ITEM 1A. RISK FACTORS
Our results of operations and financial condition could be adversely affected by numerous risks. You should carefully consider the risk factors detailed below in conjunction with the other information contained in this Form 10-K. Should any of these risks actually materialize, our business, financial condition, results of operations and future prospects could be negatively impacted.
Economic and Industry Risks
The COVID-19 pandemic has caused and may continue to cause significant disruption in our industry, which has and may continue to materially impact our business, financial condition and results of operations.
Our business has been and may continue to be materially impacted by the effects of the widespread outbreak of COVID-19, which was reported to have surfaced first in December 2019 and declared a global pandemic in March 2020. This pandemic has negatively affected the U.S. and global economies, disrupted global supply chains and financial markets, and led to significant travel and business restrictions, including mandatory closures, orders to “shelter-in-place” and restrictions on how businesses operate.
During 2020, the COVID-19 pandemic materially negatively impacted our business and results of operations. While conditions improved during 2021, the extent and duration of ongoing impacts remain uncertain. The pandemic previously resulted in temporary closures of our retail stores and the stores of our wholesale customers where our products are sold, reduced consumer traffic and consumer spending, temporary layoffs of certain employees in our North America retail stores and distribution centers and incremental operating expenses from adopting preventative health and safety measures in our stores, distribution centers and corporate offices. These negative impacts may continue or resurface depending on the ongoing development of the virus and related responses including resurgences and the impact of variants.
The disruption caused by the pandemic has and may continue to disrupt the operations of our business partners, including our customers, suppliers, and vendors, and the financial condition of certain of our partners has been and could again be significantly impacted. For example, in 2020 certain of our wholesale customers delayed purchases of our products or cancelled previously placed orders in response to pandemic-related store closures. More recently, we have experienced disruption amongst our distribution, logistics and sourcing partners, including temporary closures or other restrictions placed on factories in key sourcing countries. Additionally, the COVID-19 pandemic has caused and may continue to cause global logistical challenges, including shipping container shortages, transportation delays, port congestion and labor shortages. These challenges have and may continue to negatively impact our partners and our business, including by disrupting our inventory flow, requiring us to incur increased freight costs and requiring us to cancel or delay sales to some of our customers. This has and may continue to negatively impact our net revenues, gross margin, net income and results of operations.
The COVID-19 pandemic and resulting economic disruption has also led to significant volatility in the capital markets and adversely impacted our stock price. While we have taken measures to maintain our operations and preserve and enhance our access to liquidity, our cash generated from operations was negatively impacted during certain periods of the pandemic and future cash flows may be further impacted by the ongoing development of the pandemic. If we are unable to effectively manage our spending in response to the pandemic, our profitability may be negatively impacted.
Further, many of our employees in our corporate offices are working remotely, and may continue to do so. An extended period of remote work arrangements could introduce operational risk, including but not limited to cybersecurity risks.
The impact of the COVID-19 pandemic may also exacerbate other risks discussed below, any of which could have a material effect on us. Though we continue to monitor the COVID-19 pandemic closely, the situation is changing rapidly, including a resurgence in many countries, and additional impacts may arise that we are not aware of currently.
Our business depends on consumer purchases of discretionary items, which can be negatively impacted during an economic downturn or periods of inflation. This could materially impact our sales, profitability and financial condition.
Many of our products may be considered discretionary items for consumers. Many factors impact discretionary spending, including general economic conditions, unemployment, the availability of consumer credit
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and inflationary pressures and consumer confidence in future economic conditions. Global economic conditions may continue to be uncertain, particularly in light of the impacts of COVID-19, and the potential impacts of increasing inflation in the United States (our largest market) remain unknown, making trends in consumer discretionary spending unpredictable. Historically, consumer purchases of discretionary items tend to decline during recessionary periods when disposable income is lower or during other periods of economic instability or uncertainty, which may lead to declines in sales and slow our long-term growth expectations. Any near or long-term economic disruptions in markets where we sell our products, particularly in the United States, China or other key markets, may materially harm our sales, profitability and financial condition and our prospects for growth. In addition, as pandemic conditions improve and restrictions ease, we are unable to predict whether consumer preferences for discretionary items will shift and the level of consumer spending within our industry will be negatively impacted for a period of time. If this were to occur, our sales and prospects for growth may be negatively impacted.
We operate in highly competitive markets and the size and resources of some of our competitors may allow them to compete more effectively than we can, resulting in a loss of our market share and a decrease in our net revenues and gross profit.
The market for performance apparel, footwear and accessories is highly competitive and includes many new competitors as well as increased competition from established companies expanding their production and marketing of performance products. Many of our competitors are large apparel and footwear companies with strong worldwide brand recognition. Within our international markets, we also compete with local brands that may have strong brand recognition amongst consumers within particular regions. Due to the fragmented nature of the industry, we also compete with other manufacturers, including those specializing in products similar to ours and private label offerings of certain retailers, including some of our retail customers. Many of our competitors have significant competitive advantages, including greater financial, distribution, marketing, digital and other resources; longer operating histories; better brand recognition among consumers; more experience in global markets; greater ability to invest in technology, the digital consumer experience and innovations around sustainability; and greater economies of scale. In addition, our competitors have long-term relationships with our key retail customers that are potentially more important to those customers because of the significantly larger volume and product mix that our competitors sell to them. As a result, these competitors may be better equipped than we are to influence consumer preferences or otherwise increase their market share by quickly adapting to changes in customer requirements or consumer preferences, readily taking advantage of acquisition and other opportunities, discounting excess inventory that has been written down or written off, devoting resources to the marketing and sale of their products, including significant advertising, media placement, partnerships and product endorsement, adopting aggressive pricing policies and engaging in lengthy and costly intellectual property and other disputes.
In addition, while one of our growth strategies has been to increase floor space for our products in retail stores and in certain markets expand our distribution to other retailers, retailers have limited resources and floor space, and we must compete with others to develop relationships with them. Increased competition by existing and future competitors could result in reductions in floor space in retail locations, reductions in sales or reductions in the prices of our products, and if retailers have better sell through or earn greater margins from our competitors’ products, they may favor the display and sale of those products. Our inability to compete successfully against our competitors and maintain our gross margin could have a negative effect on our brand image and a material adverse effect on our business, financial condition and results of operations.
Our profitability may decline or our growth may be negatively impacted as a result of increasing pressure on pricing.
Our industry is subject to significant pricing pressure caused by many factors, including intense competition, consolidation in the retail industry, pressure from retailers to reduce the costs of products and changes in consumer demand. These factors may cause us to reduce our prices to retailers and consumers or engage in more promotional activity than we anticipate, which could negatively impact our margins and cause our profitability to decline if we are unable to offset price reductions with comparable reductions in our operating costs. Ongoing and sustained promotional activities could negatively impact our brand image. On the other hand, if we are unwilling to engage in promotional activity on a scale similar to that of our competitors, for instance, to protect our premium brand positioning, and unable to simultaneously offset declining promotional activity with increased sales at premium price points, our ability to achieve short-term growth targets may be negatively impacted, which could have a material adverse effect on our results of operations, financial condition and the price of our stock.
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Fluctuations in the cost of raw materials and commodities we use in our products and costs related to our supply chain could negatively affect our operating results.
The fabrics used by our suppliers and manufacturers are made of raw materials including petroleum-based products and cotton. Significant price fluctuations, including due to inflation, or shortages in petroleum or other raw materials can materially adversely affect our cost of goods sold. In addition, certain of our manufacturers are subject to government regulations related to wage rates, and therefore the labor costs to produce our products may fluctuate. The cost of transporting our products for distribution and sale is also subject to fluctuation due in large part to the price of oil. Because most of our products are manufactured abroad, our products must be transported by third parties over large geographical distances and an increase in the price of oil can significantly increase costs. Manufacturing delays, such as those caused by COVID-19 related temporary closures and other restrictions placed on factories in key sourcing countries, or unexpected transportation delays, such as those caused by COVID-19 related global logistics challenges, have caused and may continue to cause us to rely more heavily on airfreight to achieve timely delivery to our customers. In addition, shipping costs have risen significantly throughout the world in 2021. These factors have and may continue to significantly increase our freight costs. Any of these fluctuations may increase our cost of products and have an adverse effect on our profit margins, results of operations and financial condition.
Our financial results and ability to grow our business may be negatively impacted by global events beyond our control.
We operate retail, distribution and warehousing facilities and offices around the world and substantially all of our manufacturers are located outside of the United States. We are subject to numerous risks and global events beyond our control which could negatively impact consumer spending or the operations of us or our customers or business partners, and therefore our results of operations, including: political or labor unrest; military conflict; terrorism; public health crises, disease epidemics or pandemics (such as COVID-19); natural disasters and extreme weather conditions, which may increase in frequency and severity due to climate change; economic instability resulting in the disruption of trade from foreign countries; the imposition of new laws and regulations, including those relating to labor conditions, minimum wage, quality and safety standards and disease epidemics or other public health concerns, as well as rules and regulations regarding climate change; changes in trade policy or actions of foreign or U.S. governmental authorities impacting trade and foreign investment, particularly during periods of heightened tension between U.S. and foreign governments, including the imposition of new import limitations, duties, tariffs, anti-dumping penalties, trade restrictions or restrictions on the transfer of funds; inflation; and changes in local economic conditions in countries where our stores, customers, manufacturers and suppliers are located.
These risks could hamper our ability to sell products, negatively affect the ability of our manufacturers to produce or deliver our products or procure materials and increase our cost of doing business generally, any of which could have an adverse effect on our results of operations, profitability, cash flows and financial condition. In the event that one or more of these factors make it undesirable or impractical for us to conduct business in a particular country, our business could be adversely affected.
Business and Operational Risks
We derive a substantial portion of our sales from large wholesale customers. If the financial condition of our customers declines, our financial condition and results of operations could be adversely impacted.
In Fiscal 2021, sales through our wholesale channel represented approximately 57% of our net revenues. We extend credit to our wholesale customers based on an assessment of a customer’s financial condition, generally without requiring collateral or getting customer insurance against non-collection. We face increased risk of order reduction or cancellation and around collectibility when dealing with financially ailing customers or customers struggling with economic uncertainty. As a result of the COVID-19 pandemic, many of our wholesale customers throughout the world had to temporarily close their stores or operate their stores under significant restrictions and experienced reduced consumer traffic and purchasing, which resulted in lower sales and cancellations of orders of our products. Many of our wholesale customers have been able to reopen their stores and have experienced a recovery in consumer traffic and purchasing, though consumer traffic in some areas remains below pre-pandemic levels. Given the ongoing uncertainty and constantly evolving nature of the COVID-19 pandemic, it is uncertain whether our wholesale customers will have to temporarily close their stores or operate them under significant restrictions again, and whether they will again experience significantly reduced consumer traffic and purchasing. If
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our wholesale customers continue to experience significant disruptions, this could result in further reductions or cancellations of orders or late or extended payment terms to us, which could negatively impact our results of operations. In addition, during weak economic conditions, customers may be more cautious with orders or may slow investments necessary to maintain a high quality in-store experience for consumers, which may result in lower sales of our products. Furthermore, a slowing economy in our key markets or a continued decline in consumer purchases of sporting goods generally could have an adverse effect on the financial health of our company.
From time to time, certain of our customers have experienced financial difficulties. To the extent one or more of our customers experience significant financial difficulty, bankruptcy, insolvency or cease operations, this could have a material adverse effect on our sales, our ability to collect on receivables and our financial condition and results of operations.
We may not successfully execute our long-term strategies, which may negatively impact our results of operations.
Our ability to execute on our long-term strategies depends, in part, on successfully executing on strategic growth initiatives in key areas, such as our international business, footwear and our global direct-to-consumer sales channel. Our growth in these areas depends on our ability to continue to successfully grow our e-commerce and mobile application offerings and digital experiences throughout the world, expand our global network of Brand and Factory House stores and continue to successfully increase our product offerings and market share in footwear. Our ability to invest in these growth initiatives on the timeline and at the scale we expect will be negatively impacted if we again experience significant market disruption due to COVID-19 or other significant events, particularly if our North America business, which represented 67% of our total net revenues in Fiscal 2021, does not grow sufficiently. In addition, as we expand our global network of Brand and Factory House stores, if we are unable to operate our stores profitably, our financial results could be impacted, or we could be required to recognize impairment charges. Our long-term strategy also depends on our ability to successfully drive expansion of our gross margins, manage our cost structure and drive return on our investments. If we cannot effectively execute our long-term growth strategies while managing costs effectively, our business could be negatively impacted and we may not achieve our expected results of operations.
We may not fully realize the expected benefits of our restructuring plans or other operating or cost-saving initiatives, which may negatively impact our profitability.
Since 2017, we have executed three separate restructuring plans designed to more closely align our financial resources against the critical priorities of our business and rebalance our cost base to further improve future profitability and cash flow generation. We have also implemented several changes to our operating model and continue to refine our operating model in response to business and market conditions. We may not achieve the operational improvements and efficiencies that we targeted in our restructuring plans and operating model changes, which could adversely impact our results of operations and financial condition. Implementing any restructuring plan or operating model change presents significant potential risks including, among others, higher than anticipated implementation costs, management distraction from ongoing business activities, failure to maintain adequate controls and procedures while executing our restructuring plans and operating model changes, damage to our reputation and brand image and workforce attrition beyond planned reductions. If we fail to achieve targeted operating improvements and/or cost reductions, our profitability and results of operations could be negatively impacted, which may be dilutive to our earnings in the short term.
