SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended July 3, 2004
------------------------
[ ] 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 August 5, 2004 was 107,719,504.
2
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q
July 3, 2004
PAGE
NUMBER
------
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of a July 3, 2004,
January 3, 2004 and July 5, 2003............................... 3
Condensed Consolidated Statements of Income for the Six and
Three Month Periods Ended July 3, 2004 and July 5, 2003........ 4
Condensed Consolidated Statements of Cash Flows for the Six
Month Periods Ended July 3, 2004 and July 5, 2003.............. 5
Notes to Condensed Consolidated Financial Statements.............. 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 22
Item 3. Quantitative and Qualitative Disclosures About Market Risk........ 41
Item 4. Controls and Procedures........................................... 42
PART II - OTHER INFORMATION
Item 1. Legal Proceedings................................................. 43
Item 2. Changes In Securities, Use Of Proceeds And Issuer Purchases Of
Equity Securities.............................................. 43
Item 4. Submission Of Matters To A Vote Of Security Holders............... 43
Item 5. Other Information................................................. 43
Item 6. Exhibits and Reports on Form 8-K.................................. 44
SIGNATURES .................................................................. 45
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) (Unaudited)
July 3, January 3, July 5,
2004 2004 2003
------------------------------------------------
Assets
Current Assets:
Cash and cash equivalents $ 213,024 $ 293,503 $ 87,324
Marketable securities 58,576 50,414 35,058
Accounts receivable - trade, net 452,575 390,802 423,639
Inventories, net 541,400 485,182 531,706
Deferred income taxes 46,047 45,756 45,378
Other current assets 104,425 82,744 82,429
------------ ------------ ------------
Total current assets 1,416,047 1,348,401 1,205,534
------------ ------------ ------------
Property and Equipment - Net 423,967 410,741 392,383
Goodwill - Net 567,987 596,436 513,583
Intangibles - Net 271,353 244,168 218,817
Other Assets 5,161 7,253 7,938
------------ ------------ ------------
Total Assets $ 2,684,515 $ 2,606,999 $ 2,338,255
============ ============ ============
Liabilities and Stockholders' Equity
Current Liabilities:
Short-term borrowings $ 31,965 $ 18,915 $ 26,174
Accounts payable 237,736 227,125 209,376
Accrued expenses 259,943 236,134 217,898
Income taxes payable 11,038 29,316 2,292
------------ ------------ ------------
Total current liabilities 540,682 511,490 455,740
------------ ------------ ------------
Long-Term Debt 430,965 440,303 407,690
Other Non-Current Liabilities 21,034 23,526 14,157
Deferred Income Taxes 50,552 43,861 39,066
Commitments and Contingencies
Minority Interest 11,879 9,848 8,559
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 153,795 124,823 107,630
Retained earnings 2,646,818 2,539,742 2,380,410
Unearned compensation expense (41,111) (21,593) (6,108)
Accumulated other comprehensive loss (24,050) (50,207) (46,145)
------------ ------------ ------------
2,911,889 2,769,202 2,612,224
Common stock in treasury, at cost, 68,846,681, 66,865,854
and 67,580,851 shares (1,282,486) (1,191,231) (1,199,181)
------------ ------------ ------------
Total stockholders' equity 1,629,403 1,577,971 1,413,043
------------ ------------ ------------
Total Liabilities and Stockholders' Equity $ 2,684,515 $ 2,606,999 $ 2,338,255
============ ============ ============
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)
Six Months Ended Three Months Ended
---------------------------------------------------------------
(26 weeks) (27 weeks) (13 Weeks) (13 Weeks)
July 3, July 5, July 3, July 5,
2004 2003 2004 2003
---------------------------------------------------------------
Net Sales $ 2,128,691 $ 2,035,016 $ 1,025,924 $ 959,417
Cost of goods sold 1,138,227 1,153,472 536,490 533,642
------------ ------------ ------------ ------------
Gross Profit 990,464 881,544 489,434 425,775
Selling, general & administrative expenses 790,298 695,714 403,595 347,410
------------ ------------ ------------ ------------
Operating Income 200,166 185,830 85,839 78,365
Other expense - net (1,523) (556) (933) (248)
Interest expense - net (14,506) (14,823) (6,896) (8,187)
------------ ------------ ------------ ------------
Income Before Provision for Income Taxes 184,137 170,451 78,010 69,930
Provision for income taxes 64,817 61,703 27,460 25,314
------------ ------------ ------------ ------------
Net Income $ 119,320 $ 108,748 $ 50,550 $ 44,616
============ ============ ============ ============
Net Income per Weighted Average Share, Basic $1.09 $1.02 $0.47 $0.42
Net Income per Weighted Average Share, Diluted $1.08 $1.00 $0.46 $0.41
Weighted Average Shares, Basic 108,992 106,814 108,703 107,370
Weighted Average Shares, Diluted 110,730 108,763 110,216 109,605
Dividends Paid per Common Share $0.11 $0.11 $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)
Six Months Ended
--------------------------------
(26 weeks) (27 weeks)
July 3, July 5,
2004 2003
--------------------------------
Cash Flows from Operating Activities:
Net income $ 119,320 $ 108,748
Adjustments to reconcile net income to net cash used in operating
activities:
Depreciation and amortization 53,082 51,732
Deferred income taxes 429 7,127
Other - net 10,684 12,955
Change in current assets and liabilities, exclusive of
acquisitions:
(Increase) in accounts receivable - trade (66,181) (39,604)
(Increase) in inventories (60,051) (59,615)
(Increase) in other current assets (21,776) (28,047)
Increase (decrease) in accounts payable 11,451 (19,034)
Increase (decrease) in accrued expenses 33,176 (20,502)
(Decrease) in income taxes payable (18,092) (23,973)
------------ ------------
Net cash provided by (used in) operating activities 62,042 (10,213)
------------ ------------
Cash Flows from Investing Activities:
Purchases of investment instruments (49) (40)
Purchases of property and equipment (59,975) (45,891)
Payments for acquisitions (4,844) (95,805)
Payments for in-store merchandise shops (3,012) (2,297)
Other - net (3,007) 1,025
------------ ------------
Net cash used in investing activities (70,887) (143,008)
------------ ------------
Cash Flows from Financing Activities:
Proceeds from short-term debt 13,414 4,185
Commercial paper - net -- (6,819)
Proceeds from exercise of common stock options 26,893 36,046
Purchase of common stock (116,817) --
Dividends paid (12,244) (12,030)
------------ ------------
Net cash (used in) provided by financing activities (88,754) 21,382
------------ ------------
Effect of Exchange Rate Changes on Cash 17,120 7,600
------------ ------------
Net Change in Cash and Cash Equivalents (80,479) (124,239)
Cash and Cash Equivalents at Beginning of Period 293,503 211,563
------------ ------------
Cash and Cash Equivalents at End of Period $ 213,024 $ 87,324
============ ============
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 ("S.E.C."). 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 2003 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
3, 2004 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.
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. 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 Condensed 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 determined 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 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 12 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 3, 2004, 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 floating
interest rate debt for fixed rate debt in connection with the synthetic lease as
well as the swapping of 175 million euro of fixed rate debt to floating rate
debt in connection with our 350 million Eurobonds. These instruments are
designated as cash flow and
9
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
fair value hedges and, in accordance with SFAS No. 133, to the extent the hedges
are highly effective, 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
portions of the cash flow and fair value hedges, if any, are recognized in
current-period earnings. 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. Under SFAS No. 133, changes in the
fair value of these instruments are immediately recognized in foreign currency
translation, a component of Accumulated Other Comprehensive Income (Loss), to
offset the change in the value of the net investment being hedged.
Occasionally, the Company purchases short-term foreign currency contracts and
options to hedge 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 recognized in current period
earnings. No gains or losses were incurred during the quarter.
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 the Eurobonds was 374.2 million euro as of July 3,
2004. Fair values for derivatives are either obtained from counter parties or
developed using third-party valuation service 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.
