UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended April 2, 2005
----------------------------------------------
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from .......................to........................
Commission file number: 1-10689
--------
LIZ CLAIBORNE, INC.
-------------------------------------------------
(Exact name of registrant as specified in its
charter)
Delaware 13-2842791
- ----------------------------- ---------------------------
(State or other (I.R.S. Employer
jurisdiction of Identification No.)
incorporation)
1441 Broadway, New York, New York 10018
- ------------------------------------------------- ---------------------------
(Address of principal executive offices) (Zip Code)
(212) 354-4900
-------------------------------------------------
(Registrant's telephone number, including area
code)
Indicate by check whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No .
----- -----
Indicate by check whether the registrant is an accelerated filer (as
defined in Rule 12B-2 of the Exchange Act). Yes X No .
----- -----
The number of shares of Registrant's Common Stock, par value $1.00 per
share, outstanding at May 2, 2005 was 109,318,970.
2
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q
APRIL 2, 2005
PAGE
NUMBER
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of April 2, 2005
(Unaudited), January 1, 2005 and April 3, 2004 (Unaudited)....... 3
Condensed Consolidated Statements of Income for the Three Month
Periods Ended April 2, 2005 (Unaudited) and April 3, 2004
(Unaudited)...................................................... 4
Condensed Consolidated Statements of Cash Flows for the Three
Month Periods Ended April 2, 2005 (Unaudited) and April 3,
2004 (Unaudited)................................................. 5
Notes to Condensed Consolidated Financial Statements (Unaudited)... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................ 25
Item 3. Quantitative and Qualitative Disclosures About Market Risk......... 43
Item 4. Controls and Procedures............................................ 45
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.................................................. 46
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds........ 46
Item 5. Other Information.................................................. 46
Item 6. Exhibits........................................................... 47
SIGNATURES ............................................................... 48
3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(All amounts in thousands except share data)
(Unaudited) January 1, (Unaudited)
April 2, 2005 2005 April 3, 2004
------------------------------------------------
Assets
Current Assets:
Cash and cash equivalents $ 123,384 $ 385,637 $ 181,344
Marketable securities 7,578 7,797 58,727
Accounts receivable - trade, net 669,811 432,065 596,790
Inventories, net 563,133 541,139 501,982
Deferred income taxes 51,351 51,117 44,531
Other current assets 104,093 91,386 94,174
------------ ------------ ------------
Total current assets 1,519,350 1,509,141 1,477,548
------------ ------------ ------------
Property and Equipment - Net 467,169 474,573 414,316
Goodwill - Net 816,127 755,655 567,920
Intangibles - Net 295,500 280,986 274,738
Other Assets 10,901 9,397 6,298
------------ ------------ ------------
Total Assets $ 3,109,047 $ 3,029,752 $ 2,740,820
============ ============ ============
Liabilities and Stockholders' Equity
Current Liabilities:
Short-term borrowings $ 45,829 $ 56,118 $ 29,913
Accounts payable 275,084 259,965 254,306
Accrued expenses 266,617 288,490 219,732
Income taxes payable 50,234 33,028 45,335
------------ ------------ ------------
Total current liabilities 637,764 637,601 549,286
------------ ------------ ------------
Long-Term Debt 455,854 476,571 425,743
Obligations Under Capital Leases 5,494 7,945 --
Other Non-Current Liabilities 51,694 32,836 21,958
Deferred Income Taxes 52,043 49,490 48,722
Commitments and Contingencies (Note 9)
Minority Interest 3,350 13,520 10,532
Stockholders' Equity:
Preferred stock, $.01 par value, authorized shares -
50,000,000, issued shares - none -- -- --
Common stock, $1 par value, authorized shares -
250,000,000, issued shares - 176,437,234 176,437 176,437 176,437
Capital in excess of par value 197,825 176,182 149,885
Retained earnings 2,894,295 2,828,968 2,602,366
Unearned compensation expense (53,377) (36,793) (44,957)
Accumulated other comprehensive loss (52,439) (63,650) (31,371)
------------ ------------ ------------
3,162,741 3,081,144 2,852,360
Common stock in treasury, at cost, 66,832,764, 67,703,065
and 65,652,624 shares (1,259,893) (1,269,355) (1,167,781)
------------ ------------ ------------
Total stockholders' equity 1,902,848 1,811,789 1,684,579
------------ ------------ ------------
Total Liabilities and Stockholders' Equity $ 3,109,047 $ 3,029,752 $ 2,740,820
============ ============ ============
The accompanying notes to condensed consolidated financial statements are an
integral part of these statements.
4
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(All amounts in thousands, except per common share data)
(Unaudited)
Three Months Ended
------------------------------
(13 Weeks) (13 Weeks)
April 2, 2005 April 3, 2004
------------------------------
Net Sales $ 1,212,407 $ 1,102,767
Cost of goods sold 654,177 601,737
------------ ------------
Gross Profit 558,230 501,030
Selling, general & administrative expenses 439,474 386,703
------------ ------------
Operating Income 118,756 114,327
Other expense - net (614) (590)
Interest expense - net (7,588) (7,610)
------------ ------------
Income Before Provision for Income Taxes 110,554 106,127
Provision for income taxes 39,136 37,357
------------ ------------
Net Income $ 71,418 $ 68,770
============ ============
Net Income per Weighted Average Share, Basic $0.66 $0.63
Net Income per Weighted Average Share, Diluted $0.65 $0.62
Weighted Average Shares, Basic 108,063 109,281
Weighted Average Shares, Diluted 110,059 111,245
Dividends Paid per Common Share $0.06 $0.06
===== =====
The accompanying notes to condensed consolidated financial statements are an
integral part of these statements.
5
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(All dollar amounts in thousands)
(Unaudited)
Three Months Ended
--------------------------------
(13 Weeks) (13 Weeks)
April 2, 2005 April 3, 2004
--------------------------------
Cash Flows from Operating Activities:
Net income $ 71,418 $ 68,770
Adjustments to reconcile net income to net cash used in operating
activities:
Depreciation and amortization 29,040 26,049
Deferred income taxes (1,069) 969
Other - net 5,279 6,404
Change in current assets and liabilities, exclusive of
acquisitions:
(Increase) in accounts receivable - trade, net (241,975) (210,646)
(Increase) in inventories (24,393) (22,840)
(Increase) in other current assets (13,850) (12,711)
Increase in accounts payable 17,117 28,973
(Decrease) in accrued expenses (26,141) (9,852)
Increase in income taxes payable 18,064 16,594
------------ ------------
Net cash used in operating activities (166,510) (108,290)
------------ ------------
Cash Flows from Investing Activities:
Purchases of investment instruments (67) (25)
Purchases of property and equipment excluding capital leases (24,325) (29,408)
Payments for acquisitions, net of cash acquired (62,451) (4,979)
Payments for in-store merchandise shops (1,430) (1,295)
Other - net (1,068) (2,393)
------------ ------------
Net cash used in investing activities (89,341) (38,100)
------------ ------------
Cash Flows from Financing Activities:
Short term borrowings (10,289) 10,998
Principal payments under capital lease obligations (517) --
Proceeds from exercise of common stock options 9,280 21,391
Dividends paid (6,091) (6,146)
------------ ------------
Net cash (used in) provided by financing activities (7,617) 26,243
------------ ------------
Effect of Exchange Rate Changes on Cash 1,215 7,988
------------ ------------
Net Change in Cash and Cash Equivalents (262,253) (112,159)
Cash and Cash Equivalents at Beginning of Period 385,637 293,503
------------ ------------
Cash and Cash Equivalents at End of Period $ 123,384 $ 181,344
============ ============
The accompanying notes to condensed consolidated financial statements are an
integral part of these statements.
6
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The condensed consolidated financial statements of Liz Claiborne, Inc. and its
wholly-owned and majority-owned subsidiaries (the "Company") included herein
have been prepared, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission ("SEC"). Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
have been condensed or omitted from this report, as is permitted by such rules
and regulations; however, the Company believes that the disclosures are adequate
to make the information presented not misleading. It is suggested that these
condensed financial statements be read in conjunction with the financial
statements and notes thereto included in the Company's 2004 Annual Report on
Form 10-K. Results of acquired companies are included in our operating results
from the date of acquisition, and, therefore, operating results on a
period-to-period basis are not comparable. Information presented as of January
1, 2005 is derived from audited statements. Certain items previously reported in
specific captions in the accompanying financial statements have been
reclassified to conform to the current period's classifications. None of the
reclassifications were material.
In the opinion of management, the information furnished reflects all
adjustments, all of which are of a normal recurring nature, necessary for a fair
presentation of the results for the reported interim periods. Results of
operations for interim periods are not necessarily indicative of results for the
full year.
SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
The Company is engaged primarily in the design and marketing of a broad range of
apparel, accessories and fragrances.
PRINCIPLES OF CONSOLIDATION
The condensed consolidated financial statements include the accounts of the
Company and its wholly-owned and majority-owned subsidiaries. All intercompany
balances and transactions have been eliminated in consolidation.
USE OF ESTIMATES AND CRITICAL ACCOUNTING POLICIES
Use of Estimates
- ----------------
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the condensed
consolidated financial statements. These estimates and assumptions also affect
the reported amounts of revenues and expenses. Estimates by their nature are
based on judgments and available information. Therefore, actual results could
materially differ from those estimates under different assumptions and
conditions.
Critical accounting policies are those that are most important to the portrayal
of the Company's financial condition and the results of operations and require
management's most difficult, subjective and complex judgments as a result of the
need to make estimates about the effect of matters that are inherently
uncertain. The Company's most critical accounting policies, discussed below,
pertain to revenue recognition, income taxes, accounts receivable - trade, net,
inventories, net, the valuation of goodwill and intangible assets with
indefinite lives, accrued expenses and derivative instruments. In applying such
policies, management must use some amounts that are based upon its informed
judgments and best estimates. Because of the uncertainty inherent in these
estimates, actual results could differ from estimates used in applying the
critical accounting policies. Changes in such estimates, based on more accurate
future information, may affect amounts reported in future periods.
Revenue Recognition
- -------------------
Revenue within the Company's wholesale operations is recognized at the time
title passes and risk of loss is transferred to customers. Wholesale revenue is
recorded net of returns, discounts and allowances. Returns and allowances
require pre-approval from management. Discounts are based on trade terms.
Estimates for end-of-season allowances are based on historic trends, seasonal
results, an evaluation of current economic conditions and retailer performance.
The Company reviews and refines these estimates on a monthly basis based on
current
7
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
experience, trends and retailer performance. The Company's historical estimates
of these costs have not differed materially from actual results. Retail store
revenues are recognized net of estimated returns at the time of sale to
consumers. Licensing revenues are recorded based upon contractually guaranteed
minimum levels and adjusted as actual sales data is received from licensees.
Income Taxes
- ------------
Income taxes are accounted for under Statement of Financial Accounting Standards
("SFAS") No. 109, "Accounting for Income Taxes." In accordance with SFAS No.
109, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases, as measured by enacted tax rates that are expected to be in effect in the
periods when the deferred tax assets and liabilities are expected to be settled
or realized. Significant judgment is required in determining the worldwide
provisions for income taxes. In the ordinary course of a global business, there
are many transactions for which the ultimate tax outcome is uncertain. It is the
Company's policy to establish provisions for taxes that may become payable in
future years as a result of an examination by tax authorities. The Company
establishes the provisions based upon management's assessment of exposure
associated with permanent tax differences, tax credits and interest expense
applied to temporary difference adjustments. The tax provisions are analyzed
periodically (at least annually) and adjustments are made as events occur that
warrant adjustments to those provisions.
Accounts Receivable - Trade, Net
- --------------------------------
In the normal course of business, the Company extends credit to customers that
satisfy pre-defined credit criteria. Accounts receivable - trade, net, as shown
on the Consolidated Balance Sheets, is net of allowances and anticipated
discounts. An allowance for doubtful accounts is determined through analysis of
the aging of accounts receivable at the date of the financial statements,
assessments of collectibility based on an evaluation of historic and anticipated
trends, the financial condition of the Company's customers, and an evaluation of
the impact of economic conditions. An allowance for discounts is based on those
discounts relating to open invoices where trade discounts have been extended to
customers. Costs associated with potential returns of products as well as
allowable customer markdowns and operational charge backs, net of expected
recoveries, are included as a reduction to net sales and are part of the
provision for allowances included in Accounts receivable - trade, net. These
provisions result from seasonal negotiations with the Company's customers as
well as historic deduction trends (net of expected recoveries) and the
evaluation of current market conditions. The Company's historical estimates of
these costs have not differed materially from actual results.
Inventories, Net
- ----------------
Inventories are stated at lower of cost (using the first-in, first-out method)
or market. The Company continually evaluates the composition of its inventories
assessing slow-turning, ongoing product as well as prior seasons' fashion
product. Market value of distressed inventory is valued based on historical
sales trends for this category of inventory of the Company's individual product
lines, the impact of market trends and economic conditions, and the value of
current orders in-house relating to the future sales of this type of inventory.
Estimates may differ from actual results due to quantity, quality and mix of
products in inventory, consumer and retailer preferences and market conditions.
The Company's historical estimates of these costs and its provisions have not
differed materially from actual results.
Goodwill and Other Intangibles
- ------------------------------
SFAS No. 142, "Goodwill and Other Intangible Assets," requires that goodwill and
intangible assets with indefinite lives no longer be amortized, but rather be
tested at least annually for impairment. This pronouncement also requires that
intangible assets with finite lives be amortized over their respective lives to
their estimated residual values, and reviewed for impairment in accordance with
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."
A two-step impairment test is performed on goodwill. In the first step, the
Company compares the fair value of each reporting unit to its carrying value.
The Company's reporting units are consistent with the reportable segments
identified in Note 13 of Notes to Condensed Consolidated Financial Statements.
The Company determines the fair value of its reporting units using the market
approach as is typically used for companies providing products where the value
of such a company is more dependent on the ability to generate earnings than the
value of the assets used
8
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
in the production process. Under this approach the Company estimates the fair
value based on market multiples of revenues and earnings for comparable
companies. If the fair value of the reporting unit exceeds the carrying value of
the net assets assigned to that unit, goodwill is not impaired and the Company
is not required to perform further testing. If the carrying value of the net
assets assigned to the reporting unit exceeds the fair value of the reporting
unit, then the Company must perform the second step in order to determine the
implied fair value of the reporting unit's goodwill and compare it to the
carrying value of the reporting unit's goodwill. The activities in the second
step include valuing the tangible and intangible assets of the impaired
reporting unit, determining the fair value of the impaired reporting unit's
goodwill based upon the residual of the summed identified tangible and
intangible assets and the fair value of the enterprise as determined in the
first step, and determining the magnitude of the goodwill impairment based upon
a comparison of the fair value residual goodwill and the carrying value of
goodwill of the reporting unit. If the carrying value of the reporting unit's
goodwill exceeds the implied fair value, then the Company must record an
impairment loss equal to the difference.
SFAS No. 142 also requires that the fair value of the purchased intangible
assets, primarily trademarks and trade names, with indefinite lives be estimated
and compared to the carrying value. The Company estimates the fair value of
these intangible assets using independent third parties who apply the income
approach using the relief-from-royalty method, based on the assumption that, in
lieu of ownership, a firm would be willing to pay a royalty in order to exploit
the related benefits of these types of assets. This approach is dependent on a
number of factors including estimates of future growth and trends, estimated
royalty rates in the category of intellectual property, discounted rates and
other variables. The Company bases its fair value estimates on assumptions it
believes to be reasonable, but which are unpredictable and inherently uncertain.
Actual future results may differ from those estimates. The Company recognizes an
impairment loss when the estimated fair value of the intangible asset is less
than the carrying value.
Owned trademarks that have been determined to have indefinite lives are not
subject to amortization and are reviewed at least annually for potential value
impairment as mentioned above. Trademarks having definite lives are amortized
over their estimated useful lives. An independent third party values acquired
trademarks using the relief-from-royalty method. Trademarks that are licensed by
the Company from third parties are amortized over the individual terms of the
respective license agreements, which range from 5 to 15 years. Intangible
merchandising rights are amortized over a period of four years. Customer
relationships are amortized assuming gradual attrition over time. Existing
relationships are being amortized over periods ranging from 9 to 25 years.
The recoverability of the carrying values of all long-lived assets with definite
lives is reevaluated when changes in circumstances indicate the assets' value
may be impaired. Impairment testing is based on a review of forecasted operating
cash flows and the profitability of the related business. For the three months
ended April 2, 2005, there were no adjustments to the carrying values of any
long-lived assets resulting from these evaluations.
Accrued Expenses
- ----------------
Accrued expenses for employee insurance, workers' compensation, profit sharing,
contracted advertising, professional fees, and other outstanding Company
obligations are assessed based on claims experience and statistical trends, open
contractual obligations, and estimates based on projections and current
requirements. If these trends change significantly, then actual results would
likely be impacted.
Derivative Instruments
- ----------------------
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as
amended and interpreted, requires that each derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability and measured at its fair value.
The statement also requires that changes in the derivative's fair value be
recognized currently in earnings in either income (loss) from continuing
operations or Accumulated other comprehensive income (loss), depending on
whether the derivative qualifies for hedge accounting treatment.
The Company uses foreign currency forward contracts and options for the specific
purpose of hedging the exposure to variability in forecasted cash flows
associated primarily with inventory purchases mainly with the Company's European
and Canadian entities and other specific activities and the swapping of variable
interest rate debt for fixed rate debt in connection with the synthetic lease.
These instruments are designated as cash flow hedges and, in
9
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
accordance with SFAS No. 133, to the extent the hedges are highly effective, the
effective portion of the changes in fair value are included in Accumulated other
comprehensive income (loss), net of related tax effects, with the corresponding
asset or liability recorded in the balance sheet. The ineffective portion of the
cash flow hedge, if any, is recognized primarily as a component of Cost of goods
sold in current-period earnings or in the case of the swaps, in connection with
the synthetic lease, if any, to Selling, general & administrative expenses.
Amounts recorded in Accumulated other comprehensive income (loss) are reflected
in current-period earnings when the hedged transaction affects earnings. If
fluctuations in the relative value of the currencies involved in the hedging
activities were to move dramatically, such movement could have a significant
impact on the Company's results of operations.
Hedge accounting requires that, at the beginning of each hedge period, the
Company justify an expectation that the hedge will be highly effective. This
effectiveness assessment involves an estimation of the probability of the
occurrence of transactions for cash flow hedges. The use of different
assumptions and changing market conditions may impact the results of the
effectiveness assessment and ultimately the timing of when changes in derivative
fair values and underlying hedged items are recorded in earnings.
The Company hedges its net investment position in euro-functional subsidiaries
by borrowing directly in foreign currency and designating a portion of foreign
currency debt as a hedge of net investments. The change in the borrowings due to
changes in currency rates is recorded to Currency translation adjustment, a
component of Accumulated other comprehensive income (loss). The Company uses a
derivative instrument to hedge the changes in the fair value of the debt due to
interest rates, and the change in fair value is recognized currently in interest
expense together with the change in fair value of the hedged item due to
interest rates.