If we are unable to anticipate consumer preferences, successfully develop and introduce new, innovative and updated products or engage our consumers, or if consumer preferences shift away from performance products, our sales, net revenues and profitability may be negatively impacted.
Our success depends on our ability to identify and originate product trends and anticipate and react to changing consumer demands in a timely manner. All of our products are subject to changing consumer preferences that shift rapidly and cannot be predicted with certainty. Accordingly, our new products may not receive consumer acceptance. In addition, long lead times for certain of our products may make it hard for us to respond quickly to changes in consumer demands. Our ability to adequately react to and address consumer preferences depends in part upon our continued ability to develop and introduce innovative, high-quality products and to optimize available consumer data. Moreover, if consumers are not convinced performance apparel, footwear and accessories are a better choice than, and worth the additional cost over, traditional alternatives, sales of performance products may not grow or decline and growth in the industry and our business could be adversely affected. In addition, consumers are increasingly focused on the environmental and social practices of brands, including the sustainability of the
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products sold. From time to time, we may also introduce limited run or specialized products that may increase our sales in the near term, but that may fail to maintain sustained consumer demand. If we are unable to effectively anticipate and respond to consumer preferences as a result of any of these factors, our brand image could be negatively impacted, and our sales, net revenues and profitability may be negatively impacted.
Consumer shopping and engagement preferences and shifts in distribution channels continue to evolve and if we fail to adapt accordingly our results of operations or future growth could be negatively impacted.
Consumer preferences regarding the shopping experience and how to engage with brands continue to rapidly evolve. We sell our products through a variety of channels, including through wholesale customers and distribution partners, as well as our own direct-to-consumer business consisting of our Brand and Factory House stores and e-commerce platforms. If we or our wholesale customers do not provide consumers with an attractive in-store experience, our brand image and results of operations could be negatively impacted. In addition, as part of our growth strategy, we are investing significantly in enhancing our online platform capabilities and implementing systems to evolve towards a more omni-channel approach to service our consumers. We are also investing in capabilities and tools to drive higher digital engagement with our consumers and create new digital experiences. If we do not successfully execute this strategy or continue to provide an engaging, reliable and user-friendly digital commerce platform or digital experiences that attract consumers, our brand image, and results of operations as well as our opportunities for future growth could be negatively impacted.
A decline in sales to, or the loss of, one or more of our key customers could result in a material loss of net revenues and negatively impact our prospects for growth.
We generate a significant portion of our wholesale revenues from sales to our largest customers. We currently do not enter into long-term sales contracts with our key customers, relying instead on our relationships with these customers and on our position in the marketplace. As a result, we face the risk that these key customers may not increase their business with us as we expect, or may significantly decrease their business with us or terminate their relationship with us. The failure to increase or maintain our sales to these customers as much as we anticipate would have a negative impact on our growth prospects and any decrease or loss of these key customers' business could result in a material decrease in our net revenues and net income or loss. These risks have materially increased and may persist as the COVID-19 pandemic continues. In addition, our customers continue to experience ongoing industry consolidation, particularly in the sports specialty sector. As this consolidation continues, it increases the risk that if any one customer significantly reduces their purchases of our products, we may be unable to find sufficient alternative customers to continue to grow our net revenues, or our net revenues may decline materially. In addition, we may from time to time exit relationships with certain wholesale customers to further drive our premium brand position or for other reasons. This may negatively impact our net revenues if we are unable to replace those sales with additional sales to our other customers or direct sales to consumers.
We must successfully manage the increasingly complex operations of our global business, including continued expansion in certain markets where we have limited brand recognition, or our business and results of operations may be negatively impacted.
A significant element of our growth strategy depends on our continued expansion outside of North America, and we have limited brand recognition and operating experience in certain regions. We must continue to successfully manage the operational difficulties associated with expanding our business to meet increased consumer demand throughout the world. We have limited experience with regulatory requirements and market practices in certain regions outside of North America, and may face difficulties expanding into and successfully operating in those markets, including differences in regulatory environments, labor and market practices, and difficulties in keeping abreast of market, business and technical developments and consumers’ tastes and preferences. We must also continually evaluate the need to expand critical functions in our business, including sales and marketing, product development and distribution functions, our management information systems and other processes and technology. We may not manage these efforts cost-effectively or these efforts could increase the strain on our existing resources. If we experience difficulties in supporting the growth of our business, we could experience an erosion of our brand image or operational challenges leading to a decrease in net revenues and results from operations.
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Our results of operations could be materially harmed if we are unable to accurately forecast demand for our products.
To ensure adequate inventory supply, we must forecast inventory needs and place orders with our manufacturers before firm orders are placed by our customers. In addition, a significant portion of our net revenues may be generated by at-once orders for immediate delivery to customers, particularly during the last two quarters of the calendar year, which historically has been our peak season. If we fail to accurately forecast customer demand we may experience excess inventory levels or a shortage of product to deliver to our customers. Excess inventory may result in inventory write-downs or write-offs or sales at discounted prices or in less preferred distribution channels, negatively impacting gross margin. On the other hand, if we underestimate the demand for our products, our manufacturers may not be able to produce products to meet our customer requirements, resulting in delays in the shipment of our products and our ability to recognize revenue, lost sales, as well as damage to our reputation and retailer and distributor relationships.
Factors that could affect our ability to accurately forecast demand for our products include: changing consumer demand for our products; product introductions by competitors; unanticipated changes in general market or economic conditions or other factors, which may result in cancellations of advance orders or a reduction or increase in the rate of reorders or at-once orders placed by retailers; the impact on consumer demand due to unseasonable weather conditions, which may become more frequent or severe as a result of climate change; and terrorism or acts of war, or the threat thereof, political or labor instability or unrest or public health concerns and disease epidemics, such as the current COVID-19 pandemic.
The difficulty in forecasting demand also makes it difficult to estimate our future results of operations and financial condition from period to period. A failure to accurately predict the level of demand for our products could adversely impact our profitability or cause us not to achieve our expected financial results. These risks have materially increased and may persist with the market disruption caused by COVID-19.
We rely on third-party suppliers and manufacturers to provide raw materials for and to produce our products, and we have limited control over these suppliers and manufacturers and may not be able to obtain quality products on a timely basis or in sufficient quantity.
Many of the materials used in our products are technically advanced products developed by third parties and may be available, in the short-term, from a very limited number of sources. Substantially all of our products are manufactured by unaffiliated manufacturers, and, in Fiscal 2021, ten manufacturers produced approximately 65% of our apparel and accessories products, and six produced substantially all of our footwear products. We have no long-term contracts with our suppliers or manufacturing sources, and we compete with other companies for fabrics, raw materials and production capacity.
A number of factors may require us to seek alternative or additional suppliers, which we may not be able to do in a timely or cost-effective manner. We may experience a significant disruption in the supply of fabrics or raw materials from current sources or, in the event of a disruption, we may be unable to locate alternative materials suppliers of comparable quality at an acceptable price, or at all. Moreover, our suppliers may not be able to fill our orders in a timely manner depending on market conditions or increased demand for product. For example, in Fiscal 2021 certain of our manufacturers experienced significant financial and operational disruption due to COVID-19, including in key sourcing countries. We have historically provided supply chain finance support to certain of our supply chain partners. In the past, the financial markets supporting supply chain finance programs experienced disruption that resulted in a temporary disruption to our program and challenged the cash flow and liquidity of our partners. While we worked with our partners through the disruption and have re-established a supply chain finance program, there can be no guarantee that such disruption will not occur again. Additionally, if one or more of our suppliers were to experience significant financial difficulty, bankruptcy, insolvency or cease operations, or failed to comply with applicable labor or other laws, we may be required to seek alternative suppliers.
In addition, if we lose or need to replace an existing manufacturer or supplier as a result of adverse economic conditions or other reasons, additional supplies of fabrics or raw materials or additional manufacturing capacity may not be available when required on terms that are acceptable to us, or at all, or suppliers or manufacturers may not be able to allocate sufficient capacity to us in order to meet our requirements. Even if we are able to expand existing or find new manufacturing or fabric sources, we may encounter delays in production and added costs as a result of the time it takes to train our suppliers and manufacturers on our methods, products and quality control standards. Any delays, interruption or increased costs in the supply of fabric or manufacture of our products could have an adverse effect on our ability to meet retail customer and consumer demand for our products and result in lower net revenues and net income (or higher net loss) both in the short and long term.
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We have occasionally received, and may in the future continue to receive, shipments of product that fail to conform to our quality control standards. If we are unable to obtain replacement products in a timely manner, we risk the loss of net revenues resulting from the inability to sell those products and related increased administrative and shipping costs. In addition, because we do not control our manufacturers, products that fail to meet our standards or other unauthorized products could end up in the marketplace without our knowledge, which could harm our brand and our reputation in the marketplace.
Labor or other disruptions at ports or our suppliers or manufacturers may adversely affect our business.
Our business depends on our ability to source and distribute products in a timely and cost effective manner. As a result, we rely on the free flow of goods through open and operational ports worldwide and on a consistent basis from our suppliers and manufacturers. Labor disputes and disruptions at various ports or at our suppliers or manufacturers could create significant risks for our business, particularly if these disputes result in work slowdowns, decreased operations, lockouts, strikes or other disruptions during our peak importing or manufacturing seasons. For example, COVID-19 has resulted in delays and disruptions at ports due to workforce decreases, shipping backlogs and capacity constraints, container shortages and other disruptions. This has resulted, and may continue to result, in slower than planned deliveries of inventory and delayed sales to customers. If we experience significant delays or disruption in receiving and distributing our products, this could have an adverse effect on our business, potentially resulting in canceled orders by customers, unanticipated inventory accumulation or shortages, increased expense (including air freight) to deliver our products and reduced net revenues and net income or higher net loss.
If we fail to successfully manage or realize expected results from significant transactions or investments, or if we are required to recognize an impairment of our goodwill or other intangible assets, it may have an adverse effect on our results of operations and financial position.
From time to time, we may engage in acquisition opportunities we believe are complementary to our business and brand. Integrating acquired businesses can require significant efforts and resources, which could divert management attention from more profitable business operations. From time to time we have also disposed of certain assets where we did not think our activities aligned to our operating model. If we fail to successfully integrate acquired businesses or effectively manage dispositions, we may not realize the financial benefits or other synergies we anticipated. In addition, in connection with our acquisitions, we may record goodwill or other intangible assets. We have recognized goodwill impairment charges in the past, and additional goodwill impairment charges could have an adverse effect on our results of operations and financial position. Additionally, from time to time, we may invest in business infrastructure, new businesses and expansion of existing businesses, such as the expansion of our network of Brand and Factory House stores and our distribution facilities, implementing our global operating and financial reporting information technology system, supporting our digital strategy (including our e-commerce platform), or supporting our corporate infrastructure (including the development of our new global headquarters in Port Covington in Baltimore). These investments require substantial cash investments and management attention, and infrastructure investments may also divert funds from other potential business opportunities. We believe cost effective investments are essential to business growth and profitability. The failure of any significant investment to provide the returns or synergies we expect could adversely affect our financial results.
The value of our brand and sales of our products could be diminished if we are associated with negative publicity.
Our business could be adversely impacted if negative publicity regarding our brand, our company or our business partners diminishes the appeal of our brand to consumers. For example, while we require our suppliers, manufacturers and licensees of our products to operate their businesses in compliance with applicable laws and regulations as well as the social and other standards and policies we impose on them, including our code of conduct, we do not control the conduct of these third parties. A violation, or alleged violation of our policies, labor laws or other laws could interrupt or otherwise disrupt our sourcing or damage our brand image. Negative publicity regarding production methods, alleged practices or workplace or related conditions of any of our suppliers, manufacturers or licensees could adversely affect our reputation and sales and force us to locate alternative suppliers, manufacturers or licensees. The risk that our business partners may not act in accordance with our expectations may be exacerbated in markets where our direct sales, supply chain or logistics operations are not as widespread. In addition, we have sponsorship contracts with a variety of athletes, teams and leagues, and many athletes and teams use our products. Negative publicity regarding these partners could negatively impact our brand image and result in diminished loyalty to our brand, regardless of whether such claims are accurate. Furthermore, social media can potentially accelerate and increase the scope of negative publicity. This could diminish the value of our proprietary rights or harm our reputation or have a negative effect on our sales and results of operations.
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If we fail to meet the expectations of our stakeholders with respect to our environmental, social and governance practices, including those relating to sustainability and diversity, equity and inclusion, it may have an adverse effect on our brand, sales of our products and our results of operations.
Certain customers, consumers, investors and other stakeholders are increasingly focusing on the environment, social and governance (“ESG”) practices of companies, including those related to sustainability and diversity, equity and inclusion. If our ESG practices do not meet such stakeholder expectations and standards, which continue to evolve, our brand and reputation could be negatively impacted. Any sustainability report or other information that we publish or make may describe our practices, targets and commitments on a variety of ESG matters, including relating to our actions to address climate change, environmental targets and compliance, social and labor policies and practices, human capital management matters (including those relating to diversity, equity and inclusion) and the materials and manufacturing of our products. It is possible that stakeholders may not be satisfied with such disclosures, our ESG practices or the speed of their adoption. Our failure, or perceived failure, to meet stakeholder expectations or standards, or our targets or commitments, could harm our reputation, negatively impact our employee retention or have a negative effect on our sales and results of operations. We may also incur additional costs or require additional resources to monitor such stakeholder expectations and standards and to meet our targets and commitments.
The costs and return on our investments for our sports marketing sponsorships may become more challenging and this could impact the value of our brand image.