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.
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
10
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 includes the expenses incurred to acquire and produce
inventory for sale, including product costs, freight-in, import costs and
provisions for shrinkage.
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 are expensed when the
advertising is run.
Shipping and Handling Costs
- ---------------------------
Shipping and handling costs are included as a component of Selling, general &
administrative expenses 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. Accordingly, as stock options are granted at
market price, no compensation cost has been recognized for its fixed stock
option grants. Had compensation costs for the Company's stock option grants been
determined based on the fair value at the grant dates 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:
Six Months Ended Three Months Ended
----------------------------------------------------------------
(In thousands except for per share data) (26 weeks) (27 weeks) (13 Weeks) (13 Weeks)
July 3, July 5, July 3, July 5,
2004 2003 2004 2003
- ---------------------------------------- ----------------------------------------------------------------
Net income:
As reported $ 119,320 $ 108,748 $ 50,550 $ 44,616
Total stock-based employee compensation
expense determined under fair value
based method for all awards*, net of tax 10,028 8,927 5,550 4,899
------------ ------------ ------------ ------------
Pro forma $ 109,292 $ 99,821 $ 45,000 $ 39,717
============ ============ ============ ============
Basic earnings per share:
As reported $1.09 $1.02 $0.47 $0.42
Pro forma $1.01 $0.94 $0.42 $0.37
Diluted earnings per share:
As reported $1.08 $1.00 $0.46 $0.41
Pro forma $0.99 $0.93 $0.41 $0.37
* "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.
For this purpose, the fair value of each option grant is estimated on the date
of grant using the Black-Scholes option-pricing model with the following
weighted average assumptions used for grants in 2004 and 2003, respectively:
dividend yield of 0.6% and 0.8%, expected volatility of 34% and 39%, risk free
interest rates of 3.1% and 2.7% and expected lives of five years.
Fiscal Year
- -----------
The Company's fiscal year ends on the Saturday closest to December 31. The 2004
fiscal year reflects a 52-week period resulting in a 26-week six-month period,
as compared to the 2003 fiscal year, which reflected a 53-week period resulting
in a 27-week six-month period.
11
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Cash Dividend and Common Stock Repurchase
- -----------------------------------------
On July 21, 2004, 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, to be
paid on September 15, 2004 to stockholders of record at the close of business on
August 25, 2004. As of August 5, 2004, the Company has $101.5 million remaining
in buyback authorization under its share repurchase program.
Prior Years' Reclassification
- -----------------------------
Certain items previously reported in specific captions in the accompanying
financial statements and notes have been reclassified to conform to the current
year's classifications.
2. ACQUISITIONS
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 $4.8 million for certain
post-closing adjustments. Founded in 1996 and based in New York City, ENYCE is a
designer, marketer and wholesaler of fashion forward streetwear, denim-based
lifestyle products, outerwear, athletic-inspired apparel, casual tops and
knitwear for men and women through its ENYCE(R) and Lady ENYCE(R) brands. ENYCE
sells its products primarily through specialty store chains, better specialty
stores and select department stores, as well as through international
distributors in Germany, Canada and Japan. Currently, men's products account for
approximately 89% of net sales, while women's products account for the balance.
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
$6.7 million has been allocated to the value of customer relationships. The
trademarks and trade names have been classified as having indefinite lives and
will be 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 12 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"). Based in
Southern California, Juicy Couture is a premium designer, marketer and
wholesaler of sophisticated basics for women, men and children and is recognized
around the world as a leading contemporary brand of casual lifestyle clothing.
Juicy Couture had sales of approximately $47 million in 2002. 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 $85 - 90
million. 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 will be 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 2004 or 2005. The selection of the measurement
year for the contingent payment is at either party's option. The Company
estimates that if the 2004 measurement year is selected, this payment will be in
the range of 38 - 42 million Canadian dollars (or $29 - 32 million based on the
exchange rate as of July 3, 2004). 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.
12
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 to be determined as a multiple of Mexx's earnings and cash
flow performance for the year ended 2003, 2004 or 2005. The selection of the
measurement year for the contingent payment is at either party's option. The
Company notes that with respect to the Mexx payment, the Mexx sellers have
selected the 2003 measurement year for the calculation of the contingent payment
triggered under the process provided for in the Mexx acquisition agreement.
Payment is expected to be made in mid-August 2004. The contingent payment will
be approximately $192 million (160 million euro).
3. STOCKHOLDERS' EQUITY
Activity for the six months ended July 3, 2004 and July 5, 2003 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 3, 2004 $ 124,823 $ 2,539,742 $ (21,593) $ (1,191,231)
Net income -- 119,320 -- --
Additional restricted shares issued, net of
cancellations 13,664 -- (25,410) 11,746
Purchase of common stock -- -- -- (116,817)
Shares returned for taxes -- -- -- (2,647)
Stock options exercised 10,430 -- -- 16,463
Tax benefit on stock options exercised 4,878 -- -- --
Dividends declared -- (12,244) -- --
Amortization -- -- 5,892 --
------------ ------------ ------------ ------------
Balance as of July 3, 2004 $ 153,795 $ 2,646,818 $ (41,111) $ (1,282,486)
============ ============ ============ ============
Capital in Unearned Common stock
excess of par Retained compensation in treasury,
(Dollars in thousands) value earnings expense at cost
- ---------------------- ----------------------------------------------------------------
Balance as of December 28, 2002 $ 95,708 $ 2,283,692 $ (10,185) $ (1,230,974)
Net income -- 108,748 -- --
Additional restricted shares issued, net of
cancellations 418 -- (985) 461
Stock options exercised 4,820 -- -- 31,226
Tax benefit on stock options exercised 6,684 -- -- --
Dividends declared -- (12,030) -- --
Amortization -- -- 5,062 --
------------ ------------ ------------ ------------
Balance as of July 5, 2003 $ 107,630 $ 2,380,410 $ (6,108) $ (1,199,181)
============ ============ ============ ============
13
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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:
Six Months Ended Three Months Ended
----------------------------------------------------------------
(26 Weeks) (27 Weeks) (13 Weeks) (13 Weeks)
July 3, July 5, July 3, July 5,
(Dollars in thousands) 2004 2003 2004 2003
- ---------------------- ----------------------------------------------------------------
Net income $ 119,320 $ 108,748 $ 50,550 $ 44,616
Other comprehensive income (loss), net of tax:
Foreign currency translation (loss) gain 5,211 22,785 10,335 16,164
Foreign currency translation of Eurobonds 10,536 (36,785) (5,302) (26,372)
Changes in unrealized gains (losses) on
securities 5,153 (1,140) (135) (2,331)
Changes in fair value of cash flow hedges 5,257 (2,688) 2,423 (4,368)
------------ ------------ ------------ ------------
Total comprehensive income, net of tax $ 145,477 $ 90,920 $ 57,871 $ 27,709
============ ============ ============ ============
Accumulated other comprehensive income (loss) consists of the following:
July 3, January 3, July 5,
(Dollars in thousands) 2004 2004 2003
- ---------------------- ------------------------------------------------
Foreign currency translation (loss) $ (32,445) $ (48,192) $ (35,644)
(Losses) on cash flow hedging derivatives (4,814) (10,071) (8,797)
Unrealized gains (losses) on securities 13,209 8,056 (1,704)
------------ ------------ ------------
Accumulated other comprehensive (loss), net
of tax $ (24,050) $ (50,207) $ (46,145)
============ ============ ============
4. MARKETABLE SECURITIES
The following is a summary of available-for-sale marketable securities at July
3, 2004, January 3, 2004 and July 5, 2003:
July 3, 2004
----------------------------------------------------------------
Unrealized Estimated
--------------------------------
(Dollars in thousands) Cost Gains Losses Fair Value
- ---------------------- ----------------------------------------------------------------
Equity securities $ 29,000 $ 22,375 $ -- $ 51,375
Other holdings 9,234 -- (2,033) 7,201
------------ ------------ ------------ ------------
Total $ 38,234 $ 22,375 $ (2,033) $ 58,576
============ ============ ============ ============
January 3, 2004
----------------------------------------------------------------
Unrealized Estimated
--------------------------------
(Dollars in thousands) Cost Gains Losses Fair Value
- ---------------------- ----------------------------------------------------------------
Equity securities $ 29,000 $ 14,725 $ -- $ 43,725
Other holdings 8,785 -- (2,096) 6,689
------------ ------------ ------------ ------------
Total $ 37,785 $ 14,725 $ (2,096) $ 50,414
============ ============ ============ ============
July 5, 2003
----------------------------------------------------------------
Unrealized Estimated
--------------------------------
(Dollars in thousands) Cost Gains Losses Fair Value
- ---------------------- ----------------------------------------------------------------
Equity securities $ 29,000 $ 160 $ -- $ 29,160
Other holdings 8,729 -- (2,831) 5,898
------------ ------------ ------------ ------------
Total $ 37,729 $ 160 $ (2,831) $ 35,058
============ ============ ============ ============
14
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
For the six and three months ended July 3, 2004 and July 5, 2003, 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 six months ended July 3, 2004 and July 5, 2003 were a gain of
$5,124,000 (net of $2,589,000 in taxes) and a loss of $1,140,000 (net of
$650,000 in taxes), respectively, and the net adjustments to unrealized holding
gains and losses on available-for-sale securities for the three months ended
July 3, 2004 and July 5, 2003 were a loss of $373,000 (net of $202,000 in taxes)
and a loss of $2,331,000 (net of $1,320,000 in taxes), respectively, which were
included in Accumulated other comprehensive loss.