Occasionally, the Company purchases short-term foreign currency contracts and
options outside of the cash flow hedging program to neutralize quarter-end
balance sheet and other expected exposures. These derivative instruments do not
qualify as cash flow hedges under SFAS No. 133 and are recorded at fair value
with all gains or losses, which have not been significant, recognized as a
component of Selling, general & administrative expenses in current period
earnings immediately.
OTHER SIGNIFICANT ACCOUNTING POLICIES
Fair Value of Financial Instruments
- -----------------------------------
The fair value of cash and cash equivalents, receivables, short-term borrowings
and accounts payable approximates their carrying value due to their short-term
maturities. The fair value of long-term debt instruments approximates the
carrying value and is estimated based on the current rates offered to the
Company for debt of similar maturities. The fair value of the Eurobonds was
367.7 million euros as of April 2, 2005. Fair values for derivatives are either
obtained from counter parties or developed using dealer quotes or cash flow
models.
Cash and Cash Equivalents
- -------------------------
All highly liquid investments with an original maturity of three months or less
at the date of purchase are classified as cash equivalents.
Marketable Securities
- ---------------------
Investments are stated at market. The estimated fair value of the marketable
securities is based on quoted prices in an active market. Gains and losses on
investment transactions are determined using the specific identification method
and are recognized in income based on settlement dates. Unrealized gains and
losses on securities held for sale are included in Accumulated other
comprehensive income (loss) until realized. Interest is recognized when earned.
All marketable securities are considered available-for-sale. Management
evaluates securities held with unrealized losses for other-than-temporary
impairment at least on a quarterly basis. Consideration is given to: (a) the
length of time and the extent to which the fair value has been less than cost;
(b) the financial condition and near-term prospects of the issuer; and (c) the
intent and ability of the Company to retain its investment in the issuer for a
period of time sufficient to allow for any anticipated recovery in fair value.
10
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Property and Equipment
- ----------------------
Property and equipment is stated at cost less accumulated depreciation and
amortization. Buildings and building improvements are depreciated using the
straight-line method over their estimated useful lives of 20 to 39 years.
Machinery and equipment and furniture and fixtures are depreciated using the
straight-line method over their estimated useful lives of three to seven years.
Leasehold improvements are amortized over the shorter of the remaining lease
term or the estimated useful lives of the assets. Leased property meeting
certain capital lease criteria is capitalized and the present value of the
related lease payments is recorded as a liability. Amortization of capitalized
leased assets is computed on the straight-line method over the shorter of the
estimated useful life or the initial lease term.
Foreign Currency Translation
- ----------------------------
Assets and liabilities of non-U.S. subsidiaries have been translated at
period-end exchange rates. Revenues and expenses have been translated at average
rates of exchange in effect during the period. Resulting translation adjustments
have been included in Accumulated other comprehensive income (loss). Gains and
losses on translation of intercompany loans with foreign subsidiaries of a
long-term investment nature are also included in this component of stockholders'
equity.
Cost of Goods Sold
- ------------------
Cost of goods sold for wholesale operations include the expenses incurred to
acquire and produce inventory for sale, including product costs, freight-in,
import costs, third-party inspection activities, buying agent commissions and
provisions for shrinkage. For retail operations, in-bound freight from the
Company's warehouse to its own retail stores is also included. Warehousing
activities including receiving, storing, picking, packing and general
warehousing charges are included in Selling, general & administrative expenses
("SG&A") and, as such, the Company's gross profit may not be comparable to
others who may include these expenses as a component of Cost of goods sold.
Advertising, Promotion and Marketing
- ------------------------------------
All costs associated with advertising, promoting and marketing of Company
products are expensed during the periods when the activities take place. Costs
associated with cooperative advertising programs involving agreements with
customers, whereby they are required to provide documentary evidence of specific
performance, are charged to SG&A when the amount of consideration paid by the
Company for these services are at or below fair value. Costs associated with
customer cooperative advertising allowances without specific performance
guidelines are reflected as a reduction of sales revenue.
Shipping and Handling Costs
- ---------------------------
Shipping and handling costs, which are mostly comprised of warehousing
activities, are included as a component of SG&A in the Condensed Consolidated
Statements of Income.
Stock-Based Compensation
- ------------------------
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related Interpretations in accounting for its
stock-based compensation plans. All employee stock options have been granted at
or above the grant date market price. Accordingly, no compensation cost has been
recognized for its fixed stock option grants. Compensation expense for
restricted stock awards is measured at fair value on the date of grant based on
the number of shares granted and the quoted market price of the Company's common
stock. Such value is recognized as expense over the vesting period of the award.
To the extent that restricted stock awards are forfeited prior to vesting, the
previously recognized expense is reversed to stock-based compensation expense.
Had compensation costs for the Company's stock option grants been determined
based on the fair value at the grant dates
11
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
for awards under these plans in accordance with SFAS No. 123, "Accounting for
Stock-Based Compensation," the Company's net income and earnings per share would
have been reduced to the pro forma amounts as follows:
Three Months Ended
----------------------------------
(13 Weeks) (13 Weeks)
(In thousands except for per share data) April 2, 2005 April 3, 2004
- ---------------------------------------- ----------------------------------
Net income:
As reported $ 71,418 $ 68,770
Add: Stock-based employee compensation expense on
restricted shares included in reported net income,
net of taxes of $1,296 and $900 in 2005 and 2004,
respectively 2,365 1,656
Less: Total stock-based employee compensation expense
determined under fair value based method for all
awards*, net of tax (6,468) (6,134)
------------ ------------
Pro forma $ 67,315 $ 64,292
============ ============
Basic earnings per share:
As reported $0.66 $0.63
Pro forma $0.63 $0.59
Diluted earnings per share:
As reported $0.65 $0.62
Pro forma $0.62 $0.58
* "All awards" refers to awards granted, modified, or settled in fiscal periods
beginning after December 15, 1994 - that is, awards for which the fair value
was required to be measured under SFAS No. 123, net of tax ($3,545 and $3,333
for quarters ended April 2, 2005 and April 3, 2004, respectively).
The Company changed the valuation model used for estimating the fair value of
options granted in the first quarter of 2005, from a Black-Scholes
option-pricing model to a Binomial lattice-pricing model. This change was made
in order to provide a better estimate of fair value since the Binomial model is
a more flexible analysis to value employee stock options than the Black-Scholes
model. The flexibility of the simulated Binomial model stems from the ability to
incorporate inputs that change over time, such as volatility and interest rates,
and to allow for actual exercise behavior of option holders.
Three Months Ended
----------------------------------------------
April 2, 2005 April 3, 2004
Valuation Assumptions: (Binomial Lattice) (Black-Scholes)
- ---------------------- ------------------------ ---------------------
Weighted-average fair value of options granted $12.91 $12.46
Expected volatility 28.8% to 42% 34%
Weighted-average volatility 29.4% N/A
Expected term (in years) 5.2 5.2
Dividend Yield 0.55% 0.60%
Risk-free rate 3.2% to 4.6% 3.1%
Expected annual forfeiture 9.3% 4.9%
Expected volatilities are based on a term structure of implied volatility, which
assumes changes in volatility over the life of an option. The Company utilizes
historical optionee behavioral data to estimate the option exercise and
termination rates that are used in the valuation model. The expected term
represents an estimate of the period of time options are expected to remain
outstanding. The expected term provided in the above table represents an option
weighted-average expected term based on the estimated behavior of distinct
groups of employees who received options in 2005. The range of risk-free rates
is based on a forward curve of interest rates at the time of option grant.
12
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Fiscal Year
- -----------
The Company's fiscal year ends on the Saturday closest to December 31. The 2005
and 2004 fiscal years each reflect a 52-week period resulting in a 13-week
three-month period for the first quarter.
Cash Dividend and Common Stock Repurchase
- -----------------------------------------
On January 20, 2005, the Company's Board of Directors declared a quarterly cash
dividend on the Company's common stock at the rate of $0.05625 per share, paid
on March 15, 2005 to stockholders of record at the close of business on February
24, 2005. As of May 2, 2005, the Company had $90.0 million remaining in buyback
authorization under its share repurchase program.
2. ACQUISITIONS
On January 6, 2005, the Company acquired all of the equity interest of C&C
California, Inc. ("C&C"). Based in California and founded in 2002, C&C is a
designer, marketer and wholesaler of premium apparel for women, men and children
through its C&C California brand. C&C sells its products primarily through
select specialty stores as well as through international distributors in Canada,
Europe and Asia. The purchase price consisted of an initial payment of $29.5
million, including fees, plus contingent payments in fiscal years 2007, 2008 and
2009 that will be based upon a multiple of C&C's earnings in each year. C&C
generated net sales of approximately $21 million in fiscal 2004. An independent
third-party valuation of the trademarks, trade names and customer relationships
of C&C is currently in process. Based on a preliminary valuation of the tangible
and intangible assets acquired from C&C, $7.6 million of purchase price has been
allocated to the value of trademarks and trade names associated with the
business, and $10.1 million has been allocated to the value of customer
relationships. The trademarks and trade names have been classified as having
definite lives and will be amortized over their estimated useful life of 20
years. Goodwill of $8.4 million is deemed to have an indefinite life and is
subject to an annual test for impairment as required by SFAS No. 142. The value
of customer relationships is being amortized over periods ranging from 10 to 20
years. Unaudited pro forma information related to this acquisition is not
included, as the impact of this transaction is not material to the consolidated
results of the Company. The Company estimates that the aggregate of the
contingent payments will be in the range of approximately $40-60 million. The
contingent payments will be accounted for as additional purchase price.
On June 8, 1999, the Company acquired 85.0 percent of the equity interest of
Lucky Brand Dungarees, Inc. ("Lucky Brand"), whose core business consists of the
Lucky Brand Dungarees line of women's and men's denim-based sportswear. The
acquisition was accounted for using the purchase method of accounting. The total
purchase price consisted of a cash payment made at the closing date of
approximately $85 million and a payment made in April 2003 of $28.5 million. An
additional payment of $12.7 million was made in 2000 for tax-related purchase
price adjustments. On January 28, 2005, the Company entered into an agreement to
acquire the remaining 15% of Lucky Brand shares that were owned by the sellers
of Lucky Brand for aggregate consideration of $65.0 million, plus a contingent
payment for the final 2.25% based upon a multiple of Lucky Brand's 2007
earnings. On January 28, 2005, the Company paid $35.0 million for 8.25% of the
equity interest of Lucky Brand. The excess of the amount paid over the related
amount of minority interest has been recorded to goodwill. In January 2006, 2007
and 2008, the Company will acquire 1.9%, 1.5% and 1.1% of the equity interest of
Lucky Brand for payments of $10.0 million each. The Company has recorded the
present value of fixed amounts owed ($28.2 million) as an increase in Other
Current and Other Non-Current Liabilities. The excess of the liability recorded
over the related amount of minority interest has been recorded as goodwill. In
June 2008, the Company will acquire the remaining 2.25% minority share for an
amount based on a multiple of Lucky Brand's 2007 earnings, which management
estimates will be in the range of $20-24 million.
On December 1, 2003, the Company acquired 100 percent of the equity interest of
Enyce Holding LLC ("Enyce"), a privately held fashion apparel company, for a
purchase price at closing of approximately $121.9 million, including fees and
the retirement of debt at closing, and an additional $9.7 million for certain
post-closing adjustments and assumption of liabilities that were accounted for
as additional purchase price. Based upon an independent third-party valuation of
the tangible and intangible assets acquired from Enyce, $27.0 million of
purchase price has been allocated to the value of trademarks and trade names
associated with the business, and $17.5 million has been allocated to the value
of customer relationships. The trademarks and trade names have been classified
as having
13
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
indefinite lives and are subject to an annual test for impairment as required by
SFAS No. 142. The value of customer relationships is being amortized over
periods ranging from 9 to 25 years. Unaudited pro forma information related to
this acquisition is not included, as the impact of this transaction is not
material to the consolidated results of the Company.
On April 7, 2003, the Company acquired 100 percent of the equity interest of
Juicy Couture, Inc. (formerly, Travis Jeans, Inc.) ("Juicy Couture"), a
privately held fashion apparel company. The total purchase price consisted of:
(a) a payment, including the assumption of debt and fees, of $53.1 million, and
(b) a contingent payment to be determined as a multiple of Juicy Couture's
earnings for one of the years ended 2005, 2006 or 2007. The selection of the
measurement year for the contingent payment is at either party's option. The
Company estimates that, if the 2005 measurement year is selected, the contingent
payment would be in the range of approximately $111-114 million. The contingent
payment will be accounted for as additional purchase price. In March of 2005,
the contingent payment agreement was amended to include an advance option for
the sellers. If the 2005 measurement year is not selected, the sellers may elect
to receive up to 75% of the estimated contingent payment based upon 2005
results. If the 2005 and 2006 measurement years are not selected, the sellers
are eligible to elect to receive up to 85% of the estimated contingent payment
based on the 2006 measurement year net of any 2005 advances. Based upon an
independent third-party valuation of the tangible and intangible assets acquired
from Juicy Couture, $27.3 million of purchase price has been allocated to the
value of trademarks and trade names associated with the business. The trademarks
and trade names have been classified as having indefinite lives and are subject
to an annual test for impairment as required by SFAS No. 142. Unaudited pro
forma information related to this acquisition is not included, as the impact of
this transaction is not material to the consolidated results of the Company.
On July 9, 2002, the Company acquired 100 percent of the equity interest of Mexx
Canada, Inc., a privately held fashion apparel and accessories company ("Mexx
Canada"). The total purchase price consisted of: (a) an initial cash payment
made at the closing date of $15.2 million; (b) a second payment made at the end
of the first quarter 2003 of 26.4 million Canadian dollars (or $17.9 million
based on the exchange rate in effect as of April 5, 2003); and (c) a contingent
payment to be determined as a multiple of Mexx Canada's earnings and cash flow
performance for the year ended either 2004 or 2005. The fair market value of
assets acquired was $20.5 million and liabilities assumed were $17.7 million
resulting in Goodwill of $29.6 million. In December 2004, the 2004 measurement
year was selected by the seller for the calculation of the contingent payment.
The contingency was settled on April 26, 2005 for 45.3 million Canadian dollars
(or $37.1 million based on the exchange rate on such date). The contingent
payment was accounted for as additional purchase price. Unaudited pro forma
information related to this acquisition is not included, as the impact of this
transaction is not material to the consolidated results of the Company.
On May 23, 2001, the Company acquired 100 percent of the equity interest of Mexx
Group B.V. ("Mexx"), a privately held fashion apparel company incorporated and
existing under the laws of The Netherlands, for a purchase price consisting of:
(a) 295 million euro (or $255.1 million based on the exchange rate in effect on
such date), in cash at closing (including the assumption of debt), and (b) a
contingent payment determined as a multiple of Mexx's earnings and cash flow
performance for the year ended 2003, 2004 or 2005. The 2003 measurement year was
selected by the sellers for the calculation of the contingent payment, and on
August 16, 2004, the Company made the required final payment of 160 million euro
(or $192.4 million based on the exchange rate on such date). The contingent
payment was accounted for as additional purchase price.
14
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. STOCKHOLDERS' EQUITY
Activity for the three months ended April 2, 2005 and April 3, 2004 in the
Capital in excess of par value, Retained earnings, Unearned compensation expense
and Common stock in treasury, at cost accounts is summarized as follows:
Capital in Unearned Common stock
excess of par Retained compensation in treasury,
(Dollars in thousands) value earnings expense at cost
- ---------------------- ----------------------------------------------------------------
Balance as of January 1, 2005 $ 176,182 $ 2,828,968 $ (36,793) $ (1,269,355)
Net income -- 71,418 -- --
Additional restricted shares issued, net of
cancellations 14,504 -- (20,245) 5,698
Stock options exercised 5,517 -- -- 3,764
Tax benefit on stock options exercised 1,622 -- -- --
Dividends declared -- (6,091) -- --
Amortization -- -- 3,661 --
------------ ------------ ------------ ------------
Balance as of April 2, 2005 $ 197,825 $ 2,894,295 $ (53,377) $ (1,259,893)
============ ============ ============ ============
Capital in Unearned Common stock
excess of par Retained compensation in treasury,
(Dollars in thousands) value earnings expense at cost
- ---------------------- ----------------------------------------------------------------
Balance as of January 3, 2004 $ 124,823 $ 2,539,742 $ (21,593) $ (1,191,231)
Net income -- 68,770 -- --
Additional restricted shares issued, net of
cancellations 14,038 -- (25,920) 11,882
Shares returned for taxes -- -- -- (2,647)
Stock options exercised 7,176 -- -- 14,215
Tax benefit on stock options exercised 3,848 -- -- --
Dividends declared -- (6,146) -- --
Amortization -- -- 2,556 --
------------ ------------ ------------ ------------
Balance as of April 3, 2004 $ 149,885 $ 2,602,366 $ (44,957) $ (1,167,781)
============ ============ ============ ============
Comprehensive income is comprised of net income, the effects of foreign currency
translation, changes in the spot value of Eurobonds designated as a net
investment hedge, changes in unrealized gains and losses on securities and
changes in the fair value of cash flow hedges. Total comprehensive income for
interim periods was as follows:
Three Months Ended
--------------------------------
(13 Weeks) (13 Weeks)
April 2, April 3,
(Dollars in thousands) 2005 2004
- ---------------------- --------------------------------
Net income $ 71,418 $ 68,770
Other comprehensive income (loss), net of tax:
Foreign currency translation (loss) gain (15,089) (5,124)
Foreign currency translation of Eurobonds 20,837 15,838
Changes in unrealized gains (losses) on
securities, net of income tax benefit
(provision) of $106 and $(3,000) (185) 5,288
Changes in fair value of cash flow hedges,
net of income tax provision of $(2,982)
and $(2,180) 5,648 2,834
------------ ------------
Total comprehensive income, net of tax $ 82,629 $ 87,606
============ ============
15
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Accumulated other comprehensive income (loss) consists of the following:
April 2, January 1, April 3,
(Dollars in thousands) 2005 2005 2004
- ---------------------- ------------------------------------------------
Foreign currency translation (loss) $ (48,769) $ (54,517) $ (37,478)
(Losses) on cash flow hedging derivatives, net of
taxes of $1,397, $4,379 and $3,534 (2,490) (8,138) (7,237)
Unrealized gains (losses) on securities, net of
taxes of $(644), $(538) and $7,573 (1,180) (995) 13,344
------------ ------------ ------------
Accumulated other comprehensive (loss), net
of tax $ (52,439) $ (63,650) $ (31,371)
============ ============ ============
4. MARKETABLE SECURITIES
On December 14, 2004, the Company sold all 1.5 million shares of the Class A
stock of Kenneth Cole Productions, Inc. ("KCP"). In accordance with SFAS No.