A key element of our marketing strategy has been to create a link in the consumer market between our products and professional and collegiate athletes. We have developed licensing and sponsorship agreements with a variety of sports teams and athletes at the collegiate and professional level to be their official supplier of performance apparel and footwear. We have also developed licensing agreements to be an official supplier of footwear and/or performance apparel to a variety of professional sports leagues and clubs. However, as competition in the performance apparel and footwear industry has increased, the costs associated with athlete sponsorships and official supplier licensing agreements, including the costs of obtaining and retaining these sponsorships and agreements, have varied and at times increased greatly. If we are unable to maintain our current association with professional and collegiate athletes, teams and leagues, or to do so at a reasonable cost, we could lose the on-field authenticity associated with our products, and we may be required to modify and substantially increase our marketing investments. In addition, because travel and business restrictions related to the COVID-19 pandemic have caused and may continue to cause professional and collegiate athletics and other sporting events to be cancelled or delayed, we may not realize the expected benefits of these relationships. As a result, our brand image, net revenues, expenses and profitability could be materially adversely affected.
If we encounter problems with our distribution system, our ability to deliver our products to the market could be adversely affected.
We rely on a limited number of distribution facilities for our product distribution. Our distribution facilities utilize computer controlled and automated equipment, which means the operations are complicated and may be subject to a number of risks related to security or computer viruses or malware, the proper operation of software and hardware, power interruptions or other system failures. In addition, because many of our products are distributed from a limited number of locations, our operations could also be interrupted by severe weather conditions, floods, fires or other natural disasters in these locations, as well as labor or other operational difficulties or interruptions, including public health crises or disease epidemics. For example, the current COVID-19 pandemic may impede our ability to operate our distribution facilities at full capacity and may similarly impact our third-party logistics providers. We maintain business interruption insurance, but it may not adequately protect us from the adverse effects that could be caused by significant disruptions in our distribution facilities or from all types of events causing such disruptions. Significant disruptions could lead to loss of customers or an erosion of our brand image. In addition, our distribution capacity is dependent on the timely performance of services by third parties. This includes the shipping of product to and from our distribution facilities, as well as partnering with third-party distribution facilities in certain regions where we do not maintain our own facilities. From time to time, certain of our partners have experienced and may continue to experience disruptions to their operations, including cyber-related disruptions and disruptions related to the COVID-19 pandemic. If we or our partners encounter such problems, our results of operations, as well as our ability to meet customer expectations, manage inventory, complete sales and achieve objectives for operating efficiencies could be materially adversely affected.
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We rely significantly on information technology and any failure, inadequacy or interruption of that technology could harm our ability to effectively operate our business.
We rely on our own and our vendors' information technology throughout our business operations, including to design, forecast and order product, manage and maintain our inventory and internal reports, manage sales and distribution, operate our e-commerce website and mobile applications, process transactions, manage retail operations and other key business activities. We also communicate electronically throughout the world with our employees and with third parties, such as customers, suppliers, vendors and consumers. Our operations are dependent on the reliable performance of these systems and technologies and their underlying technical infrastructure, which incorporate complex software. Any of these information systems could fail or experience a service interruption for a number of reasons, including computer viruses, ransomware or other malware, programming errors, hacking or other unlawful activities, disasters or a failure to properly maintain system redundancy or protect, repair, maintain or upgrade the systems. For example, in 2021, a remote code execution vulnerability in Apache log4j was identified as affecting large amounts of systems worldwide, including ours. We have not experienced any material operational disruptions related to this event.
From time to time we have experienced, and may continue to experience, operational disruption due to attacks on our systems and those of our vendors. Although we maintain certain business continuity plans, there can be no assurance that our business continuity plans, or those of our vendors, will anticipate all material risks that may arise or will effectively resolve the issues in a timely manner or adequately protect us from the adverse effects that could be caused by significant disruptions in key information technology. The failure of these systems to operate effectively or to integrate with other systems, or a breach in security of these systems could cause delays in product fulfillment and reduced efficiency of our operations, lost sales, the exposure of sensitive business of personal information and damage to the reputation of our brand. Depending on the system and scope of disruption, in some instances a service interruption or shutdown could have a material adverse impact on our operating activities or results of operations. Remediation and repair of any failure, problem or breach of our key systems or known potential vulnerabilities could require significant capital investments, as well as divert resources and management attention from key projects or initiatives.
We also heavily rely on information systems to process financial and accounting information for financial reporting purposes. If we experience any significant disruption to our financial information systems that we are unable to mitigate, our ability to timely report our financial results could be impacted, which could negatively impact our stock price.
Our future success is substantially dependent on the continued service of our senior management and other key employees, and our continued ability to attract and retain highly talented new team members.
Our future success is substantially dependent on the continued service of our senior management, particularly Kevin A. Plank, our founder, Executive Chairman and Brand Chief, Patrik Frisk, our Chief Executive Officer and President, other top executives and key employees who have substantial experience and expertise in our business, including product creation, innovation, sales, marketing, supply chain, informational technology, operational and other support personnel. The loss of the services of our senior management or other key employees could make it more difficult to successfully operate our business and achieve our business goals and could result in harm to key customer relationships, loss of key information, expertise or know-how and unanticipated recruitment and training costs.
In addition, to profitably grow our business and manage our operations, we will need to continue to attract, retain and motivate highly talented management and other employees with a range of skills, backgrounds and experiences. Competition for employees in our industry is intense and in Fiscal 2021, we experienced the effects of increased employee turnover that impacted global labor markets in many of our key operating jurisdictions. Additionally, adoption of new work models and requirements about when or how often employees work on-site or remotely may present new challenges. As certain jobs and employers increasingly operate remotely, traditional geographic competition for talent may change in ways that cannot be fully predicted at this time, If we are unable to attract, retain and motivate management and other employees with the necessary skills, we may not be able to grow or successfully operate our business and achieve our long-term objectives. In addition, we have invested significant time and resources in building, maintaining and evolving our company culture and our values, which we believe to be critical to our future success. Failure to maintain and continue to evolve our culture could negatively affect our ability to attract, retain and motivate talented management and employees and to achieve our long-term objectives.
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Financial Risks
Our credit agreement contains financial covenants, and both our credit agreement and debt securities contain other restrictions on our actions, which could limit our operational flexibility or otherwise adversely affect our financial condition.
We have, from time to time, financed our liquidity needs in part from borrowings made under our credit facility and the issuance of debt securities. Our Senior Notes limit our ability to, subject to certain significant exceptions, incur secured debt and engage in sale leaseback transactions. Our amended credit agreement contains negative covenants that, subject to significant exceptions limit our ability, among other things to incur additional indebtedness, make restricted payments, sell or dispose of assets, pledge assets as security, make investments, loans, advances, guarantees and acquisitions, undergo fundamental changes and enter into transactions with affiliates. In addition, we must maintain a certain leverage ratio and interest coverage ratio as defined in the amended credit agreement. Our ability to continue to borrow amounts under our amended credit agreement is limited by continued compliance with these financial covenants, and in the past we have amended our credit agreement to provide certain relief from and revisions to our financial covenants for specified periods to provide us with sufficient access to liquidity during those periods. Failure to comply with these operating or financial covenants could result from, among other things, changes in our results of operations or general economic conditions. These covenants may restrict our ability to engage in transactions that would otherwise be in our best interests. Failure to comply with any of the covenants under the amended credit agreement or our Senior Notes could result in a default, which could negatively impact our access to liquidity.
In addition, the amended credit agreement includes a cross default provision whereby an event of default under certain other debt obligations (including our debt securities) will be considered an event of default under the amended credit agreement. If an event of default occurs, the commitments of the lenders under the amended credit agreement may be terminated and the maturity of amounts owed may be accelerated. Our debt securities include a cross acceleration provision which provides that the acceleration of certain other debt obligations (including our credit agreement) will be considered an event of default under our debt securities and, subject to certain time and notice periods, give bondholders the right to accelerate our debt securities.
We may need to raise additional capital to manage and grow our business, and we may not be able to raise capital on terms acceptable to us or at all.
Managing and growing our business will require significant cash outlays and capital expenditures and commitments. We have utilized cash on hand and cash generated from operations, accessed our credit facility and issued debt securities as sources of liquidity. For example, during the first and second quarters of Fiscal 2020, our cash generated from operations was negatively impacted due to widespread temporary store closures as a result of the COVID-19 pandemic. As of December 31, 2021, our cash and cash equivalents totaled $1.7 billion. However, if in future periods our cash on hand, cash generated from operations and availability under our credit agreement are not sufficient to meet our cash requirements, we will need to seek additional capital, potentially through debt or equity financing, to fund our operations and future growth, and we may be unable to obtain debt and/or equity financing on favorable terms or at all. Our ability to access the credit and capital markets in the future as a source of liquidity, and the borrowing costs associated with such financing, are dependent upon market conditions and our credit rating and outlook. Our credit ratings have been downgraded in the past, and we cannot assure that we will be able to maintain our current ratings, which could increase our cost of borrowing in the future. In addition, equity financing may be on terms that are dilutive or potentially dilutive to our stockholders, and the prices at which new investors would be willing to purchase our securities may be lower than the current price per share of our common stock. The holders of new securities may also have rights, preferences or privileges which are senior to those of existing holders of common stock. If new sources of financing are required, but are insufficient or unavailable, we will be required to modify our growth and operating plans based on available funding, if any, which would harm our ability to grow our business.
Our operating results are subject to seasonal and quarterly variations in our net revenues and income from operations, which could adversely affect the price of our publicly traded common stock.
We have experienced, and expect to continue to experience, seasonal and quarterly variations in our net revenues and income or loss from operations. The majority of our net revenues are historically generated during the last two quarters of the calendar year. Our quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including the timing of our customer orders, our ability to timely delivery, the timing of marketing expenses and changes in our product mix. As a result of these seasonal and quarterly fluctuations, we
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believe that comparisons of our operating results between different quarters within a single year are not necessarily meaningful and that these comparisons cannot be relied upon as indicators of our future performance. Any seasonal or quarterly fluctuations that we report in the future may not match the expectations of market analysts and investors. This could cause the price of our publicly traded stock to fluctuate significantly.
Our results of operations are affected by the performance of our equity investments, over which we do not exercise control.
We maintain certain minority investments, and may in the future invest in additional minority investments, which we account for under the equity method, and are required to recognize our allocable share of its net income or loss in our Consolidated Financial Statements. Our results of operations are affected by the performance of these businesses, over which we do not exercise control, and our net income or loss may be negatively impacted by losses realized by these investments. For example, we have previously recognized losses related to our Japanese licensee’s business. We are also required to regularly review our investments for impairment, and an impairment charge may result from the occurrence of adverse events or management decisions that impact the fair value or estimated future cash flows to be generated from our investments. In addition, to the extent our Japanese licensee continues to experience challenges in the performance of its business, we may not continue to realize the licensing revenues from our Japanese licensee in line with its past results, which could negatively impact our net revenues and results of operations. Furthermore, based on its financial performance, our ability to recover our investment in the long term may be limited.
Our financial results could be adversely impacted by currency exchange rate fluctuations.
During Fiscal 2021, we generated approximately 33% of our consolidated net revenues outside the United States. As our international business grows, our results of operations could be adversely impacted by changes in foreign currency exchange rates. Revenues and certain expenses in markets outside of the United States are recognized in local foreign currencies, and we are exposed to potential gains or losses from the translation of those amounts into U.S. dollars for consolidation into our financial statements. Similarly, we are exposed to gains and losses resulting from currency exchange rate fluctuations on transactions generated by our foreign subsidiaries in currencies other than their local currencies. In addition, the business of our independent manufacturers may also be disrupted by currency exchange rate fluctuations by making their purchases of raw materials more expensive and more difficult to finance. As a result, foreign currency exchange rate fluctuations may adversely impact our results of operations. In addition, we have previously designated cash flow hedges against certain forecasted transactions. If we determine that such a transaction is no longer probable to occur in the time period we expected, we are required to de-designate the hedging relationship and immediately recognize the derivative instrument gain or loss in our earnings. The ongoing impacts of COVID-19 have caused and may continue to cause uncertainty in forecasted cash flows, which has resulted and may continue to result in the de-designation of certain hedged transactions.
Legal, Regulatory and Compliance Risks
Our business is subject to a wide array of laws and regulations, and our failure to comply with these requirements could lead to investigations or actions by government regulators, increased expense or reputational damage.
Our business is subject to a wide array of laws and regulations, including those addressing consumer protection, safety, labeling, distribution, importation, environmental matters, the marketing and sale of our products and other matters. These requirements are enforced by various federal agencies, including the Federal Trade Commission, Consumer Product Safety Commission and state attorneys general in the United States, as well as by various other federal, state, provincial, local and international regulatory authorities in the locations in which our products are distributed or sold. If we fail to comply with these regulations, we could become subject to significant penalties or claims or be required to stop selling or otherwise recall products, which could negatively impact our results of operations and disrupt our ability to conduct our business, as well as damage our brand image with consumers. In addition, the adoption of new legislation, regulations or industry standards, including related to climate change, or changes in the interpretation of existing regulations may result in significant unanticipated compliance costs or discontinuation of product sales and may impair the marketing of our products, resulting in significant loss of net revenues.
Our international operations are also subject to compliance with the U.S. Foreign Corrupt Practices Act, or FCPA, and U.S. sanctions laws, as well as other anti-bribery and sanctions laws of foreign jurisdictions where we
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conduct business. Although we have policies and procedures to address compliance with the FCPA and similar laws and sanctions requirements, there can be no assurance that all of our employees, contractors, agents and other partners will not take actions in violations of our policies or that our procedures will effectively mitigate against such risks. Any such violation could subject us to sanctions or other penalties that could negatively affect our reputation, business and operating results.
