filings.toolsItem 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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The following discussion and analysis of our financial condition, results of operations, and liquidity and capital resources for the 53 weeks ended February 3, 2019 (“fiscal 2018”), the 52 weeks ended January 28, 2018 (“fiscal 2017”), and the 52 weeks ended January 29, 2017 (“fiscal 2016”) should be read in conjunction with our Consolidated Financial Statements and notes thereto. As fiscal 2018 is a 53-week year as compared to a 52-week year in fiscal 2017, our discussion of fiscal 2018 results below includes approximately $85,000,000 of net revenues and $0.10 of diluted earnings per share associated with the additional week. All explanations of changes in operational results are discussed in order of magnitude.
OVERVIEW
Net revenues in fiscal 2018, including the impact of the additional week, increased by $379,234,000, or 7.2%, compared to fiscal 2017, with comparable brand revenue growth of 3.7%. This increase in net revenues was driven by a 10.9% increase in e-commerce net revenues and a 3.0% increase in retail net revenues, with particular strength in furniture. Total fiscal 2018 net revenue growth was partially attributable to a 1.6% increase in store leased square footage and a 5.7% increase in international revenues, primarily related to our company-owned international operations, as well as the favorable impact of the adoption of ASU 2014-09 primarily associated with the reclassification of other income from selling, general and administrative expenses into net revenues (see Note A to our Consolidated Financial Statements). Revenue growth was also supported by our double digit new customer growth, which reflects the success of our strategies to increase customer acquisition and drive our future growth.
All brands delivered positive comparable brand revenue growth in fiscal 2018. Growth in Pottery Barn accelerated from last year, driven by strength in e-commerce and growth in new businesses: Marketplace and Pottery Barn Apartment, as well as strong upholstery growth. The Pottery Barn Kids and Teen business improved from last year, delivering combined comparable brand revenue growth of 2.8%. Our Baby business continued to gain momentum attracting new customers as the entry point to our brand and through registry creations. West Elm had another year of double digit net revenue growth driven by strong e-commerce performance and continued strength in the core furniture business. The Williams Sonoma brand delivered comparable brand revenue growth of 1.7%. And, our emerging brands, Rejuvenation and Mark and Graham, continued to scale with double digit net revenue growth and increased profitability.
Across the business, fiscal 2018 was a year of delivering more compelling experiences for our customers. As part of our strategic priority of digital leadership, we enhanced the e-commerce experience through two differentiators: content and convenience. In fiscal 2018, we updated our shop path with more accurate and engaging content that is inspirational and drives conversion. We also enhanced our product information pages with a focus on product quality and reasons to buy. To provide our customers with omni-channel convenience, we launched Buy Online Pickup In Store in our brands and are in the process of scaling other fulfillment capabilities such as Buy Online Ship To Store and Buy Online Ship From Store. As a result, our e-commerce revenue growth almost doubled in fiscal 2018. With over 54% of our business conducted online, we are among the top 25 e-commerce retailers in North America.
We are using cross-brand initiatives to strengthen our position as the resource for all home furnishing, cooking and entertaining needs. In fiscal 2018, we continued to scale our loyalty program, The Key, where we have seen strong membership growth over the past year, as well as our complimentary design service, Design Crew. We also launched two new initiatives during the year: Design Crew Room Planner and The One Registry collective, both of which are enabling a more personalized and convenient shopping experience for our customers.
In our supply chain, we continued to drive operational improvements in fiscal 2018. In our non-furniture business, our order consolidation efforts and continued improvement in distribution center productivity enabled us to lower our cartons-per-order and order-to-delivery time so that our customers received their orders faster this holiday season and with less waste. Additionally, we were proud to be recognized once again by Barron’s for all of our sustainability efforts across the business. At a ranking of number 24, we were the only company in our industry to be among the financial publication’s annual list of 100 Most Sustainable U.S. companies.
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In summary, 2018 was another year of solid financial and operational accomplishments resulting in earnings and cash flow generation that allowed us to return approximately $435,629,000 to our stockholders through stock repurchases and dividends.
Over the next few years, we plan target whitespace in the market; we plan to drive cross-brand initiatives that leverage our platform; and we plan to bring technology innovation and continued improvement in customer experience. We have a strong foundation to support the execution of our initiatives in fiscal 2019 and beyond, as well as to deliver long-term shareholder value.
