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:
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 July 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
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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 July 2, 2005, we had no debt outstanding under the Agreement.
As of July 2, 2005, January 1, 2005 and July 3, 2004, we had lines of credit aggregating $571 million, $551 million and $543 million, respectively, which were primarily available to cover trade letters of credit. At July 2, 2005, January 1, 2005 and July 3, 2004, we had outstanding trade letters of credit of $338 million, $310 million and $360 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 $151.1 million (based on the exchange rates as of July 2, 2005), which is included in the aforementioned $571 million available lines of credit. As of July 2, 2005, a total of $72.3 million of borrowings denominated in foreign currencies was outstanding at an average interest rate of 2.8%. 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 less than one year and will be refinanced under existing credit lines. The capital lease obligations in Europe expire in 2007 and 2008.
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 July 2, 2005, we had various euro currency collars outstanding with a net notional amount of $37 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 $19 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 no collars at the end of the second quarter of 2004. At the end of the second quarter of 2005, we also had forward contracts maturing through December 2005 to sell 21 million euro for $26.5 million and to sell 15 million Canadian dollars for $12.3 million
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and to sell 5.0 million Pounds Sterling for 7.2 million euro. The notional value of the foreign exchange forward contracts at the end of the second quarter of 2005 was approximately $47.6 million, as compared with approximately $45 million at year-end 2004 and approximately $83 million at the end of the second quarter of 2004. Unrealized gains (losses) for outstanding foreign exchange forward contracts and currency options were approximately $2.1 million at the end of the second quarter of 2005, ($6.2) million at year-end 2004 and approximately ($4.5) million at the end of the second quarter of 2004. The ineffective portion of these swaps is recognized currently in earnings and was not material for the six months ended July 2, 2005. Approximately $1.0 million of income relating to cash flow hedges in Accumulated other comprehensive income (loss) will be reclassified into earnings in the next twelve months as the inventory is sold.
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 six months ended July 2, 2005. Approximately $0.4 million of expense 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 Cumulative translation adjustment; a component of Accumulated other comprehensive income (loss). The unrealized gain (loss) recorded to Cumulative translation adjustment was $31.0 million for the quarter ended July 2, 2005 and ($5.3) million for the quarter ended July 3, 2004. The unrealized gain recorded to Cumulative translation adjustment was $51.5 million and $10.6 million of income for the six months ended July 2, 2005 and July 3, 2004, respectively.
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 was 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 July 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
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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 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.
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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 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 six months ended July 2, 2005, there were no material adjustments to the carrying values of any long-lived assets resulting from these evaluations.
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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, 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 Cumulative 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 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.
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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 has not affected our 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). We are 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 early adoption of SFAS No. 123R, commencing July 3, utilizing the modified prospective basis, inclusive of the shift towards restricted stock, will reduce 2005 fully diluted earnings per share by an estimated $0.11 and reduce fiscal 2006 fully diluted earnings per share by an estimated $0.18 - $0.22.
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.
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. We will consider the guidance provided by SAB 107 as we implement SFAS 123R in the fiscal 2005 third quarter as discussed above and previously disclosed.
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20 and FASB Statement No. 3.” This Statement changes the requirements for the accounting for and reporting of a change in accounting principle. Previously, most voluntary changes in accounting principles required recognition through a cumulative adjustment within net income of the period of the change. The new standard requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine the period-specific effects or the cumulative effect of the change. SFAS No. 154 does not change the transition provisions of any existing pronouncements. We do not believe that the adoption of SFAS No. 154 will have a significant impact on our consolidated financial condition, results of operations or cash flows.
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:
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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:
• | 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; |
• | The Company’s ability to effectively anticipate, gauge and respond to changing consumer demands and tastes, across multiple product lines, shopping channels and geographies; |
• | 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; |
• | 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; |
• | 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; |
• | 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; |
• | 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: |
| - | 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; |
• | 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 |
• | 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. |
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Management and Employee Risks
• | 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; |
• | The Company’s ability to hire and train qualified retail management and associates; |
• | 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 |
• | Risks associated with the Company’s providing for the succession of senior management. |
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Economic, Social and Political Factors
Also impacting the Company and its operations are a variety of economic, social and political factors, including the following:
• | 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; |
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• | 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 revaluations in countries in which we source product; |
• | Changes in social, political, legal and other conditions affecting foreign operations; |
• | Risks of increased sourcing costs, including costs for materials and labor, including as a result of the elimination of quota on apparel products; |
• | 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; |
• | 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 |
• | 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. |
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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:
• | 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; |
• | 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; |
• | Possible difficulties, delays and/or unanticipated costs in integrating the business, operations, personnel, and/or systems of an acquired business; |
• | Risks that projected or satisfactory level of sales, profits and/or return on investment for a new business will not be generated; |
• | Risks involving the Company’s ability to retain and appropriately motivate key personnel of an acquired business; |
• | Risks that expenditures required for capital items or working capital will be higher than anticipated; |
• | Risks associated with unanticipated events and unknown or uncertain liabilities; |
• | Uncertainties relating to the Company’s ability to successfully integrate an acquisition, maintain product licenses, or successfully launch new products and lines; |
• | Certain new businesses may be lower margin businesses and may require the Company to achieve significant cost efficiencies; and |
• | 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. |
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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.