Data security or privacy breaches could damage our reputation, cause us to incur additional expense, expose us to litigation and adversely affect our business and results of operations.
We collect sensitive and proprietary business information as well as personally identifiable information in connection with digital marketing, digital commerce, our in-store payment processing systems and our digital business (including our MapMyFitness platform). We collect and store a variety of information regarding our consumers, and on some of our platforms allow users to share their personal information with each other and with third parties. We also rely on third parties for the operation of certain of our e-commerce websites, and do not control these service providers. Like other companies in our industry, we have in the past experienced, and we expect to continue to experience, cyberattacks, including phishing, cyber fraud incidents and other attempts to gain unauthorized access to our systems. These attempted attacks have increased as COVID-19 has progressed and many employees continue to work from home. To date, these attacks have not had a material impact on our operations, but there can be no assurance that they will not have an impact in the future. Any breach of our data security or that of our service providers could result in an unauthorized release or transfer of customer, consumer, vendor or employee information, or the loss of money, valuable business data or cause a disruption in our business. These events could give rise to unwanted media attention, damage our reputation, damage our customer, consumer or user relationships and result in lost sales, fines or lawsuits. We may also be required to expend significant capital and other resources to protect against or respond to or alleviate problems caused by a security breach, which could negatively impact our results of operations.
We must also comply with increasingly complex and evolving regulatory standards throughout the world enacted to protect personal information and other data, including the General Data Protection Regulation, the ePrivacy Directive, the California Consumer Privacy Act, the California Privacy Rights Act, the Virginia Consumer Data Privacy Act, the Colorado Privacy Act and the Personal Information Protection Law in China. These laws and related regulations impact our ability to engage with our consumers, and some of these privacy laws prohibit the transfer of personal information to certain other jurisdictions. Compliance with existing laws and regulations can be costly and could negatively impact our profitability. Moreover, data privacy laws and regulations continue to evolve and it may be costly for us to adjust our operations to comply with new requirements. Regulatory bodies throughout the world have increased enforcement efforts against companies who fail to comply with privacy requirements. Failure to comply with these regulatory standards could result in a violation of data privacy laws and regulations and subject us to legal proceedings against us by governmental entities or others, imposition of fines by governmental authorities, negative publicity and damage to our brand image, all of which could have a negative impact on our profitability.
Changes in tax laws and unanticipated tax liabilities could adversely affect our effective income tax rate and profitability.
We are subject to income taxes in the United States and numerous foreign jurisdictions. Our effective income tax rate could be adversely affected in the future by a number of factors, including changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in tax laws and regulations or their interpretations and application, the outcome of income tax audits in various jurisdictions around the world, and any repatriation of non-U.S. earnings for which we have not previously provided applicable foreign withholding taxes, certain U.S. state income taxes, or foreign exchange rate impacts.
Moreover, we also engage in multiple types of intercompany transactions, and our allocation of profits and losses among us and our subsidiaries through our intercompany transfer pricing arrangements are subject to review by the Internal Revenue Service and foreign tax authorities. Although we believe we have clearly reflected the economics of these transactions in accordance with current rules and regulations, which are generally consistent with the arms-length standard, and the proper documentation is in place, tax authorities may propose and sustain adjustments that could result in changes that may materially impact our tax provision.
Additionally, many countries have implemented legislation and other guidance to align their international tax rules with the Organization for Economic Co-operation and Development’s (“OECD”) Base Erosion and Profit Shifting recommendations and action plan, which aim to standardize and modernize global corporate tax policy and include changes to cross-border tax, transfer pricing documentation rules and nexus-based tax incentive practices.
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As a result of this heightened scrutiny, we may experience an increase in income tax audits and prior decisions by tax authorities regarding treatments and positions of corporate income taxes could be subject to enforcement activities and/or legislative investigation, which could also result in changes in tax policies or prior tax rulings. Any such activities may result in the taxes we previously paid being subject to change, which could have a material impact on our tax provision.
Further, the U.S. House of Representatives passed the Build Back Better Act in November 2021 and the U.S. Senate Finance Committee has drafted similar legislation. If these or similar legislation is enacted in the United States, it could materially and adversely impact our tax provision, cash tax liability and effective tax rate.
In addition, member states of the OECD are continuing discussions surrounding fundamental changes to the taxing rights of governments and allocation of profits among tax jurisdictions in which companies do business. Specifically, the OECD has proposed rules intended to provide governments new taxing rights over the digital economy and specified digital services as well as the implementation of a global minimum tax (“Pillar One” and “Pillar Two,” respectively). The enactment of the Pillar One and/or Pillar Two Model Rules in jurisdictions where we have operations may have a material impact on our global transfer pricing arrangements and a materially adverse impact on our tax provision, cash tax liability and effective tax rate.
Failure to protect our intellectual property rights, or our conflict with the rights of others, could damage our brand, weaken our competitive position and negatively impact our results of operations.
Our success depends in large part on our brand image. We currently rely on a combination of copyright, trademark, trade dress, patent, anti-counterfeiting and unfair competition laws, confidentiality procedures and licensing arrangements to establish and protect our intellectual property rights. The steps taken by us to protect our proprietary rights may not be adequate to prevent infringement of our trademarks and proprietary rights by others, including imitation of our products and misappropriation of our brand and intellectual property protection may be unavailable or limited in some jurisdictions. In addition, intellectual property rights in the technology, fabrics and processes used to manufacture the majority of our products are generally owned or controlled by our suppliers and are generally not unique to us, and our current and future competitors are able to manufacture and sell products with performance characteristics and fabrications similar to certain of our products.
From time to time, we have brought claims relating to the enforcement of our intellectual property rights against others or have discovered unauthorized products in the marketplace that are either counterfeit reproductions of our products or unauthorized irregulars that do not meet our quality control standards. If we fail to protect, maintain and enforce our intellectual property rights, the value of our brand could decrease and our competitive position may suffer. In addition, from time to time others may seek to enforce infringement claims against us. Successful infringement claims against us could result in significant monetary liability or prevent us from selling or providing some of our products. The resolution of such claims may require us to pull product from the market, redesign our products, license rights belonging to third parties or cease using those rights altogether. Any of these events could harm our business and have a material adverse effect on our results of operations and financial condition.
We are the subject of a number of ongoing legal proceedings that have resulted in significant expense, and adverse developments in our ongoing proceedings and/or future legal proceedings could have a material adverse effect on our business, reputation, financial condition, results of operations or stock price.
We are actively involved in a variety of litigation and other legal matters and may be subject to additional litigations, investigations, arbitration proceedings, audits, regulatory inquiries and similar actions, including matters related to commercial disputes, intellectual property, employment, securities laws, disclosures, environmental, tax, accounting, class action and product liability, as well as trade, regulatory and other claims related to our business and our industry, which we refer to collectively as legal proceedings. For example, we are subject to an ongoing securities class action proceeding regarding our prior disclosures (including regarding the use of "pull forward" sales) and derivative complaints regarding related matters, as well as past related party transactions, among other legal proceedings. Refer to Note 9 to our Consolidated Financial Statements of this Annual Report on Form 10-K for additional information regarding these specific matters.
Legal proceedings in general, and securities and class action litigation and regulatory investigations in particular, can be expensive and disruptive. We cannot predict the outcome of any particular legal proceeding, or whether ongoing legal proceedings will be resolved favorably or ultimately result in charges or material damages, fines or other penalties. Our insurance may not cover all claims that may be asserted against us, and we are unable to predict how long the legal proceedings to which we are currently subject will continue. An unfavorable outcome of any legal proceeding may have an adverse impact on our business, financial condition and results of operations or
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our stock price. Any legal proceeding could negatively impact our reputation among our customers or our shareholders. Furthermore, publicity surrounding ongoing legal proceedings, even if resolved favorably for us, could result in additional legal proceedings against us, as well as damage our brand image.
Risks Related to our Common Stock
Kevin Plank, our Executive Chairman and Brand Chief, controls the majority of the voting power of our common stock.
Our Class A common stock has one vote per share, our Class B common stock has 10 votes per share and our Class C common stock has no voting rights (except in limited circumstances). Our Executive Chairman and Brand Chief, Kevin A. Plank, beneficially owns all outstanding shares of Class B common stock. As a result, Mr. Plank has the majority voting control and is able to direct the election of all of the members of our Board of Directors and other matters we submit to a vote of our stockholders. Under certain circumstances, the Class B common stock automatically converts to Class A common stock, which would also result in the conversion of our Class C common stock into Class A common stock. As specified in our charter, these circumstances include when Mr. Plank beneficially owns less than 15.0% of the total number of shares of Class A and Class B common stock outstanding, if Mr. Plank were to resign as an Approved Executive Officer of the Company (or was otherwise terminated for cause) or if Mr. Plank sells more than a specified number of any class of our common stock within a one-year period. This concentration of voting control may have various effects including, but not limited to, delaying or preventing a change of control or allowing us to take action that the majority of our stockholders do not otherwise support. In addition, we utilize shares of our Class C common stock to fund employee equity incentive programs and may do so in connection with future stock-based acquisition transactions, which could prolong the duration of Mr. Plank’s voting control.
The trading prices for our Class A and Class C common stock may differ and fluctuate from time to time.
The trading prices of our Class A and Class C common stock may differ and fluctuate from time to time in response to various factors, some of which are beyond our control. These factors may include, among others, overall performance of the equity markets and the economy as a whole, variations in our quarterly results of operations or those of our competitors, our ability to meet our published guidance and securities analyst expectations, or recommendations by securities analysts. In addition, our non-voting Class C common stock has traded at a discount to our Class A common stock, and there can be no assurance that this will not continue.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2. PROPERTIES
The following includes a summary of the principal properties that we own or lease as of December 31, 2021.
Our principal executive and administrative offices are located at an office complex in Baltimore, Maryland, the majority of which we own and a portion of which we lease. We also own office space and undeveloped acreage near our office complex which we are in the process of renovating and further developing. We expect to move our principal executive and administrative offices to this location by late 2024. For each of our EMEA, Latin America and Asia Pacific headquarters, we lease office space.
We lease our primary distribution facilities, which are located in Sparrows Point, Maryland, Mount Juliet, Tennessee and Rialto, California. Combined, these facilities represent approximately 3.5 million square feet of facility space. These leases expire at various dates, with the earliest lease termination date through May 2023. We believe our distribution facilities and space available through our third-party logistics providers will be adequate to meet our short term needs.
In addition, as of December 31, 2021, we leased 422 Brand and Factory House stores located primarily in the United States, China, Canada, Mexico, Malaysia, Australia and Korea with lease end dates in 2022 through 2035. We also lease additional office space for sales, quality assurance and sourcing, marketing and administrative
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functions. We anticipate that we will be able to extend these leases that expire in the near future on satisfactory terms or relocate to other locations.
ITEM 3. LEGAL PROCEEDINGS
From time to time, we have been involved in litigation and other proceedings, including matters related to commercial disputes and intellectual property, as well as trade, regulatory and other claims related to our business. See Note 9 to our Consolidated Financial Statements for information on certain legal proceedings, which is incorporated by reference herein.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
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PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Under Armour’s Class A Common Stock and Class C Common Stock are traded on the New York Stock Exchange (“NYSE”) under the symbols “UAA” and "UA", respectively. As of February 14, 2022, there were 2,405 record holders of our Class A Common Stock, 5 record holders of Class B Convertible Common Stock which are beneficially owned by our Executive Chairman and Brand Chief, Kevin A. Plank, and 1,676 record holders of our Class C Common Stock.
Our Class A Common Stock was listed on the NYSE under the symbol “UA” until December 6, 2016 and under the symbol "UAA" since December 7, 2016. Prior to November 18, 2005, there was no public market for our Class A Common Stock. Our Class C Common Stock was listed on the NYSE under the symbol “UA.C” since its initial issuance on April 8, 2016 until December 6, 2016 and under the symbol "UA" since December 7, 2016.
Dividends
No cash dividends were declared or paid during Fiscal 2021 or Fiscal 2020 on any class of our common stock. We currently anticipate we will retain future earnings for use in our business. As a result, we do not anticipate paying any cash dividends in the foreseeable future. However, if we were to consider declaring a cash dividend to our stockholders, we may be limited in our ability to do so under our credit facility. Refer to “Financial Position, Capital Resources and Liquidity” within Management’s Discussion and Analysis and Note 8 to the Consolidated Financial Statements for a further discussion of our credit facility.
Stock Compensation Plans
See Item 12 "Security Ownership of Certain beneficial Owners and Management and Related Stockholder Matters" for information regarding our equity compensation plans.
Stock Performance Graph
The stock performance graph below compares cumulative total return on Under Armour, Inc. Class A Common Stock to the cumulative total return of the S&P 500 Index and S&P 500 Apparel, Accessories and Luxury Goods Index from December 31, 2016 through December 31, 2021. The graph assumes an initial investment of $100 in Under Armour and each index as of December 31, 2016 and reinvestment of any dividends. The performance shown on the graph below is not intended to forecast or be indicative of possible future performance of our common stock.
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ITEM 6. [RESERVED]
Not applicable.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to help readers understand our results of operations and financial condition, and is provided as a supplement to, and should be read in conjunction with, our Consolidated Financial Statements and the accompanying Notes to our Consolidated Financial Statements under Part II, Item 8 and the information contained elsewhere in this Annual Report on Form 10-K under the captions “Risk Factors" and “Business.”