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Results of Operations
NET REVENUES
Net revenues consist of e-commerce net revenues and retail net revenues. E-commerce net revenues include sales of merchandise to customers through our e-commerce websites and our catalogs, as well as shipping fees. Retail net revenues include sales of merchandise to customers at our retail stores and to our franchisees, as well as shipping fees on any products shipped to our customers’ homes. Shipping fees consist of revenue received from customers for delivery of merchandise to their homes. Revenues are presented net of sales returns and other discounts. Due to the adoption of ASU 2014-09 in fiscal 2018, certain incentives received from credit card issuers as well as breakage income related to our unredeemed stored-value cards are now presented within net revenues (see Note A to our Consolidated Financial Statements).
| In thousands | Fiscal 2018 (53 Weeks) | % Total | Fiscal 2017 (52 Weeks) | % Total | Fiscal 2016 (52 Weeks) | % Total | ||||||||||||||||||
| E-commerce net revenues | $ | 3,082,064 | 54.3% | $ | 2,778,457 | 52.5% | $ | 2,633,602 | 51.8% | |||||||||||||||
| Retail net revenues | 2,589,529 | 45.7% | 2,513,902 | 47.5% | 2,450,210 | 48.2% | ||||||||||||||||||
| Net revenues | $ | 5,671,593 | 100.0% | $ | 5,292,359 | 100.0% | $ | 5,083,812 | 100.0% |
Net revenues in fiscal 2018, including the impact of the additional week of net revenues, increased by $379,234,000 or 7.2%, compared to fiscal 2017, with comparable brand revenue growth of 3.7%. This increase in net revenues was driven by a 10.9% increase in e-commerce net revenues (primarily driven by West Elm, Pottery Barn and Pottery Barn Kids and Teen) and a 3.0% increase in retail net revenues (primarily driven by West Elm and Pottery Barn), with particular strength in furniture. Total fiscal 2018 net revenue growth was partially attributable to a 1.6% increase in store leased square footage and a 5.7% increase in international revenues primarily related to our company-owned international operations, as well as the favorable impact of the adoption of ASU 2014-09 primarily associated with the reclassification of other income from selling, general and administrative expenses into net revenues (see Note A to our Consolidated Financial Statements).
Net revenues in fiscal 2017 increased by $208,547,000 or 4.1%, compared to fiscal 2016, with comparable brand revenue growth of 3.2%. This increase in net revenues was driven by a 5.5% increase in e-commerce net revenues (primarily driven by West Elm, Williams Sonoma and Rejuvenation) and a 2.6% increase in retail net revenues (primarily driven by Pottery Barn and West Elm), with particular strength in furniture. Total fiscal 2017 net revenue growth was partially attributable to a 1.4% increase in store leased square footage primarily due to 2 net new stores, and a 2.2% increase in international revenues primarily related to our company-owned international operations.
The following table summarizes our net revenues by brand for fiscal 2018, fiscal 2017 and fiscal 2016:
| In thousands | Fiscal 2018 (53 Weeks) | Fiscal 2017 (52 Weeks) | Fiscal 2016 (52 Weeks) | |||||||||
| Pottery Barn | $ | 2,177,344 | $ | 2,066,302 | $ | 2,024,218 | ||||||
| West Elm | 1,292,928 | 1,114,339 | 971,568 | |||||||||
| Williams Sonoma | 1,056,125 | 1,022,434 | 1,002,194 | |||||||||
| Pottery Barn Kids and Teen_1_ | 895,762 | 860,468 | 873,199 | |||||||||
| Other_2_ | 249,434 | 228,816 | 212,633 | |||||||||
| Total | $ | 5,671,593 | $ | 5,292,359 | $ | 5,083,812 |
| 1 | Net revenues of the Pottery Barn Kids and PBteen brands are being reported on a combined basis as Pottery Barn Kids and Teen. |
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| 2 | Primarily consists of net revenues from our international franchise operations, Rejuvenation and Mark and Graham. |
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Comparable Brand Revenue
Comparable brand revenue includes retail comparable store sales and e-commerce sales, as well as shipping fees, sales returns and other discounts associated with current period sales. Comparable stores are defined as
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permanent stores where gross square footage did not change by more than 20% in the previous 12 months and which have been open for at least 12 consecutive months without closure for seven or more consecutive days. Outlet comparable store net revenues are included in their respective brands. Sales to our international franchisees are excluded from comparable brand revenue as their stores and e-commerce websites are not operated by us. Sales from certain operations are also excluded until such time that we believe those sales are meaningful to evaluating their performance. Additionally, comparable brand revenue growth for newer concepts is not separately disclosed until such time that we believe those sales are meaningful to evaluating the performance of the brand.