115, "Accounting for Certain Investments in Debt and Equity Securities", a
pre-tax gain of $11.9 million was recorded. These shares were initially acquired
in August 1999, in conjunction with the Company's consummation of a license
agreement with KCP. The shares were considered available-for-sale and were
recorded at fair market value with unrealized gains/losses net of taxes reported
as a component of Accumulated other comprehensive income (loss). The unrealized
gains have been reclassified from Accumulated other comprehensive income (loss)
to Other income (expense) - net, upon sale of the securities.
In June 2000, the Company purchased an equity index mutual fund as a long-term
investment for $8.5 million. The investment has been impaired since 2000
reflective of general stock market conditions over that period and has been
evaluated under EITF No. 03-01 to determine if the impairment is
other-than-temporary. This equity index mutual fund has historically provided
moderate growth and has recovered $2.4 million in value from its low of $4.8
million over the past two and a half years. The severity of the impairment is
currently 19.6% of the carrying value. The Company is forecasting continued
recovery for this investment. Based on that evaluation and the Company's ability
and intent to hold this investment for a reasonable period of time sufficient
for a forecasted recovery of fair value, the Company does not consider this
investment to be other-than-temporarily impaired at April 2, 2005.
The following table shows the investments' gross unrealized losses and fair
value, aggregated by investment category and length of time that individual
securities have been in a continuous unrealized loss position at April 2, 2005:
Less than 12 Months 12 Months or Longer Total
----------------------------- ----------------------------- -----------------------------
Gross Gross Gross
(In thousands) Unrealized Unrealized Unrealized
- -------------- Estimated Gains Estimated Gains Estimated Gains
Description of Securities Fair Value (Losses) Fair Value (Losses) Fair Value (Losses)
- -------------------------------------------------------- ----------------------------- -----------------------------
Equity investments $ -- $ -- $ 8,986 $ (1,757) $ 8,986 $ (1,757)
Other investments -- -- 416 (67) 416 (67)
----------- ----------- ----------- ----------- ----------- -----------
Total $ -- $ -- $ 9,402 $ (1,824) $ 9,402 $ (1,824)
=========== =========== =========== =========== =========== ===========
The following is a summary of available-for-sale marketable securities at April
2, 2005, January 1, 2005 and April 3, 2004:
April 2, 2005
--------------------------------------------------------
Unrealized
---------------------------- Estimated
(Dollars in thousands) Cost Gains Losses Fair Value
- ---------------------- --------------------------------------------------------
Equity investments $ 8,986 $ -- $ (1,757) $ 7,229
Other investments 416 -- (67) 349
------------ ------------ ------------ ------------
Total $ 9,402 $ -- $ (1,824) $ 7,578
============ ============ ============ ============
16
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
January 1, 2005
--------------------------------------------------------
Unrealized
---------------------------- Estimated
(Dollars in thousands) Cost Gains Losses Fair Value
- ---------------------- --------------------------------------------------------
Equity investments $ 8,919 $ -- $ (1,483) $ 7,436
Other investments 411 -- (50) 361
------------ ------------ ------------ ------------
Total $ 9,330 $ -- $ (1,533) $ 7,797
============ ============ ============ ============
April 3, 2004
--------------------------------------------------------
Unrealized
---------------------------- Estimated
(Dollars in thousands) Cost Gains Losses Fair Value
- ---------------------- --------------------------------------------------------
Equity securities $ 29,000 $ 22,810 $ -- $ 51,810
Equity investments 8,810 -- (1,893) 6,917
------------ ------------ ------------ ------------
Total $ 37,810 $ 22,810 $ (1,893) $ 58,727
============ ============ ============ ============
For the three months ended April 2, 2005 and April 3, 2004, there were no
realized gains or losses on sales of available-for-sale securities. The net
adjustments to unrealized holding gains and losses on available-for-sale
securities for the three months ended April 2, 2005 and April 3, 2004 were a
loss of $106,000 (net of $185,000 in taxes) and a gain of $5,497,000 (net of
$2,791,000 in taxes), respectively, which were included in Accumulated other
comprehensive income (loss).
5. INVENTORIES, NET
Inventories consist of the following:
April 2, January 1, April 3,
(Dollars in thousands) 2005 2005 2004
- ---------------------- -----------------------------------------------
Raw materials $ 32,881 $ 30,916 $ 21,467
Work in process 17,409 5,172 12,384
Finished goods 512,843 505,051 468,131
------------ ------------ ------------
Total $ 563,133 $ 541,139 $ 501,982
============ ============ ============
6. PROPERTY AND EQUIPMENT, NET
Property and equipment consist of the following:
April 2, January 1, April 3,
(Dollars in thousands) 2005 2005 2004
- ---------------------- -----------------------------------------------
Land and buildings $ 139,993 $ 139,993 $ 139,984
Machinery and equipment 351,398 345,179 331,441
Furniture and fixtures 194,669 192,097 149,365
Leasehold improvements 361,304 357,194 298,341
------------ ------------ ------------
1,047,364 1,034,463 919,131
Less: Accumulated depreciation
and amortization 580,195 559,890 504,815
------------ ------------ ------------
Total property and equipment, net $ 467,169 $ 474,573 $ 414,316
============ ============ ============
17
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
7. GOODWILL AND INTANGIBLES, NET
The following tables disclose the carrying value of all the intangible assets:
Estimated
(Dollars in thousands) Lives April 2, 2005 January 1, 2005 April 3,2004
- ---------------------- ----------------------------------------------------------------------
Amortized intangible assets:
- ----------------------------
Gross Carrying Amount:
Licensed trademarks 5-15 years $ 42,849 $ 42,849 $ 42,849
Owned trademarks 20 years 7,600 -- --
Customer relationships 5-25 years 27,600 17,500 6,700
Merchandising rights 4 years 54,045 52,625 72,424
------------ ------------ ------------
Subtotal $ 132,094 $ 112,974 $ 121,973
------------ ------------ ------------
Accumulated Amortization:
Licensed trademarks $ (19,049) $ (18,187) $ (14,831)
Owned trademarks (95) -- --
Customer relationships (1,566) (933) (120)
Merchandising rights (32,240) (29,224) (48,640)
------------ ------------ ------------
Subtotal $ (52,950) $ (48,344) $ (63,591)
------------ ------------ ------------
Net:
Licensed trademarks $ 23,800 $ 24,662 $ 28,018
Owned trademarks 7,505 -- --
Customer relationships 26,034 16,567 6,580
Merchandising rights 21,805 23,401 23,784
------------ ------------ ------------
Total amortized intangible assets, net $ 79,144 $ 64,630 $ 58,382
============ ============ ============
Unamortized intangible assets:
- ------------------------------
Owned trademarks $ 216,356 $ 216,356 $ 216,356
------------ ------------ ------------
Total intangible assets $ 295,500 $ 280,986 $ 274,738
============ ============ ============
As required under SFAS No. 142, the Company completed its annual impairment
tests as of the first day of the third quarters of each of fiscal 2004 and
fiscal 2003. No impairment was recognized at either date. Intangible
amortization expense was $4.6 million for the three months ended April 2, 2005
and $4.4 million for the three months ended April 3, 2004.
The estimated intangible amortization expense for the next five years is as
follows:
(In millions)
Fiscal Year Amortization Expense
- ----------------------------------------------------------------
2005 $ 16.0
2006 11.5
2007 9.9
2008 7.4
2009 5.5
The changes in carrying amount of goodwill for the three months ended April 2,
2005 are as follows:
Wholesale Wholesale
(Dollars in thousands) Apparel Non-Apparel Total
- ---------------------- ------------------------------------------------
Balance, January 1, 2005 $ 746,060 $ 9,595 $ 755,655
Acquisition of C&C California 8,375 -- 8,375
Additional purchase price of Lucky Brand 52,417 -- 52,417
Translation difference (320) -- (320)
------------ ------------ ------------
Balance, April 2, 2005 $ 806,532 $ 9,595 $ 816,127
============ ============ ============
There is no goodwill recorded in our retail segment.
18
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
8. DEBT
On August 7, 2001, the Company issued 350 million euros (or $307.2 million based
on the exchange rate in effect on such date) of 6.625% notes due on August 7,
2006 (the "Eurobonds"). The Eurobonds are listed on the Luxembourg Stock
Exchange and received a credit rating of BBB from Standard & Poor's and Baa2
from Moody's Investor Services. Interest on the Eurobonds is being paid on an
annual basis until maturity. These bonds are designated as a hedge of the
Company's net investment in Mexx (see Note 2 of Notes to Condensed Consolidated
Financial Statements).
On October 17, 2003, the Company entered into a $375 million, 364-day unsecured
financing commitment under a bank revolving credit facility, replacing the
existing $375 million, 364-day unsecured credit facility scheduled to mature in
October 2003, and on October 21, 2002, the Company received a $375 million,
three-year bank revolving credit facility. The aforementioned bank facilities
replaced an existing $750 million bank facility which was scheduled to mature in
November 2003. The three-year facility included a $75 million multi-currency
revolving credit line, which permitted the Company to borrow in U.S. dollars,
Canadian dollars and euro. At April 3, 2004, the Company had no debt outstanding
under these facilities. The carrying amount of the Company's borrowings under
the commercial paper program approximates fair value because the interest rates
are based on floating rates, which are determined by prevailing market rates.
On October 13, 2004, the Company entered into a $750 million, five-year
revolving credit agreement (the "Agreement"), replacing the $375 million,
364-day unsecured credit facility that was scheduled to mature in October 2004
and the existing $375 million bank revolving credit facility which was scheduled
to mature in October 2005. A portion of the funds available under the Agreement
not in excess of $250 million is available for the issuance of letters of
credit. Additionally, at the request of the Company, the amount of funds
available under the Agreement may be increased at any time or from time to time
by an aggregate principal amount of up to $250 million with only the consent of
the lenders (which may include new lenders) participating in such increase. The
Agreement includes a $150 million multi-currency revolving credit line, which
permits the Company to borrow in U.S. dollars, Canadian dollars and euro. The
Agreement has two borrowing options, an "Alternative Base Rate" option, as
defined in the Agreement, and a Eurocurrency rate option with a spread based on
the Company's long-term credit rating. The Agreement contains certain customary
covenants, including financial covenants requiring the Company to maintain
specified debt leverage and fixed charge coverage ratios, and covenants
restricting the Company's ability to, among other things, incur indebtedness,
grant liens, make investments and acquisitions, and sell assets. The Company
believes it is in compliance with such covenants. The funds available under the
Agreement may be used to refinance existing debt, provide working capital and
for general corporate purposes of the Company, including, without limitation,
the repurchase of capital stock and the support of the Company's $750 million
commercial paper program. The Company's ability to obtain funding through its
commercial paper program is subject to, among other things, the Company
maintaining an investment-grade credit rating. At April 2, 2005, the Company had
no debt outstanding under the Agreement.
As of April 2, 2005, January 1, 2005 and April 3, 2004, the Company had lines of
credit aggregating $588 million, $551 million and $503 million, respectively,
which were primarily available to cover trade letters of credit. At April 2,
2005, January 1, 2005 and April 3, 2004, the Company had outstanding trade
letters of credit of $271 million, $310 million and $298 million, respectively.
These letters of credit, which have terms ranging from one to ten months,
primarily collateralize the Company's obligations to third parties for the
purchase of inventory. The fair value of these letters of credit approximates
contract values.
The Company's Canadian and European subsidiaries have unsecured lines of credit
totaling approximately $158.3 million (based on the exchange rates as of April
2, 2005). As of April 2, 2005, a total of $45.8 million of borrowings
denominated in foreign currencies was outstanding at an average interest rate of
2.3%. These lines of credit bear interest at rates based on indices specified in
the contracts plus a margin. The lines of credit are in effect for less than one
year and mature at various dates in 2005. These lines are guaranteed by the
Company. With the exception of the Eurobonds, which mature in 2006, most of the
Company's debt will mature in less than one year and will be refinanced under
existing credit lines. The capital lease obligations in Europe expire in 2007
and 2008.
19
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
9. CONTINGENCIES AND COMMITMENTS
On May 22, 2001, the Company entered into an off-balance sheet financing
arrangement (commonly referred to as a "synthetic lease") to acquire various
land and equipment and construct buildings and real property improvements
associated with warehouse and distribution facilities in Ohio and Rhode Island.
The leases expire on November 22, 2006, with renewal subject to the consent of
the lessor. The lessor under the operating lease arrangements is an independent
third-party limited liability company, wholly owned by a publicly traded
corporation. That public corporation consolidates the financial statements of
the lessor in its financial statements. The lessor has other leasing activities
and has contributed equity of 5.75% of the $63.7 million project costs. The
leases include guarantees by the Company for a substantial portion of the
financing and options to purchase the facilities at original cost; the maximum
guarantee is approximately $56 million. The guarantee becomes effective if the
Company declines to purchase the facilities at the end of the lease and the
lessor is unable to sell the property at a price equal to or greater than the
original cost. The Company selected this financing arrangement to take advantage
of the favorable financing rates such an arrangement afforded as opposed to the
rates available under alternative real estate financing options. The lessor
financed the acquisition of the facilities through funding provided by
third-party financial institutions. In December 2003, the Financial Accounting
Standards Board ("FASB") issued FASB Interpretation No. 46R, "Consolidation of
Variable Interest Entities" ("FIN 46R"), which amends the same titled FIN 46
that was issued in January 2003. FIN 46R addresses how to identify variable
interest entities and the criteria that requires the consolidation of such
entities. The third-party lessor does not meet the definition of a variable
interest entity under FIN 46R, and therefore consolidation by the Company is not
required.
The Company has not entered into any other off-balance sheet arrangements.
Various legal actions are pending against the Company. Although the outcome of
any such actions cannot be determined with certainty, management is of the
opinion that the final outcome of any of these actions should not have a
materially adverse effect on the Company's results of operations or financial
position. Please refer to Note 11 and Note 25 of Notes to Consolidated Financial
Statements in the Company's 2004 Annual Report on Form 10-K.
10. RESTRUCTURING CHARGES
In December 2004, the Company recorded a net pretax restructuring charge of $9.8
million ($6.5 million after tax) that was recorded as an operating expense.
Substantially all of the restructuring charge is expected to be a cash charge.
The Company projects that the majority of the charge will be paid and all
associated activities will be completed in the second quarter of fiscal 2005.
The charge is comprised of the following:
o $5.7 million of the charge (the majority of which relates to employee
severance costs) is associated with the restructuring of the Company's
European operations, aimed at centralizing strategic decision-making and
facilitate the management of a multi-brand platform, as well as the closure
of its Mexx Europe catalog business.
o $4.1 million of the charge is attributable to employee severance costs
associated with the closure of the Company's Secaucus, New Jersey
distribution center. Products currently distributed through the Secaucus
facility will be distributed through existing facilities as well as a new
leased facility in Allentown, Pennsylvania.
In December 2002, the Company recorded a net restructuring charge of $7.1
million (pretax), representing a charge of $9.9 million in connection with the
closure of the 22 remaining domestic Liz Claiborne brand specialty stores,
offset by a $2.8 million reversal of liabilities recorded in connection with the
December 2001 restructuring that were no longer required. This determination to
close the stores was intended to eliminate redundancy between this retail format
and the wide department store base in which Liz Claiborne products are
available. The $9.9 million charge included costs associated with lease
obligations ($5.4 million), asset write-offs ($3.3 million) and other store
closing costs ($1.2 million). In December 2003 and September 2004, the Company
recorded net pretax restructuring gains of $672,000 and $105,000, respectively,
representing the reversal of amounts provided in December 2002 no longer
required. These activities were completed as of January 1, 2005.
20
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
A summary of the changes in the restructuring reserves is as follows:
Operating &
Administrative
(Dollars in thousands) Exit Costs
- ---------------------- ----------------
Balance at January 1, 2005 $ 9,866
Spending for three months ended April 2, 2005 (1,943)
Translation difference (226)
--------
Balance at April 2, 2005 $ 7,697
========
11. EARNINGS PER COMMON SHARE
The following is an analysis of the differences between basic and diluted
earnings per common share in accordance with SFAS No. 128, "Earnings per Share."
April 2, 2005 April 3, 2004
------------------------------------------- -------------------------------------------
Weighted Net Income Weighted Net Income
All amounts in thousands Average per Common Average per Common
except per share data Net Income Shares Share Net Income Shares Share
- ---------------------------------------------------------------------- -------------------------------------------
Basic $ 71,418 108,063 $ 0.66 $ 68,770 109,281 $ 0.63
Effect of dilutive
securities:
Stock options and
restricted stock grants -- 1,996 0.01 -- 1,964 0.01
----------- ---------- ------ ----------- ---------- ------
Diluted $ 71,418 110,059 $ 0.65 $ 68,770 111,245 $ 0.62
=========== ========== ====== =========== ========== ======
Options to purchase 13,000 and 2,707,000 shares of common stock were outstanding
as of April 2, 2005 and April 3, 2004, respectively, but were not included in
the computation of diluted EPS for the quarters then ended because the options
were anti-dilutive.
12. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTARY DISCLOSURES
During the three months ended April 2, 2005, the Company made income tax
payments of $26,914,000 and interest payments of $848,000. During the three
months ended April 3, 2004, the Company made income tax payments of $18,518,000
and interest payments of $503,000.
13. SEGMENT REPORTING
The Company operates the following business segments: Wholesale Apparel,
Wholesale Non-Apparel and Retail. The Wholesale Apparel segment consists of
women's, men's and children's apparel designed and marketed worldwide under
various trademarks owned by the Company or licensed by the Company from
third-party owners, including wholesale sales of women's, men's and children's
apparel designed and marketed in Europe, Canada, the Asia-Pacific Region and the
Middle East under the Mexx brand names. The Wholesale Non-Apparel segment
includes handbags, small leather goods, fashion accessories, jewelry and
cosmetics designed and marketed worldwide under certain owned or licensed
trademarks. The Retail segment consists of the Company's worldwide retail
operations that sell most of these apparel and non-apparel products to the
public through the Company's specialty retail stores, outlet stores, and
concession stores and e-commerce sites. The Company also presents its results on
a geographic basis based on selling location, between Domestic (wholesale
customers and Company specialty retail and outlet stores located in the United
States) and International (wholesale customers and Company specialty retail,
outlet and concession stores located outside of the United States). The Company,
as licensor, also licenses to third parties the right to produce and market
products bearing certain Company-owned trademarks; the
21
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
resulting royalty income is not allocated to any of the specified operating
segments, but is rather included in the line "Sales from external customers"
under the caption "Corporate/Eliminations."
The Company evaluates performance and allocates resources based on operating
profits or losses. The accounting policies of the reportable segments are the
same as those described in the summary of significant accounting policies in its
2004 Annual Report on Form 10-K. Intersegment sales are recorded at cost. There
is no intercompany profit or loss on intersegment sales, however, the wholesale
segments are credited with their proportionate share of the operating profit
generated by the Retail segment. The profit credited to the wholesale segments
from the Retail segment is eliminated in consolidation.