This Annual Report on Form 10-K, including this MD&A, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 21E of the U.S. Securities Exchange Act of 1934, as amended (the Exchange Act), and Section 27A of the U.S. Securities Act of 1933, as amended ("the Securities Act"), and is subject to the safe harbors created by those sections. All statements other than statements of historical facts are statements that could be deemed forward-looking statements. See "Forward Looking Statements."
All dollar and percentage comparisons made herein refer to Fiscal 2021 compared with Fiscal 2020, unless otherwise noted. Please refer to Part II, Item 7 of our Annual Report on Form 10-K for Fiscal 2020, filed with the Securities Exchange Commission ("SEC") on February 24, 2021, for a comparative discussion of our Fiscal 2020 financial results as compared to Fiscal 2019.
OVERVIEW
We are a leading developer, marketer, and distributor of branded performance apparel, footwear, and accessories. Our brand’s moisture-wicking fabrications are engineered in various designs and styles for wear in nearly every climate to provide a performance alternative to traditional products. Our products are sold worldwide and worn by athletes at all levels, from youth to professional, on playing fields around the globe, and by consumers with active lifestyles.
During Fiscal 2021, we realized better than expected wholesale and direct-to-consumer sales based on better sell through and demand for Under Armour products in North America, Asia-Pacific, and EMEA. Throughout Fiscal 2021, we remained focused on the quality of our sales driven by four main strategies, particularly in our North America business: reducing our promotional activities; constraining supply against demand; exiting undifferentiated retail; and maintaining an appropriate level of liquidation sales within our wholesale channel. Strategically and operationally, we remain focused on driving premium brand-right growth and improved profitability. Over the long term, our growth strategy is predicated on delivering industry-leading product innovation; return-driven investments focused on connecting with our consumers through marketing activations and premium experiences; and the expansion of our direct-to-consumer and international businesses.
Fiscal 2021 Performance
Financial highlights for Fiscal 2021 as compared to Fiscal 2020 include:
•Total net revenues increased 27.0%.
•Within our channels, wholesale revenue increased 36.2% and direct-to-consumer revenue increased 25.6%.
•Within our product categories, apparel revenue increased 33.3%, footwear revenue increased 35.3%, and accessories revenue increased 11.5%.
•Net revenue in our North America, EMEA, Asia-Pacific, and Latin-America segments increased 29.4%, 40.8%, 32.3%, and 18.5%, respectively.
•Net revenues from Corporate Other decreased 97.4% primarily due to the sale of the MyFitnessPal platform in December 2020.
•Gross margin increased 200 basis points to 50.3%.
•Selling, general and administrative expenses increased 7.5%.
•Restructuring and impairment charges, net decreased 93.3% from $601.6 million during Fiscal 2020 to $40.5 million during Fiscal 2021.
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COVID-19 Update
The COVID-19 pandemic has caused, and we expect will continue to cause, disruption and volatility in our business and in the businesses of our wholesale customers, licensing partners, suppliers, logistics providers and vendors.
For instance, during Fiscal 2021 the pandemic caused manufacturing challenges, with temporary closures or other restrictions placed on factories, in key sourcing countries in Southeast Asia, including Vietnam, where we source approximately one third of our products, and certain partners continue to operate at reduced capacity. Additionally, the COVID-19 pandemic has caused global logistical challenges, including shipping container shortages, transportation delays, labor shortages and port congestion. These challenges have disrupted some of our normal inbound and outbound inventory flow, which has required us to incur increased freight costs, and are impacting the timing of sales to some of our customers as we work to manage product availability and inventory levels and in certain cases adjust orders and shipping with our factory partners and logistic suppliers. Simultaneously, freight and logistics costs have significantly increased throughout global supply chains. We expect that these manufacturing and sourcing challenges will continue into the next few quarters and will negatively impact our financial results, resulting in delayed sales to certain of our wholesale customers as well as unfulfilled demand or cancelled sales. We also expect gross margin to be negatively impacted due to increased freight costs and logistics costs over the next few quarters.
Moreover, governments worldwide continue to periodically impose preventative and protective actions, such as temporary travel bans, forced business closures, and stay-at-home orders, all in an effort to reduce the spread of the virus. However, such government measures are not implemented consistently or simultaneously around the world, thus making our business susceptible to volatility on a global and regional basis. We believe we may continue to experience varying degrees of volatility, business disruptions and periods of closure of our stores, distribution centers and corporate facilities, although, as of December 31, 2021, substantially all of our Brand and Factory House stores and the stores of our wholesale customers were open. Where reopening has been permitted, some of these retail stores are operating with restrictive and precautionary measures in place such as reduced operating hours, physical distancing, enhanced cleaning and sanitation, and limited occupancy levels.
The COVID-19 pandemic and related disruptions across the global supply chain and retail environment, remains a risk that could have material adverse impacts to our future revenue growth as well as to our overall profitability. The extent of the impact of the COVID-19 pandemic on our operational and financial performance depends on future developments that are outside of our control. For a more complete discussion of the COVID-19 related risks facing our business, refer to our "Risk Factors" section included in Item 1A of this Annual Report on Form 10-K.
In connection with global legislation, including the Coronavirus Aid, Relief, and Economic Security ("CARES") Act, we recognized certain incentives totaling $2.5 million for Fiscal 2021, and $9.0 million for Fiscal 2020. The incentives were recorded as a reduction of the associated costs which we incurred within selling, general and administrative expenses in the Consolidated Statements of Operations.
Effects of Inflation
Despite recent heightened inflation in key global markets, including the United States, we do not believe that inflation had a material impact on our results of operations in Fiscal 2021 or Fiscal 2020. However, our business could be impacted by continued or increasing inflation in future periods. See "Risk Factors—Economic and Industry Risks—Our business depends on consumer purchases of discretionary items, which can be negatively impacted during an economic downturn or periods of inflation. This could materially harm our sales, profitability and financial condition" and "—Fluctuations in the cost of raw materials and commodities we use in our products and costs related to our supply chain could negatively affect our operating results" included in Item 1A of this Annual Report on Form 10-K.
Segment Presentation and Marketing
As previously disclosed, effective January 1, 2021, we no longer report Connected Fitness as a discrete reportable operating segment. Corporate Other now includes the remaining Connected Fitness business consisting of our MapMyRun and MapMyRide platforms (collectively "MMR") for Fiscal 2021 and the entire Connected Fitness business for Fiscal 2020. Please refer to Note 1to our Consolidated Financial Statements for a basis of our presentation and to Note 19to our Consolidated Financial Statements for a complete presentation of the segment data. All prior period balances have been recast to conform to current period presentation.
Corporate Other consists primarily of revenue and costs related to our MMR platforms, as well as general and administrative expenses not allocated to an operating segment, including expenses associated with centrally
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managed departments such as global marketing, global IT, global supply chain, innovation, and other corporate support functions; costs related to our global assets and global marketing, costs related to our headquarters; restructuring and impairment related charges; and certain foreign currency hedge gains and losses.
Fiscal Year End Change
During the first quarter of Fiscal 2021, our Board of Directors approved a change in our fiscal year end from December 31 to March 31, effective for the fiscal year beginning April 1, 2022. Because our largest quarters are currently realized in the period from July 1 through December 31, we believe that this change will provide greater alignment with our business cycle and financial reporting. There was no change to Fiscal 2021, which ended on December 31, 2021. Following a three month-transition period (January 1, 2022 - March 31, 2022), our Fiscal 2023 will run from April 1, 2022 through March 31, 2023. Consequently, there will be no Fiscal 2022.
2020 Restructuring
During Fiscal 2020, our Board of Directors approved a restructuring plan ranging between $550.0 million to $600.0 million in costs (the "2020 restructuring plan") designed to rebalance our cost base to further improve profitability and cash flow generation.
Restructuring and related impairment charges and recoveries require us to make certain judgments and estimates regarding the amount and timing as to when these charges or recoveries occur. The estimated liability could change subsequent to its recognition, requiring adjustments to the expense and the liability recorded. On a quarterly basis, we conduct an evaluation of the related liabilities and expenses and may revise our assumptions and estimates as appropriate, as new or updated information becomes available. As of December 31, 2021, we currently estimate total restructuring and related charges associated with the 2020 restructuring plan will range between $525.0 million to $550.0 million.
The restructuring and related charges primarily consist of up to approximately:
•$172.0 million of cash restructuring charges, of which approximately $26.0 million relates to employee severance and benefit costs, $14.0 million relates to facility and lease termination costs and $132.0 million relates to contract termination and other restructuring costs; and
•$378.0 million of non-cash charges, of which approximately $293.0 million relates to an impairment charge on our New York City flagship store and $85.0 million relates to intangibles and other asset related impairments.
We recorded $41.0 million of restructuring and related impairment charges for Fiscal 2021 and $472.7 million for Fiscal 2020, under the 2020 restructuring plan. For more details on the 2020 restructuring plan, see Note 12 to our Consolidated Financial Statements.
We expect to recognize any remaining charges related to this plan by the end of the first quarter of Fiscal 2023.
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RESULTS OF OPERATIONS
The following tables set forth key components of our results of operations for the periods indicated, both in dollars and as a percentage of net revenues:
Year ended December 31,
Income (loss) from equity method investments 1,255 $ (7,246) $ (47,679)
Year ended December 31,
Selling, general and administrative expenses 41.1 % 48.5 % 42.4 %
Restructuring and impairment charges 0.7 % 13.4 % — %
Income (loss) from operations 8.6 % (13.7) % 4.5 %
Interest income (expense), net (0.8) % (1.1) % (0.4) %
Other income (expense), net (0.9) % 3.8 % (0.1) %
Income (loss) before income taxes 6.9 % (11.0) % 4.0 %
Income tax expense (benefit) 0.6 % 1.1 % 1.3 %
Loss from equity method investment — % (0.2) % (0.9) %
Net income (loss) 6.3 % (12.3) % 1.7 %
Revenues:
Net revenues consist of net sales, license revenues, and revenues from digital subscriptions, sale of digital assets and advertising. Net sales consist of sales from apparel, footwear and accessories products. Our license revenues primarily consist of fees paid to us by licensees in exchange for the use of our trademarks on their products. Net revenues by product category are summarized below for the periods indicated:
Year ended December 31,
(In thousands) 2021 2020 $ Change % Change 2019 $ Change % Change
(1) Corporate Other primarily includes foreign currency hedge gains and losses related to revenues generated by entities within our operating segments but managed through our central foreign exchange risk management program. Effective January 1, 2021, included within Corporate
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Other is the operating results of the remaining Connected Fitness business consisting of MMR for Fiscal 2021 and the entire Connected Fitness for Fiscal 2020 and Fiscal 2019. All prior periods were recast to conform to the current period presentation. Such reclassifications did not affect total consolidated revenues, consolidated income from operations or consolidated net income (see Note 1 to our Consolidated Financial Statements).
Net sales
Net sales increased by $1,336.3 million, or 31.6%, to $5,567.3 million in Fiscal 2021 from $4,231.0 million in Fiscal 2020, primarily driven by increased unit sales across all our product categories. These increases as compared to Fiscal 2020 were primarily due to the significant COVID-19 disruptions we experienced during Fiscal 2020, including cancellations of orders by our wholesale partners and closures of retail stores. Net sales growth for Fiscal 2021 was also impacted by previously disclosed changes to customer order flow and supply chain timing resulting in sales shifting from the fourth quarter of Fiscal 2020 to the first quarter of Fiscal 2021. Net sales for Fiscal 2021 increased 12% compared to Fiscal 2019.
License revenues
License revenues increased by $6.8 million, or 6.5%, to $112.6 million in Fiscal 2021, from $105.8 million in Fiscal 2020, driven by higher demand and improved business and financial conditions of our licensees. The increased revenue was primarily from our licensing partners in North America, as this region continues to recover from the impacts of COVID-19.
Corporate Other revenues
Revenues from Corporate Other decreased by $134.3 million in Fiscal 2021, primarily due to the sale of MyFitnessPal in December 2020. See Note 1 to our Consolidated Financial Statements for more details.
Gross Profit
Cost of goods sold consists primarily of product costs, inbound freight and duty costs, outbound freight costs, handling costs to make products floor-ready to customer specifications, royalty payments to endorsers based on a predetermined percentage of sales of selected products, and write downs for inventory obsolescence. In general, as a percentage of net revenues, we expect cost of goods sold associated with our apparel and accessories to be lower than that of our footwear. A limited portion of cost of goods sold is associated with digital subscription and advertising revenues, primarily website hosting costs, and no cost of goods sold is associated with our license revenues.
We include outbound freight costs associated with shipping goods to customers as cost of goods sold; however, we include the majority of outbound handling costs as a component of selling, general and administrative expenses. As a result, our gross profit may not be comparable to that of other companies that include outbound handling costs in their cost of goods sold. Outbound handling costs include costs associated with preparing goods to ship to customers and certain costs to operate our distribution facilities. These costs were $82.9 million and $80.5 million for Fiscal 2021 and Fiscal 2020, respectively.
Gross profit increased by $701.4 million to $2,861.5 million in Fiscal 2021, as compared to $2,160.1 million in Fiscal 2020. Gross profit as a percentage of net revenues, or gross margin, increased 210 basis points to 50.3%, compared to 48.3% in Fiscal 2020.
This increase in gross margin was primarily driven by the following benefits:
•approximately 360 basis points of pricing improvements driven by lower promotional activity within our direct-to-consumer channel, favorable pricing related to liquidation sales and lower promotions and markdowns across our wholesale channel; and
•approximately 40 basis points from changes in foreign currency.