5. INVENTORIES, NET
Inventories are stated at the lower of cost (using the first-in, first-out
method) or market and consist of the following:
July 3, January 3, July 5,
(Dollars in thousands) 2004 2004 2003
- ---------------------- ------------------------------------------------
Raw materials $ 28,531 $ 25,922 $ 28,931
Work in process 18,447 6,085 13,046
Finished goods 494,422 453,175 489,729
------------ ------------ ------------
Total $ 541,400 $ 485,182 $ 531,706
============ ============ ============
6. PROPERTY AND EQUIPMENT, NET
Property and equipment consist of the following:
July 3, January 3, July 5,
(Dollars in thousands) 2004 2004 2003
- ---------------------- ------------------------------------------------
Land and buildings $ 139,983 $ 140,198 $ 140,311
Machinery and equipment 340,386 328,525 322,206
Furniture and fixtures 158,216 145,423 129,107
Leasehold improvements 312,016 282,373 261,698
------------ ------------ ------------
950,601 896,519 853,322
Less: Accumulated depreciation
and amortization 526,634 485,778 460,939
------------ ------------ ------------
Total property and equipment, net $ 423,967 $ 410,741 $ 392,383
============ ============ ============
7. GOODWILL AND INTANGIBLES, NET
SFAS No. 142, "Goodwill and Other Intangible Assets," requires that goodwill and
intangible assets with indefinite useful lives are no longer to be amortized,
but will rather be tested at least annually for impairment. SFAS No. 142 also
requires that intangible assets with finite useful lives will continue to be
amortized over their respective useful 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." Trademarks that are owned are no
longer amortized, as they have been deemed to have indefinite lives. Such
trademarks are reviewed at least annually for potential value impairment. The
Company adopted the provisions of SFAS No. 142 effective December 30, 2001. The
Company will perform its annual impairment analysis as of the first day of the
third quarter of 2004.
15
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The following table discloses the carrying value of all the intangible assets:
July 3, January 3, July 5,
(Dollars in thousands) 2004 2004 2003
- ---------------------- ------------------------------------------------
Amortized intangible assets:
- ----------------------------
Gross Carrying Amount:
Licensed trademarks $ 42,849 $ 42,849 $ 42,849
Customer relationships 6,700 -- --
Merchandising rights 74,100 71,138 76,217
------------ ------------ ------------
Subtotal $ 123,649 $ 113,987 $ 119,066
------------ ------------ ------------
Accumulated Amortization:
Licensed trademarks $ (15,991) $ (13,963) $ (12,102)
Customer relationships (391) -- --
Merchandising rights (52,270) (45,212) (50,203)
------------ ------------ ------------
Subtotal $ (68,652) $ (59,175) $ (62,305)
------------ ------------ ------------
Net:
Licensed trademarks $ 26,858 $ 28,886 $ 30,747
Customer relationships 6,309 -- --
Merchandising rights 21,830 25,926 26,014
------------ ------------ ------------
Total amortized intangible assets, net $ 54,997 $ 54,812 $ 56,761
============ ============ ============
Unamortized intangible assets:
- ------------------------------
Owned trademarks $ 216,356 $ 189,356 $ 162,056
------------ ------------ ------------
Total intangible assets $ 271,353 $ 244,168 $ 218,817
============ ============ ============
Intangible amortization expense was $9.5 million and $8.1 million for the six
months ended July 3, 2004 and July 5, 2003, respectively, and $5.1 million and
$3.1 million for the three months ended July 3, 2004 and July 5, 2003,
respectively.
The estimated intangible amortization expense for the next five years is as
follows:
(In millions)
Fiscal Year Amortization Expense
- ----------------------------------------------------------------
2004 $ 18.4
2005 11.7
2006 7.3
2007 5.7
2008 3.7
The changes in carrying amount of goodwill for the six months ended July 3, 2004
are as follows:
Wholesale Wholesale
(Dollars in thousands) Apparel Non-Apparel Total
- ---------------------- ------------------------------------------------
Balance January 3, 2004 $ 586,841 $ 9,595 $ 596,436
Enyce:
Reclassification for trademarks (27,000) -- (27,000)
Reclassification for customer relationships (6,700) -- (6,700)
Additional purchase price 6,825 -- 6,825
Translation difference (1,003) -- (1,003)
Other (571) -- (571)
------------ ------------ ------------
Balance July 3, 2004 $ 558,392 $ 9,595 $ 567,987
============ ============ ============
There is no goodwill recorded in our retail segment.
16
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
8. DEBT
On August 7, 2001, the Company issued 350 million euro (or $307.2 million based
on the exchange rate in effect on such date) of 6.625% notes due in 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.
On October 21, 2002, the Company entered into a $750 million credit agreement
(the "Agreement") consisting of a $375 million, 364-day unsecured financing
commitment under a bank revolving credit facility, replacing a $500 million,
364-day unsecured credit facility scheduled to mature in November 2002, and a
$375 million, three-year bank revolving credit facility, replacing an existing
$250 million bank revolving credit facility which was scheduled to mature in
November 2003. 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. The three-year facility includes a $75 million
multi-currency revolving credit line, which permits the Company to borrow in
U.S. dollars, Canadian dollars and euro. Repayment of outstanding balances of
the 364-day facility can be extended for one year after the maturity date. 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 the Company 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. The Company believes it is in compliance with
such covenants. The Agreement may be directly drawn upon, or used, to support
the Company's $750 million commercial paper program, which is used from time to
time to fund working capital and other general corporate requirements. 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 3, 2004, the Company had no borrowings outstanding under
the Agreement.
As of July 3, 2004, January 3, 2004 and July 5, 2003, the Company had lines of
credit aggregating $543 million, $487 million and $466 million, respectively,
which were primarily available to cover trade letters of credit. At July 3,
2004, January 3, 2004 and July 5, 2003, the Company had outstanding trade
letters of credit of $360 million, $254 million and $328 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 $112.6 million (based on the exchange rates as July 3,
2004), which is included in the aforementioned $543 million available lines of
credit. As of July 3, 2004, a total of $31.8 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 2004 and 2005. These lines are guaranteed by
the Company. With the exception of the Eurobonds, which mature in 2006,
substantially all of the Company's debt will mature in less than one year and
will be refinanced under existing credit lines.