| Comparable brand revenue growth (decline)1 | Fiscal 2018 (53 Weeks) | Fiscal 2017 (52 Weeks) | Fiscal 2016 (52 Weeks) | |||||||||
| Pottery Barn | 1.2% | 1.0% | (3.5% | ) | ||||||||
| West Elm | 9.5% | 10.2% | 12.8% | |||||||||
| Williams Sonoma | 1.7% | 3.2% | 1.3% | |||||||||
| Pottery Barn Kids and Teen | 2.8% | (1.7% | ) | (2.8% | ) | |||||||
| Total_2_ | 3.7% | 3.2% | 0.7% |
| 1 | Comparable brand revenue is calculated on a 53-week to 53-week basis for fiscal 2018 and on a 52-week to 52-week basis for fiscal 2017 and fiscal 2016. |
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| 2 | Total comparable brand revenue growth includes the results of Rejuvenation and Mark and Graham. |
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RETAIL STORE DATA
| In thousands | Fiscal 2018 (53 Weeks) | Fiscal 2017 (52 Weeks) | Fiscal 2016 (52 Weeks) | |||||||||
| Retail net revenues | $ | 2,589,529 | $ | 2,513,902 | $ | 2,450,210 | ||||||
| Retail net revenue growth (decline) | 3.0% | 2.6% | (0.1% | ) | ||||||||
| Store count – beginning of year | 631 | 629 | 618 | |||||||||
| Store openings_1_ | 23 | 28 | 29 | |||||||||
| Store closings_1_ | (29 | ) | (26 | ) | (18 | ) | ||||||
| Store count – end of year | 625 | 631 | 629 | |||||||||
| Store selling square footage at year-end | 4,105,000 | 4,019,000 | 3,951,000 | |||||||||
| Store leased square footage (“LSF”) at year-end | 6,557,000 | 6,451,000 | 6,359,000 |
| 1 | Store openings and closings in fiscal 2017 include two Williams Sonoma, two Pottery Barn and one West Elm temporary closures in Puerto Rico and Florida due to hurricanes in these areas. These stores reopened during the fourth quarter of fiscal 2017. |
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| Fiscal 2018 | Fiscal 2017 | Fiscal 2016 | ||||||||||||||||||||||
| Store Count | Avg. LSF Per Store | Store Count | Avg. LSF Per Store | Store Count | Avg. LSF Per Store | |||||||||||||||||||
| Williams Sonoma | 220 | 6,900 | 228 | 6,700 | 234 | 6,600 | ||||||||||||||||||
| Pottery Barn | 205 | 14,200 | 203 | 13,900 | 201 | 13,900 | ||||||||||||||||||
| West Elm | 112 | 13,100 | 106 | 13,100 | 98 | 13,300 | ||||||||||||||||||
| Pottery Barn Kids | 78 | 7,500 | 86 | 7,400 | 89 | 7,400 | ||||||||||||||||||
| Rejuvenation | 10 | 8,500 | 8 | 8,800 | 7 | 9,100 | ||||||||||||||||||
| Total | 625 | 10,500 | 631 | 10,200 | 629 | 10,100 |
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COST OF GOODS SOLD
| In thousands | Fiscal 2018 (53 Weeks) | % Net Revenues | Fiscal 2017 (52 Weeks) | % Net Revenues | Fiscal 2016 (52 Weeks) | % Net Revenues | ||||||||||||||||||
| Cost of goods sold_1_ | $ | 3,570,580 | 63.0% | $ | 3,360,648 | 63.5% | $ | 3,200,502 | 63.0% |
| 1 | Includes occupancy expenses of $702,537, $683,958 and $664,177 in fiscal 2018, fiscal 2017 and fiscal 2016, respectively. |
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Cost of goods sold includes cost of goods, occupancy expenses and shipping costs. Cost of goods consists of cost of merchandise, inbound freight expenses, freight-to-store expenses and other inventory related costs such as shrinkage, damages and replacements. Occupancy expenses consist of rent, depreciation and other occupancy costs, including common area maintenance, property taxes and utilities. Shipping costs consist of third-party delivery services and shipping materials.
Our classification of expenses in cost of goods sold may not be comparable to other public companies, as we do not include non-occupancy-related costs associated with our distribution network in cost of goods sold. These costs, which include distribution network employment, third-party warehouse management and other distribution-related administrative expenses, are recorded in selling, general and administrative expenses.
Within our reportable segments, the e-commerce channel does not incur freight-to-store or store occupancy expenses, and typically operates with lower markdowns and inventory shrinkage than the retail channel. However, the e-commerce channel incurs higher customer shipping, damage and replacement costs than the retail channel.
Fiscal 2018 vs. Fiscal 2017
Cost of goods sold increased by $209,932,000, or 6.2%, in fiscal 2018 compared to fiscal 2017. Cost of goods sold as a percentage of net revenues decreased to 63.0% in fiscal 2018 from 63.5% in fiscal 2017. This decrease was primarily driven by the leverage of occupancy costs and includes the favorable impact from the adoption of ASU 2014-09, primarily associated with the reclassification of other income from selling, general and administrative expenses into net revenues.
In the e-commerce channel, cost of goods sold as a percentage of net revenues decreased in fiscal 2018 compared to fiscal 2017, primarily driven by higher selling margins.
In the retail channel, cost of goods sold as a percentage of net revenues increased in fiscal 2018 compared to fiscal 2017, primarily driven by lower selling margins, partially offset by the leverage of occupancy costs.
