB Opinion 23.
20. Retirement Plan
The Company has a 401(k) Profit Sharing Plan (the “Plan”) in which eligible employees may participate. Employees are eligible to participate in the Plan upon the attainment of age 21, and completion of three months of service. Participants may elect to contribute up to 60% of their compensation, subject to maximum statutory limits. The Company under the provisions of the plan, may
make discretionary matching contributions equal to a percentage of each participant’s annual compensation. The percentage will be determined annually by the Board. The Company may also elect to make additional profit sharing contributions on behalf of participants in amounts determined by the Board at the end of the Plan year. The Company’s contributions to the Plan were approximately $199,000, $328,000, and $446,000 for the fiscal years ended January 31, 2002, 2003 and 2004, respectively.
21. Benefit Plans
Perry Ellis sponsors two qualified pension plans as a result of the Salant acquisition that occurred in June 2003.
The following tables provide a reconciliation of the changes in the plans’ benefit obligations and fair value of assets over the period beginning June 1, 2003, the acquisition measurement date, and ending December 31, 2003, and a statement of the funded status as of December 31, 2003. The plans were frozen and merged as of December 31, 2003.
The following table provides the amounts recognized in the consolidated balance sheet as of January 31, 2004:
Information for pension plans with an accumulated benefit obligation in excess of plan assets as of December 31, 2003:
The following table provides the components of net benefit cost for the plans for the fiscal year ended January 31:
There was no amount included within other comprehensive income arising from a change in the additional minimum pension liability as of December 31, 2003.
The prior service costs are amortized on a straight-line basis over the average remaining service period of active participants. Gains and losses in excess of 10% of the greater of the benefit obligation and the market-related value of assets are amortized over the average remaining service period of active participants.
The assumptions used in the measurement of the Company’s benefit obligation are shown in the following table:
The assumptions used in the measurement of the net periodic benefit cost for period ended December 31 are as follows:
The pension plan weighted-average asset allocations at December 31, 2003 and 2002, by asset category are as follows:
The expected long-term return on assets is a blended rate based on asset mix. In general, the methodology used to determine the rate is reviewed annually, taking into consideration the respective asset allocation, historical returns on the types of assets held, and the current economic environment. The expected long-term return on assets is a blended rate based on the target asset allocation of the plan, applied principally to historical market returns and trends. For estimation purposes, the Company assumes a long-term asset mix generally consistent with the investment policy of the funded plan. Changes in the asset mix or investment policy could impact the amount of recorded pension income or expense, the funded status of the plan, and the need for future cash contributions.
The Company’s investment strategy for defined benefit plans is to utilize broadly diversified passive vehicles where appropriate, with an investment mix and risk profile consistent with plan liabilities. Periodic studies are undertaken to determine the asset mix that will meet pension obligations at a reasonable cost to the Company and are consistent with the fiduciary requirements of local pension regulations. The weighted average target allocation for our plan is 65% equity and 35% fixed income. The overall allocation may include a 10% maximum allocation to alternative strategies.
The Company expects to contribute approximately $ 0.2 million to its pension plan during fiscal 2005. Benefit payments, which include the effects of expected future service, as appropriate, are expected to be approximately $3.0 million for each of the fiscal years 2005 through 2009.
22. Related Party Transactions
The Company leases certain office and warehouse space owned by the Chairman of the Board of Directors and Chief Executive Officer under certain lease arrangements, most of which are month-to-month. Rent expense, including taxes, for these leases amounted to approximately $537,000, $525,000, and $388,000 for the years ended January 31, 2002, 2003 and 2004, respectively.
The Company entered into licensing agreements (the “License Agreements”) with Isaco International, Inc. (“Isaco”), pursuant to which Isaco was granted the exclusive license to use the Natural Issue, Perry Ellis, John Henry and Career Club brand names in the United States and Puerto Rico to market a line of men’s underwear, hosiery and loungewear. The principal shareholder of Isaco is the father-in-law of the Company’s President and Chief Operating Officer. Royalty income earned from the License Agreements amounted to approximately $1,230,000, $2,131,000, and $2,204,000 for the years ended January 31, 2002, 2003 and 2004, respectively.