Certain items in the Company's International businesses have been reclassified
to conform to current year's classifications. In addition, as the Company is
creating the multi-brand platform in Europe, it has the opportunity to
reengineer cost allocation processes to reflect the current operating results
for each of its segments.
The Company's segments are business units that offer either different products
or distribute similar products through different distribution channels.
Additional categorization across the segments is impractical and not relevant in
that the segments are each managed separately because they either contract to
manufacture and distribute distinct products with different production processes
or distribute similar products through different distribution channels.
For the Three Months Ended April 2, 2005
--------------------------------------------------------------------------
Wholesale Wholesale Corporate/
(Dollars in thousands) Apparel Non-Apparel Retail Eliminations Total
- ---------------------- -------------- -------------- -------------- -------------- --------------
NET SALES:
Total net sales $ 857,304 $ 140,975 $ 255,534 $ (41,406) $ 1,212,407
Intercompany sales (47,658) (4,315) -- 51,973 --
----------- ----------- ----------- ----------- -----------
Sales from external customers $ 809,646 $ 136,660 $ 255,534 $ 10,567 $ 1,212,407
=========== =========== =========== =========== ===========
OPERATING INCOME:
Total operating income (loss) $ 109,093 $ 13,225 $ (7,463) $ 3,901 $ 118,756
Intercompany segment operating
(income) loss (3,668) (1,277) -- 4,945 --
----------- ----------- ----------- ----------- -----------
Segment operating income (loss)
from external customers $ 105,425 $ 11,948 $ (7,463) $ 8,846 $ 118,756
=========== =========== =========== =========== ===========
For the Three Months Ended April 3, 2004
--------------------------------------------------------------------------
Wholesale Wholesale Corporate/
(Dollars in thousands) Apparel Non-Apparel Retail Eliminations Total
- ---------------------- -------------- -------------- -------------- -------------- --------------
NET SALES:
Total net sales $ 812,093 $ 114,373 $ 208,023 $ (31,722) $ 1,102,767
Intercompany sales (37,658) (3,367) -- 41,025 --
----------- ----------- ----------- ----------- -----------
Sales from external customers $ 774,435 $ 111,006 $ 208,023 $ 9,303 $ 1,102,767
=========== =========== =========== =========== ===========
OPERATING INCOME:
Total operating income (loss) $ 109,826 $ 7,196 $ (6,758) $ 4,063 $ 114,327
Intercompany segment operating
(income) loss (2,729) (1,033) -- 3,762 --
----------- ----------- ----------- ----------- -----------
Segment operating income (loss)
from external customers $ 107,097 $ 6,163 $ (6,758) $ 7,825 $ 114,327
=========== =========== ============ =========== ===========
22
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
April 2, January 1, April 3,
(Dollars in thousands) 2005 2005 2004
- ---------------------- ---------------------------------------------
SEGMENT ASSETS:
Wholesale Apparel $ 2,480,357 $ 2,411,354 $ 2,151,203
Wholesale Non-Apparel 171,351 128,650 161,499
Retail 668,499 686,884 535,479
Corporate 163,823 152,360 187,084
Eliminations (374,983) (349,496) (294,445)
----------- ----------- -----------
Total assets $ 3,109,047 $ 3,029,752 $ 2,740,820
=========== =========== ===========
GEOGRAPHIC DATA:
Three Months Ended
------------------------------
(Dollars in thousands) April 2, 2005 April 3, 2004
- ---------------------- ------------------------------
NET SALES:
Domestic $ 900,064 $ 834,513
International 312,343 268,254
----------- -----------
Total net sales $ 1,212,407 $ 1,102,767
=========== ===========
OPERATING INCOME:
Domestic $ 99,651 $ 94,616
International 19,105 19,711
----------- -----------
Total operating income $ 118,756 $ 114,327
=========== ===========
April 2, January 1, April 3,
(Dollars in thousands) 2005 2005 2004
- ---------------------- ---------------------------------------------
TOTAL ASSETS:
Domestic $ 1,991,448 $ 1,891,476 $ 1,951,682
International 1,117,599 1,138,276 789,138
----------- ----------- -----------
Total assets $ 3,109,047 $ 3,029,752 $ 2,740,820
=========== =========== ===========
14. DERIVATIVE INSTRUMENTS
At April 2, 2005, the Company had various euro currency collars outstanding with
a net notional amount of $49 million, maturing through December 2005 and with
values ranging between 1.20 and 1.38 U.S. dollar per euro and various Canadian
currency collars outstanding with a net notional amount of $25 million, maturing
through October 2005 and with values ranging between 1.18 and 1.25 Canadian
dollar per U.S. dollar, as compared to $53 million in euro currency collars and
$27 million in Canadian currency collars at year-end 2004 and $26 million in
euro currency collars at the end of the first quarter of 2004. At the end of the
first quarter of 2005, the Company also had forward contracts maturing through
September 2005 to sell 13 million euro for $17 million and to sell 2.5 million
Pounds Sterling for 3.6 million euro. The notional value of the foreign exchange
forward contracts at the end of the first quarter of 2005 was approximately $22
million, as compared with approximately $45 million at year-end 2004 and
approximately $93 million at the end of the first quarter of 2004. Unrealized
losses for outstanding foreign exchange forward contracts and currency options
were approximately $1.2 million at the end of the first quarter of 2005, $6.2
million at year-end 2004 and approximately $5.5 million the end of the first
quarter of 2004. The ineffective portion of these swaps is recognized currently
in earnings and was not material for the three months ended April 2, 2005.
Approximately $1.7 million relating to cash flow hedges in Accumulated other
comprehensive income (loss) will be reclassified into earnings in the next
twelve months.
In connection with the variable rate financing under the synthetic lease
agreement, the Company has entered into two interest rate swap agreements with
an aggregate notional amount of $40.0 million that began in January 2003 and
will terminate in May 2006, in order to fix the interest component of rent
expense at a rate of 5.56%. The Company has entered into these arrangements to
hedge against potential future interest rate increases. The change in fair value
of the effective portion of the interest rate swap is recorded as a component of
Accumulated other
23
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
comprehensive income (loss) since these swaps are designated as cash flow
hedges. The ineffective portion of these swaps is recognized currently in
earnings and was not material for the three months ended April 2, 2005.
Approximately $0.5 million relating to cash flow hedges in Accumulated other
comprehensive income (loss) will be reclassified into earnings in the next
twelve months.
The Company hedges its net investment position in euro functional subsidiaries
by designating the 350 million Eurobonds as a hedge of net investments. The
change in the Eurobonds due to changes in currency rates is recorded to Currency
translation adjustment, a component of Accumulated other comprehensive income
(loss). The loss recorded to Currency translation adjustment was $20.5 million
for the quarter ended April 2, 2005 and $15.9 million for the quarter ended
April 3, 2004.
On February 11, 2004, the Company entered into interest rate swap agreements for
the notional amount of 175 million euro in connection with its 350 million
Eurobonds maturing August 7, 2006. This converted a portion of the fixed rate
Eurobonds interest expense to floating rate at a spread over six month EURIBOR.
The first interest rate setting occurred on August 7, 2004 and will be reset
each six-month period thereafter until maturity. This is designated as a fair
value hedge. The favorable interest accrual was not material for the quarter
ended April 2, 2005.
15. RECENT ACCOUNTING PRONOUNCEMENTS
In March 2004, the Emerging Issues Task Force ("EITF") reached a consensus on
recognition and measurement guidance previously discussed under EITF Issue No.
03-01. The consensus clarifies the meaning of "other-than-temporary impairment"
and its application to investments classified as either available-for-sale or
held-to-maturity under SFAS No. 115, "Accounting for Certain Investments in Debt
and Equity Securities," and investments accounted for under the cost method or
the equity method. In September 2004 the FASB issued a final FASB Staff Position
("FSP"), FSP EITF Issue No. 03-01-1, delaying the effective date for the
measurement and recognition guidance of EITF Issue No. 03-01, however the
disclosure requirements remain effective and the applicable ones have been
adopted for the Company's fiscal year ended January 1, 2005. The implementation
of EITF Issue No. 03-01 is not expected to have a material impact on the
Company's results of operations and financial condition.
In September 2004, the EITF reached a consensus on applying Paragraph 19 of SFAS
No. 131 in EITF Issue No. 04-10, "Determining Whether to Aggregate Operating
Segments That Do Not Meet the Quantitative Thresholds." The consensus states
that operating segments that do not meet the quantitative thresholds can be
aggregated only if aggregation is consistent with the objective and basic
principles of SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information," the segments have similar economic characteristics, and
the segments share a majority of the aggregation criteria (a)-(e) listed in
paragraph 17 of SFAS No. 131. The effective date of the consensus in this Issue
is for fiscal years ending after October 13, 2004. Adoption of the EITF has not
affected the Company's segment classifications.
In November 2004, the EITF reached a consensus on EITF Issue No. 03-13,
"Applying the Conditions in Paragraph 42 of FASB Statement No. 144, in
Determining Whether to Report Discontinued Operations." The consensus requires
an evaluation of whether the operations and cash flows of a disposed component
have been or will be substantially eliminated from the ongoing operations of the
entity or will migrate or continue. This consensus should be applied to a
component of an enterprise that is either disposed of or classified as held for
sale in fiscal periods beginning after December 15, 2004. Adoption of the EITF
in the first quarter of fiscal 2005 should not have a material affect on the
Company's results of operations and financial position.
In December 2004, the FASB released revised SFAS No. 123R, "Share-Based
Payment." The pronouncement requires public companies to measure the cost of
employee services received in exchange for an award of equity instruments based
on the grant-date fair value of the award. That cost will be recognized over the
period during which an employee is required to provide service in exchange for
the award--the requisite service period (typically the vesting period). SFAS No.
123R is effective as of the beginning of the first interim or annual reporting
period that begins after June 15, 2005. The Company is shifting the composition
of its equity compensation plan towards restricted stock and away from stock
options. This shift towards restricted stock will ultimately reduce dilution, as
fewer shares will be used for equity compensation purposes. The adoption of SFAS
No. 123R utilizing the modified
24
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
prospective basis, inclusive of the shift towards restricted stock, will reduce
2005 fully diluted earnings per share by an estimated $0.10-0.12.
On December 21, 2004, the FASB issued FSP No. 109-2, "Accounting and Disclosure
Guidance for the Foreign Earnings Repatriation Provision Within the American
Jobs Creation Act of 2004." FSP No. 109-2 allows for additional time to assess
the effect of repatriating foreign earnings, which under SFAS No. 109,
"Accounting for Income Taxes," would typically be required to be recorded in the
period of enactment. The American Jobs Creation Act of 2004 creates a temporary
incentive for U.S. corporations to repatriate accumulated income earned abroad.
The Company is currently analyzing the potential impact of utilizing the
incentive.
In March 2005 the SEC issued Staff Accounting Bulletin ("SAB") No. 107
"Share-Based Payment." SAB No. 107 expresses views of the SEC staff regarding
the interaction between SFAS No. 123R and certain SEC rules and regulations and
provide the staff's views regarding the valuation of share-based payment
arrangements. Subsequently the SEC decided to delay the required implementation
of SFAS No. 123R to years beginning after June 15, 2005. The Company will adopt
SFAS No. 123R for its fiscal 2005 third quarter as discussed above and
previously disclosed.
16. SUBSEQUENT EVENTS
On April 26, 2004, the Company settled the contingency for the acquisition of
Mexx Canada for 45.3 million Canadian dollars (or $37.1 million based on the
exchange rate on such date). The Mexx Canada shareholders were paid in cash.
Mexx Canada, Inc., was acquired in July 2002 for a total purchase price
consisted of: (a) an initial cash payment made at the closing date of $15.2
million; (b) a second payment made at the end of the first quarter 2003 of 26.4
million Canadian dollars (or $17.9 million based on the exchange rate in effect
as of April 5, 2003); and (c) a contingent payment to be determined as a
multiple of Mexx Canada's earnings and cash flow performance for the year ended
2004 or 2005. In December 2004, the 2004 measurement year was selected by the
seller for the calculation of the contingent payment. The contingent payment was
accounted for as additional purchase price.
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
- --------
Business/Segments
- -----------------
We operate the following business segments: Wholesale Apparel, Wholesale
Non-Apparel and Retail.
o Wholesale Apparel consists of women's and men's apparel designed and marketed
-----------------
worldwide under various trademarks owned by the Company or licensed by the
Company from third-party owners. This segment includes our businesses in our
LIZ CLAIBORNE and LIZ brands along with our better apparel (CLAIBORNE
(men's), INTUITIONS, REALITIES, SIGRID OLSEN and SWE), bridge priced (DANA
BUCHMAN and ELLEN TRACY), Special Markets (which is comprised of our mid-tier
brands (AXCESS, CRAZY HORSE, FIRST ISSUE and VILLAGER) and moderate
department store brands (EMMA JAMES and J.H. COLLECTIBLES)), denim/street
wear (ENYCE and LUCKY BRAND DUNGAREES) and contemporary sportswear (JUICY
COUTURE, C&C CALIFORNIA and LAUNDRY BY SHELLI SEGAL) businesses, as well as
our licensed DKNY(R) JEANS, DKNY(R) ACTIVE, and CITY DKNY(R) businesses. The
Wholesale Apparel segment also includes wholesale sales of women's, men's and
children's apparel designed and marketed in Europe, Canada, the Asia-Pacific
region and the Middle East under our MEXX brand names.
o Wholesale Non-Apparel consists of handbags, small leather goods, fashion
----------------------
accessories, jewelry and cosmetics designed and marketed worldwide under
certain of the above listed and other owned or licensed trademarks, including
our MONET, TRIFARI and MARVELLA labels.
o Retail consists of our worldwide retail operations that sell most of these
------
apparel and non-apparel products to the public through our 288 outlet stores,
273 specialty retail stores and 597 international concession stores (where
the retail selling space is either owned and operated by the department store
in which the retail selling space is located, or leased and operated by a
third party, while, in each case, the Company owns the inventory), and our
e-commerce sites. This segment includes specialty retail and outlet stores
operating under the following formats: MEXX, LUCKY BRAND DUNGAREES, LIZ
CLAIBORNE, ELISABETH, DKNY(R) JEANS, DANA BUCHMAN, ELLEN TRACY, SIGRID OLSEN,
MONET, LAUNDRY BY SHELLI SEGAL and JUICY COUTURE, as well as our Special
Brands Outlets which include products from our Special Markets divisions.
The Company, as licensor, also licenses to third parties the right to produce
and market products bearing certain Company-owned trademarks. The resulting
royalty income is not allocated to any of the specified operating segments, but
is rather included in the line "Sales from external customers" under the caption
"Corporate/Eliminations" in Note 13 of Notes to Condensed Consolidated Financial
Statements.
Competitive Profile
- -------------------
We operate in global fashion markets that are intensely competitive. Our ability
to continuously evaluate and respond to changing consumer demands and tastes,
across multiple market segments, distribution channels and geographies, is
critical to our success. Although our brand portfolio approach is aimed at
diversifying our risks in this regard, misjudging shifts in consumer preferences
could have a negative effect. Other key aspects of competition include quality,
brand image, distribution methods, price, customer service and intellectual
property protection. Our size and global operating strategies help us to compete
successfully by positioning us to take advantage of synergies in product design,
development, sourcing and distribution of our products throughout the world. We
believe we owe much of our recent success to our ability to identify strategic
acquisitions, our ability to grow our existing businesses, to our product
designs and to our having successfully leveraged our competencies in technology
and supply chain management for the benefit of existing and new (both acquired
and internally developed) businesses. Our success in the future will depend on
our ability to continue to design products that are acceptable to the
marketplaces that we serve, to source the manufacture of our products on a
competitive basis, particularly in light of the impact of the recent elimination
of quota for apparel products, and to leverage our technology competencies.
Reference is also made to the other economic, competitive, governmental and
technological factors affecting the Company's operations, markets, products,
services and prices as are set forth under "Statement Regarding Forward-Looking
Disclosure" below and in our 2004 Annual Report on Form 10-K, including, without
limitation, those set forth under the heading "Business-Competition; Certain
Risks."
26
2005 First Quarter Overall Results
- ----------------------------------
Net Sales
- ---------
Net sales for the first quarter of 2005 were a record $1.212 billion, an
increase of $109.6 million, or 9.9%, over 2004 first quarter net sales, as we
continued the disciplined execution of our brand portfolio strategy, under which
we strive to offer consumers apparel and non-apparel products across a range of
styles, price points and channels of distribution.
The sales results reflect continued growth in our JUICY COUTURE apparel and
accessories, MEXX Europe and DKNY(R) Jeans businesses. Approximately $16.8
million of the sales increase was due to the impact of foreign currency exchange
rates, primarily as a result of the strengthening euro, on the reported results
of our international businesses. We also experienced sales increases in our
Canadian and LUCKY BRAND DUNGAREES businesses and added sales of our recent
acquisition of C&C CALIFORNIA.
These increases more than offset sales decreases in our LIZ CLAIBORNE apparel
business and the impact of the discontinuation of our KENNETH COLE womenswear
license in December 2004. Our LIZ CLAIBORNE apparel business has been challenged
by increasingly conservative buying patterns of our retail store customers as
they continue to focus on inventory productivity and seek to differentiate their
offerings from those of their competitors, the growth in department store
private label brands and increased competition in the department store channel.
In addition, the department store sector is experiencing a period of
consolidation, as evidenced recently by the announcement of the merger of
Federated Department Stores and The May Company. Such consolidations present
challenges in operating in the department store sector. The department store
channel has also been challenged by migration of consumers away from malls to
national chains and off-priced retailers, as well as a general decline in prices
for non-luxury apparel products.
Looking forward, we expect that our retail partners will continue a conservative
approach to planning inventory levels, with continued focus on inventory
productivity and an increasing emphasis on reorder (quick turn) business, and
will continue to strive for differentiation, while the domestic department store
sector will continue to experience consolidation. Our state-of-the-art
technology coupled with modern business models and an evolving supply chain
enable us to partner with our customers, to quickly identify and reorder those
items that are trending well with consumers. We will continue to make
investments in the LIZ CLAIBORNE brand through a variety of marketing
initiatives. With our acquisitions and the growth in our moderate and mid-tier
department store brands, non-apparel businesses including our LIZ CLAIBORNE
branded non-apparel products, and specialty retail businesses; we have
diversified our business by channels of distribution and target consumer. We
have also diversified geographically, with our international operations
representing over 25% of our sales. We continue to view international as an
important area of growth for us and are working to build the capability to
launch brands from our domestic portfolio in markets outside the United States
while continuing to evaluate growth opportunities available through business
development efforts outside the United States.