Fiscal 2017 vs. Fiscal 2016
Cost of goods sold increased by $160,146,000, or 5.0%, in fiscal 2017 compared to fiscal 2016. Cost of goods sold as a percentage of net revenues increased to 63.5% in fiscal 2017 from 63.0% in fiscal 2016. This increase was driven by lower merchandise margins, higher shipping costs and reduced shipping income, partially offset by reduced fulfillment-related costs in our supply chain and the leverage of occupancy costs.
In the e-commerce channel, cost of goods sold as a percentage of net revenues increased in fiscal 2017 compared to fiscal 2016 primarily driven by lower merchandise margins, reduced shipping income and higher shipping costs, partially offset by reduced fulfillment-related costs in our supply chain and a reduction in occupancy costs.
In the retail channel, cost of goods sold as a percentage of net revenues increased in fiscal 2017 compared to fiscal 2016 primarily driven by lower selling margins, as well as higher occupancy costs to support our growth initiatives.
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SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
| In thousands | Fiscal 2018 (53 weeks)1 | % Net Revenues1 | Fiscal 2017 (52 weeks) | % Net Revenues | Fiscal 2016 (52 weeks) | % Net Revenues | ||||||||||||||||||
| Selling, general and administrative expenses | $ | 1,665,060 | 29.4% | $ | 1,477,900 | 27.9% | $ | 1,410,711 | 27.7% |
| 1 | Includes the impact of the adoption of ASU 2014-09 primarily from the reclassification of other income from selling, general and administrative expenses into net revenues. |
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Selling, general and administrative expenses consist of non-occupancy-related costs associated with our retail stores, distribution and manufacturing facilities, customer care centers, supply chain operations (buying, receiving and inspection) and corporate administrative functions. These costs include employment, advertising, third-party credit card processing and other general expenses.
We experience differing employment and advertising costs as a percentage of net revenues within the retail and e-commerce channels due to their distinct distribution and marketing strategies. Employment costs represent a greater percentage of net revenues within the retail channel as compared to the e-commerce channel. However, advertising expenses are higher within the e-commerce channel than in the retail channel.
Fiscal 2018 vs. Fiscal 2017
Selling, general and administrative expenses increased by $187,160,000, or 12.7%, in fiscal 2018 compared to fiscal 2017. Selling, general and administrative expenses as a percentage of net revenues increased to 29.4% in fiscal 2018 from 27.9% in fiscal 2017. This increase as a percentage of net revenues was driven by an increase in general expenses primarily from the reclassification of other income from selling, general and administrative expenses into net revenues due to the adoption of ASU 2014-09, an increase in incentive compensation, as well as increased hourly wages and digital advertising from the reinvestment of tax savings, the impact from our acquisition of Outward, and impairment and early lease termination charges related to underperforming retail stores. This was partially offset by the optimization of catalog advertising costs.
In the e-commerce channel, selling, general and administrative expenses as a percentage of net revenues increased in fiscal 2018 compared to fiscal 2017, driven by an increase in general expenses primarily associated with the reclassification of other income from selling, general and administrative expenses into net revenues, the impact from our acquisition of Outward, as well as increased hourly wages and digital advertising from the reinvestment of tax savings, partially offset by the optimization of catalog advertising costs.
In the retail channel, selling, general and administrative expenses as a percentage of net revenues increased in fiscal 2018 compared to fiscal 2017, driven by an increase in general expenses primarily associated with the reclassification of other income from selling, general and administrative expenses into net revenues as well as impairment and early lease termination charges related to underperforming retail stores.
Fiscal 2017 vs. Fiscal 2016
Selling, general and administrative expenses increased by $67,189,000, or 4.8%, in fiscal 2017 compared to fiscal 2016. Selling, general and administrative expenses as a percentage of net revenues increased to 27.9% in fiscal 2017 from 27.7% in fiscal 2016. This increase as a percentage of net revenues was primarily driven by higher digital advertising expenses resulting from our focus on new customer acquisition. This increase was partially offset by lower employment expenses within the unallocated segment.
In the e-commerce channel, selling, general and administrative expenses as a percentage of net revenues increased in fiscal 2017 compared to fiscal 2016 primarily driven by higher digital advertising expenses.
In the retail channel, selling, general and administrative expenses as a percentage of net revenues increased in fiscal 2017 compared to fiscal 2016 primarily driven by an increase in employment expenses to support our growth initiatives.
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INCOME TAXES
The 2017 Tax Cuts and Jobs Act (“the Tax Act”) was enacted on December 22, 2017. Among other things, the Tax Act reduced the corporate income tax rate to 21% as of January 1, 2018, introduced a new tax on global intangible low-taxed income (“GILTI”), and implemented a modified territorial tax system that includes a transition tax on deemed repatriated earnings of foreign subsidiaries.
Staff Accounting Bulletin No. 118 (“SAB 118”) issued by the SEC in December 2017 provided us with up to one year to finalize our measurement of the income tax effects of the Tax Act on our fiscal year ended January 28, 2018. As of January 28, 2018, we had made reasonable estimates of the income tax effects of the Tax Act, including the transition tax under Internal Revenue Code section 965.