In December 2003, the Company entered into an aircraft charter agreement with a third party. There is no minimum usage requirement, and the charter agreement can be terminated with 60 days notice. The third party charters the aircraft from an entity controlled by the Chief Executive Officer and the Chief Operating Officer. The Company paid the third party approximately $37,000 in fiscal 2004 under this agreement.
The Company is a party to licensing agreements with Tropi-Tracks LLC, pursuant to which Tropi-Tracks was granted an exclusive license to use the Jantzen brand name in the United States, Canada, and Mexico to market a line of men’s, women’s and junior’s casual and leisure footwear. One of the Company’s directors and the son-in-law of the Chairman of the Board and Chief Executive Officer, is a member of Tropi-Tracks. The Tropi-Tracks license agreement provides for a minimum annual guaranteed royalty of $215,000. Royalty income earned from the Tropi-Tracks license agreement amounted to approximately $81,000 and $6,000 for fiscal 2004 and 2003, respectively.
23. Stock Options and Warrants
Stock Options - In 1993, the Company adopted a Stock Option Plan (the “1993 Plan”), which was amended in 1998 and 1999 to increase the number of shares reserved for issuance thereunder. The 1993 Plan authorized the Company to grant stock options (“Option” or “Options”) to purchase up to an aggregate of 1,500,000 shares of the Company’s Common Stock. In 2002, prior to the termination of the 1993 Plan in 2003, the Company adopted the 2002 Stock Option Plan (the “2002 Plan”). The 2002 Plan was amended in 2003 to increase the number of shares reserved for issuance thereunder. As amended, the 2002 Plan allows the Company to grant Options exercisable up to an aggregate of 1,500,000 shares of the Company’s Common Stock. Both Stock Option Plans were designed to serve as an incentive for attracting and retaining qualified and competent employees, directors, consultants, and independent contractors of the Company.
The 2002 Plan provides for the granting of Incentive Stock Options and Nonstatutory Stock Options. An Incentive Stock Option is an option to purchase Common Stock, that meets the requirements
as set forth under Section 422 of the Internal Revenue Code of 1986, as amended (“Section 422”). A Nonstatutory Stock Option is an option to purchase Common Stock, that meets the requirements of the 2002 Plan, but does not meet the definition of an “incentive stock option” under Section 422.
The 2002 Plan is administered by the compensation committee of the Board (“Committee”), which is comprised of two or more nonemployee directors. The Committee determines the participants, the allotment of shares, and the term of the Options. The Committee also determines the exercise price of the Options, provided however that the per share exercise price of Options granted under the 2002 Plan may not be less than the fair market value of the common stock on the date of grant, and in the case of an incentive stock option granted to a 10% shareholder, the per share exercise price will not be less than 110% of such fair market value.
A summary of the stock option activity for options issued under the 1993 Plan and the 2002 Plan is as follows for the years ended January 31:
As described in Note 2, we account for stock-based compensation using the provisions of APB No. 25 and related interpretations. No compensation expense has been recognized in the years ended January 31, 2002, 2003 and 2004 as the exercise prices for the stock options granted were equal to their fair market value at the time of grant. Had compensation cost for options granted been determined in accordance with the fair value provisions of SFAS No. 123, our net income and net income per share would have been reduced to the pro forma amounts presented below for the years ended January 31:
The fair value of these options was estimated at the date of grant using the Black-Scholes Option Pricing Model with the following weighted-average assumptions for 2002, 2003 and 2004:
Using the Black-Scholes Option Pricing Model, the estimated weighted-average fair value per option granted in 2002, 2003 and 2004 was $2.75, $10.84, and $15.96, respectively.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because our stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of our stock options.
The pro forma amounts may not be representative of the future effects on reported net income and net income per share that will result from the future granting of stock options, since the pro forma compensation expense is allocated over the periods in which options become exercisable and new option awards are granted each year.