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We do not speculate on the future direction of interest rates. As of July 2, 2005, January 1, 2005 and July 3, 2004 our exposure to changing market rates was as follows:
Dollars in millions | July 2, 2005 | January 1, 2005 | July 3, 2004 |
Variable rate debt | $72.3 | $56.1 | $31.8 |
Average interest rate | 2.8% | 2.7% | 2.8% |
| | | |
Notional amount of interest rate swap | $211.5 | $237.2 | $215.0 |
Current implied interest rate | 5.63% | 5.68% | 5.71% |
A ten percent change in the average rate would have resulted in a $0.7 million change in interest expense during the first half 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 July 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.
Growth in our European and Canadian businesses, 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 than one year and to hedge expected payment of intercompany transactions with our non-U.S. subsidiaries. Gains and losses on contracts, which hedge specific foreign currency denominated commitments, are recognized in the period in which the transaction is completed.
At July 2, 2005, January 1, 2005 and July 3, 2004, we had outstanding foreign currency collars with net notional amounts aggregating to $56 million, $80 million and $0, respectively. We had forward contracts aggregating to $47.6 million at July 2, 2005, $45 million at January 1, 2005 and $83 million at July 3, 2004. Unrealized gains (losses) for outstanding foreign currency options and foreign exchange forward contracts were approximately $2.1 million at July 2, 2005, ($6.2) million at January 1, 2005 and approximately ($4.5) million at July 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 $7.2 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 $6.2 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 July 2, 2005:
| U.S. Dollar | Euro | Contract | Unrealized |
Currency in thousands | Amount | Amount | Rate | Gain (Loss) |
Forward Contracts: | | | | |
Euros | $26,500 | | 1.2047 to 1.2800 | $251 |
Canadian Dollars | 12,281 | | 0.8176 to 0.8199 | 98 |
Pounds Sterling | | 7,247 | 0.6815 to 0.7024 | (78) |
| | | | |
Foreign Exchange Collar Contracts: | | | | |
Euros | $37,000 | | 1.2000 to 1.3753 | $735 |
Canadian Dollars | 19,472 | | 0.8000 to 0.8484 | 306 |
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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 July 3, 2004:
| U.S. Dollar | Euro | Contract | Unrealized |
Currency in thousands | Amount | Amount | Rate | Gain (Loss) |
Forward Contracts: | | | | |
Euros | $76,100 | | 1.0665 to 1.2650 | $(4,508) |
Canadian Dollars | 760 | | 0.7596 | 4 |
Pounds Sterling | | 5,171 | 0.6746 to 0.6799 | (3) |
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 July 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 second quarter of fiscal 2005 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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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 July 2, 2005 of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act:
Period | (a) Total Number of Shares Purchased
(in thousands) | (b) Average Price Paid Per Share | (c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (in thousands) | (d) Maximum Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or 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 (1) | $ 40.79 | N/A | $ 101,516 |
April 3, 2005 - April 30, 2005 | 139.0 | $ 35.06 | 139.0 | $ 96,642 |
May 1, 2005 - June 4, 2005 | 2,689.5 | $ 37.29 | 2,689.5 | $ 246,351 (3) |
June 5, 2005 - July 2, 2005 | -- | $ -- | N/A | $ 246,351 |
Total six months | 2,836.0 | $ 37.19 | 2,828.5 | $ 246,351 |
(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 $1.925 billion. As of July 2, 2005, the Company had $246.4 million remaining in buyback authorization under its program. |
(3) | On May 19, 2005, the Company’s Board of Directors authorized the Company to purchase up to an additional $250 million of its Common Stock for cash in open market purchases and privately negotiated transactions. |
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Company’s 2005 Annual Meeting of Stockholders held on May 19, 2005, the stockholders of the Company (i) approved the ratification of the appointment of Deloitte & Touche LLP as the Company’s independent auditors for fiscal 2005 (the number of affirmative votes cast was 94,648,148, the number of negative votes cast was 4,114,148 and the number of abstentions was 619,047); (ii) approved the Liz Claiborne, Inc. Section 162(m) Long Term Performance Plan (the number of affirmative votes cast was 95,892,642, the number of negative votes cast was 2,781,896 and the number of abstentions was 707,649); (iii) approved the Liz Claiborne, Inc. 2005 Stock Incentive Plan (the number of affirmative votes cast was 65,858,106, the number of negative votes cast was 21,944,097 and the number of abstentions was 722,632); and (iv) elected the following nominees to the Company’s Board of Directors, to serve until the 2008 annual meeting of stockholders and until their respective successors are duly elected and qualified;
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| Votes |
Nominee | For | Withheld |
Paul R. Charron | 97,989,633 | 1,392,554 |
Kay Koplovitz | 94,152,500 | 5,229,687 |
Oliver R. Sockwell | 98,491,359 | 890,828 |
The other directors, whose terms of office continued after the Annual Meeting, are: Bernard W. Aronson, Raul J. Fernandez, Mary Kay Haben, Nancy J. Karch, Kenneth P. Kopelman, Arthur C. Martinez and Paul E. Tierney, Jr.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
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. |
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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. |
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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.
| LIZ CLAIBORNE, INC. | | LIZ CLAIBORNE, INC. |
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| By: | /s/ Michael Scarpa | | By: | /s/ Elaine H. Goodell |
| | MICHAEL SCARPA | | | ELAINE H. GOODELL |
| | Senior Vice President, Finance & Distribution and Chief Financial Officer (Principal financial officer) | | | Vice President - Corporate Controller and Chief Accounting Officer (Principal accounting officer) |