As of February 3, 2019, we have completed the accounting for the income tax effects of the Tax Act based on our current interpretation of available notices and regulations issued and proposed by the U.S. Department of the Treasury and the Internal Revenue Service. As a result, during fiscal 2018 we recorded an immaterial adjustment to the fiscal 2017 provisional transition tax amount. In addition, during fiscal 2018, we booked a net tax benefit of approximately $10,576,000 from the re-measurement of our deferred tax assets.
We have historically elected not to provide for U.S. income taxes with respect to the undistributed earnings of our foreign subsidiaries as we intended to utilize those earnings in our foreign operations for an indefinite period of time. Under Internal Revenue Code section 965 of the Tax Act, we are deemed to have distributed all the post-1986 earnings of our foreign subsidiaries to the U.S. as of December 31, 2017. In light of the Tax Act, we re-evaluated our permanent reinvestment assertion with respect to unremitted foreign earnings, and we are now only permanently reinvested with respect to our foreign earnings in Canada beginning in fiscal 2018. As a result, we recorded approximately $1,493,000 of foreign withholding tax and additional state income tax in fiscal 2018. As of February 3, 2019, the post-fiscal 2017 earnings of our Canadian subsidiary are permanently reinvested. If we did not consider these earnings to be permanently reinvested, the deferred tax liability would have been immaterial as of February 3, 2019.
In fiscal 2018, we are subject to several provisions of the Tax Act, including GILTI, the base erosion anti-abuse tax and a deduction for foreign-derived intangible income. We have elected to account for GILTI as a periodic expense when the tax arises. The net impact due to these provisions was immaterial in fiscal 2018.
Our effective tax rate was 22.3% for fiscal 2018, 42.6% for fiscal 2017 and 35.3% for fiscal 2016. The decrease in the effective tax rate from fiscal 2017 was primarily due to the reduction of the U.S. corporate income tax rate from 35% to 21% as of January 1, 2018 as a result of the Tax Act, as well as the tax benefit from the true up of the remeasurement of our deferred tax assets under SAB 118.
LIQUIDITY AND CAPITAL RESOURCES
As of February 3, 2019, we held $338,954,000 in cash and cash equivalents, the majority of which was held in interest-bearing demand deposit accounts and money market funds, and of which $185,810,000 was held by our foreign subsidiaries. As is consistent within our industry, our cash balances are seasonal in nature, with the fourth quarter historically representing a significantly higher level of cash than other periods.
Throughout the fiscal year, we utilize our cash balances to build our inventory levels in preparation for our fourth quarter holiday sales. In fiscal 2019, we plan to use our cash resources to fund our inventory and inventory-related purchases, advertising and marketing initiatives, stock repurchases and dividend payments, and property and equipment purchases. In addition to our cash balances on hand, we have a credit facility which provides for a $500,000,000 unsecured revolving line of credit (“revolver”), and a $300,000,000 unsecured term loan facility (“term loan”). The revolver may be used to borrow revolving loans or to request the issuance of letters of credit. We may, upon notice to the administrative agent, request existing or new lenders to increase the revolver by up to $250,000,000, at such lenders’ option, to provide for a total of $750,000,000 of unsecured revolving credit. During fiscal 2018, we had borrowings under the revolver of $60,000,000, all of which were repaid in the fourth quarter of fiscal 2018. During fiscal 2017, we had borrowings under the revolver of $170,000,000, all of which
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were repaid in the fourth quarter of fiscal 2017. As of February 3, 2019, we had $300,000,000 outstanding under our term loan. The term loan matures on January 8, 2021, at which point all outstanding principal and any accrued interest must be repaid. Additionally, as of February 3, 2019, a total of $11,732,000 in issued but undrawn standby letters of credit were outstanding under the credit facility. The standby letters of credit were issued to secure the liabilities associated with workers’ compensation and other insurance programs.
Additionally, we have three unsecured letter of credit reimbursement facilities, which were amended during the year, for a total of $70,000,000, of which an aggregate of $6,820,000 was outstanding as of February 3, 2019. These letter of credit facilities represent only a future commitment to fund inventory purchases to which we had not taken legal title.
We are currently in compliance with all of our financial covenants under the credit facility and, based on our current projections, we expect to remain in compliance throughout fiscal 2019. We believe our cash on hand, in addition to our available credit facilities, will provide adequate liquidity for our business operations over the next 12 months.
Cash Flows from Operating Activities
For fiscal 2018, net cash provided by operating activities was $585,986,000 compared to $499,704,000 in fiscal 2017. For fiscal 2018, net cash provided by operating activities was primarily attributable to net earnings adjusted for non-cash items, an increase in accounts payable and accrued expenses and other liabilities, as well as an increase in gift card and other deferred revenue, partially offset by an increase in merchandise inventories and prepaid expenses and other assets and a decrease in income taxes payable. This represents an increase in net cash provided by operating activities compared to fiscal 2017 primarily due to an increase in accounts payable and accrued expenses and other liabilities offset by a change in income taxes payable.