Gross Profit and Net Income
- ---------------------------
Our gross profit improved in the first quarter of 2005 reflecting continued
focus on inventory management and lower sourcing costs, offsetting gross margin
pressure resulting from a highly promotional retail environment. Our gross
profit also benefited from the continued growth of our MEXX Europe and domestic
specialty retail businesses, as each of these businesses run at gross profit
rates higher than the Company average. Overall net income increased to $71.4
million in the first quarter of 2005 from $68.8 million in the first quarter of
2004, reflecting the benefit received from our sales and gross profit rate
improvements.
Balance Sheet
- -------------
Our financial position continues to be strong. We ended the first quarter of
2005 with a net debt position of $376.2 million as compared to $215.6 million at
April 3, 2004. We generated $399.0 million in cash from operations over the past
twelve months, which enabled us to fund the first quarter acquisition of C&C
CALIFORNIA, the purchase of an additional 8.25% of Lucky Brand, the final
payment to acquire MEXX Europe, our second quarter 2004 share repurchase and our
capital expenditures of $141.5 million, while increasing our net debt by $160.6
million. The effect of foreign currency translation on our Eurobond added $29.3
million to our debt balance.
27
International Operations
- ------------------------
In the first quarter of 2005, sales from our international segment represented
25.8% of our overall sales, as opposed to 24.3% in the first quarter of 2004. We
expect our international sales to continue to represent an increasingly higher
percentage of our overall sales volume as a result of further anticipated growth
in our MEXX Europe business and from the recent launch of a number of our
current domestic brands in Europe utilizing the MEXX corporate platform.
Accordingly, our overall results can be greatly impacted by changes in foreign
currency exchange rates. For example, the impact of foreign currency exchange
rates represented $16.8 million, or 38.0%, of the increase of international
sales from the first quarter of 2004. Over the past few years, the euro and the
Canadian dollar have strengthened against the U.S. dollar. While this trend has
benefited our sales results and earnings in light of the growth of our MEXX
Europe and MEXX Canada businesses, these businesses' inventory, accounts
receivable and debt balances have likewise increased. Although we use foreign
currency forward contracts and options to hedge against our exposure to exchange
rate fluctuations affecting the actual cash flows associated with our
international operations, unanticipated shifts in exchange rates could have an
impact on our financial results.
Recent Acquisitions
- -------------------
On January 6, 2005, we acquired all of the equity interest of C&C California,
Inc. ("C&C"). Based in California and founded in 2002, C&C is a designer,
marketer and wholesaler of premium apparel for women, men and children through
its C&C CALIFORNIA brand. C&C sells its products primarily through select
specialty stores as well as through international distributors in Canada, Europe
and Asia. The purchase price consisted of an initial payment of $29.5 million,
including fees, plus contingent payments in fiscal years 2007, 2008 and 2009
that will be based upon a multiple of C&C's earnings in each year. C&C generated
net sales of approximately $21 million in fiscal 2004. An independent
third-party valuation of the trademarks, trade names and customer relationships
of C&C is currently in process. Based on a preliminary valuation of the tangible
and intangible assets acquired from C&C, $7.6 million of purchase price has been
allocated to the value of trademarks and trade names associated with the
business, and $10.1 million has been allocated to the value of customer
relationships. The trademarks and trade names have been classified as having
definite lives and will be amortized over their estimated useful life of 20
years. Goodwill of $8.4 million is deemed to have an indefinite life and is
subject to an annual test for impairment as required by Statement of Financial
Accounting Standards ("SFAS") No. 142. The value of customer relationships is
being amortized over periods ranging from 10 to 20 years. Unaudited pro forma
information related to this acquisition is not included as the impact of this
transaction is not material to the consolidated results of the Company. We
estimate that the aggregate of the contingent payments will be in the range of
approximately $40-60 million. The contingent payments will be accounted for as
additional purchase price.
On June 8, 1999, we acquired 85.0 percent of the equity interest of Lucky Brand
Dungarees, Inc. ("Lucky Brand"), whose core business consists of the Lucky Brand
Dungarees line of women's and men's denim-based sportswear. The acquisition was
accounted for using the purchase method of accounting. The total purchase price
consisted of a cash payment made at the closing date of approximately $85
million and a payment made in April 2003 of $28.5 million. An additional payment
of $12.7 million was made in 2000 for tax-related purchase price adjustments. On
January 28, 2005, we entered into an agreement to acquire the remaining 15% of
Lucky Brand shares that were owned by the sellers of Lucky Brand for an
aggregate consideration of $65.0 million, plus a contingent payment for the
final 2.25% based upon a multiple of Lucky Brand's 2007 earnings. On January 28,
2005, we paid $35.0 million for 8.25% of the equity interest of Lucky Brand. The
excess of the amount paid over the related amount of minority interest has been
recorded to goodwill. In January 2006, 2007 and 2008, we will acquire 1.9%, 1.5%
and 1.1% of the equity interest of Lucky Brand for payments of $10.0 million
each. We have recorded the present value of fixed amounts owed ($28.2 million)
as an increase in Other Current and Other Non-Current Liabilities. The excess of
the liability recorded over the related amount of minority interest has been
recorded as goodwill. In June 2008, we will acquire the remaining 2.25% minority
share for an amount based on a multiple of Lucky Brand's 2007 earnings, which we
estimate will be in the range of $20-24 million.
On December 1, 2003, we acquired 100 percent of the equity interest of Enyce
Holding LLC ("Enyce"), a privately held fashion apparel company, for a purchase
price of approximately $121.9 million, including fees and the retirement of debt
at closing, and an additional $9.7 million for certain closing adjustments and
assumptions of liabilities that were accounted for as additional purchase price.
Based upon an independent third-party valuation of the tangible and intangible
assets acquired from Enyce, $27.0 million of purchase price has been allocated
to the value of trademarks and trade names associated with the business, and
$17.5 million has been allocated to the value of customer relationships. The
trademarks and trade names have been classified as having indefinite lives and
are
28
subject to an annual test for impairment as required by SFAS No. 142. The value
of customer relationships is being amortized over periods ranging from 9 to 25
years.
On April 7, 2003, we acquired 100 percent of the equity interest of Juicy
Couture, Inc. (formerly, Travis Jeans Inc.) ("Juicy Couture"), a privately held
fashion apparel company. The total purchase price consisted of: (a) a payment,
including the assumption of debt and fees, of $53.1 million, and (b) a
contingent payment to be determined as a multiple of Juicy Couture's earnings
for one of the years ended 2005, 2006 or 2007. The selection of the measurement
year for the contingent payment is at either party's option. We estimate that if
the 2005 measurement year is selected, the contingent payment would be in the
range of approximately $111-114 million. The contingent payment will be
accounted for as additional purchase price. In March of 2005, the contingent
payment agreement was amended to include an advance option for the sellers. If
the 2005 measurement year is not selected, the sellers may elect to receive up
to 75% of the estimated contingent payment based upon 2005 results. If the 2005
and 2006 measurement years are not selected, the sellers are eligible to elect
to receive up to 85% of the estimated contingent payment based on the 2006
measurement year net of any 2005 advances. Based upon an independent third-party
valuation of the tangible and intangible assets acquired from Juicy Couture,
$27.3 million of purchase price has been allocated to the value of trademarks
and trade names associated with the business. The trademarks and trade names
have been classified as having indefinite lives and are subject to an annual
test for impairment as required by SFAS No. 142.
On July 9, 2002, we acquired 100 percent of the equity interest of Mexx Canada,
Inc., a privately held fashion apparel and accessories company ("Mexx Canada").
The total purchase price consisted of: (a) an initial cash payment made at the
closing date of $15.2 million; (b) a second payment made at the end of the first
quarter 2003 of 26.4 million Canadian dollars (or $17.9 million based on the
exchange rate in effect as of April 5, 2003); and (c) a contingent payment to be
determined as a multiple of Mexx Canada's earnings and cash flow performance for
the year ended either 2004 or 2005. The fair market value of assets acquired was
$20.5 million and liabilities assumed were $17.7 million resulting in goodwill
of $29.6 million. In December 2004, the 2004 measurement year was selected by
the seller for the calculation of the contingent payment. The contingency was
settled on April 26, 2005 for 45.3 million Canadian dollars (or $37.1 million
based on the exchange rate on such date). The contingent payment was accounted
for as additional purchase price. Unaudited pro forma information related to
this acquisition is not included, as the impact of this transaction is not
material to the consolidated results of the Company.
On May 23, 2001, we acquired 100 percent of the equity interest of Mexx Group
B.V. ("Mexx"), a privately held fashion apparel company incorporated and
existing under the laws of The Netherlands, for a purchase price consisting of:
(a) $255.1 million (295 million euro), in cash at closing (including the
assumption of debt), and (b) a contingent payment to be determined as a multiple
of Mexx's earnings and cash flow performance for the year ended 2003, 2004 or
2005. The 2003 measurement year was selected by the sellers for the calculation
of the contingent payment, and on August 16, 2004, we made the required final
payment of $192.4 million (160 million euro). The contingent payment was
accounted for as additional purchase price.
RESULTS OF OPERATIONS
- ---------------------
We present our results based on the three business segments discussed in the
Overview section, as well as on the following geographic basis based on selling
location:
o Domestic: wholesale customers and Company Specialty Retail and Outlet stores
--------
located in the United States; and our e-commerce sites; and
o International: wholesale customers and Company Specialty Retail and Outlet
-------------
stores and Concession stores located outside of the United States, primarily
in our MEXX Europe and MEXX Canada operations.
All data and discussion with respect to our specific segments included within
this "Management's Discussion and Analysis" is presented after applicable
intercompany eliminations.
29
2005 VS. 2004
- -------------
The following table sets forth our operating results for the 13 weeks ended
April 2, 2005 compared to the 13 weeks ended April 3, 2004:
Three months ended Variance
------------------------------------------------------------------
Dollars in millions April 2, 2005 April 3, 2004 $ %
- -------------------------------------------------------------------------------------------------------
Net Sales $ 1,212.4 $ 1,102.8 $ 109.6 9.9%
Gross Profit 558.2 501.0 57.2 11.4%
Selling, general & administrative
expenses 439.5 386.7 52.8 13.6%
Operating Income 118.8 114.3 4.5 3.9%
Other income (expense) - net (0.6) (0.6) 0.0 0.0%
Interest (expense) - net (7.6) (7.6) 0.0 0.0%
Provision for income taxes 39.1 37.3 1.8 4.8%
Net Income $ 71.4 $ 68.8 $ 2.6 3.8%
Net Sales
- ---------
Net sales for the first quarter of 2005 were a record $1.212 billion, an
increase of $109.6 million, or 9.9%, over net sales for the first quarter of
2004. The inclusion of sales from our C&C CALIFORNIA business (acquired January
6, 2005) added approximately $4.1 million in net sales during the quarter.
Continued growth of our JUICY COUTURE business, MEXX Europe business and our
Accessories and Jewelry businesses added approximately $59.1 million in net
sales for the quarter. The impact of foreign currency exchange rates, primarily
as a result of the strengthening of the euro, in our international businesses
added approximately $16.8 million in sales during the quarter. Net sales results
for our business segments are provided below:
o Wholesale Apparel net sales increased $35.2 million, or 4.6%, to $809.6
------------------
million. This result reflected the following:
- The addition of $4.1 million of sales from our recently acquired C&C
CALIFORNIA business;
- A $9.5 million increase resulting from the impact of foreign currency
exchange rates in our international businesses; and
- A $21.6 million net increase, primarily reflecting the continued growth of
our JUICY COUTURE business (which added $19.0 million of sales due to
increased customer demand mostly reflected in higher volume), increases in
our licensed DKNY(R) Jeans business (due to the addition of new retail
customers) and LUCKY BRAND DUNGAREES business (due to increased customer
demand and an increase in department store locations) and increases in our
moderate and mid-tier department store brands (due to higher volume), as
well as growth in our DANA BUCHMAN business, partially offset by a 9.2%
decrease in our LIZ CLAIBORNE business (resulted from lower unit pricing)
and the discontinuance of our KENNETH COLE womenswear license.
o Wholesale Non-Apparel net sales increased $25.7 million, or 23.1%, to $136.7
----------------------
million. The increase was primarily due to the addition of our JUICY COUTURE
Accessories business (launched in February 2004), as well as increases in our
Jewelry, Handbags and Cosmetics businesses. Net sales in our domestic LIZ
CLAIBORNE business increased 6.9% to last year. The impact of foreign
currency exchange rates in our international businesses was not material in
this segment.
o Retail net sales increased $47.5 million, or 22.8%, to $255.5 million. The
------
increase reflected the following:
- A $7.1 million increase resulting from the impact of foreign currency
exchange rates in our international businesses; and
30
- A $40.4 million net increase primarily driven by higher comparable store
sales in our Specialty Retail business (including a 29.1% comparable store
sales increase in our LUCKY BRAND DUNGAREES business and a 15.4% increase
in comparable store sales in our MEXX Europe business), the net addition
of 20 new Specialty Retail and Outlet stores in our MEXX Europe business,
18 SIGRID OLSEN Specialty Retail stores, 14 new Specialty Retail and
Outlet stores in Canada, 11 new LUCKY BRAND DUNGAREES stores, 9 new
domestic LIZ CLAIBORNE Outlet stores, 5 MEXX USA Specialty Retail stores
and 37 new international concession stores over the last twelve months.
Comparable store sales in our Company-operated stores increased by 3.6%
overall, driven by a 15.0% increase in our Specialty Retail business,
partially offset by a 5.2% decrease in our Outlet business. We ended the
quarter with a total of 288 Outlet stores, 273 Specialty Retail stores and
597 international concession stores. Comparable store sales are calculated as
sales from existing stores, plus new stores, less closed stores as follows:
new stores become comparable after 15 full months of being open. Closed
stores become non-comparable one month before they close. If a store
undergoes renovations and increases or decreases substantially in size as the
result of renovations, it becomes non-comparable. If a store is relocated,
stays the same size, and has no interruption of selling, then the store
remains comparable. If, however, a location change causes a significant
increase or decrease in size, then the location becomes non-comparable.
Stores that are acquired are not considered comparable until they have been
reflected in our results for a period of 12 months. Comparable store sales do
not include concession sales.
o Corporate net sales, consisting of licensing revenue, increased $1.3 million
---------
to $10.6 million as a result of revenues from new licenses and growth from
our existing license portfolio.
Viewed on a geographic basis, Domestic net sales increased by $65.6 million, or
--------
7.9%, to $900.0 million, reflecting the continued growth in our JUICY COUTURE
apparel and accessories and DKNY(R) Jeans businesses, partially offset by
declines in our LIZ CLAIBORNE business. International net sales increased $44.1
-------------
million, or 16.4%, to $312.3 million. The international increase reflected the
results of our MEXX Europe business; approximately $16.8 million of this
increase was due to the impact of currency exchange rates.
Gross Profit
- ------------
Gross profit increased $57.2 million, or 11.4%, to $558.2 million in the first
quarter of 2005 over the first quarter of 2004. Gross profit as a percent of net
sales increased to 46.0% in 2005 from 45.4% in 2004. Approximately $9.3 million
of the increase in the quarter was due to the impact of foreign currency
exchange rates, primarily as a result of the strengthening of the euro. The
increased gross profit rate reflected lower sourcing costs and a change in the
mix of product offerings within our portfolio reflecting continued growth of our
MEXX Europe and domestic specialty retail businesses, as these businesses run at
higher gross profit rates than the Company average, partially offset by higher
promotional activity in our wholesale businesses as well as additional
liquidation of excess inventory.
Warehousing activities including receiving, storing, picking, packing and
general warehousing charges are included in Selling, general & administrative
expenses ("SG&A"); accordingly, our gross margin may not be comparable to others
who may include these expenses as a component of cost of goods sold.
Selling, General & Administrative Expenses
- ------------------------------------------
SG&A increased $52.8 million, or 13.6%, to $439.5 million in the first quarter
of 2005 over the first quarter of 2004 and as a percent of net sales increased
to 36.2% from 35.1%. The SG&A increase reflected the following:
o The inclusion of $1.5 million of expenses from our recently acquired C&C
CALIFORNIA business and the start-up of new businesses;
o Approximately $8.3 million of the increase was due to the impact of foreign
currency exchange rates, primarily as a result of the strengthening of the
euro;
o A $6.9 million increase in investments in marketing activities, particularly
focused on in-store activities across our portfolio;
o Approximately $0.7 million of incremental equity based compensation expense
resulting from the migration of our long-term compensation plan primarily to
restricted stock in anticipation of the expensing of stock options; and
o A $35.4 million net increase primarily resulting from the expansion of our
domestic and international retail businesses and increased expenses in our
MEXX Europe wholesale business.
31
The SG&A rate primarily reflected the unfavorable impact of the increased
proportion of expenses related to our MEXX Europe business, which runs at a
higher SG&A rate than the Company average, and reduced expense leverage
resulting from the decreased proportion of expenses related to our LIZ CLAIBORNE
business, which runs at a lower SG&A rate than the Company average as well as
the increased investment in marketing activities described above, partially
offset by Company-wide expense control initiatives.
Operating Income
- ----------------
Operating income for the first quarter of 2005 was $118.8 million, an increase
of $4.4 million, or 3.9%, over last year. Operating income as a percent of net
sales decreased to 9.8% in 2005 compared to 10.4% in 2004. The decrease was the
result of increased marketing expenditures and higher promotional activities
discussed above as well as continued expenditures associated with expanding the
European multi-brand platform, partially offset by lower sourcing costs and
expense reductions. Approximately $1.0 million of the increase was due to the
impact of foreign currency exchange rates, primarily as a result of the
strengthening of the euro. Operating income by business segment is provided
below:
o Wholesale Apparel operating income was $105.4 million (13.0% of net sales) in
-----------------
2005 compared to $107.1 million (13.8% of net sales) in 2004, principally
reflecting reduced profits in our LIZ CLAIBORNE business as a result of the
lower sales pricing discussed above, as well as reduced profits in our LUCKY
BRAND DUNGAREES and ELLEN TRACY businesses, mostly offset by the continued
growth of our JUICY COUTURE, MEXX Europe business, as well as growth in our
moderate and mid-tier department store business, growth in our DANA BUCHMAN
business and the favorable impact of the discontinuation of our KENNETH COLE
womenswear license.
o Wholesale Non-Apparel operating income was $12.0 million (8.7% of net sales)
----------------------
in 2005 compared to $6.2 million (5.6% of net sales) in 2004, principally due
to the addition of our JUICY COUTURE Accessories business as well as
increased profits in our LIZ CLAIBORNE and MONET Jewelry and Cosmetics
businesses, partially offset by decreased profits in our Fashion Accessories
business.
o Retail operating loss was $7.5 million (-2.9% of net sales) in 2005 compared
------
to a $6.8 million loss (-3.2% of net sales) in 2004, principally reflecting
continued investment in retail infrastructure and new stores, as well as
decreased profits in our MEXX Europe business due to continued expenditures
associated with expanding the European multi-brand platform as well as
aggressive liquidation of inventory in our European outlet business,
partially offset by an increase in profits from our LUCKY BRAND DUNGAREES
Retail stores and MONET Europe concession businesses.
o Corporate operating income, primarily consisting of licensing operating
---------
income, increased $1.0 million to $8.8 million as a result of revenues from
our new licenses and growth from our existing license portfolio.