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, which 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 $54 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
17
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 the Company or any of its employees,
directors or affiliates, and the Company's 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 Condensed
Consolidated Statements of Income. In December 2003, the 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
material adverse effect on the Company's results of operations or financial
position. Please refer to Note 10 and Note 24 of Notes to Consolidated Financial
Statements in the Company's 2003 Annual Report on Form 10-K.
10. RESTRUCTURING CHARGE
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); of these amounts, approximately $6.6 million was
expected to be paid out in cash. The remaining balance of the 2002 restructuring
liability as of July 3, 2004 was $288,000. The Company expects that these
activities will be complete by December 2004.
A summary of the changes in the restructuring reserves is as follows:
Estimated
Operating & Occupancy
Store Closure Administrative Costs & Asset
(Dollars in thousands) Costs Exit Costs Write Downs Total
- ---------------------- ----------------------------------------------------------------
Balance at January 3, 2004 $ 1,739 $ 200 $ 30 $ 1,969
Spending for six months ended July 3, 2004 1,634 17 30 1,681
-------- -------- -------- --------
Balance at July 3, 2004 $ 105 $ 183 $ -- $ 288
======== ======== ======== ========
11. EARNINGS PER COMMON SHARE
The following is a reconciliation of the shares outstanding used in the
calculation of basic and diluted earnings per share:
Six Months Ended Three Months Ended
----------------------------------------------------------------
July 3, July 5, July 3, July 5,
(Amounts in thousands) 2004 2003 2004 2003
- ---------------------- ----------------------------------------------------------------
Weighted average common shares outstanding 108,992 106,814 108,703 107,370
Effect of dilutive securities:
Stock options and restricted stock grants 1,738 1,949 1,513 2,235
------------ ------------ ------------ ------------
Weighted average common shares outstanding and
common share equivalents 110,730 108,763 110,216 109,605
============ ============ ============ ============
18
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
12. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTARY DISCLOSURES
During the six months ended July 3, 2004, the Company made income tax payments
of $76,435,000 and interest payments of $1,228,000. During the six months ended
July 5, 2003, the Company made income tax payments of $75,994,000 and interest
payments of $859,000. During the three months ended July 3, 2004, the Company
made income tax payments of $57,917,000 and interest payments of $725,000.
During the three months ended July 5, 2003, the Company made income tax payments
of $53,829,000 and interest payments of $493,000.
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 and men'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 consists of
accessories, jewelry and cosmetics designed and marketed worldwide under certain
owned or licensed trademarks. The Retail segment consists of our worldwide
retail operations that sell most of these apparel and non-apparel products to
the public through our specialty retail stores, outlet stores, and concession
stores. As a result of the Company's 2001 acquisition of Mexx, the Company also
presents its results on a geographic basis 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 resultant 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 our
2003 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 more fairly reflect the operating income for each
of its segments. It is the Company's obligation to reflect these changes and
present historical financial information on a comparable basis.
The Company's segments are business units that offer either different products
or distribute similar products through different distribution channels. The
segments are each managed separately because they either manufacture and
distribute distinct products with different production processes or distribute
similar products through different distribution channels.
19
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
For the Six Months Ended July 3, 2004
--------------------------------------------------------------------------
Wholesale Wholesale Corporate/
(Dollars in thousands) Apparel Non-Apparel Retail Eliminations Total
- ---------------------- --------------------------------------------------------------------------
NET SALES:
Total net sales $ 1,489,919 $ 236,880 $ 471,955 $ (70,063) $ 2,128,691
Intercompany sales (79,958) (7,057) -- 87,015 --
----------- ----------- ----------- ----------- -----------
Sales from external customers $ 1,409,961 $ 229,823 $ 471,955 $ 16,952 $ 2,128,691
=========== =========== =========== =========== ===========
OPERATING INCOME:
Total operating income (loss) $ 170,589 $ 20,267 $ 20,992 $ (11,682) $ 200,166
Intercompany segment operating
income (loss) (21,136) (4,098) -- 25,234 --
----------- ----------- ----------- ----------- -----------
Segment operating income (loss)
from external customers $ 149,453 $ 16,169 $ 20,992 $ 13,552 $ 200,166
=========== =========== =========== =========== ===========
For the Six Months Ended July 5, 2003
--------------------------------------------------------------------------
Wholesale Wholesale Corporate/
(Dollars in thousands) Apparel Non-Apparel Retail Eliminations Total
- ---------------------- --------------------------------------------------------------------------
NET SALES:
Total net sales $ 1,474,259 $ 233,761 $ 404,052 $ (77,056) $ 2,035,016
Intercompany sales (84,096) (8,151) -- 92,247 --
----------- ----------- ----------- ----------- -----------
Sales from external customers $ 1,390,163 $ 225,610 $ 404,052 $ 15,191 $ 2,035,016
=========== =========== =========== =========== ===========
OPERATING INCOME:
Total operating income (loss) $ 156,960 $ 19,769 $ 22,735 $ (13,634) $ 185,830
Intercompany segment operating
income (loss) (19,811) (3,693) -- 23,504 --
----------- ----------- ----------- ----------- -----------
Segment operating income (loss)
from external customers $ 137,149 $ 16,076 $ 22,735 $ 9,870 $ 185,830
=========== =========== =========== =========== ===========
For the Three Months Ended July 3, 2004
--------------------------------------------------------------------------
Wholesale Wholesale Corporate/
(Dollars in thousands) Apparel Non-Apparel Retail Eliminations Total
- ---------------------- --------------------------------------------------------------------------
NET SALES:
Total net sales $ 677,826 $ 122,507 $ 263,932 $ (38,341) $ 1,025,924
Intercompany sales (42,300) (3,690) -- 45,990 --
----------- ----------- ----------- ----------- -----------
Sales from external customers $ 635,526 $ 118,817 $ 263,932 $ 7,649 $ 1,025,924
=========== =========== =========== =========== ===========
OPERATING INCOME:
Total operating income (loss) $ 60,763 $ 13,070 $ 27,750 $ (15,744) $ 85,839
Intercompany segment operating
income (loss) (18,407) (3,065) -- 21,472 --
----------- ----------- ----------- ----------- -----------
Segment operating income (loss)
from external customers $ 42,356 $ 10,005 $ 27,750 $ 5,728 $ 85,839
=========== =========== =========== =========== ===========
20
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
For the Three Months Ended July 5, 2003
--------------------------------------------------------------------------
Wholesale Wholesale Corporate/
(Dollars in thousands) Apparel Non-Apparel Retail Eliminations Total
- ---------------------- --------------------------------------------------------------------------
NET SALES:
Total net sales $ 649,063 $ 111,868 $ 220,937 $ (22,451) $ 959,417
Intercompany sales (28,787) (766) -- 29,553 --
----------- ----------- ----------- ----------- -----------
Sales from external customers $ 620,276 $ 111,102 $ 220,937 $ 7,102 $ 959,417
=========== =========== =========== =========== ===========
OPERATING INCOME:
Total operating income (loss) $ 57,858 $ 9,430 $ 25,668 $ (14,591) $ 78,365
Intercompany segment operating
income (loss) (16,170) (2,456) -- 18,626 --
----------- ----------- ----------- ----------- -----------
Segment operating income (loss)
from external customers $ 41,688 $ 6,974 $ 25,668 $ 4,035 $ 78,365
=========== =========== =========== =========== ===========
July 3, January 3, July 5,
(Dollars in thousands) 2004 2004 2003
- ---------------------- ---------------------------------------------
SEGMENT ASSETS:
Wholesale Apparel $ 2,103,374 $ 2,006,673 $ 1,790,015
Wholesale Non-Apparel 147,917 170,315 192,649
Retail 540,462 524,721 474,407
Corporate 180,547 186,390 173,362
Eliminations (287,785) (281,100) (292,178)
----------- ----------- -----------
Total assets $ 2,684,515 $ 2,606,999 $ 2,338,255
=========== =========== ===========
GEOGRAPHIC DATA:
Six Months Ended Three Months Ended
------------------------------------------------------------
July 3, July 5, July 3, July 5,
(Dollars in thousands) 2004 2003 2004 2003
- ---------------------- ------------------------------------------------------------
NET SALES:
Domestic sales $ 1,625,591 $ 1,617,008 $ 791,078 $ 762,975
International sales 503,100 418,008 234,846 196,442
----------- ----------- ----------- -----------
Total net sales $ 2,128,691 $ 2,035,016 $ 1,025,924 $ 959,417
=========== =========== =========== ===========
OPERATING INCOME:
Domestic operating income $ 175,859 $ 158,751 $ 81,243 $ 69,145
International operating income 24,307 27,079 4,596 9,220
----------- ----------- ----------- -----------
Total operating income $ 200,166 $ 185,830 $ 85,839 $ 78,365
=========== =========== =========== ===========
July 3, January 3, July 5,
(Dollars in thousands) 2004 2004 2003
- ---------------------- ---------------------------------------------
TOTAL ASSETS:
Domestic $ 1,875,047 $ 1,821,706 $ 1,662,351
International 809,468 785,293 675,904
----------- ----------- -----------
Total assets $ 2,684,515 $ 2,606,999 $ 2,338,255
=========== =========== ===========
14. ACCOUNTING FOR DERIVATIVES AND HEDGING ACTIVITIES
At July 3, 2004, the Company had forward contracts maturing through May 2005 to
sell 66 million euro for $76 million, 3.5 million Pounds Sterling for 5.2
million euro and 1 million Canadian dollars for $760,000. The notional value of
the foreign exchange forward contracts at the end of the second quarter of 2004
was approximately $83
21
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
million, as compared with approximately $76 million at year-end 2003 and
approximately $30 million at the end of the second quarter of 2003. At the end
of the second quarter of 2004, the Company had no euro currency collars
outstanding as compared to $42 million in euro currency collars at year-end 2003
and $48 million in euro currency collars at the end of the second quarter of
2003. Unrealized losses for outstanding foreign exchange forward contracts were
approximately $4.5 million at the end of the second quarter of 2004, $11.8
million at year-end 2003 and approximately $8.9 million at the end of the second
quarter of 2003. The ineffective portion of these contracts was approximately
$700,000 and was expensed in 2004.