For fiscal 2017, net cash provided by operating activities was $499,704,000 compared to $524,709,000 in fiscal 2016. For fiscal 2017, net cash provided by operating activities was primarily attributable to net earnings adjusted for non-cash items, an increase in income taxes payable, as well as deferred rent and lease incentives, partially offset by an increase in merchandise inventories. This represents a decrease in net cash provided by operating activities compared to fiscal 2016 primarily due to an increase in merchandise inventories and a decrease in net earnings, partially offset by a decrease in income taxes paid in fiscal 2017 compared to fiscal 2016.
Cash Flows from Investing Activities
For fiscal 2018, net cash used in investing activities was $187,899,000 compared to $269,760,000 in fiscal 2017, and was primarily attributable to purchases of property and equipment. Net cash used in investing activities compared to fiscal 2017 is lower due to the acquisition of Outward in fiscal 2017 (see Note O to our Consolidated Financial Statements).
For fiscal 2017, net cash used in investing activities was $269,760,000 compared to $196,975,000 in fiscal 2016, and was primarily attributable to purchases of property and equipment and the acquisition of Outward. Net cash used in investing activities compared to fiscal 2016 increased due to the acquisition of Outward.
Cash Flows from Financing Activities
For fiscal 2018, net cash used in financing activities was $450,066,000 compared to $51,707,000 in fiscal 2017. For fiscal 2018, net cash used in financing activities was primarily attributable to repurchases of common stock of $295,304,000 and the payment of dividends of $140,325,000. Net cash used in financing activities compared to fiscal 2017 decreased primarily due to term loan borrowings in fiscal 2017 and an increase in repurchases of common stock in fiscal 2018.
For fiscal 2017, net cash used in financing activities was $51,707,000 compared to $305,806,000 in fiscal 2016. For fiscal 2017, net cash used in financing activities was primarily attributable to repurchases of common stock of $196,179,000 and the payment of dividends of $135,010,000, partially offset by proceeds from issuance of long-term debt of $300,000,000. Net cash used in financing activities compared to fiscal 2016 decreased primarily due to proceeds from the issuance of long-term debt, partially offset by an increase in repurchases of common stock.
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Dividends
In fiscal 2018, fiscal 2017 and fiscal 2016, total cash dividends declared were approximately $144,609,000, or $1.72 per common share, $135,779,000, or $1.56 per common share, and $133,588,000, or $1.48 per common share, respectively. In March 2019, our Board of Directors authorized a $0.05, or 11.6%, increase in our quarterly cash dividend, from $0.43 to $0.48 per common share, for an annual cash dividend of $1.92 per share, subject to capital availability. Our quarterly cash dividend may be limited or terminated at any time.
Stock Repurchase Programs
See section titled Stock Repurchase Programs within Part II, Item 5 of this Annual Report on Form 10-K for further information.
Contractual Obligations
The following table provides summary information concerning our future contractual obligations as of February 3, 2019:
| Payments Due by Period_1_ | ||||||||||||||||||||
| In thousands | Fiscal 2019 | Fiscal 2020 to Fiscal 2022 | Fiscal 2023 to Fiscal 2024 | Thereafter | Total | |||||||||||||||
| Long-term debt 2 | $ | — | $ | 300,000 | $ | — | $ | — | $ | 300,000 | ||||||||||
| Interest | 10,898 | 10,232 | — | — | 21,130 | |||||||||||||||
| Operating leases_3_ | 292,387 | 678,447 | 298,086 | 422,024 | 1,690,944 | |||||||||||||||
| Purchase obligations_4_ | 960,132 | 29,271 | 186 | — | 989,589 | |||||||||||||||
| Total | $ | 1,263,417 | $ | 1,017,950 | $ | 298,272 | $ | 422,024 | $ | 3,001,663 |
| 1 | This table excludes $40.6 million of liabilities for unrecognized tax benefits associated with uncertain tax positions as we are not able to reasonably estimate when and if cash payments for these liabilities will occur. This amount, however, has been recorded as a liability in our accompanying Consolidated Balance Sheet as of February 3, 2019. |
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| 2 | Long-term debt consists of term loan borrowings under our credit facility. See Note C to our Consolidated Financial Statements for discussion of our borrowing arrangements. |
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| 3 | Projected undiscounted payments include only those amounts that are fixed and determinable as of the reporting date. See Note E to our Consolidated Financial Statements for discussion of our operating leases. |
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| 4 | Represents estimated commitments at year-end to purchase inventory and other goods and services in the normal course of business to meet operational requirements. |
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Other Contractual Obligations
We have other liabilities reflected in our Consolidated Balance Sheet. The payment obligations associated with these liabilities are not reflected in the table above due to the absence of scheduled maturities. The timing of these payments cannot be determined, except for amounts estimated to be payable in fiscal 2019, which are included in our current liabilities as of February 3, 2019.