These benefits were partially offset by the following negative impacts:
•approximately 110 basis points related to the absence of MyFitnessPal, which was sold in December 2020;
•approximately 50 basis points related to supply chain impacts as benefits in product costs were more than offset by higher inbound freight and logistics costs due to COVID-19-related supply chain pressures; and
•approximately 30 basis points related to channel mix as benefits of lower liquidation sales were more than offset by lower e-commerce and a higher distributor sales.
We expect freight costs to continue negatively impacting our gross margin for the next few quarters.
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Selling, General and Administrative Expenses
Our selling, general and administrative expenses consist of costs related to marketing, selling, product innovation and supply chain, and corporate services. We consolidate our selling, general and administrative expenses into two primary categories: marketing and other. The other category is the sum of our selling, product innovation and supply chain, and corporate services categories. The marketing category consists primarily of sports and brand marketing, media, and retail presentation. Sports and brand marketing includes professional, club and collegiate sponsorship agreements, individual athlete and influencer agreements, and providing and selling products directly to teams and individual athletes. Media includes digital, broadcast, and print media outlets, including social and mobile media. Retail presentation includes sales displays and concept shops and depreciation expense specific to our in-store fixture programs. Our marketing costs are an important driver of our growth.
Year ended December 31,
(In thousands) 2021 2020 $ Change % Change 2019 $ Change % Change
Selling, general and administrative expenses increased by$162.8 million, or 7.5%,to $2,334.7 million in Fiscal 2021, as compared to $2,171.9 million in Fiscal 2020. Within selling, general and administrative expense:
•Marketing costs increased $98.8 million or 18.0%, primarily due to reduced marketing activity in the prior fiscal year due to the COVID-19 pandemic. This increase was partially offset by reductions in fees associated with sports marketing assets. As a percentage of net revenues, marketing costs decreased to 11.4% from 12.3% in Fiscal 2020.
•Other costs increased $64.0 million or 3.9%, primarily driven by higher incentive compensation, non salaried wages, retail facility expenses, and a general increase in business activities in Fiscal 2021, as compared to Fiscal 2020, which was more severely impacted by COVID-19. These increases were partially offset by lower legal and depreciation expense. As a percentage of net revenues, other costs decreased to 29.7% from 36.2% in Fiscal 2020.
As a percentage of net revenues, selling, general and administrative expenses decreased to 41.1% as compared to 48.5% in Fiscal 2020.
Restructuring and Impairment Charges
Year ended December 31,
(In thousands) 2021 2020 $ Change % Change 2019 $ Change % Change
Restructuring and impairment charges within our operating expenses were $40.5 million and $601.6 million in Fiscal 2021 and Fiscal 2020, respectively. Included in the prior fiscal year was $141.2 million of long-lived asset and goodwill impairment charges, as well as a right of use asset impairment charge of $290.8 million relating to our flagship store in New York City.
Income (Loss) from Operations
Year ended December 31,
(In thousands) 2021 2020 $ Change % Change 2019 $ Change % Change
Income from operations increased by $1,099.7 million to $486.3 million in Fiscal 2021. The increase in income from operations was driven primarily by increased revenues along with significantly lower restructuring and impairment charges compared to the prior fiscal year.
Interest Expense, Net
Interest expense, net is primarily comprised of interest incurred on our debt facilities, offset by interest income earned on our cash and cash equivalents.
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Year ended December 31,
(In thousands) 2021 2020 $ Change % Change 2019 $ Change % Change
Interest expense, net decreased by $3.0 million to $44.3 million in Fiscal 2021, as compared to $47.3 million in Fiscal 2020. The decrease was primarily due to a reduction in interest expense related to borrowings on our revolving credit facility which were drawn on in the prior fiscal year, and a reduction in interest expense on our Convertible Senior Notes as a result of our repurchase of approximately $419.1 million in aggregate principal amount during Fiscal 2021, partially offset by higher interest expense on our Convertible Senior Notes resulting from the full year impact of interest expense associated with our Convertible Senior Notes issued in May 2020. See Note 8 to our Consolidated Financial Statements.
Other Income (Expense)
Other income (expense), net primarily consists of unrealized and realized gains and losses on our foreign currency derivative financial instruments, and unrealized and realized gains and losses on adjustments that arise from fluctuations in foreign currency exchange rates relating to transactions generated by our international subsidiaries. Other income (expense), net also includes rent expense relating to lease assets held solely for sublet purposes, primarily the lease related to our New York City flagship store.
Year ended December 31,
(In thousands) 2021 2020 $ Change % Change 2019 $ Change % Change
Other income (expense), net decreased by $219.3 million in Fiscal 2021 as compared to Fiscal 2020. This was primarily due to a gain of $179.3 million on the sale of MyFitnessPal platform in Fiscal 2020. In addition, we recognized a $58.5 million loss upon the extinguishment of an aggregate $419.1 million in principal amount of our Convertible Senior Notes in Fiscal 2021 and a loss of $10.7 million associated with changes in foreign exchange rates. These were partially offset by a $35 million earn out recorded in connection with the sale of the MyFitnessPal platform.
Income Tax Expense
Year ended December 31,
(In thousands) 2021 2020 $ Change % Change 2019 $ Change % Change
Income tax expense decreased by $17.3 million to $32.1 million in Fiscal 2021 as compared to $49.4 million in Fiscal 2020. We recorded 2021 income tax expense on pretax earnings, inclusive of benefits for the reduction in U.S. valuation allowances, compared to 2020 income tax expense on pretax losses, which included the impact of recording valuation allowances for previously recognized deferred tax assets in the U.S. and China.
Income (Loss) from Equity Method Investments
Income from equity method investment increased by $8.5 million to $1.3 million in Fiscal 2021, as compared to a loss of $7.2 million in Fiscal 2020, which was impacted by a $8.6 million impairment of our equity method investment in our Japanese licensee.
SEGMENT RESULTS OF OPERATIONS
Our operating segments are based on how our Chief Operating Decision Maker (“CODM”) makes decisions about allocating resources and assessing performance. Our segments are defined by geographic regions, including North America, EMEA, Asia-Pacific, and Latin America.
Prior to the sale of MyFitnessPal in December 2020, our CODM also received discrete financial information for our Connected Fitness Segment. However, beginning January 1, 2021, we no longer report Connected Fitness as a discrete reportable operating segment. All prior period balances have been recast to conform to current period presentation. Such reclassifications did not affect total consolidated revenues, consolidated income from operations or consolidated net income. See Note 1 to our Consolidated Financial Statements.
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We exclude certain corporate costs from our segment profitability measures. We report these costs within Corporate Other, which is designed to provide increased transparency and comparability of our operating segments performance. The costs included within Corporate Other consists largely of revenue and costs related to our MMR platforms and other digital business opportunities, as well as general and administrative expenses not allocated to an operating segment, including expenses associated with centrally managed departments such as global marketing, global IT, global supply chain and innovation, and other corporate support functions; costs related to our global assets and global marketing; costs related to our headquarters; restructuring and restructuring related charges; and certain foreign currency hedge gains and losses.
The net revenues and operating income (loss) associated with our segments are summarized in the following tables.
Net revenues by segment and Corporate Other:
Year ended December 31,
(In thousands) 2021 2020 $ Change % Change 2019 $ Change % Change
(1)Corporate Other primarily includes foreign currency hedge gains and losses related to revenues generated by entities within our operating segments but managed through our central foreign exchange risk management program. Effective January 1, 2021, included within Corporate Other is the operating results of the remaining Connected Fitness business consisting of our MMR platforms for Fiscal 2021 and the entire Connected Fitness business for Fiscal 2020. All prior period balances were recast to conform to the current period presentation. Such reclassifications did not affect total consolidated revenues, consolidated income from operations or consolidated net income. See Note 1 to our Consolidated Financial Statements.
Net revenues increased across each of our regional operating segments primarily due to increased sales, as compared to Fiscal 2020, as we experienced significant disruptions in Fiscal 2020 related to COVID-19. The increase in total net revenues for Fiscal 2021, compared to Fiscal 2020, was driven by the following:
•Net revenues in our North America region increased $865.4 million, or 29.4%, to $3,810.4 million for Fiscal 2021, as compared to $2,945.0 million during Fiscal 2020. This increase was driven by growth within our wholesale and direct-to-consumer channels. When compared to Fiscal 2019, net revenues in our North America region increased by 4.2%.
•Net revenues in our EMEA region increased $244.2 million, or 40.8%, to $842.5 million for Fiscal 2021, as compared to $598.3 million in Fiscal 2020. This increase was primarily driven by growth within our wholesale, distributor and direct-to-consumer channels. The increase in sales was also due to timing shifts related to changes in customer order flow and supply chain timing from the fourth quarter of Fiscal 2020 to the first quarter of Fiscal 2021. When compared to Fiscal 2019, net revenues in our EMEA region increased by 35.6%.
•Net revenues in our Asia-Pacific region increased $203.1 million, or 32.3%, to $831.8 million for Fiscal 2021, as compared to $628.7 million during Fiscal 2020. This increase was primarily driven by growth within our wholesale and direct-to-consumer channels. The increase in sales was also due to timing shifts related to changes in customer order flow and supply chain timing from the fourth quarter of Fiscal 2020 to the first quarter of Fiscal 2021. When compared to Fiscal 2019, net revenues in our Asia-Pacific region increased by 30.7%.
•Net revenues in our Latin America region increased $30.4 million, or 18.5%, to $195.2 million for Fiscal 2021, as compared to $164.8 million in Fiscal 2020. This increase was primarily driven by growth within our wholesale and distributor channel partially offset by a decrease in our direct-to-consumer channel as we have moved to a distributor operating model for certain countries within this region. When compared to Fiscal 2019, net revenues in our Latin America region decreased by 0.5%.
•The decrease in Corporate Other for Fiscal 2021, as compared to Fiscal 2020 is primarily due to the sale of MyFitnessPal in December 2020.
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Operating income (loss) by segment and Corporate Other:
Year ended December 31,
(In thousands) 2021 2020 $ Change % Change (1) 2019 $ Change % Change (1)
(1)"N/M" = not meaningful
(2) Corporate Other primarily includes foreign currency hedge gains and losses related to revenues generated by entities within our operating segments but managed through our central foreign exchange risk management program. Effective January 1, 2021, included within Corporate Other is the operating results of the remaining Connected Fitness business consisting of our MMR platforms for Fiscal 2021 and the entire Connected Fitness business for Fiscal 2020. All prior period balances were recast to conform to the current period presentation. Such reclassifications did not affect total consolidated revenues, consolidated income from operations or consolidated net income. See Note 1 to our Consolidated Financial Statements.
The increase in total operating income was driven by the following:
•Operating income in our North America region increased $497.5 million to $972.1 million for the Fiscal 2021, as compared to $474.6 million in Fiscal 2020. This was due to the increases in net revenues discussed above and improvements in gross margin due to pricing improvements, including lower promotional activity and markdowns, as well as improved sales mix due to lower liquidations. Additionally, North America incurred lower bad debt expense and lower long lived asset impairment charges. These decreases were partially offset by increased incentive compensation expense, non-salaried wages and increased marketing-related expenses.
•Operating income in our EMEA region increased $72.0 million to $132.6 million for Fiscal 2021, as compared to $60.6 million in Fiscal 2020. This was due to the increases in net revenues discussed above, improved gross margins due to lower discounts and markdowns and lower selling expenses. These improvements were partially offset by an increase in marketing-related expenses, increased incentive compensation expense, non-salaried wages as well as increased distribution related expenses.
•Operating income in our Asia-Pacific region increased $132.9 million to $132.9 million for Fiscal 2021, as compared to $2.0 thousand in Fiscal 2020. This was due to the increases in net revenues discussed above, and improvements in gross margin due to pricing improvements driven primarily by lower discounts to franchise partners and promotional activity. Additionally, operating income in our Asia-Pacific region was impacted by lower long-lived asset impairment charges. These improvements were partially offset by an increase in marketing and facility related expenses.
•Operating income in our Latin America region increased $65.2 million to $22.4 million for Fiscal 2021, as compared to a loss of $42.8 million in Fiscal 2020. This was due to the increases in net revenues discussed above, lower long-lived asset impairment charges, as well as a reduction in operational costs related to our changing to a distributor model in certain countries within this region.
•Operating loss in our Corporate Other non-operating segment decreased $332.1 million to $773.7 million for Fiscal 2021, as compared to $1,105.8 million in Fiscal 2020. The decrease in operating loss was primarily due to lower restructuring and impairment charges incurred in Fiscal 2021 as compared to Fiscal 2020, partially offset by the sale of MyFitnessPal in December 2020.
LIQUIDITY AND CAPITAL RESOURCES
Our cash requirements have principally been for working capital and capital expenditures. We fund our working capital, primarily inventory, and capital investments from cash flows from operating activities, cash and cash equivalents on hand, and borrowings available under our credit and long term debt facilities. Our working capital requirements generally reflect the seasonality in our business as we historically recognize the majority of our net revenues in the last two quarters of the calendar year. Our capital investments have generally included expanding our in-store fixture and branded concept shop program, improvements and expansion of our distribution and
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corporate facilities, leasehold improvements to our Brand and Factory House stores, and investment and improvements in information technology systems. Our inventory strategy is focused on continuing to meet consumer demand while improving our inventory efficiency over the long term by putting systems and processes in place to improve our inventory management. These systems and processes are designed to improve our forecasting and supply planning capabilities. In addition to systems and processes, key areas of focus that we believe enhance inventory performance are added discipline around the purchasing of product, production lead time reduction, and better planning and execution in selling of excess inventory through our Factory House stores and other liquidation channels.