Viewed on a geographic basis, Domestic operating profit increased by $5.0
--------
million, or 5.3%, to $99.7 million, predominantly reflecting the continued
growth in our JUICY COUTURE Wholesale and LUCKY BRAND DUNGAREES Retail
businesses as well as increased profits in our moderate and mid-tier department
store business, partially offset by reduced profits in our core LIZ CLAIBORNE
business. International operating profit decreased $0.6 million, or 3.1% to
-------------
$19.1 million. The international decrease reflected the increased SG&A costs at
our MEXX retail business.
Net Other Expense
- -----------------
Net other expense in the first quarter of 2005 was $0.6 million compared to $0.6
million in the first quarter of 2004. In 2005 net other expense was comprised of
$0.6 million of minority interest expense (which relates to the 6.75% minority
interest in Lucky Brand and the 1.8% minority interest in Segrets, Inc.),
partially offset by other non-operating income. In 2004, net other expense was
principally comprised of $0.7 million of minority interest expense, partially
offset by other non-operating income.
Net Interest Expense
- --------------------
Net interest expense in the first quarter of 2005 was flat at $7.6 million
compared to the first quarter of 2004, both of which were principally related to
borrowings incurred to finance our strategic initiatives, including
acquisitions.
Provision for Income Taxes
- --------------------------
The income tax rate in the first quarter of 2005 increased to 35.4% from 35.2%
in the prior year as a result of changes in state tax laws.
32
Net Income
- ----------
Net income in the first quarter of 2005 increased to $71.4 million, or 5.9% of
net sales, from $68.8 million in the first quarter of 2004, or 6.2% of net
sales. Diluted earnings per common share ("EPS") increased to $0.65 in 2005,
from $0.62 in 2004, a 4.8% increase.
Average diluted shares outstanding decreased by 1.2 million shares to 110.1
million in the first quarter of 2005 on a period-to-period basis, as a result of
the 2004 share repurchases, mostly offset by the exercise of stock options and
the effect of dilutive securities.
FORWARD OUTLOOK
- ---------------
These forward-looking statements are qualified in their entirety by reference to
the risks and uncertainties set forth under the heading "STATEMENT REGARDING
FORWARD-LOOKING DISCLOSURE" below.
For the full year 2005, we are reaffirming our previous guidance, forecasting a
net sales increase of 6 - 8%, an operating margin in the range of 10.9% - 11.1%
and EPS in the range of $2.96 - $3.02, including the impact, which we estimate
will be $0.10 - $0.12, resulting from the planned adoption in the third quarter
of 2005 of SFAS No. 123R ("Accounting for Share-Based Payment") and a shift in
the composition of the Company's 2005 equity-based compensation discussed above.
We are proceeding with the adoption of FASB 123R in spite of the SEC recently
delaying the mandatory adoption period. It is also important to note that the
shift toward restricted stock should ultimately reduce dilution, as we expect
that fewer shares will be used for equity-based compensation purposes than was
the case in prior years. We do not expect foreign currency exchange rates in our
international businesses to have a material impact on full year 2005 results.
o In our Wholesale Apparel segment, we expect fiscal 2005 net sales to increase
in the range of 3 - 4% due to the impact of the factors described above with
growth primarily driven by the acquisition of C&C CALIFORNIA in addition to
increases in our JUICY COUTURE, MEXX Europe, moderate and mid-tier department
store businesses, LUCKY BRAND DUNGAREES, licensed DKNY(R) Jeans, SIGRID OLSEN
and LAUNDRY BY SHELLI SEGAL businesses, as well as our TINT, METROCONCEPTS,
BELONGINGS and TAPEMEASURE businesses, partially offset by the impact of the
discontinuation of our KENNETH COLE womenswear license. We expect net sales
in our domestic LIZ CLAIBORNE business to decrease in the mid teens
year-over-year.
o In our Wholesale Non-Apparel segment, we expect fiscal 2005 net sales to
increase in the range of 10 - 12%, primarily driven by increases in our
Cosmetics, JUICY COUTURE Accessories, Handbags and Jewelry businesses. We
expect our LIZ CLAIBORNE business to increase in the high single digits
year-over-year, as a result of recent strength in these businesses.
o In our Retail segment, we expect fiscal 2005 net sales to increase in the
range of 14 - 17%, primarily driven by continued growth in our LUCKY BRAND
DUNGAREES, MEXX Europe, Outlet, SIGRID OLSEN, LIZ CLAIBORNE Canada, MEXX
Canada and MEXX USA businesses. We project comparable store sales to be flat
to up low single digits over fiscal 2004.
o We expect fiscal 2005 licensing revenue to increase by 15% over fiscal 2004.
For the second quarter of 2005, we are providing our initial guidance,
forecasting a net sales increase of 6 - 8% (including an approximate 1% sales
increase due to the projected impact of foreign currency exchange rates), an
operating margin in the range of 7.8% - 8.2% and EPS in the range of $0.46 -
$0.48, including the impact, which we estimate will be $0.01, resulting from the
shift in the composition of the Company's 2005 equity-based management
compensation discussed above.
o In our Wholesale Apparel segment, we expect second quarter 2005 net sales to
increase in the range of 2 - 4%, primarily driven by the acquisition of C&C
CALIFORNIA as well as increases in our Mexx Europe, JUICY COUTURE, LUCKY
BRAND DUNGAREES, JH COLLECTIBLES and AXCESS men's and women's businesses,
partially offset by a decrease in our LIZ CLAIBORNE business as well as the
impact of the discontinuation of our licensed KENNETH COLE womenswear
business.
o In our Wholesale Non-Apparel segment, we expect second quarter 2005 net sales
to increase in the range of 10 - 12%, primarily driven by increases in our
Cosmetics, Jewelry and Handbags businesses.
o In our Retail segment, we expect second quarter 2005 net sales to increase in
the range of 13 - 15%, primarily driven by increases in our MEXX Europe,
LUCKY BRAND DUNGAREES, MEXX Canada and SIGRID OLSEN businesses.
o We expect second quarter 2005 licensing revenue to increase by 10%.
33
All of these forward-looking statements exclude the impact of any future
acquisitions or stock repurchases.
FINANCIAL POSITION, CAPITAL RESOURCES AND LIQUIDITY
- ---------------------------------------------------
Cash Requirements. Our primary ongoing cash requirements are to fund growth in
- -------------------
working capital (primarily accounts receivable and inventory) to support
projected sales increases, investment in the technological upgrading of our
distribution centers and information systems, and other expenditures related to
retail store expansion, in-store merchandise shops and normal maintenance
activities. We also require cash to fund our acquisition program. In addition,
the Company will require cash to fund any repurchase of Company stock under its
previously announced share repurchase program; as of May 2, 2005, the Company
had $90.0 million remaining in buyback authorization under the program.
Sources of Cash. Our historical sources of liquidity to fund ongoing cash
- ----------------
requirements include cash flows from operations, cash and cash equivalents and
securities on hand, as well as borrowings through our commercial paper program
and bank lines of credit (which include revolving and trade letter of credit
facilities); in 2001, we issued euro-denominated bonds (the "Eurobonds") to fund
the initial payment in connection with our acquisition of MEXX Europe. These
bonds are designated as a hedge of our net investment in MEXX (see Note 2 of
Notes to Condensed Consolidated Financial Statements). We anticipate that cash
flows from operations, our commercial paper program and bank and letter of
credit facilities will be sufficient to fund our next twelve months' liquidity
requirements and that we will be able to adjust the amounts available under
these facilities if necessary (see "Commitments and Capital Expenditures" for
more information on future requirements). Such sufficiency and availability may
be adversely affected by a variety of factors, including, without limitation,
retailer and consumer acceptance of our products, which may impact our financial
performance, maintenance of our investment-grade credit rating, as well as
interest rate and exchange rate fluctuations.
2005 vs. 2004
- -------------
Cash and Debt Balances. We ended the first quarter of 2005 with $131.0 million
- ------------------------
in cash and marketable securities, compared to $240.1 million at April 3, 2004
and $393.4 million at January 1, 2005, and with $507.2 million of debt
outstanding compared to $455.7 million at April 3, 2004 and $540.6 million at
January 1, 2005. The $160.6 million increase in our net debt position on a
year-over-year basis is primarily attributable to the 160 million euro (or
$192.4 million based on the exchange rate in effect on the payment date)
required final contingent payment to complete the purchase of MEXX Europe, the
$29.5 million payment made related to the acquisition of C&C CALIFORNIA, the $35
million payment to Lucky Brand shareholders to purchase an additional 8.25%
interest in Lucky Brand, the $116.8 million in share repurchases, $141.5 million
for capital and in-store expenditures and the effect of foreign currency
translation on our Eurobond, which added $29.3 million to our debt balance,
partially offset by cash flow from operations for the year of $399.0 million. We
ended the quarter with $1.903 billion in stockholders' equity, giving us a total
debt to total capital ratio of 21.0% compared to $1.685 billion in stockholders'
equity last year with a debt to total capital ratio of 21.3% and $1.811 billion
in stockholders' equity at year end with a debt to total capital ratio of 23.0%.
Accounts Receivable increased $73.0 million, or 12.2%, at the end of the first
- --------------------
quarter 2005 compared to the end of first quarter 2004, primarily due to
increased sales volumes and timing of shipments. The impact of foreign currency
exchange rates of $10.3 million, primarily related to the strengthening of the
euro. Accounts receivable increased $237.8 million, or 55.0%, at April 2, 2005
compared to January 1, 2005 due primarily to the timing of shipments in our
domestic operations.
Inventories increased $61.2 million, or 12.2%, at the end of first quarter 2005
- -----------
compared to the end of first quarter 2004. New business initiatives and the
expansion of our retail businesses were responsible for $33.5 million of the
increase in inventory over April 3, 2004. Approximately $10.9 million of the
increase is related to the impact of currency exchange rates, primarily relating
to the strengthening of the euro. Inventories increased by $22.0 million, or
4.1%, compared to January 1, 2005, primarily due to a shift in timing of our
current season and in-transit inventories within our domestic wholesale apparel
businesses as well as increases in our distressed inventory levels. Our average
inventory turnover rate was relatively flat at 4.5 times for the twelve-month
period ended April 2, 2005, 4.6 times for the twelve-month period ended April 3,
2004 and 4.5 times for the twelve-month period ended January 1, 2005.
34
Borrowings under our revolving credit facility and other credit facilities
- ----------
peaked at $96 million during the first quarter of 2005; at the end of the first
quarter of 2005, our borrowings under these facilities were $45.8 million.
Net cash used in operating activities was $166.5 million in the first quarter of
- -------------------------------------
2005, compared to $108.3 million in the first quarter of 2004. This $58.2
million decrease in cash flow was primarily due to a $271.2 million use of cash
for working capital in 2005 compared to a $210.5 million use of cash for working
capital in 2004, driven primarily by year-over-year changes in accounts
receivable due to timing of shipments to customers as well as in the accounts
payable due to timing of payments for inventory purchases and in accrued
expenses due to the payment of certain employment-related obligations.
Net cash used in investing activities was $89.3 million in the first quarter of
- --------------------------------------
2005, compared to $38.1 million in the first quarter of 2004. Net cash used in
the first quarter of 2005 primarily reflected payments of $35.0 million for the
acquisition of additional Lucky Brand shares, payments of $29.5 for the
acquisition of C&C and $25.8 million for capital and in-store expenditures. Net
cash used in the first quarter of 2004 primarily reflected $30.7 million for the
capital and in-store expenditures.
Net cash used in financing activities was $7.6 million in the first quarter of
- --------------------------------------
2005, compared to $26.2 million provided by the first quarter of 2004. The $33.9
million year-over-year decrease primarily reflected reduced proceeds from
commercial paper in the first quarter of 2005, in addition to a decrease in
proceeds received from the exercise of stock options and proceeds from
short-term debt.
Commitments and Capital Expenditures
- ------------------------------------
We may be required to make additional payments in connection with our
acquisitions. If paid in cash, these payments will be funded with net cash
provided by operating activities, our revolving credit and other credit
facilities and/or the issuance of debt:
o On January 28, 2005, we entered into an agreement to acquire the remaining
15% of Lucky Brand shares that were owned by the sellers of Lucky Brand for
aggregate consideration of $65.0 million, plus a contingent payment for the
final 2.25% based upon a multiple of Lucky Brand's 2007 earnings. On January
28, 2005, we paid $35.0 million for 8.25% of the equity interest of Lucky
Brand. The excess of the amount paid over the related amount of minority
interest has been recorded to goodwill. In January 2006, 2007 and 2008, we
will acquire 1.9%, 1.5% and 1.1% of the equity interest of Lucky Brand for
payments of $10.0 million each. We have recorded the present value of fixed
amounts owed ($28.2 million) as an increase in Other Current and Other
Non-Current Liabilities. The excess of the liability recorded over the
related amount of minority interest has been recorded as goodwill. In June
2008, we will acquire the remaining 2.25% minority share for an amount based
on a multiple of Lucky Brand's 2007 earnings, which we estimate will be in
the range of $20-24 million.
o Under the Segrets acquisition agreement, we may elect, or be required, to
purchase the minority interest shares in Segrets. We estimate that if the
eligible payment for Segrets is triggered in 2005, it would fall in the range
of $2 - 4 million, and the payment will be made in either cash or shares of
our common stock at the option of either the Company or the seller.
o The Mexx Canada acquisition agreement provides for a contingent payment to be
determined as a multiple of Mexx Canada's earnings and cash flow performance
for the year ended 2004 or 2005. The selection of the measurement year was at
the option of the Company or the seller. In December 2004, the seller
selected the 2004 measurement year for the calculation of the contingent
payment. The contingency was settled on April 26, 2005 for 45.3 million
Canadian dollars (or $37.1 million based on the exchange rate on such date).
The contingent payment was accounted for as additional purchase price.
o The Juicy Couture acquisition agreement provides for a contingent payment to
be determined as a multiple of Juicy Couture's earnings for one of the years
ended 2005, 2006 or 2007. We estimate that if the 2005 measurement year were
selected, the Juicy Couture contingent payment in 2006 would be in the range
of $111-114 million. This payment will be made in either cash or shares of
our common stock at the option of the Company. In March of 2005, the
contingent payment agreement was amended to include an advance option for the
sellers. If the 2005 measurement year is not selected, the sellers may elect
to receive up to 75% of the estimated contingent payment based upon 2005
results. If the 2005 and 2006 measurement years are not selected, the sellers
are eligible to elect to receive up to 85% of the estimated contingent
payment based on the 2006 measurement year net of any 2005 advances.
o The C&C acquisition agreement provides for contingent payments in fiscal
years 2007, 2008 and 2009 that will be based upon a multiple of C&C's
earnings in each year. Contingent payments in aggregate are estimated by
35
the Company to be in the range of approximately $40-60 million. The
contingent payments will be accounted for as additional purchase price.
Financing Arrangements
- ----------------------
On August 7, 2001, we issued 350 million euro (or $307.2 million based on the
exchange rate in effect on such date) of 6.625% notes due on August 7, 2006 (the
"Eurobonds"). The Eurobonds are listed on the Luxembourg Stock Exchange and
received a credit rating of BBB from Standard & Poor's and Baa2 from Moody's
Investor Services. Interest on the Eurobonds is being paid on an annual basis
until maturity. These bonds are designated as a hedge of our net investment in
Mexx (see Note 2 of Notes to Consolidated Financial Statements).
On October 17, 2003, we entered into a $375 million, 364-day unsecured financing
commitment under a bank revolving credit facility, replacing the existing $375
million, 364-day unsecured credit facility scheduled to mature in October 2003,
and on October 21, 2002, we received a $375 million, three-year bank revolving
credit facility. The aforementioned bank facilities replaced an existing $750
million bank facility which was scheduled to mature in November 2003. The
three-year facility included a $75 million multi-currency revolving credit line,
which permitted us to borrow in U.S. dollars, Canadian dollars and euro. At
April 3, 2004, we had no debt outstanding under these facilities. The carrying
amount of our borrowings under the commercial paper program approximates fair
value because the interest rates are based on floating rates, which are
determined by prevailing market rates.
On October 13, 2004, we entered into a $750 million, five-year revolving credit
agreement (the "Agreement"), replacing the $375 million, 364-day unsecured
credit facility scheduled to mature in October 2004 and the existing $375
million bank revolving credit facility which was scheduled to mature in October
2005. A portion of the funds available under the Agreement not in excess of $250
million is available for the issuance of letters of credit. Additionally, at our
request, the amount of funds available under the Agreement may be increased at
any time or from time to time by an aggregate principal amount of up to $250
million with only the consent of the lenders (which may include new lenders)
participating in such increase. The Agreement includes a $150 million
multi-currency revolving credit line, which permits us to borrow in U.S.
dollars, Canadian dollars and euro. The Agreement has two borrowing options, an
"Alternative Base Rate" option, as defined in the Agreement, and a Eurocurrency
rate option with a spread based on our long-term credit rating. The Agreement
contains certain customary covenants, including financial covenants requiring us
to maintain specified debt leverage and fixed charge coverage ratios, and
covenants restricting our ability to, among other things, incur indebtedness,
grant liens, make investments and acquisitions, and sell assets. We believe we
are in compliance with such covenants. The funds available under the Agreement
may be used to refinance existing debt, provide working capital and for general
corporate purposes of the Company, including, without limitation, the repurchase
of capital stock and the support of our $750 million commercial paper program.
The Company's ability to obtain funding through its commercial paper program is
subject to, among other things, the Company maintaining an investment-grade
credit rating. At April 2, 2005, we had no debt outstanding under the Agreement.
As of April 2, 2005, January 1, 2005 and April 3, 2004, we had lines of credit
aggregating $588 million and $551 million and $503 million, respectively, which
were primarily available to cover trade letters of credit. At April 2, 2005,
January 1, 2005 and April 3, 2004, we had outstanding trade letters of credit of
$271 million, $310 million and $298 million, respectively. These letters of
credit, which have terms ranging from one to ten months, primarily collateralize
our obligations to third parties for the purchase of inventory. The fair value
of these letters of credit approximates contract values.
Our Canadian and European subsidiaries have unsecured lines of credit totaling
approximately $158.3 million (based on the exchange rates as of April 2, 2005),
which is included in the aforementioned $588 million available lines of credit.