We are party to a variety of contractual agreements under which we may be obligated to indemnify the other party for certain matters. These contracts primarily relate to commercial matters, operating leases, trademarks, intellectual property and financial matters. Under these contracts, we may provide certain routine indemnification relating to representations and warranties or personal injury matters. The terms of these indemnifications range in duration and may not be explicitly defined. Historically, we have not made significant payments for these indemnifications. We believe that if we were to incur a loss in any of these matters, the loss would not have a material effect on our financial condition or results of operations.
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Commercial Commitments
The following table provides summary information concerning our outstanding commercial commitments as of February 3, 2019:
| Amount of Outstanding Commitment Expiration by Period_1_ | ||||||||||||||||||||
| In thousands | Fiscal 2019 | Fiscal 2020 to Fiscal 2022 | Fiscal 2023 to Fiscal 2024 | Thereafter | Total | |||||||||||||||
| Standby letters of credit | $ | 11,732 | $ | — | $ | — | $ | — | $ | 11,732 | ||||||||||
| Letter of credit facilities | 6,820 | — | — | — | 6,820 | |||||||||||||||
| Total | $ | 18,552 | $ | — | $ | — | $ | — | $ | 18,552 |
| 1 | See Note C to our Consolidated Financial Statements for discussion of our borrowing arrangements. |
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IMPACT OF INFLATION
The impact of inflation (or deflation) on our results of operations for the past three fiscal years has not been significant. However, we cannot be certain of the effect inflation (or deflation) may have on our results of operations in the future.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management’s Discussion and Analysis of Financial Condition and Results of Operations is based on our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these Consolidated Financial Statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. These estimates and assumptions are evaluated on an ongoing basis and are based on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ from these estimates.
We believe the following critical accounting policies used in the preparation of our Consolidated Financial Statements include the significant estimates and assumptions that we consider to be the most critical to an understanding of our financial statements because they involve significant judgments and uncertainties. See Note A to our Consolidated Financial Statements for further discussion of each policy.
Merchandise Inventories
Merchandise inventories, net of an allowance for shrinkage and obsolescence, are stated at the lower of cost (weighted average method) or market. To determine if the value of our inventory should be reduced below cost, we consider current and anticipated demand, customer preferences and age of the merchandise. The significant estimates used in inventory valuation are obsolescence (including excess and slow-moving inventory and lower of cost or market reserves) and estimates of inventory shrinkage. We reserve for obsolescence based on historical trends of inventory sold below cost and specific identification.
Reserves for shrinkage are estimated and recorded throughout the year as a percentage of net sales based on historical shrinkage results, cycle count results within our distribution centers, expectations of future shrinkage and current inventory levels. Actual shrinkage is recorded at year-end based on the results of our cycle count and year end physical inventory counts and can vary from our estimates due to such factors as changes in operations, the mix of our inventory (which ranges from large furniture to small tabletop items) and execution against loss prevention initiatives in our stores, distribution facilities, off-site storage locations, and with our third-party warehouse and transportation providers. Accordingly, there is no shrinkage reserve at year-end, with the exception of a cycle count reserve based on the historical cycle count results in our distribution centers. This reserve was not material to our Consolidated Financial Statements as of February 3, 2019. Historically, actual shrinkage has not differed materially from our estimates.
Our obsolescence and shrinkage reserve calculations contain estimates that require management to make assumptions and to apply judgment regarding a number of factors, including market conditions, the selling
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environment, historical results and current inventory trends. If actual obsolescence or shrinkage estimates change from our original estimate, we will adjust our reserves accordingly throughout the year. We have made no material changes to our assumptions included in the calculations of the obsolescence and shrinkage reserves throughout the year. In addition, we do not believe a 10% change in our inventory reserves would have a material effect on our net earnings. As of February 3, 2019 and January 28, 2018, our inventory obsolescence reserves were $13,580,000 and $12,649,000, respectively.
Property and Equipment
Property and equipment is stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets.
We review the carrying value of all long-lived assets for impairment, primarily at an individual store level, whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Our impairment analyses determine whether projected cash flows from operations are sufficient to recover the carrying value of these assets. Impairment may result when the carrying value of the asset exceeds the estimated undiscounted future cash flows over its remaining useful life. For store impairment, our estimate of undiscounted future cash flows over the store lease term is based upon our experience, the historical operations of the stores and estimates of future store profitability and economic conditions. The estimates of future store profitability and economic conditions require estimating such factors as sales growth, gross margin, employment costs, lease escalations, inflation and the overall economics of the retail industry, and are therefore subject to variability and difficult to predict. Actual future results may differ from those estimates. If a long-lived asset is found to be impaired, the amount recognized for impairment is equal to the excess of the asset’s net carrying value over its fair value. Long-lived assets are measured at fair value on a nonrecurring basis using Level 3 inputs as defined in the fair value hierarchy (see Note M to our Consolidated Financial Statements). The fair value is based on the present value of estimated future cash flows using a discount rate that approximates our weighted average cost of capital.