In connection with the variable rate financing under the synthetic lease
agreement, the Company has entered into 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 this arrangement to provide
protection 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 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 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 six months ended
July 3, 2004.
15. NEW ACCOUNTING PRONOUNCEMENTS
In March 2004, the FASB published an Exposure Draft, "Share-Based Payment," an
amendment of FASB Statements No. 123 and 95. Under this FASB proposal, all forms
of share-based payment to employees, including employee stock options, would be
treated as compensation and recognized in the income statement. This proposed
statement would be effective for fiscal years beginning after December 15, 2004.
The Company currently accounts for stock options under APB No. 25. The pro forma
impact of expensing options is disclosed in Note 1 of Notes to Condensed
Consolidated Financial Statements.
In December 2003, the 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. This statement did not have an impact on the Company's Condensed
Consolidated Financial Statements.
In March 2004, the Emerging Issues Task Force ("EITF") reached a consensus on
recognition and measurement guidance previously discussed under EITF 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 115, "Accounting for Certain Investments in Debt and
Equity Securities," and investments accounted for under the cost method or the
equity method. The recognition and measurement guidance for which the consensus
was reached is to be applied to other-than-temporary impairment evaluations in
reporting periods beginning after June 15, 2004. The implementation of this EITF
consensus in the third quarter of 2004 is not expected to have a material impact
on the Company's results of operations or financial condition.
22
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 core LIZ CLAIBORNE brand along with our better-priced
specialty apparel (INTUITIONS, SIGRID OLSEN and REALITIES), bridge-priced
(DANA BUCHMAN and ELLEN TRACY), men's (CLAIBORNE), moderate-priced special
markets (AXCESS, CRAZY HORSE, EMMA JAMES, FIRST ISSUE, VILLAGER and J.H.
COLLECTIBLES), premium denim (LUCKY BRAND DUNGAREES) and contemporary
sportswear and dress (LAUNDRY, JUICY COUTURE, JANE STREET, ENYCE and SWC)
businesses, as well as our licensed DKNY(R)JEANS, DKNY(R)ACTIVE, and CITY
DKNY(R)businesses and our licensed KENNETH COLE NEW YORK and REACTION
KENNETH COLE businesses (as previously announced, our KENNETH COLE apparel
license will expire at the end of the year). 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 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 273 outlet
stores, 239 specialty retail stores and 608 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). This segment includes stores operating under the following
formats: MEXX, LUCKY BRAND DUNGAREES, LIZ CLAIBORNE, ELISABETH,
DKNY(R)JEANS, DANA BUCHMAN, ELLEN TRACY, SIGRID OLSEN, LAUNDRY and MONET,
as well as our Special Brands Outlets which include products from our
Special Markets divisions. On February 20, 2003, we announced our decision
to close our 22 LIZ CLAIBORNE domestic Specialty Retail stores (see Note 10
of Notes to Condensed Consolidated Financial Statements).
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.
Certain items in our International businesses have been reclassified to conform
to current year's classifications. In addition, as we are creating the
multi-brand platform in Europe we have the opportunity to reengineer cost
allocation processes to more fairly reflect the operating income for each of our
segments. It is our obligation to reflect these changes and present historical
financial information on a comparable basis.
Competitive Profile
- -------------------
We operate in global fashion markets that are highly 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
successfully compete by positioning us to take advantage of synergies in product
design, development, sourcing and distributing of our products throughout the
world. We believe we owe much of our recent success 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 and to source the
manufacture of our products on a competitive basis, particularly in light of the
impact of the elimination of quota for apparel products scheduled for 2005. We
expect that the anticipated elimination of quota
23
will result in a general reduction in the cost of sourcing and manufacturing
apparel products; however, there can be no assurances that the cost savings will
be directly reflected in the Company's gross profit rate. In addition, the
change to a quota-free environment may present operational challenges to the
Company and other apparel companies as the transition is made to the new quota
regime.
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 2003 Annual Report on Form 10-K, including, without
limitation, those set forth under the heading "Business-Competition; Certain
Risks."
2004 First Half Overall Results
- -------------------------------
Net Sales
- ---------
Net sales for the first half of 2004 were a record $2.129 billion, an increase
of $93.7 million, or 4.6%, over 2003 first half 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 $98.3 million of sales from our recently acquired
JUICY COUTURE and ENYCE businesses. Approximately $47.7 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 MEXX Europe, SIGRID
OLSEN, DKNY(R) Jeans and LUCKY BRAND DUNGAREES businesses.
These increases more than offset sales decreases in our core LIZ CLAIBORNE
better-priced department store business and our moderate-priced Special Markets
businesses. Our LIZ CLAIBORNE business continues to be challenged by
increasingly conservative buying patterns of our retail store customers as they
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 as a result of the
introduction of new offerings by our competitors. Because of these challenges,
we continue to plan our 2004 core LIZ CLAIBORNE business down in the mid-teens
on a percentage basis. Notwithstanding this, we note that the sales performance
of our LIZ CLAIBORNE brands at retail has been encouraging overall year-to-date,
with above plan sales and inventory levels significantly below those of the
prior year period. Our moderate businesses also face challenges of retailer
focus on inventory productivity and conservative planning. For our moderate
businesses, we are planning sales to be down 10%, reflecting an improvement from
the previously forecasted mid-teens decrease, as a result of the recent improved
performance of a number of our moderate brands. We believe these expected
declines will be more than offset in 2004 by increases in other brands within
our portfolio, including MEXX, as well as our recently acquired JUICY COUTURE
and ENYCE brands, which will include a full year's sales in 2004. In addition,
we expect to continue to pursue our acquisition strategy, seeking out
opportunities that are on strategy, financially attractive and involve
manageable execution risks.