As of April 2, 2005, a total of $45.8 million of borrowings denominated in
foreign currencies was outstanding at an average interest rate of 2.3%. These
lines of credit bear interest at rates based on indices specified in the
contracts plus a margin. The lines of credit are in effect for less than one
year and mature at various dates in 2005. These lines are guaranteed by the
Company. With the exception of the Eurobonds, which mature in 2006, most of our
debt will mature in 2005 and will be refinanced under existing credit lines. The
capital lease obligations in Europe expire in 2007 and 2008.
36
Off-Balance Sheet Arrangements
- ------------------------------
On May 22, 2001, we entered into an off-balance sheet financing arrangement
(commonly referred to as a "synthetic lease") to acquire various land and
equipment and construct buildings and real property improvements associated with
warehouse and distribution facilities in Ohio and Rhode Island. The leases
expire on November 22, 2006, with renewal subject to the consent of the lessor.
The lessor under the operating lease arrangements is an independent third-party
limited liability company, wholly owned by a publicly traded corporation. That
public corporation consolidates the financial statements of the lessor in its
financial statements. The lessor has other leasing activities and has
contributed equity of 5.75% of the $63.7 million project costs. The leases
include guarantees by us for a substantial portion of the financing and options
to purchase the facilities at original cost; the maximum guarantee is
approximately $56 million. The guarantee becomes effective if we decline to
purchase the facilities at the end of the lease and the lessor is unable to sell
the property at a price equal to or greater than the original cost. We selected
this financing arrangement to take advantage of the favorable financing rates
such an arrangement afforded as opposed to the rates available under alternative
real estate financing options. The lessor financed the acquisition of the
facilities through funding provided by third-party financial institutions. The
lessor has no affiliation or relationship with us or any of our employees,
directors or affiliates, and our transactions with the lessor are limited to the
operating lease agreements and the associated rent expense that will be included
in Selling, general & administrative expense in the Consolidated Statements of
Income.
In December 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN
46R"), which amends the same titled FIN 46 that was issued in January 2003. FIN
46R addresses how to identify variable interest entities and the criteria that
requires the consolidation of such entities. The third-party lessor does not
meet the definition of a variable interest entity under FIN 46R, and therefore
consolidation by the Company is not required.
Hedging Activities
- ------------------
At April 2, 2005, we had various euro currency collars outstanding with a net
notional amount of $49 million, maturing through December 2005 and with values
ranging between 1.20 and 1.38 U.S. dollar per euro and various Canadian currency
collars outstanding with a net notional amount of $25 million maturing through
October 2005 and with values ranging between 1.18 and 1.25 Canadian dollar per
U.S. dollar, as compared to $53 million in euro currency collars and $27 million
in Canadian currency collars at year-end 2004 and $26 million in euro currency
collars at the end of the first quarter of 2004. At the end of the first quarter
of 2005, we also had forward contracts maturing through September 2005 to sell
13 million euro for $17 million and to sell 2.5 million Pounds Sterling for 3.6
million euro. The notional value of the foreign exchange forward contracts at
the end of the first quarter of 2005 was approximately $22 million, as compared
with approximately $45 million at year-end 2004 and approximately $93 million at
the end of the first quarter of 2004. Unrealized losses for outstanding foreign
exchange forward contracts and currency options were approximately $1.2 million
at the end of the first quarter of 2005, $6.2 million at year-end 2004 and
approximately $5.5 million the end of the first quarter of 2004. The ineffective
portion of these swaps is recognized currently in earnings and was not material
for the three months ended April 2, 2005. Approximately $1.7 million relating to
cash flow hedges in Accumulated other comprehensive income (loss) will be
reclassified into earnings in the next twelve months.
In connection with the variable rate financing under the synthetic lease
agreement, we have entered into two interest rate swap agreements with an
aggregate notional amount of $40.0 million that began in January 2003 and will
terminate in May 2006, in order to fix the interest component of rent expense at
a rate of 5.56%. We have entered into these arrangements hedge against potential
future interest rate increases. The change in fair value of the effective
portion of the interest rate swap is recorded as a component of Accumulated
other comprehensive income (loss) since these swaps are designated as cash flow
hedges. The ineffective portion of these swaps is recognized currently in
earnings and was not material for the quarter ended April 2, 2005. Approximately
$0.5 million relating to cash flow hedges in Accumulated other comprehensive
income (loss) will be reclassified into earnings in the next twelve months.
We hedge our net investment position in euro functional subsidiaries by
designating the 350 million Eurobonds as a hedge of net investments. The change
in the Eurobonds due to changes in currency rates is recorded to Currency
translation adjustment, a component of Accumulated other comprehensive income
(loss). The loss recorded to Currency translation adjustment was $20.5 million
for the quarter ended April 2, 2005 and $15.9 million for the quarter ended
April 3, 2004.
37
On February 11, 2004, we entered into interest rate swap agreements for the
notional amount of 175 million euro in connection with our 350 million Eurobonds
maturing August 7, 2006. This converted a portion of the fixed rate Eurobonds
interest expense to floating rate at a spread over six month EURIBOR. The first
interest rate setting will be August 7, 2004 and will be reset each six-month
period thereafter until maturity. This is designated as a fair value hedge. The
favorable interest accrual was not material for the quarter ended April 2, 2005.
USE OF ESTIMATES AND CRITICAL ACCOUNTING POLICIES
- -------------------------------------------------
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and revenues and expenses during the
period. Significant accounting policies employed by us, including the use of
estimates, are presented in the Notes to Consolidated Financial Statements in
our 2004 Annual Report on Form 10-K.
Use of Estimates
- ----------------
Estimates by their nature are based on judgments and available information. The
estimates that we make are based upon historical factors, current circumstances
and the experience and judgment of our management. We evaluate our assumptions
and estimates on an ongoing basis and may employ outside experts to assist in
our evaluations. Therefore, actual results could materially differ from those
estimates under different assumptions and conditions.
Critical Accounting Policies are those that are most important to the portrayal
of our financial condition and the results of operations and require
management's most difficult, subjective and complex judgments as a result of the
need to make estimates about the effect of matters that are inherently
uncertain. Our most critical accounting policies, discussed below, pertain to
revenue recognition, income taxes, accounts receivable - trade, net,
inventories, net, the valuation of goodwill and intangible assets with
indefinite lives, accrued expenses and derivative instruments. In applying such
policies, management must use some amounts that are based upon its informed
judgments and best estimates. Because of the uncertainty inherent in these
estimates, actual results could differ from estimates used in applying the
critical accounting policies. Changes in such estimates, based on more accurate
future information, may affect amounts reported in future periods.
For accounts receivable, we estimate the net collectibility, considering both
historical and anticipated trends as well as an evaluation of economic
conditions and the financial positions of our customers. For inventory, we
review the aging and salability of our inventory and estimate the amount of
inventory that we will not be able to sell in the normal course of business.
This distressed inventory is written down to the expected recovery value to be
realized through off-price channels. If we incorrectly anticipate these trends
or unexpected events occur, our results of operations could be materially
affected. We use independent third-party appraisals to estimate the fair values
of both our goodwill and intangible assets with indefinite lives. These
appraisals are based on projected cash flows, interest rates and other
competitive market data. Should any of the assumptions used in these projections
differ significantly from actual results, material impairment losses could
result where the estimated fair values of these assets become less than their
carrying amounts. For accrued expenses related to items such as employee
insurance, workers' compensation and similar items, accruals are assessed based
on outstanding obligations, claims experience and statistical trends; should
these trends change significantly, actual results would likely be impacted.
Derivative instruments in the form of forward contracts and options are used to
hedge the exposure to variability in probable future cash flows associated with
inventory purchases and sales collections primarily associated with our European
and Canadian entities. If fluctuations in the relative value of the currencies
involved in the hedging activities were to move dramatically, such movement
could have a significant impact on our results. Changes in such estimates, based
on more accurate information, may affect amounts reported in future periods. We
are not aware of any reasonably likely events or circumstances which would
result in different amounts being reported that would materially affect our
financial condition or results of operations.
Revenue Recognition
- -------------------
Revenue within our wholesale operations is recognized at the time title passes
and risk of loss is transferred to customers. Wholesale revenue is recorded net
of returns, discounts and allowances. Returns and allowances require
pre-approval from management. Discounts are based on trade terms. Estimates for
end-of-season allowances are based on historic trends, seasonal results, an
evaluation of current economic conditions and retailer performance. We review
and refine these estimates on a monthly basis based on current experience,
trends and retailer performance. Our historical estimates of these costs have
not differed materially from actual results. Retail store revenues are
recognized net of estimated returns at the time of sale to consumers. Retail
revenues are recorded net
38
of returns. Licensing revenues are recorded based upon contractually guaranteed
minimum levels and adjusted as actual sales data is received from licensees.
Income Taxes
- ------------
Income taxes are accounted for under SFAS No. 109, "Accounting for Income
Taxes." In accordance with SFAS No. 109, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases, as measured by enacted tax rates that are expected
to be in effect in the periods when the deferred tax assets and liabilities are
expected to be settled or realized. Significant judgment is required in
determining the worldwide provisions for income taxes. In the ordinary course of
a global business, there are many transactions for which the ultimate tax
outcome is uncertain. It is our policy to establish provisions for taxes that
may become payable in future years as a result of an examination by tax
authorities. We establish the provisions based upon management's assessment of
exposure associated with permanent tax differences, tax credits and interest
expense applied to temporary difference adjustments. The tax provisions are
analyzed periodically (at least annually) and adjustments are made as events
occur that warrant adjustments to those provisions.
Accounts Receivable - Trade, Net
- --------------------------------
In the normal course of business, we extend credit to customers that satisfy
pre-defined credit criteria. Accounts receivable - trade, net, as shown on the
Consolidated Balance Sheets, is net of allowances and anticipated discounts. An
allowance for doubtful accounts is determined through analysis of the aging of
accounts receivable at the date of the financial statements, assessments of
collectibility based on an evaluation of historic and anticipated trends, the
financial condition of our customers, and an evaluation of the impact of
economic conditions. An allowance for discounts is based on those discounts
relating to open invoices where trade discounts have been extended to customers.
Costs associated with potential returns of products as well as allowable
customer markdowns and operational charge backs, net of expected recoveries, are
included as a reduction to net sales and are part of the provision for
allowances included in Accounts receivable - trade, net. These provisions result
from seasonal negotiations with our customers as well as historic deduction
trends net of expected recoveries and the evaluation of current market
conditions. Should circumstances change or economic or distribution channel
conditions deteriorate significantly, we may need to increase its provisions.
Our historical estimates of these costs have not differed materially from actual
results.
Inventories, Net
- ----------------
Inventories are stated at lower of cost (using the first-in, first-out method)
or market. We continually evaluate the composition of our inventories assessing
slow-turning, ongoing product as well as prior seasons' fashion product. Market
value of distressed inventory is valued based on historical sales trends for the
category of inventory of our individual product lines, the impact of market
trends and economic conditions, and the value of current orders in-house
relating to the future sales of this type of inventory. Estimates may differ
from actual results due to quantity, quality and mix of products in inventory,
consumer and retailer preferences and market conditions. We review our inventory
position on a monthly basis and adjust our estimates based on revised
projections and current market conditions. If economic conditions worsen, we
incorrectly anticipate trends or unexpected events occur, our estimates could be
proven overly optimistic, and required adjustments could materially adversely
affect future results of operations. Our historical estimates of these costs and
our provisions have not differed materially from actual results.
Goodwill and Other Intangibles
- ------------------------------
SFAS No. 142, "Goodwill and Other Intangible Assets," requires that goodwill and
intangible assets with indefinite lives no longer be amortized, but rather be
tested at least annually for impairment. This pronouncement also requires that
intangible assets with finite lives be amortized over their respective lives to
their estimated residual values, and reviewed for impairment in accordance with
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."
A two-step impairment test is performed on goodwill. In the first step, we
compare the fair value of each reporting unit to its carrying value. Our
reporting units are consistent with the reportable segments identified in Note
13 of Notes to Condensed Consolidated Financial Statements. We determine the
fair value of our reporting units using the market approach as is typically used
for companies providing products where the value of such a company is more
dependent on the ability to generate earnings than the value of the assets used
in the production process. Under this approach we estimate the fair value based
on market multiples of revenues and earnings for comparable companies. If the
fair value of the reporting unit exceeds the carrying value of the net assets
assigned to that unit, goodwill is not impaired and we are not required to
perform further testing. If the carrying value of the net assets assigned to the
39
reporting unit exceeds the fair value of the reporting unit, then we must
perform the second step in order to determine the implied fair value of the
reporting unit's goodwill and compare it to the carrying value of the reporting
unit's goodwill. The activities in the second step include valuing the tangible
and intangible assets of the impaired reporting unit, determining the fair value
of the impaired reporting unit's goodwill based upon the residual of the summed
identified tangible and intangible assets and the fair value of the enterprise
as determined in the first step, and determining the magnitude of the goodwill
impairment based upon a comparison of the fair value residual goodwill and the
carrying value of goodwill of the reporting unit. If the carrying value of the
reporting unit's goodwill exceeds the implied fair value, then we must record an
impairment loss equal to the difference.
SFAS No. 142 also requires that the fair value of the purchased intangible
assets, primarily trademarks and trade names, with indefinite lives be estimated
and compared to the carrying value. We estimate the fair value of these
intangible assets using independent third parties who apply the income approach
using the relief-from-royalty method, based on the assumption that in lieu of
ownership, a firm would be willing to pay a royalty in order to exploit the
related benefits of these types of assets. This approach is dependent on a
number of factors including estimates of future growth and trends, estimated
royalty rates in the category of intellectual property, discounted rates and
other variables. We base our fair value estimates on assumptions we believe to
be reasonable, but which are unpredictable and inherently uncertain. Actual
future results may differ from those estimates. We recognize an impairment loss
when the estimated fair value of the intangible asset is less than the carrying
value.
Owned trademarks that have been determined to have indefinite lives are not
subject to amortization and are reviewed at least annually for potential value
impairment as mentioned above. Trademarks having definite lives are amortized
over their estimated useful lives. An independent third party values acquired
trademarks using the relief-from-royalty method. Trademarks that are licensed by
the Company from third parties are amortized over the individual terms of the
respective license agreements, which range from 5 to 15 years. Intangible
merchandising rights are amortized over a period of four years. Customer
relationships are amortized assuming gradual attrition over time. Existing
relationships are being amortized over periods ranging from 9 to 25 years.
The recoverability of the carrying values of all long-lived assets with definite
lives is reevaluated when changes in circumstances indicate the assets' value
may be impaired. Impairment testing is based on a review of forecasted operating
cash flows and the profitability of the related business. For the three months
ended April 2, 2005, there were no material adjustments to the carrying values
of any long-lived assets resulting from these evaluations.
Accrued Expenses
- ----------------
Accrued expenses for employee insurance, workers' compensation, profit sharing,
contracted advertising, professional fees, and other outstanding Company
obligations are assessed based on claims experience and statistical trends, open
contractual obligations, and estimates based on projections and current
requirements. If these trends change significantly, then actual results would
likely be impacted. Our historical estimates of these costs and our provisions
have not differed materially from actual results.
Derivative Instruments
- ----------------------
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as
amended and interpreted, requires that each derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability and measured at its fair value.
The statement also requires that changes in the derivative's fair value be
recognized currently in earnings in either income (loss) from continuing
operations or Accumulated other comprehensive income (loss), depending on
whether the derivative qualifies for hedge accounting treatment.
We use foreign currency forward contracts and options for the specific purpose
of hedging the exposure to variability in forecasted cash flows associated
primarily with inventory purchases mainly with our European and Canadian
entities and other specific activities and the swapping of variable interest
rate debt for fixed rate debt in connection with the synthetic lease. These
instruments are designated as cash flow hedges and, in accordance with SFAS No.
133, to the extent the hedges are highly effective, the effective portion of the
changes in fair value are included in Accumulated other comprehensive income
(loss), net of related tax effects, with the corresponding asset or liability
recorded in the balance sheet. The ineffective portion of the cash flow hedge,
if any, is recognized primarily as a component of Cost of goods sold in
current-period earnings or in the case of the swaps, in connection with the
synthetic lease, if any to SG&A. Amounts recorded in Accumulated other
comprehensive income (loss) are reflected in current-period earnings when the
hedged transaction affects earnings. If fluctuations in the relative value of
the currencies involved in the hedging activities were to move dramatically,
such movement could have a significant impact on our results of operations. We
are not aware of any reasonably likely events or circumstances
40
which would result in different amounts being reported that would materially
affect its financial condition or results of operations.
Hedge accounting requires that at the beginning of each hedge period, we justify
an expectation that the hedge will be highly effective. This effectiveness
assessment involves an estimation of the probability of the occurrence of
transactions for cash flow hedges. The use of different assumptions and changing
market conditions may impact the results of the effectiveness assessment and
ultimately the timing of when changes in derivative fair values and underlying
hedged items are recorded in earnings.
We hedge our net investment position in euro-functional subsidiaries by
borrowing directly in foreign currency and designating a portion of foreign
currency debt as a hedge of net investments. The change in the borrowings due to
changes in currency rates is recorded to Currency translation adjustment, a
component of Accumulated other comprehensive income (loss). We use a derivative
instrument to hedge the changes in the fair value of the debt due to interest
rates, and the change in fair value is recognized currently in interest expense
together with the change in fair value of the hedged item due to interest rates.
Occasionally, we purchase short-term foreign currency contracts and options
outside of the cash flow hedging program to neutralize quarter-end balance sheet
and other expected exposures. These derivative instruments do not qualify as
cash flow hedges under SFAS No. 133 and are recorded at fair value with all
gains or losses, which have not been significant, recognized as a component of
Selling, general & administrative expenses in current period earnings
immediately.
RECENT ACCOUNTING PRONOUNCEMENTS
- --------------------------------
In March 2004, the Emerging Issues Task Force ("EITF") reached a consensus on
recognition and measurement guidance previously discussed under EITF Issue No.
03-01. The consensus clarifies the meaning of "other-than-temporary impairment"
and its application to investments classified as either available-for-sale or
held-to-maturity under SFAS No. 115, "Accounting for Certain Investments in Debt
and Equity Securities," and investments accounted for under the cost method or
the equity method. In September 2004 the FASB issued a final FASB Staff
Position, FSP EITF Issue No. 03-01-1, delaying the effective date for the
measurement and recognition guidance of EITF Issue No. 03-01, however the
disclosure requirements remain effective and the applicable ones have been
adopted for our fiscal year ended January 1, 2005. The implementation of EITF
Issue No. 03-01 is not expected to have a material impact on our results of
operations or financial condition.
In September 2004, the EITF reached a consensus on applying Paragraph 19 of SFAS
No. 131 in EITF Issue No. 04-10, "Determining Whether to Aggregate Operating
Segments That Do Not Meet the Quantitative Thresholds." The consensus states
that operating segments that do not meet the quantitative thresholds can be
aggregated only if aggregation is consistent with the objective and basic
principles of SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information," the segments have similar economic characteristics, and
the segments share a majority of the aggregation criteria (a)-(e) listed in
paragraph 17 of SFAS No. 131. The effective date of the consensus in this Issue
is for fiscal years ending after October 13, 2004. Adoption of the EITF has not
affected the Company's segment classifications.