24. Segment Information
In accordance with SFAS No. 131, “Disclosure About Segments of an Enterprise and Related Information”, the Company’s principal segments are grouped between the generation of revenues from products and royalties. The Licensing segment derives its revenues from royalties associated from the use of its brand names, principally Perry Ellis, John Henry, Manhattan and Munsingwear. The Product segment derives its revenues from the design, import and distribution of apparel to department stores and other retail outlets, principally throughout the United States. Trademark assets and costs have been allocated among the divisions where the brands are shared.
25. Commitments and Contingencies
The Company has licensing agreements, as licensee, for the use of certain branded and designer labels. The license agreements expire on varying dates through December 31, 2003. Total royalty payments under these license agreements amounted to $1,635,239, $3,394,820, and $9,032,613 for the years ended January 31, 2002, 2003 and 2004, respectively, and were classified as cost of sales.
The Company leases three warehouse facilities in Miami totaling approximately 103,000 square feet from its chairman and chief executive officer, to handle the overflow of bulk shipments and the specialty and PING operations. All leases are on a month-to-month basis.
The Company leases several locations in New York City totaling approximately 97,000 square feet, with leases expiring from August 2005 to December 2012. These locations are used for office, design and showroom space.
The Company operates 38 retail outlet stores comprising approximately 94,500 square feet of selling space, all of which are leased.
The Company has a lease agreement for office space used by Perry Ellis’ Jantzen swimwear business in Portland, Oregon. This facility totals approximately 45,200 square feet with a lease that expires in December 2004.
In order to monitor production of Perry Ellis products in the Far East, Perry Ellis maintains offices in South Korea, Vietnam and China, and also leases offices jointly with GFX Corporation, a company controlled by the Chairman of the Board and Chief Executive Officer, in Beijing, China and Taipei, Taiwan.
Minimum aggregate annual commitments for all of the Company’s non-cancelable operating lease commitments are as follows:
Rent expense for these operating leases, including the related party rent payments discussed in Note 22, amounted to $2,526,293, $3,032,324, and $7,166,103 for fiscal January 31, 2002, 2003 and 2004, respectively.
The Company is subject to claims and suits in the ordinary course of business. The Company does not believe that the resolution of any pending matters will have a material adverse effect on its financial position, results of operations or cash flows.
27. Summarized Quarterly Financial Data (Unaudited)
28. CONSOLIDATING CONDENSED FINANCIAL STATEMENTS
The Company has senior secured debt outstanding, some of which is guaranteed by certain of the Company’s subsidiaries (the “Guarantors”). The following are consolidating condensed financial statements, which present, in separate columns: Perry Ellis International, Inc., the Guarantors on a combined, or where appropriate, consolidated basis, and the Non-Guarantors on a consolidated basis. Additional columns present eliminating adjustments and consolidated totals as of January 31, 2004 and January 31, 2003, and for the three years ended January 31, 2004. The combined Guarantors are wholly owned subsidiaries of Perry Ellis International, Inc., and have fully and unconditionally guaranteed the senior secured notes on a joint and several basis. The Company has not presented separate financial statements and other disclosures concerning the combined Guarantors because management has determined that such information is not material to investors.
PERRY ELLIS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF JANUARY 31, 2004
PERRY ELLIS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF JANUARY 31, 2003
PERRY ELLIS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE TWELVE MONTHS ENDED JANUARY 31, 2004
PERRY ELLIS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE TWELVE MONTHS ENDED JANUARY 31, 2003
PERRY ELLIS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE TWELVE MONTHS ENDED JANUARY 31, 2002
PERRY ELLIS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE TWELVE MONTHS ENDED JANUARY 31, 2004
PERRY ELLIS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE TWELVE MONTHS ENDED JANUARY 31, 2003
PERRY ELLIS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE TWELVE MONTHS ENDED JANUARY 31, 2002
Exhibit Index