Gross Profit and Net Income
- ---------------------------
Our gross profit improved in the first half of 2004 reflecting continued focus
on inventory management and lower sourcing costs. Our gross profit also
benefited from the acquisition of JUICY COUTURE and the continued growth of our
MEXX Europe business, as each of these businesses run at gross profit rates
higher than the Company average. Overall net income increased to $119.3 million
in the first half of 2004 from $108.7 million in 2003, 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 half of 2004
with a net debt position of $191.3 million as compared to $311.5 million at July
5, 2003. This $120.2 million decrease in our net debt position on a
year-over-year basis is primarily attributable to cash flow from operations for
the trailing twelve months of $464.3 million partially offset by the payments
made to acquire ENYCE and JUICY COUTURE, stock repurchases of $116.8 million and
the effect of foreign currency translation on our Eurobonds, which added $27.8
million to our debt balance.
24
International Operations
- ------------------------
In the first half of 2004, sales from our international segment represented
23.6% of our overall sales, as opposed to 20.5% in the 2003 first half. 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 the planned launch of a number of our brands in
Europe utilizing the MEXX corporate platform, including ELLEN TRACY, ENYCE and
LUCKY BRAND DUNGAREES. 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 $47.7 million, or 56.1%, of the
increase of international sales from the 2003 first half. Over the past few
years, the Euro and the Canadian dollar have strengthened against the US 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
- -------------------
In connection with the May 2001 acquisition of Mexx Group B.V. ("MEXX Europe"),
we agreed to make 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
selection of the measurement year is at either party's option. We note that with
respect to the MEXX payment, the MEXX sellers have selected the 2003 measurement
year for the calculation of the contingent payment triggered under the process
provided for in the MEXX acquisition agreement. Payment is expected to be made
in mid-August 2004. The contingent payment will be approximately $192 million
(160 million euro).
In July 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
half 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 selection of the measurement year for
the contingent payment is at either party's option. We estimate that if the 2004
measurement year is selected the payment would be in the range of 38 - 42
million Canadian dollars (or $29 - 32 million based on the exchange rate in
effect at July 3, 2004).
In September 2002, we acquired 100 percent of the equity interest of Ellen
Tracy, Inc., a privately held fashion apparel company, and related companies
(collectively "Ellen Tracy") for a purchase price of $177.0 million, including
the assumption of debt and fees. Ellen Tracy designs, wholesales and markets
women's sportswear. Founded in 1949 and based in New York City, Ellen Tracy
sells its products predominantly to select specialty stores and upscale
department stores at bridge price points which are somewhat higher than the
Company's core better-priced businesses. Brands include ELLEN TRACY, LINDA
ALLARD ELLEN TRACY and COMPANY ELLEN TRACY.
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. Founded in 1994 and based in southern California, JUICY
COUTURE is a premium designer, marketer and wholesaler of sophisticated basics
for women, men and children and is recognized around the world as a leading
contemporary brand of casual lifestyle clothing. JUICY COUTURE sells its
products predominantly through select specialty stores and upscale department
stores and price points. 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 $85 - 90 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 at closing of approximately $121.9 million, including fees and the
retirement of debt at closing, and an additional $4.8 million for certain
post-closing adjustments.
Founded in 1996 and based in New York City, ENYCE is a designer, marketer and
wholesaler of fashion forward
25
streetwear, denim-based lifestyle products, outerwear, athletic-inspired
apparel, casual tops and knitwear for men and women through its ENYCE(R) and
Lady ENYCE(R) brands. ENYCE sells its products primarily through specialty store
chains, better specialty stores and select department stores, as well as through
international distributors (where arrangements are under review) in Germany,
Canada and Japan. Currently, men's products account for approximately 89% of net
sales, while women's products account for the balance.
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:
o Domestic: wholesale customers and Company specialty retail and outlet
--------
stores located in the United States; and
o International: wholesale customers and Company specialty retail and outlet
-------------
stores and concession stores located outside of the United States,
primarily MEXX Europe and MEXX Canada.
All data and discussion with respect to our specific segments included within
this "Management's Discussion and Analysis" is presented after applicable
intercompany eliminations. This presentation reflects a change instituted
effective with the first half of Fiscal 2003, from our prior practice of
presenting specific segment information prior to intercompany eliminations.
Fiscal 2003 data presented in this "Management's Discussion and Analysis" have
been restated to conform to the presentation methodology used for Fiscal 2004.
THREE MONTHS ENDED JULY 3, 2004 COMPARED TO THREE MONTHS ENDED JULY 5, 2003
- ---------------------------------------------------------------------------
The following table sets forth our operating results for the three months ended
July 3, 2004 compared to the three months ended July 5, 2003:
Three months ended Variance
---------------------------------------------
July 3, July 5,
Dollars in millions 2004 2003 $ %
- --------------------------------------------------------------------------------
Net Sales $ 1,025.9 $ 959.4 $ 66.5 6.9%
Gross Profit 489.4 425.8 63.6 15.0%
Selling, general & administrative
expenses 403.6 347.4 56.2 16.2%
Operating Income 85.8 78.4 7.4 9.5%
Other income (expense) - net (0.9) (0.2) 0.7 350.0%
Interest (expense) - net (6.9) (8.2) (1.3) (15.9)%
Provision for income taxes 27.4 25.4 2.0 7.9%
Net Income $ 50.6 $ 44.6 $ 6.0 13.4%
Net Sales
- ---------
Net sales for the second quarter of 2004 were a record $1.026 billion, an
increase of $66.5 million, or 6.9%, over net sales for the second quarter of
2003. The acquisition of ENYCE (acquired December 1, 2003) added approximately
$17.1 million in net sales for the quarter. The impact of foreign currency
exchange rates, primarily as a result of the strengthening of the euro, added
approximately $11.8 million in sales during the quarter. Net sales results for
our business segments are provided below:
o Wholesale Apparel net sales increased $15.3 million, or 2.5%, to $635.5
------------------
million. This result reflected the following:
- The addition of $17.1 million of sales from our recently acquired
ENYCE business;
26
- A $5.3 million increase resulting from the impact of foreign currency
exchange rates in our international businesses; and
- A $7.1 million net decrease primarily reflecting a 19.4% decrease in
our LIZ CLAIBORNE business (a 16.5% sales decrease excluding the
impact of lower shipments to the off-price channel) and a 10.7%
decrease in our Special Markets business, partially offset by
increases, exclusive of the impact of foreign currency exchange rates,
in our MEXX Europe (due to continued growth), JUICY COUTURE (due to
continued increases in demand), ELLEN TRACY (due to the strength of
the higher-priced Collection business), DANA BUCHMAN (due to higher
average unit prices resulting from new luxury product offerings),
licensed DKNY(R) Jeans business (due to an increase in replenishment
programs (which provide for the reordering by retail customers of
basic ongoing styles) and expansion in existing accounts) and SIGRID
OLSEN (due to a strong demand in the recently introduced replenishment
programs) businesses. The decrease in our LIZ CLAIBORNE business
resulted from a continued focus by our retail customers on inventory
productivity and conservative planning, lower volume due to the upward
migration of certain retailers to exclusive and differentiated product
offerings, growth in department store private label brands and the
introduction of new competitive offerings. The decrease in our Special
Markets business resulted from lower volume due to the continued focus
by our retail customers on inventory productivity and conservative
planning.
o Wholesale Non-Apparel net sales increased $7.7 million, or 6.9%, to $118.8
----------------------
million. The increase was primarily due to new products representing the
extension of our JUICY COUTURE and ELLEN TRACY apparel brands into the
non-apparel segment, as well as notable growth in our MONET Jewelry,
Fashion Accessories, licensed KENNETH COLE and LUCKY BRAND businesses.
These gains were partially offset by planned decreases in our Cosmetics
business.