In November 2004, the EITF reached a consensus on EITF Issue No. 03-13,
"Applying the Conditions in Paragraph 42 of FASB Statement No. 144 in
Determining Whether to Report Discontinued Operations." The consensus requires
an evaluation of whether the operations and cash flows of a disposed component
have been or will be substantially eliminated from the ongoing operations of the
entity or will migrate or continue. This consensus should be applied to a
component of an enterprise that is either disposed of or classified as held for
sale in fiscal periods beginning after December 15, 2004. Adoption of the EITF
in the first quarter of fiscal 2005 should not have a material affect on our
results of operations and financial position.
On December 21, 2004, the FASB issued Staff Position ("FSP") No. 109-2,
"Accounting and Disclosure Guidance for the Foreign Earnings Repatriation
Provision Within the American Jobs Creation Act of 2004." FSP No. 109-2 allows
for additional time to assess the effect of repatriating foreign earnings, which
under SFAS No. 109, "Accounting for Income Taxes," would typically be required
to be recorded in the period of enactment. The American Jobs Creation Act of
2004 creates a temporary incentive for U.S. corporations to repatriate
accumulated income earned abroad. We are currently analyzing the potential
impact of utilizing the incentive.
41
In December 2004, the FASB released revised SFAS No. 123R, "Share-Based
Payment." The pronouncement requires public companies to measure the cost of
employee services received in exchange for an award of equity instruments based
on the grant-date fair value of the award. That cost will be recognized over the
period during which an employee is required to provide service in exchange for
the award--the requisite service period (typically the vesting period). SFAS No.
123R is effective as of the beginning of the first interim or annual reporting
period that begins after June 15, 2005. We are planning on shifting the
composition of our equity compensation plan towards restricted stock and away
from stock options. This shift towards restricted stock will ultimately reduce
dilution, as fewer shares will be used for equity compensation purposes. The
adoption of SFAS No. 123R utilizing the modified prospective basis, inclusive of
the shift towards restricted stock, will reduce 2005 fully diluted earnings per
share by an estimated $0.10-$0.12.
In March 2005 the SEC issued Staff Accounting Bulletin ("SAB") No. 107
"Share-Based Payment." SAB No. 107 expresses views of the SEC staff regarding
the interaction between SFAS No. 123R and certain SEC rules and regulations and
provide the staff's views regarding the valuation of share-based payment
arrangements. Subsequently the SEC decided to delay the required implementation
of SFAS No. 123R to years beginning after June 15, 2005. The Company will adopt
SFAS No. 123R for its fiscal 2005 third quarter as discussed above and
previously disclosed.
STATEMENT REGARDING FORWARD-LOOKING DISCLOSURE
- ----------------------------------------------
Statements contained herein and in future filings by the Company with the
Securities and Exchange Commission (the "SEC"), in the Company's press releases,
and in oral statements made by, or with the approval of, authorized personnel
that relate to the Company's future performance, including, without limitation,
statements with respect to the Company's anticipated results of operations or
level of business for fiscal 2005, any fiscal quarter of 2005 or any other
future period, including those herein under the heading "Forward Outlook" or
otherwise, are forward-looking statements within the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995. Such statements, which are
indicated by words or phrases such as "intend," "anticipate," "plan,"
"estimate," "project," "management expects," "the Company believes," "we are
optimistic that we can," "current visibility indicates that we forecast" or
"currently envisions" and similar phrases are based on current expectations
only, and are subject to certain risks, uncertainties and assumptions. Should
one or more of these risks or uncertainties materialize, or should underlying
assumptions prove incorrect, actual results may vary materially from those
anticipated, estimated or projected. Included among the factors that could cause
actual results to materially differ are risks with respect to the following:
Risks Associated with Competition and the Marketplace
- -----------------------------------------------------
The apparel and related product markets are highly competitive, both within the
United States and abroad. The Company's ability to compete successfully within
the marketplace depends on a variety of factors, including:
o The continuing challenging retail and macroeconomic environment, including
the levels of consumer confidence and discretionary spending, and levels of
customer traffic within department stores, malls and other shopping and
selling environments, and a continuation of the deflationary trend for
apparel products;
o The Company's ability to effectively anticipate, gauge and respond to
changing consumer demands and tastes, across multiple product lines, shopping
channels and geographies;
o The Company's ability to translate market trends into appropriate, saleable
product offerings relatively far in advance, while minimizing excess
inventory positions, including the Company's ability to correctly balance the
level of its fabric and/or merchandise commitments with actual customer
orders;
o Consumer and customer demand for, and acceptance and support of, Company
products (especially by the Company's largest customers) which are in turn
dependent, among other things, on product design, quality, value and service;
o The ability of the Company, especially through its sourcing, logistics and
technology functions, to operate within substantial production and delivery
constraints, including risks associated with the possible failure of the
Company's unaffiliated manufacturers to manufacture and deliver products in a
timely manner, to meet quality standards or to comply with the Company's
policies regarding labor practices or applicable laws or regulations;
o The Company's ability to adapt to and compete effectively in the new quota
environment, including changes in sourcing patterns resulting from the
elimination of quota on apparel products, as well as lowered barrier to
entry;
o Risks associated with the Company's dependence on sales to a limited number
of large United States department store customers, including risks related to
the Company's ability to respond effectively to:
42
- these customers' buying patterns, including their purchase and retail
floor space commitments for apparel in general (compared with other
product categories they sell), and our products specifically (compared
with products offered by our competitors, including with respect to
customer and consumer acceptance, pricing, and new product introductions);
- these customers' strategic and operational initiatives, including their
continued focus on further development of their "private label"
initiatives;
- these customers' desire to have us provide them with exclusive and/or
differentiated designs and product mixes;
- these customers' requirements for vendor margin support;
- any credit risks presented by these customers, especially given the
significant proportion of our accounts receivable they represent; and
- the effect that any potential consolidation among one or more of these
larger customers, such as the proposed merger between Federated Department
Stores, Inc. and The May Department Store Company, might have on the
foregoing and/or other risks;
o Risks associated with maintaining and enhancing favorable brand recognition,
which may be affected by consumer attitudes towards the desirability of
fashion products bearing a "mega brand" label and which are widely available
at a broad range of retail stores; and
o Risks associated with the Company's operation and expansion of retail
business, including the ability to successfully find appropriate sites,
negotiate favorable leases, design and create appealing merchandise,
appropriately manage inventory levels, install and operate effective retail
systems, apply appropriate pricing strategies, and integrate such stores into
the Company's overall business mix.
Management and Employee Risks
- -----------------------------
o The Company's ability to attract and retain talented, highly qualified
executives and other key personnel in design, merchandising, sales,
marketing, production, systems and other functions;
o The Company's ability to hire and train qualified retail management and
associates;
o Risks associated with any significant disruptions in the Company's
relationship with its employees, including union employees, and any work
stoppages by the Company's employees, including union employees; and
o Risks associated with the Company's providing for the succession of senior
management.
Economic, Social and Political Factors
- --------------------------------------
Also impacting the Company and its operations are a variety of economic, social
and political factors, including the following:
o Risks associated with war, the threat of war, and terrorist activities,
including reduced shopping activity as a result of public safety concerns and
disruption in the receipt and delivery of merchandise;
o Changes in national and global microeconomic and macroeconomic conditions in
the markets where the Company sells or sources its products, including the
levels of consumer confidence and discretionary spending, consumer income
growth, personal debt levels, rising energy costs and energy shortages, and
fluctuations in foreign currency exchange rates, interest rates and stock
market volatility, and currency devaluations in countries in which we source
product;
o Changes in social, political, legal and other conditions affecting foreign
operations;
o Risks of increased sourcing costs, including costs for materials and labor,
including as a result of the elimination of quota on apparel products;
o Any significant disruption in the Company's relationships with its suppliers,
manufacturers as well as work stoppages by any of the Company's suppliers or
service providers;
o The enactment of new legislation or the administration of current
international trade regulations, or executive action affecting international
textile agreements, including the United States' reevaluation of the trading
status of certain countries, and/or retaliatory duties, quotas or other trade
sanctions, which, if enacted, would increase the cost of products purchased
from suppliers in such countries, and the January 1, 2005 elimination of
quota, which may significantly impact sourcing patterns; and
o Risks related to the Company's ability to establish, defend and protect its
trademarks and other proprietary rights and other risks relating to managing
intellectual property issues.
Risks Associated with Acquisitions and New Product Lines and Markets
- --------------------------------------------------------------------
The Company, as part of its growth strategy, from time to time acquires new
product lines and/or enters new markets, including through licensing
arrangements. These activities (which also include the development and launch of
new product categories and product lines), are accompanied by a variety of risks
inherent in any such new business venture, including the following:
43
o Ability to identify appropriate acquisition candidates and negotiate
favorable financial and other terms, against the background of increasing
market competition (from both strategic and financial buyers) for the types
of acquisitions the Company have been making;
o Risks that the new product lines or market activities may require methods of
operations and marketing and financial strategies different from those
employed in the Company's other businesses, including risks associated with
acquisitions with significant foreign operations. In addition, these
businesses may involve buyers, store customers and/or competitors different
from the Company's historical buyers, store customers and competitors;
o Possible difficulties, delays and/or unanticipated costs in integrating the
business, operations, personnel, and/or systems of an acquired business;
o Risks that projected or satisfactory level of sales, profits and/or return on
investment for a new business will not be generated;
o Risks involving the Company's ability to retain and appropriately motivate
key personnel of an acquired business;
o Risks that expenditures required for capital items or working capital will be
higher than anticipated;
o Risks associated with unanticipated events and unknown or uncertain
liabilities;
o Uncertainties relating to the Company's ability to successfully integrate an
acquisition, maintain product licenses, or successfully launch new products
and lines;
o Certain new businesses may be lower margin businesses and may require the
Company to achieve significant cost efficiencies; and
o With respect to businesses where the Company acts as licensee, the risks
inherent in such transactions, including compliance with terms set forth in
the applicable license agreements, including among other things the
maintenance of certain levels of sales, and the public perception and/or
acceptance of the licensor's brands or other product lines, which are not
within the Company's control.
The Company undertakes no obligation to publicly update or revise any forward-
looking statements, whether as a result of new information, future events or
otherwise.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have exposure to interest rate volatility relating to interest rate changes
applicable to our revolving credit facility, other credit facilities and our 175
million euro fixed rate to floating rate swap associated with our 350 million
Eurobonds. These loans and swaps bear interest at rates which vary with changes
in prevailing market rates.
We do not speculate on the future direction of interest rates. As of April 2,
2005, January 1, 2005 and April 3, 2004 our exposure to changing market rates
was as follows:
Dollars in millions April 2, 2005 January 1, 2005 April 3, 2004
- --------------------------------------------------------------------------------
Variable rate debt $45.8 $56.1 $29.9
Average interest rate 2.3% 2.7% 2.7%
Notional amount of interest rate $226.9 $237.2 $212.3
swap
Current implied interest rate 5.75% 5.68% 5.55%
A ten percent change in the average rate would have resulted in a $0.4 million
change in interest expense during the first quarter of 2005.
We finance our capital needs through available cash and marketable securities,
operating cash flows, letters of credit, synthetic lease and bank revolving
credit facilities, other credit facilities and commercial paper issuances. Our
floating rate bank revolving credit facility, bank lines, euro interest rate
swap and commercial paper program expose us to market risk for changes in
interest rates. As of April 2, 2005, we have not employed interest rate hedging
to mitigate such risks with respect to our floating rate facilities. We believe
that our Eurobond offering, which is a fixed rate obligation, partially
mitigates the risks with respect to our variable rate financing.
The acquisition of MEXX, which transacts business in multiple currencies, has
increased our exposure to exchange rate fluctuations. We mitigate the risks
associated with changes in foreign currency rates through foreign exchange
forward contracts and collars to hedge transactions denominated in foreign
currencies for periods of generally less
44
than one year and to hedge expected payment of intercompany transactions with
our non-U.S. subsidiaries, which now include MEXX. Gains and losses on
contracts, which hedge specific foreign currency denominated commitments, are
recognized in the period in which the transaction is completed.
At April 2, 2005, January 1, 2005 and April 3, 2004, we had outstanding foreign
currency collars with net notional amounts aggregating to $74 million, $80
million and $26 million, respectively. We had forward contracts aggregating to
$22 million at April 2, 2005, $45 million at January 1, 2005 and $93 million at
April 3, 2004. Unrealized losses for outstanding foreign currency options and
foreign exchange forward contracts were approximately $1.2 million at April 2,
2005, $6.2 million at January 1, 2005 and $5.5 million at April 3, 2004. A
sensitivity analysis to changes in the foreign currencies when measured against
the U.S. dollar indicates if the U.S. dollar uniformly weakened by 10% against
all of the hedged currency exposures, the fair value of instruments would
decrease by $7.4 million. Conversely, if the U.S. dollar uniformly strengthened
by 10% against all of the hedged currency exposures, the fair value of these
instruments would increase by $6.6 million. Any resulting changes in the fair
value would be offset by changes in the underlying balance sheet positions. The
sensitivity analysis assumes a parallel shift in foreign currency exchange
rates. The assumption that exchange rates change in a parallel fashion may
overstate the impact of changing exchange rates on assets and liabilities
denominated in foreign currency. We do not hedge all transactions denominated in
foreign currency.
The table below presents the amount of contracts outstanding, the contract rate
and unrealized gain or (loss), as of April 2, 2005:
U.S. Dollar Euro Contract Unrealized
Currency in thousands Amount Amount Rate Gain (Loss)
- ---------------------------------------- ---------------- ----------------- ------------------ -------------------
Forward Contracts:
Euros $16,900 1.2177 to 1.2800 $(731)
Pounds Sterling 3,575 0.6964 to 0.7025 (63)
Foreign Exchange Collar Contracts:
Euros $49,000 1.2000 to 1.3753 $(439)
Canadian Dollars 25,026 0.8000 to 0.8484 72
The table below presents the amount of contracts outstanding, the contract rate
and unrealized gain or (loss), as of January 1, 2005:
U.S. Dollar Contract Unrealized
Currency in thousands Amount Rate Gain (Loss)
- ---------------------------------------- ---------------- ------------------- -------------------
Forward Contracts:
Euros $43,000 1.2197 to 1.3234 $(3,758)
Canadian Dollars 1,664 0.8310 to 0.8314 2
Foreign Exchange Collar Contracts:
Euros $53,000 1.2000 to 1.3753 $(2,123)
Canadian Dollars 26,625 0.8000 to 0.8484 (337)
The table below presents the amount of contracts outstanding, the contract rate
and unrealized gain or (loss), as of April 3, 2004:
U.S. Dollar Euro Contract Unrealized
Currency in thousands Amount Amount Rate Gain (Loss)
- ---------------------------------------- ---------------- ----------------- ------------------ -------------------
Forward Contracts:
Euros $75,000 1.0665 to 1.2650 $(3,532)
Canadian Dollars 9,112 0.7502 to 0.7622 (32)
Pounds Sterling 7,406 0.6694 to 0.6799 (27)
Foreign Exchange Collar Contracts:
Euros $26,000 1.0750 to 1.1400 $(1,904)
45
ITEM 4. CONTROLS AND PROCEDURES
The Company's management, under the supervision and with the participation of
the Company's Chief Executive Officer and Chief Financial Officer, has evaluated
the Company's disclosure controls and procedures as of April 2, 2005, and has
concluded that the Company's disclosure controls and procedures are effective in
ensuring that all material information required to be filed in this quarterly
report has been made known to them in a timely fashion. There was no change in
the Company's internal control over financial reporting during the first quarter
of fiscal 2005 that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
46
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Various legal actions are pending against the Company. Certain of the legal
actions include claims for substantial compensatory and/or punitive damages or
claims for indeterminate amounts of damages. The Company contests liability
and/or the amount of damages in each pending matter. Although the outcome of any
such actions cannot be determined with certainty, management is of the opinion
that the final outcome of any of these actions should not have a material
adverse effect on the Company's consolidated results of operations or financial
position. Please refer to Note 11 and Note 25 of Notes to Consolidated Financial
Statements in our 2004 Annual Report on Form 10-K.
During 2004, our Augusta, Georgia facility, which is no longer operational,
became listed on the State of Georgia's Hazardous Site Inventory of
environmentally impacted sites due to the detection of certain chemicals at the
site. To date, we have not been required to take any action regarding this
matter, however we are continuing to monitor this situation.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table summarizes information about purchases by the Company during
the quarter ended April 2, 2005 of equity securities that are registered by the
Company pursuant to Section 12 of the Exchange Act:
(d) Maximum
(a) Total Approximate Dollar
Number of (c) Total Number of Value of Shares that
Shares Shares Purchased as May Yet Be
Purchased (b) Average Part of Publicly Purchased Under the
(in thousands) Price Paid Per Announced Plans or Plans or Programs
Period (1) Share Programs (in thousands) (2)
- --------------------------------------------------------------------------------------------------------------------
January 2, 2005 - January 29, 2005 -- $ -- N/A $ 101,516
January 30, 2005 - March 5, 2005 -- -- N/A $ 101,516
March 6, 2005 - April 2, 2005 7.5 40.79 N/A $ 101,516
------- ---------
Total three months 7.5 $ 40.79 N/A $ 101,516
(1) Represents shares withheld to cover tax-withholding requirements relating to
the vesting of restricted stock issued to employees pursuant to the
Company's shareholder-approved stock incentive plans.
(2) The Company initially announced the authorization of a share buyback program
in December 1989. Since its inception, the Company's Board of Directors has
authorized the purchase under the program of an aggregate of $1.675 billion.
As of April 2, 2005, the Company had $101.5 million remaining in buyback
authorization under its program.
ITEM 5. OTHER INFORMATION
None.
47
ITEM 6. EXHIBITS
10(a) Form of Restricted Stock Grant Certificate.
31(a) Certification of Chief Executive Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31(b) Certification of Chief Financial Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32(a)* Certification of Chief Executive Officer Pursuant to Section 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32(b)* Certification of Chief Financial Officer Pursuant to Section 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
* A signed original of the written statement required by Section 906 has been
provided to the Company and will be retained by the Company and forwarded to
the S.E.C. or its staff upon request.
SIGNATURES
- ----------
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE
REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED THEREUNTO DULY AUTHORIZED.
DATE: May 10, 2005
LIZ CLAIBORNE, INC. LIZ CLAIBORNE, INC.
By: /s/ Michael Scarpa By: /s/ Elaine H. Goodell
------------------------------ -------------------------------------
MICHAEL SCARPA ELAINE H. GOODELL
Senior Vice President - Vice President - Corporate Controller
Chief Financial Officer and Chief Accounting Officer
(Principal financial officer) (Principal accounting officer)