During fiscal 2018, we recorded asset impairment charges of approximately $9,639,000, related to our retail stores, which is recorded within selling, general and administrative expenses. During fiscal 2017, we did not record any asset impairment charges. During fiscal 2016, we recorded asset impairment charges of approximately $1,765,000 related to our retail stores.
Business Combinations
We account for acquired businesses when we obtain control of the business using the acquisition method of accounting. Assets acquired and liabilities assumed are recorded based upon the estimated fair value as of the acquisition date. Estimated fair values represent the estimated price that would be paid by a third-party market participant based upon the highest and best use of the assets acquired or liabilities assumed. The determination of the fair value of assets acquired and liabilities assumed requires significant judgment and estimates. In making such judgments and estimates, we utilize inputs from independent third-party valuation specialists and other internal sources. Any excess of the purchase price over the estimated fair value of the identifiable net assets acquired is recorded as goodwill. Acquisition-related expenses are expensed as incurred. During fiscal 2017, we acquired Outward (see Note O to our Consolidated Financial Statements). During the second quarter of fiscal 2018, we finalized the valuation of intangible assets acquired, which primarily represent 3-D imaging data and core intellectual property which are being amortized over a useful life of four years.
Goodwill
Goodwill is initially recorded as of the acquisition date, and is measured as any excess of the purchase price over the estimated fair value of the identifiable net assets acquired. Goodwill is not amortized, but rather is subject to impairment testing annually (on the first day of the fourth quarter), or between annual tests whenever events or changes in circumstances indicate that the fair value of a reporting unit may be below its carrying amount. We first perform a qualitative assessment to evaluate goodwill for potential impairment. If based on that assessment it is more likely than not that the fair value of the reporting unit is below its carrying value, a quantitative impairment test is necessary. The quantitative impairment test requires determining the fair value of the reporting
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unit. We use the income approach, whereby we calculate the fair value based on the present value of estimated future cash flows using a discount rate that approximates our weighted average cost of capital. The process of evaluating the potential impairment of goodwill is subjective and requires significant estimates and assumptions about the future such as sales growth, gross margins, employment costs, capital expenditures, inflation and future economic and market conditions. Actual future results may differ from those estimates. If the carrying value of the reporting unit’s assets and liabilities, including goodwill, exceeds its fair value, impairment is recorded for the excess, not to exceed the total amount of goodwill allocated to the reporting unit.
As of February 3, 2019 and January 28, 2018, we had goodwill of $85,382,000 and $18,838,000, respectively, primarily related to our fiscal 2017 acquisition of Outward and our fiscal 2011 acquisition of Rejuvenation, Inc. In fiscal 2018, fiscal 2017, and fiscal 2016, we performed a qualitative assessment of potential goodwill impairment and determined it was more likely than not that the fair value of each of our reporting units exceeded its carrying value. Accordingly, no further impairment testing of goodwill was performed. We did not recognize any goodwill impairment in fiscal 2018, fiscal 2017, or fiscal 2016.
Self-Insured Liabilities
We are primarily self-insured for workers’ compensation, employee health benefits, product and other general liability claims. We record self-insurance liability reserves based on claims filed, including the development of those claims, and an estimate of claims incurred but not yet reported, based on an actuarial analysis of historical claims data. Factors affecting these estimates include future inflation rates, changes in severity, benefit level changes, medical costs and claim settlement patterns. Should a different number of claims occur compared to what was estimated, or costs of the claims increase or decrease beyond what was anticipated, reserves may need to be adjusted accordingly. Self-insurance reserves for workers’ compensation, employee health benefits, product and other general liability claims were $28,542,000 and $26,370,000 as of February 3, 2019 and January 28, 2018, respectively.
Income Taxes
Income taxes are accounted for using the asset and liability method. Under this method, deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in our Consolidated Financial Statements. We record reserves for our estimates of the additional income tax liability that is more likely than not to result from the ultimate resolution of foreign and domestic tax examinations. At any one time, many tax years are subject to examination by various taxing jurisdictions. The results of these audits and negotiations with taxing authorities may affect the ultimate settlement of these issues. We review and update the estimates used in the accrual for uncertain tax positions as more definitive information becomes available from taxing authorities, upon completion of tax examination, upon expiration of statutes of limitation, or upon occurrence of other events.
In order to compute income tax on an interim basis, we estimate what our effective tax rate will be for the full fiscal year and adjust these estimates throughout the year as necessary. Adjustments to our income tax provision due to changes in our estimated effective tax rate are recorded in the interim period in which the change occurs. The tax expense (or benefit) related to items other than ordinary income is individually computed and recognized when the items occur. Our effective tax rate in a given financial statement period may be materially impacted by changes in the mix and level of our earnings in various taxing jurisdictions or changes in tax law.
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