The impact of foreign currency exchange rates in our international
businesses was not material in this segment.
o Retail net sales increased $43.0 million, or 19.5%, to $263.9 million. The
------
increase reflected the following:
- A $6.3 million increase resulting from the impact of foreign currency
exchange rates in our international businesses; and
- A $36.7 million net increase primarily driven by increases in our
MONET International business, higher comparable store sales in our
Specialty Retail business (including a 14% comparable store sales
increase in our LUCKY BRAND business), the net addition of 10 new
LUCKY BRAND stores, 8 new Specialty Retail and Outlet stores in our
MEXX Europe business and 8 new Specialty Retail and Outlet stores in
our MEXX Canada business, in addition to the opening of 3 MEXX USA and
16 Sigrid Olsen Specialty Retail stores over the last twelve months.
We also opened 112 net new international concession stores in Europe
over the last twelve months.
Comparable store sales increased by 0.5% in our Outlet business and
increased by 8.6% overall in our Specialty Retail business. We ended the
quarter with a total of 273 Outlet stores, 239 Specialty Retail stores and
608 international concession stores.
o Corporate net sales, consisting of licensing revenue, increased $0.5
---------
million to $7.6 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 $28.1 million, or
--------
3.7%, to $791.1 million, reflecting the contributions of new product launches
and recent acquisitions, partially offset by declines in our core LIZ CLAIBORNE
and Special Markets businesses. International net sales increased $38.4 million,
-------------
or 19.5%, to $234.8 million, reflecting the results of our MEXX Europe business;
approximately $11.8 million of this increase was due to the impact of currency
exchange rates.
Gross Profit
- ------------
Gross profit increased $63.6 million, or 15.0%, to $489.4 million in the second
quarter of 2004 over the second quarter of 2003. Gross profit as a percent of
net sales increased to 47.7% in 2004 from 44.4% in 2003. Approximately $6.8
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 a continued focus on inventory management;
lower sourcing costs and higher overall sell-through of our products at retail.
Growth in our
26
MEXX Europe business also contributed to the rate increase, as this business
runs at a higher gross profit rate than the Company average.
Selling, General & Administrative Expenses
- ------------------------------------------
Selling, general & administrative expenses ("SG&A") increased $56.2 million, or
16.2%, to $403.6 million in the second quarter of 2004 over the second quarter
of 2003 and as a percent of net sales increased to 39.3% from 36.2%.
Approximately $6.7 million of the increase was due to the impact of foreign
currency exchange rates, primarily as a result of the strengthening of the euro,
while approximately $14.7 million of the increase in the quarter was related to
the acquisition of ENYCE and the start-up of new businesses. The higher SG&A
rate primarily reflected reduced expense leverage resulting from the sales
decreases in our LIZ CLAIBORNE and Special Markets businesses, the increased
proportion of expenses related to our MEXX Europe business, which runs at a
higher SG&A rate than the Company average, and additional costs associated with
the creation of a multi-brand platform in Europe, partially offset by the
favorable impact of Company-wide expense control initiatives.
Operating Income
- ----------------
Operating income for the second quarter of 2004 was $85.8 million, an increase
of $7.4 million, or 9.5%, over last year. Operating income as a percent of net
sales increased to 8.4% in 2004 compared to 8.2% in 2003. The increase was the
result of increased sales, lower sourcing costs, improved inventory management,
partially offset by increased expenses related to the start up of new businesses
and retail expansion. The impact of foreign currency exchange rates in our
international businesses was not material to operating income. Operating income
by business segment is provided below:
o Wholesale Apparel operating income increased slightly to $42.4 million
------------------
(6.7% of net sales) in 2004 compared to $41.7 million (6.7% of net sales)
in 2003, principally reflecting the inclusion of our recently acquired
ENYCE business and increased profits in our JUICY COUTURE, licensed DKNY(R)
Jeans, ELLEN TRACY, DANA BUCHMAN, Special Markets, LUCKY BRAND, SIGRID
OLSEN and CLAIBORNE Men's businesses, offset by reduced profits in our LIZ
CLAIBORNE business as a result of the lower sales volume and the increased
costs associated with the creation of a multi-brand platform in Europe
discussed above.
o Wholesale Non-Apparel operating income was $10.0 million (8.4% of net
----------------------
sales) in 2004 compared to $7.0 million (6.3% of net sales) in 2003,
principally due to the addition of our recently launched JUICY COUTURE
business and increases in our Fashion Accessories and MONET Jewelry
businesses, partially offset by planned decreases in our Cosmetics
business.
o Retail operating income was $27.8 million (10.5% of net sales) in 2004
------
compared to $25.7 million (11.6% of net sales) in 2003, principally
reflecting increased profits from our MONET International and LUCKY BRAND
businesses, partially offset by losses in our LIZ CLAIBORNE Europe
concession business (due to weak consumer response in the European markets
and investments associated with a new management structure and new product
design team put into place in the fourth quarter of 2003) and costs
associated with our direct to consumer initiatives (namely, the MEXX USA
and SIGRID OLSEN Specialty Retail formats and our Liz.com website).
o Corporate operating income, primarily consisting of licensing operating
---------
income, increased $1.7 million to $5.7 million in 2004 compared to $4.0
million in 2003.
Viewed on a geographic basis, Domestic operating profit increased by $12.1
--------
million, or 17.5%, to $81.2 million, predominantly reflecting the contribution
of new and recent acquisitions, offset by reduced profits in our core LIZ
CLAIBORNE and Special Markets businesses. International operating profit
-------------
decreased $4.6 million, or 50.2% to $4.6 million, reflecting losses in our LIZ
CLAIBORNE Europe business and the incremental costs associated with the creation
of the multi-brand platform in Europe, and well as the reasons discussed above.
Net Other Expense
- -----------------
Net other expense in the second quarter of 2004 was $0.9 million compared to
$0.2 million in the second quarter of 2003. In 2004 net other expense was
comprised of $1.3 million of minority interest expense (which relates to the 15%
minority interest in Lucky Brand Dungarees, Inc. and the 2.5% minority interest
in Segrets, Inc.), partially offset by other non-operating income. In 2003, net
other expense was principally comprised of $0.8 million of minority interest
expense, partially offset by other non-operating income.
28
Net Interest Expense
- --------------------
Net interest expense in the second quarter of 2004 was $6.9 million, compared to
$8.2 million in the second quarter of 2003, both of which were principally
related to borrowings incurred to finance our strategic initiatives, including
acquisitions. The impact of lower effective interest rates from our interest
rate swap agreements accounted for the majority of the decrease.
Provision for Income Taxes
- --------------------------
The income tax rate in the second quarter of 2004 decreased to 35.2% from 36.2%
in the prior year as a result of change to the European organizational structure
and the integration of our LIZ CLAIBORNE Europe and MEXX operations in nine
European countries.
Net Income
- ----------
Net income in the second quarter of 2004 increased to $50.6 million, or 4.9% of
net sales, from $44.6 million in the second quarter of 2003, or 4.7% of net
sales. Diluted earnings per common share ("EPS") increased to $0.46 in 2004,
from $0.41 in 2003, a 12.2% increase.
Average diluted shares outstanding increased by 0.6 million shares to 110.2
million in the second quarter of 2004 on a period-to-period basis, as a result
of the exercise of stock options and the effect of dilutive securities,
partially offset by the impact of shares repurchased during the quarter.