As of December 31, 2021, we had $1.7 billion of cash and cash equivalents. We believe our cash and cash equivalents on hand, cash from operations, our ability to reduce our expenditures as needed, borrowings available to us under our amended credit agreement, our ability to access the capital markets, and other financing alternatives are adequate to meet our liquidity needs and capital expenditure requirements for at least the next twelve months. In addition, from time to time, based on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors and subject to compliance with applicable laws and regulations, we may seek to utilize cash on hand, borrowings or raise capital to retire, repurchase or redeem our debt securities, repay debt, repurchase shares of our common stock or otherwise enter into similar transactions to support our capital structure and business or utilize excess cash flow on a strategic basis. For example, in May 2021 and August 2021, we entered in Exchange Agreements pursuant to which we repurchased $250 million and $169.1 million, respectively, aggregate principal amount of our Convertible Senior Notes in exchange for a combination of cash and shares for our Class C Common Stock.
As discussed above, COVID-19 has continued to create supply chain challenges that will impact the availability of inventory over the next few quarters. If there are unexpected material impacts to our business in future periods from COVID-19 and we need to raise or conserve additional cash to fund our operations, we may consider additional alternatives similar to those we used in Fiscal 2020, including further reducing our expenditures, changing our investment strategies, negotiating payment terms with our customers and vendors, reductions in compensation costs, including through temporary reductions in pay and layoffs, and limiting certain marketing and capital expenditures. In addition, we may seek alternative sources of liquidity, including but not limited to, accessing the capital markets, sale leaseback transactions or other sales of assets, or other alternative financing measures. However, instability in, or tightening of the capital markets, could adversely affect our ability to access the capital markets on terms acceptable to us or at all. Although we believe we have adequate sources of liquidity over the long term, a prolonged or more severe economic recession, inflationary pressure, or a slow recovery could adversely affect our business and liquidity.
Refer to our “Risk Factors” section included in Item 1A in this Annual Report on Form 10-K.
At December 31, 2021, $612.2 million or approximately 37%, of cash and cash equivalents was held by our foreign subsidiaries. Based on the capital and liquidity needs of our foreign operations, we intend to indefinitely reinvest these funds outside the United States. In addition, our United States operations do not require the repatriation of these funds to meet our currently projected liquidity needs. Should we require additional capital in the United States, we may elect to repatriate indefinitely reinvested foreign funds or raise capital in the United States.
The Company will continue to permanently reinvest these earnings, as well as future earnings from our foreign subsidiaries, to fund international growth and operations. If we were to repatriate indefinitely reinvested foreign funds, we would be required to accrue and pay certain taxes upon repatriation, including foreign withholding taxes and certain U.S. state taxes and record foreign exchange rate impacts. Determination of the unrecorded deferred tax liability that would be incurred if such amounts were repatriated is not practicable.
Contractual Commitments
We lease warehouse space, office facilities, space for our Brand and Factory House stores and certain equipment under non-cancelable operating leases. The leases expire at various dates through 2035, excluding extensions at our option, and include provisions for rental adjustments. In addition, this table includes executed lease agreements for Brand and Factory House stores that we did not yet occupy as of December 31, 2021. The operating leases generally contain renewal provisions for varying periods of time. Our significant contractual obligations and commitments as of December 31, 2021 are summarized in the following table:
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Payments Due by Period
(1) Includes estimated interest payments based on applicable fixed interest rates as of December 31, 2021, timing of scheduled payments, and the term of the debt obligations.
(2) Includes the minimum payments for lease obligations. The lease obligations do not include any contingent rent expense we may incur at our Brand and Factory house stores based on future sales above a specified minimum or payments made for maintenance, insurance and real estate taxes. Contingent rent expense was $16.1 million for Fiscal 2021.
(3) We generally place orders with our manufacturers at least three to four months in advance of expected future sales. The amounts listed for product purchase obligations primarily represent our open production purchase orders with our manufacturers for our apparel, footwear and accessories, including expected inbound freight, duties and other costs. These open purchase orders specify fixed or minimum quantities of products at determinable prices. The product purchase obligations also includes fabric commitments with our suppliers, which secure a portion of our material needs for future seasons. The reported amounts exclude product purchase liabilities included in accounts payable as of December 31, 2021.
(4) Includes sponsorships with professional teams, professional leagues, colleges and universities, individual athletes, athletic events and other marketing commitments in order to promote our brand. Some of these sponsorship agreements provide for additional performance incentives and product supply obligations. It is not possible to determine how much we will spend on product supply obligations on an annual basis as contracts generally do not stipulate specific cash amounts to be spent on products. The amount of product provided to these sponsorships depends on many factors including general playing conditions, the number of sporting events in which they participate and our decisions regarding product and marketing initiatives. In addition, it is not possible to determine the performance incentive amounts we may be required to pay under these agreements as they are primarily subject to certain performance based and other variables. The amounts listed above are the fixed minimum amounts required to be paid under these sponsorship agreements. Additionally, these amounts include minimum guaranteed royalty payments to endorsers and licensors based upon a predetermined percent of sales of particular products.
The table above excludes a liability of $38.9 million for uncertain tax positions, including the related interest and penalties, recorded in accord with applicable accounting guidance, as we are unable to reasonable estimate the timing of settlement. Refer to Note 17to the Consolidated Financial Statements for a further discussion of our uncertain tax positions.
Cash Flows
The following table presents the major components of our cash flows provided by and used in operating, investing and financing activities for the periods presented:
Year ended December 31,
Net cash provided by (used in):
Operating Activities
Cash flows provided by operating activities increased by $452.0 million, as compared to Fiscal 2020, primarily driven by an increase in net income, before the impact of non-cash items, of $632.3 million, partially offset by a decrease from changes in working capital of $180.4 million.
The changes in working capital were primarily due to decreases of:
•$433.3 million resulting from changes in accrued expenses and other liabilities, primarily due to the commencement of the operating lease relating to our New York City flagship store which was included in Fiscal 2020;
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•$198.8 million resulting from changes in accounts receivable primarily due to our previously disclosed changes to customer order flow and supply chain timing from the fourth quarter of Fiscal 2020 to the first quarter of Fiscal 2021, and an increase in net revenues of $1,208.8 million; and
•$19.6 million resulting from changes in customer refund liability.
These decreases in working capital were partially offset by increases in working capital of:
•$339.5 million resulting from changes in other non-current assets, primarily due to the commencement of our New York City flagship store and the related operating lease ROU asset which was included in Fiscal 2020;
•$78.0 million resulting from changes in inventories on account of better inventory management and demand constraints; and
•$66.7 million resulting from changes in accounts payable.
Investing Activities
Cash flows used in investing activities decreased by $134.7 million, as compared to Fiscal 2020, primarily due to proceeds from the sale of MyFitnessPal of $198.9 million in Fiscal 2020.
Total capital expenditures in Fiscal 2021 were $69.8 million, or approximately 1% of net revenues, representing a $22.5 million decline from $92.3 million in Fiscal 2020. In Fiscal 2020 and Fiscal 2021, we reduced capital expenditures in response to ongoing uncertainty related to COVID-19 and to preserve working capital. Moving forward, we anticipate capital expenditures to normalize back towards our long-term operating principle of between 3% and 5% of annual net revenues as we invest in our global direct-to-consumer, e-Commerce and digital businesses, informational technology systems, distribution centers and our global offices. With regard to our new corporate headquarters, in April 2021, we unveiled plans to construct a new global headquarters in the Port Covington area of Baltimore, Maryland. We are designing our new headquarters in line with our long-term sustainability strategy, which includes a commitment to reduce greenhouse gas emissions and increase sourcing of renewable electricity in our owned and operated facilities. We expect a portion of our capital expenditures over the short term to include investments incorporating sustainable and intelligent building design features into this facility.
Financing Activities
Cash flows used in financing activities increased by $855.6 million, as compared to Fiscal 2020. During Fiscal 2021, we used $418.7 million of cash for financing activities, whereas during Fiscal 2020, we had cash inflow of $436.9 million from financing activities. The cash outflow of $418.7 million was primarily related to approximately $506.3 million paid to certain holders for the exchange of $419.1 million in aggregate principal amount of our 1.50% convertible senior notes (the "Convertible Senior Notes"). Concurrently with these exchanges we entered into agreements to terminate a portion of the capped call transactions previously entered into in connection with our initial offering of the Convertible Senior Notes and received approximately $91.7 million from the option counterparties in connection with such termination agreements. For more details, see discussion below under "1.50% Convertible Senior Notes".
Capital Resources
Credit Facility
On March 8, 2019, we entered into an amended and restated credit agreement by and among us, as borrower, JPMorgan Chase Bank, N.A., as administrative agent, and the other lenders and arrangers party thereto (the “credit agreement”). In May 2020, we entered into an amendment to the credit agreement (the “first amendment”), pursuant to which the prior revolving credit commitments were reduced from $1.25 billion to $1.1 billion of borrowings. Subsequently, in May 2021, we entered into a second amendment to the credit agreement (the "second amendment"), which provides for certain changes to our covenants and decreases to certain applicable rates effected by the first amendment. In December 2021, we entered into a third amendment to the credit agreement (the "third amendment" and, the credit agreement as amended by the first amendment, the second amendment and the third amendment, the "amended credit agreement" or the "revolving credit facility"), which extends the term of the credit agreement from March 8, 2024 to December 3, 2026, with permitted extension under certain circumstances. As of December 31, 2021 and December 31, 2020, there were no amounts outstanding under the revolving credit facility.
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Where the first amendment previously provided for suspensions of and adjustments to our existing interest coverage covenant and leverage covenant (each as defined below), and further required us to maintain a specific amount of minimum liquidity during certain quarters, the second amendment provided that these financial covenants became effective again as of March 31, 2021 and removed the minimum liquidity covenant. The second amendment also (i) decreases the interest rate margins that were previously provided for under the first amendment; (ii) reverses limitations effected by the first amendment on expansions of and extensions of the maturity of the revolving credit facility during the covenant suspension period; and (iii) removes additional limitations on the availability of certain exceptions to the negative covenants, including the restricted payments covenant, that were imposed during the covenant suspension period.
The third amendment also (i) decreases the applicable margins for borrowings and undrawn commitment fees; (ii) provides for the fall away of collateral and guarantee requirements following an investment-grade rating from two rating agencies; (iii) implements SOFR as the replacement of LIBOR as a benchmark interest rate for U.S. dollar borrowings (and analogous benchmark rate replacements for borrowings in Yen, Canadian Dollars, Pound Sterling and Euro); and (iv) amends certain affirmative and negative covenants and related definitions.
At our request and a lender's consent, commitments under the amended credit agreement may be increased by up to $300.0 million in aggregate, subject to certain conditions as set forth in the amended credit agreement. Incremental borrowings are uncommitted and the availability thereof will depend on market conditions at the time we seek to incur such borrowings.
Borrowings, if any, under the revolving credit facility have maturities of less than one year. Up to $50.0 million of the facility may be used for the issuance of letters of credit. As of December 31, 2021, there was $4.3 million of letters of credit outstanding (December 31, 2020 had $4.3 million letters of credit outstanding).
Our obligations under the amended credit agreement are guaranteed by certain domestic significant subsidiaries of Under Armour, Inc., subject to customary exceptions (the “subsidiary guarantors”) and primarily secured by a first-priority security interest in substantially all of the assets of Under Armour, Inc. and the subsidiary guarantors, excluding real property, capital stock in and debt of subsidiaries of Under Armour, Inc. holding certain real property and other customary exceptions. However, the third amendment provides for the permanent fall away of guarantees and collateral upon our achievement of investment grade rating from two rating agencies.
The amended credit agreement contains negative covenants that, subject to significant exceptions, limit our ability to, among other things: incur additional secured and unsecured indebtedness; pledge the assets as security; make investments, loans, advances, guarantees and acquisitions, (including investments in and loans to non-guarantor subsidiaries); undergo fundamental changes; sell assets outside the ordinary course of business; enter into transactions with affiliates; and make restricted payments.
We are also required to maintain a ratio of consolidated EBITDA, to consolidated interest expense of not less than 3.50 to 1.0 (the "interest coverage covenant") and we are not permitted to allow the ratio of consolidated total indebtedness to consolidated EBITDA to be greater than 3.25 to 1.0 (the "leverage covenant"), as described in more detail in the amended credit agreement.
As of December 31, 2021, we were in compliance with the applicable covenants.
In addition, the amended credit agreement contains events of default that are customary for a facility of this nature, and includes a cross default provision whereby an event of default under other material indebtedness, as defined in the amended credit agreement, will be considered an event of default under the amended credit agreement.
Borrowings under the amended credit agreement bear interest at a rate per annum equal to, at our option, either (a) an alternate base rate (for borrowings in U.S. dollars), (b) a term rate (for borrowings in U.S. dollars, Euros, Japanese Yen or Canadian Dollars) or (c) a "risk free" rate (for borrowings in U.S. dollars or Pounds Sterling), plus in each case an applicable margin. The applicable margin for loans will be adjusted by reference to a grid (the “pricing grid”) based on the leverage ratio of consolidated total indebtedness to consolidated EBITDA and ranges between 1.00% to 1.75% (or, in the case of alternate base rate loans 0.00% to 0.75%). We will also pay a commitment fee determined in accordance with the pricing grid on the average daily unused amount of the revolving credit facility and certain fees with respect to letters of credit.
The weighted average interest rate under the revolving credit facility borrowings was 2.3% during Fiscal 2020. There were no borrowings outstanding during Fiscal 2021. As of December 31, 2021, the commitment fee was 15 basis points.
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1.50% Convertible Senior Notes
In May 2020, we issued $500.0 million aggregate principal amount of 1.50% convertible senior notes due 2024 (the “Convertible Senior Notes”). The Convertible Senior Notes bear interest at the rate of 1.50% per annum, payable semiannually in arrears on June 1 and December 1 of each year, beginning December 1, 2020. The Convertible Senior Notes will mature on June 1, 2024, unless earlier converted in accordance with their terms, redeemed in accordance with their terms or repurchased.
The net proceeds from the offering (including the net proceeds from the exercise of the over-allotment option) were $488.8 million, after deducting the initial purchasers’ discount and estimated offering expenses that we paid, of which we used $47.9 million to pay the cost of the capped call transactions described below. We utilized $439.9 million to repay indebtedness that was outstanding under our revolving credit facility at the time, and to pay related fees and expenses.
The Convertible Senior Notes are not secured and are not guaranteed by any of our subsidiaries. The indenture governing the Convertible Senior Notes does not contain any financial or operating covenants or restrictions on the payments of dividends, the incurrence of indebtedness or the issuance or repurchase of securities by us or any of our subsidiaries.
In May 2021, we entered into exchange agreements with certain holders of the Convertible Senior Notes (the "first exchanging holders"), who agreed to exchange $250.0 million in aggregate principal amount of the Convertible Senior Notes for cash and/or shares of our Class C Common Stock, plus payment for accrued and unpaid interest (the "First Exchange"). In connection with the First Exchange, we paid approximately $300.0 million cash and issued approximately 11.1 million shares of the Company's Class C Common Stock to the first exchanging holders. In August 2021, we entered into additional exchange agreements with certain holders of the Convertible Senior Notes (the "second exchanging holders"), who agreed to exchange approximately $169.1 million in aggregate principal amount of the Convertible Senior Notes for cash and/or shares of our Class C Common Stock, plus payment for accrued and unpaid interest (the "Second Exchange" and, together with the First Exchange, the "Exchanges"). In connection with the Second Exchange, we paid approximately $207.0 million cash and issued approximately 7.7 million shares of our Class C Common Stock to the second exchanging holders. In connection with the Exchanges, we recognized a loss on debt extinguishment of approximately $58.5 million for Fiscal 2021, which has been recorded within Other Income (Expense), net on our Consolidated Statement of Operations. Following the Exchanges, approximately $80.9 million aggregate principal amount of the Convertible Senior Notes remain outstanding.
The Convertible Senior Notes are convertible into cash, shares of our Class C Common Stock or a combination of cash and shares of Class C Common Stock, at our election, as described further below. The initial conversion rate is 101.8589 shares of our Class C Common Stock per $1,000 principal amount of Convertible Senior Notes (equivalent to an initial conversion price of approximately $9.82 per share of Class C Common Stock), subject to adjustment if certain events occur. Prior to the close of business on the business day immediately preceding January 1, 2024, holders may (at their option) convert their Convertible Senior Notes only upon satisfaction of one or more of the following conditions:
•during any calendar quarter commencing after the calendar quarter ended on September 30, 2020 (and only during such calendar quarter), if the last reported sale price of our Class C Common Stock for at least 20 trading days (whether or not consecutive) during the period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day;
•during the five business day period after any five consecutive trading day period (the “measurement period”) in which the trading price per $1,000 principal amount of Convertible Senior Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of our Class C Common Stock and the conversion rate on each such trading day;
•upon the occurrence of specified corporate events or distributions on our Class C Common Stock; or
•if we call any Convertible Senior Notes for redemption prior to the close of business on the business day immediately preceding January 1, 2024.
On or after January 1, 2024, until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert all or any portion of their Convertible Senior Notes at the conversion rate at any time irrespective of the foregoing conditions.
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On or after December 6, 2022, we may redeem for cash all or any part of the Convertible Senior Notes, at our option, if the last reported sale price of our Class C Common Stock has been at least 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period (including the last trading day of such period) ending on, and including, the trading day immediately preceding the date on which we provide notice of redemption at a redemption price equal to 100% of the aggregate principal amount of the Convertible Senior Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date.
If we undergo a fundamental change (as defined in the indenture governing the Convertible Senior Notes) prior to the maturity date, subject to certain conditions, holders may require us to repurchase for cash all or any portion of their Convertible Senior Notes in principal amounts of $1,000 or an integral multiple thereof at a price which will be equal to 100% of the aggregate principal amount of the Convertible Senior Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date.
Concurrently with the offering of the Convertible Senior Notes, we entered into privately negotiated capped call transactions with JPMorgan Chase Bank, National Association, HSBC Bank USA, National Association, and Citibank, N.A. (the “option counterparties”). The capped call transactions are expected generally to reduce potential dilution to our Class C Common Stock upon any conversion of Convertible Senior Notes and/or offset any cash payments we are required to make in excess of the aggregate principal amount of converted Convertible Senior Notes upon any conversion thereof, as the case may be, with such reduction and/or offset subject to a cap based on the cap price. The cap price of the capped call transactions is initially $13.4750 per share of our Class C Common Stock, representing a premium of 75% above the last reported sale price of our Class C Common Stock on May 21, 2020, and is subject to certain adjustments under the terms of the capped call transactions.
In May 2021 and August 2021, concurrently with the Exchanges, we entered into, with each of the option counterparties, termination agreements relating to a number of options corresponding to the number of Convertible Senior Notes exchanged. Pursuant to such termination agreements, each of the option counterparties paid us a cash settlement amount in respect of the portion of capped call transactions being terminated. We received approximately $53.0 million and $38.6 million in connection with such termination agreements related to the First Exchange and the Second Exchange, respectively.
The Convertible Senior Notes contain a cash conversion feature, and as a result, we have separated it into liability and equity components. We valued the liability component based on our borrowing rate for a similar debt instrument that does not contain a conversion feature. The equity component, which is recognized as a debt discount, was valued as the difference between the face value of the Convertible Senior Notes and the fair value of the liability component.
In connection with the Convertible Senior Notes issuance, we incurred deferred financing costs of $12.3 million, primarily related to fees paid to the initial purchasers of the offering, as well as legal and accounting fees. These costs were allocated on a pro rata basis, with $10.0 million allocated to the debt component and $2.2 million allocated to the equity component. As of December 31, 2021, the equity component, net of issuance costs was $88.7 million.
The debt discount and the debt portion of the deferred financing costs are being amortized to interest expense over the term of the Convertible Senior Notes using the effective interest rate method. The effective interest rate for the three months ended December 31, 2021 was 6.8%.
3.250% Senior Notes
In June 2016, we issued $600.0 million aggregate principal amount of 3.250% senior unsecured notes due June 15, 2026 (the “Senior Notes”). The proceeds were used to pay down amounts outstanding under the revolving credit facility, at the time. Interest is payable semi-annually on June 15 and December 15 beginning December 15, 2016. Prior to March 15, 2026 (three months prior to the maturity date of the Notes), we may redeem some or all of the Senior Notes at any time or from time to time at a redemption price equal to the greater of 100% of the principal amount of the Senior Notes to be redeemed or a "make-whole" amount applicable to such Senior Notes as described in the indenture governing the Senior Notes, plus accrued and unpaid interest to, but excluding, the redemption date.
The indenture governing the Senior Notes contains covenants, including limitations that restrict our ability and the ability of certain of our subsidiaries to create or incur secured indebtedness and enter into sale and leaseback transactions and our ability to consolidate, merge or transfer all or substantially all of our properties or assets to another person, in each case subject to material exceptions described in the indenture.
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CRITICAL ACCOUNTING ESTIMATES AND ASSUMPTIONS
Our Consolidated Financial Statements have been prepared in accordance with U.S. GAAP. To prepare these financial statements, we must make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, as well as the disclosures of contingent assets and liabilities. Our estimates are often based on complex judgments, probabilities and assumptions that management believes to be reasonable, but that are inherently uncertain and unpredictable. It is also possible that other professionals, applying reasonable judgment to the same facts and circumstances, could develop and support a range of alternative estimated amounts. Actual results could be significantly different from these estimates. We believe the following addresses the critical accounting estimates and assumptions that are necessary to understand and evaluate our reported financial results.
Revenue Recognition
We recognize revenue pursuant to Accounting Standards Codification 606 ("ASC 606"). The amount of revenue recognized considers terms of sale that create variability in the amount of consideration that we ultimately expect to be entitled to in exchange for the products or services and is subject to an overall constraint that a significant revenue reversal will not occur in future periods.
We record reductions to revenue at the time of the transaction for estimated customer returns, allowances, markdowns and discounts. We base these estimates on historical rates of customer returns and allowances as well as the specific identification of outstanding returns, markdowns and allowances that have not yet been received by us. The actual amount of customer returns and allowances, which are inherently uncertain, may differ from our estimates. If we determine that actual or expected returns or allowances are significantly higher or lower than the reserves we established, we would record a reduction or increase, as appropriate, to net sales in the period in which we make such a determination. Provisions for customer specific discounts are based on contractual obligations with certain major customers. Reserves for returns, allowances, markdowns and discounts are included within customer refund liability and the value of inventory associated with reserves for sales returns are included within prepaid expenses and other current assets on the Consolidated Balance Sheets. As of December 31, 2021 and 2020, there were $164.3 million and $203.4 million, respectively, in reserves for returns, allowances, markdowns and discounts within customer refund liability and $47.6 million and $57.9 million, respectively, as the estimated value of inventory associated with the reserves for sales returns within prepaid expenses and other current assets on the Consolidated Balance Sheets.
Allowance for Doubtful Accounts
We make ongoing estimates relating to the collectability of accounts receivable and maintain an allowance for estimated losses resulting from the inability of our customers to make required payments. In determining the amount of the reserve, we consider historical levels of credit losses and significant economic developments within the retail environment that could impact the ability of our customers to pay outstanding balances and make judgments about the creditworthiness of significant customers based on ongoing credit evaluations. Because we cannot predict future changes in the financial stability of our customers, actual future losses from uncollectible accounts may differ from estimates. If the financial condition of customers were to deteriorate, resulting in their inability to make payments, a larger reserve might be required. In the event we determine a smaller or larger reserve is appropriate, we would record a benefit or charge to selling, general and administrative expense in the period in which such a determination was made. As of December 31, 2021 and 2020, the allowance for doubtful accounts was$7.1 million and $20.4 million, respectively.
Inventory Valuation and Reserves
Inventories consist primarily of finished goods. Costs of finished goods inventories include all costs incurred to bring inventory to its current condition, including inbound freight, duties and other costs. We value our inventory at standard cost which approximates landed cost, using the first-in, first-out method of cost determination. Net realizable value is estimated based upon assumptions made about future demand and retail market conditions. If we determine that the estimated net realizable value of our inventory is less than the carrying value of such inventory, we record a charge to cost of goods sold to reflect the lower of cost or net realizable value. If actual market conditions are less favorable than those that we projected, further adjustments may be required that would increase the cost of goods sold in the period in which such a determination was made. As of December 31, 2021 and 2020, the inventory reserve was$32.0 million and $44.6 million, respectively.
Goodwill, Intangible Assets and Long-Lived Assets
Goodwill and intangible assets are recorded at their estimated fair values at the date of acquisition and are allocated to the reporting units that are expected to receive the related benefits. Goodwill and indefinite lived
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intangible assets are not amortized and are required to be tested for impairment at least annually or sooner whenever events or changes in circumstances indicate that it is more likely than not that the fair value of the reporting unit is less than its carrying amount. In conducting an annual impairment test, we first review qualitative factors to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If factors indicate that is the case, we perform the goodwill impairment test. We compare the fair value of the reporting unit with its carrying amount. We estimate fair value using the discounted cash flows model, under the income approach, which indicates the fair value of the reporting unit based on the present value of the cash flows that we expect the reporting unit to generate in the future. Our significant estimates in the discounted cash flows model include: our weighted average cost of capital, long-term rate of growth and profitability of the reporting unit's business, and working capital effects. If the carrying amount of a reporting unit exceeds its fair value, goodwill is impaired to the extent that the carrying value exceeds the fair value of the reporting unit.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred income tax assets and liabilities are established for temporary differences between the financial reporting basis and the tax basis of our assets and liabilities at tax rates expected to be in effect when such assets or liabilities are realized or settled. Deferred income tax assets are reduced by valuation allowances when necessary. The Company has made the policy election to record any liability associated with Global Intangible Low Taxed Income (“GILTI”) in the period in which it is incurred.
Income taxes include the largest amount of tax benefit for an uncertain tax position that is more likely than not to be sustained upon audit based on the technical merits of the tax position. Settlements with tax authorities, the expiration of statutes of limitations for particular tax positions or obtaining new information on particular tax positions may cause a change to the effective tax rate. We recognize accrued interest and penalties related to unrecognized tax benefits in the provision for income taxes on the Consolidated Statement of Operations.
Assessing whether deferred tax assets are realizable requires significant judgment. We consider all available positive and negative evidence, including historical operating performance and expectations of future operating performance. The ultimate realization of deferred tax assets is often dependent upon future taxable income and therefore can be uncertain. To the extent we believe it is more likely than not that all or some portion of the asset will not be realized, valuation allowances are established against our deferred tax assets, which increase income tax expense in the period when such a determination is made.
A significant portion of our deferred tax assets relate to U.S. federal and state taxing jurisdictions. Realization of these deferred tax assets is dependent on future U.S. pre-tax earnings. In evaluating the recoverability of these deferred tax assets as of December 31, 2021, the Company has considered all available evidence, both positive and negative, including but not limited to the following:
Positive
•Current year pre-tax earnings.
•Restructuring plans undertaken in 2017, 2018, and 2020, which aim to improve future profitability.
•No history of U.S. federal and state tax attributes expiring unused.