SIX MONTHS ENDED JULY 3, 2004 COMPARED TO SIX MONTHS ENDED JULY 5, 2003
- -----------------------------------------------------------------------
The following table sets forth our operating results for the six months ended
July 3, 2004 (comprised of 26 weeks) compared to the six months ended July 5,
2003 (comprised of 27 weeks):
Six months ended Variance
---------------------------------------------
July 3, July 5,
Dollars in millions 2004 2003 $ %
- --------------------------------------------------------------------------------
Net Sales $ 2,128.7 $ 2,035.0 $ 93.7 4.6%
Gross Profit 990.5 881.5 109.0 12.4%
Selling, general & administrative
expenses 790.3 695.7 94.6 13.6%
Operating Income 200.2 185.8 14.4 7.7%
Other income (expense) - net (1.6) (0.6) 1.0 166.7%
Interest (expense) - net (14.5) (14.8) (.3) (2.0%)
Provision for income taxes 64.8 61.7 3.1 5.0%
Net Income $ 119.3 $ 108.7 $ 10.6 9.8%
Net Sales
- ---------
Net sales for the first half of 2004 (which was comprised of 26 weeks) were a
record $2.129 billion, an increase of $93.7 million, or 4.6%, over net sales for
the first half of 2003 (which was comprised of 27 weeks). The acquisitions of
JUICY COUTURE (acquired April 7, 2003) and ENYCE (acquired December 1, 2003)
added approximately $98.3 million in net sales in the first half. Approximately
$47.7 million of the year-over-year increase was due to the impact of foreign
currency exchange rates, primarily as a result of the strengthening of the euro.
Net sales results for our business segments are provided below:
o Wholesale Apparel net sales increased $19.8 million, or 1.4%, to $1.410
------------------
billion. This result reflected:
- A $89.6 million increase resulting from the acquisitions of JUICY
COUTURE and ENYCE;
29
- A $27.6 million increase resulting from the impact of foreign currency
exchange rates in our international businesses; and
- A $97.4 million net decrease primarily reflecting a 24.6% decrease in
our core LIZ CLAIBORNE business (a 19.9% sales decrease excluding the
impact of lower shipments to the off-price channel) and a 14.9%
decrease in our Special Markets business (due to the challenging
retail environment and conservative inventory management of retailers
in this sector), partially offset by increases, exclusive of the
impact of foreign currency exchange rates, in our MEXX Europe business
(due to continued growth), ELLEN TRACY (due to the strength of the
higher-priced Collection business), and licensed DKNY(R) Jeans and
SIGRID OLSEN (due to a strong increase in their new replenishment
programs (which provide for the reordering by retail customers of
basic ongoing styles)) businesses. The decrease in our LIZ CLAIBORNE
and Special Markets businesses resulted from lower volume due to the
factors described above in the Overview section, and in the case of
the LIZ CLAIBORNE business a lower amount of shipments to off price
channels resulting from conservative inventory planning and
management.
o Wholesale Non-Apparel net sales increased by $4.2 million, or 1.9%, to
----------------------
$229.8 million. The increase primarily reflected increases in our MONET
Jewelry business, the addition of our recently launched JUICY COUTURE
business and the introduction of products under our KENNETH COLE Jewelry
license. These gains were partially offset by planned decreases in our
Cosmetics business.
The impact of foreign currency exchange rates in our international
businesses was not material in this segment.
o Retail net sales increased $67.9 million, or 16.8%, to $472.0 million. The
------
increase reflected the following:
- A $19.6 million increase resulting from the impact of foreign currency
exchange rates in our international businesses; and
- A $48.3 million net increase primarily driven by higher comparable
store sales in our Specialty Retail business (including a 15%
comparable store sales increase in our LUCKY BRAND business) and the
net store openings and new concessions mentioned above.
Comparable store sales increased 5.6% in our Specialty Retail business and
decreased 0.2% in our Outlet business. Excluding the extra week in the 2003
period, Specialty Retail comparable store sales increased 9.7% and Outlet
comparable store sales increased 3.9%.
o Corporate net sales, consisting of licensing revenue, increased $1.8
---------
million to $17.0 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 $8.6 million, or
--------
0.5%, to $1.626 billion, reflecting the contributions of new product launches
and recent acquisitions, partially offset by declines in our core LIZ CLAIBORNE
and Special Markets businesses, International net sales increased $85.1 million,
-------------
or 20.4%, to $503.1 million, reflecting the results of our MEXX Europe and MEXX
Canada businesses; approximately $47.7 million of this increase was due to the
impact of currency exchange rates.
Gross Profit
- ------------
Gross profit increased $109.0 million, or 12.4%, to $990.5 million in the first
half of 2004 over the first half of 2003. Gross profit as a percent of net sales
increased to 46.5% in 2004 from 43.3% in 2003. Approximately $25.8 million of
the increase in the half 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 a continued focus on inventory management and lower
sourcing costs. Our gross profit also benefited from the acquisition of JUICY
COUTURE and the continued growth in our MEXX Europe business, as each of these
businesses run at a higher gross profit rate than the Company average.
Selling, General & Administrative Expenses
- ------------------------------------------
SG&A increased $94.6 million, or 13.6%, to $790.3 million in the first half of
2004 over the first half of 2003 and as a percent of net sales increased to
37.1% from 34.2%. Approximately $37.1 million of the increase resulted from the
acquisitions of JUICY COUTURE and ENYCE and the start-up of new businesses,
while approximately $22.9 million of the increase resulted from the impact of
foreign currency exchange rates in our international businesses, primarily as a
result of the strengthening of the euro. The remainder of the increase resulted
from volume-related growth and cost increases.
30
SG&A as a percent of sales increased due to reduced expense leverage resulting
from the sales decreases in our LIZ CLAIBORNE and Special Markets businesses,
the increased proportion of expenses related to our MEXX Europe business, which
runs at a higher SG&A rate than the Company average, and additional costs
associated with the creation of a multi-brand platform in Europe, partially
offset by the favorable impact of Company-wide expense control initiatives.
Operating Income
- ----------------
Operating income in the first half of 2004 was $200.2 million, an increase of
$14.3 million, or 7.7%, over 2003. Operating income as a percent of net sales
increased to 9.4% in the first half of 2004 compared to 9.1% in 2003, primarily
as a result of increased net sales and the improved gross margin rate discussed
earlier. Approximately $2.9 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 increased $12.4 million to $149.5
------------------
million (10.6% of net sales) in the first half of 2004 compared to $137.1
million (9.9% of net sales) in 2003, principally reflecting the
acquisitions of JUICY COUTURE and ENYCE and increased profits in our
licensed DKNY(R) Jeans, ELLEN TRACY, CLAIBORNE Men's, LUCKY BRAND and
SIGRID OLSEN businesses, partially offset by reduced profits in our LIZ
CLAIBORNE business as a result of the lower sales volume discussed above.
o Wholesale Non-Apparel operating income was nearly flat at $16.2 million
----------------------
(7.0% of net sales) in the first half of 2004 compared to $16.1 million
(7.1% of net sales) in 2003, reflecting increases in our MONET Jewelry and
department store Fashion Accessories businesses and the addition of our
recently launched JUICY COUTURE Accessories business, partially offset by
the impact of reduced sales volume in our Cosmetics business due to
weakness in demand.
o Retail operating income decreased $1.7 million to $21.0 million (4.4% of
------
net sales) in 2004 compared to $22.7 million (5.6% of net sales) in 2003,
principally reflecting losses in our LIZ CLAIBORNE Europe business (which
is primarily a concession business) due to weak consumer response to Spring
offerings and investments associated with a new management structure and
new product design team put into place in the fourth quarter of 2004, as
well as costs associated with our direct-to-consumer initiatives (namely,
the MEXX USA and SIGRID OLSEN specialty retail formats and our Liz.com
website), partially offset by an increase in profits from our MONET
International and LUCKY BRAND businesses and the impact of the closure of
our domestic LIZ CLAIBORNE Specialty stores in 2003.
o Corporate operating income, primarily consisting of licensing operating
---------
income, increased $3.7 million to $13.6 million in 2004 compared to $9.9
million in 2003.
Viewed on a geographic basis, Domestic operating profit increased by $17.1
--------
million, or 10.8%, to $175.9 million, predominantly reflecting the contribution
of new and recent acquisitions, offset by reduced profits in our core LIZ
CLAIBORNE and Special Markets businesses. International operating profit
-------------
decreased $2.8 million, or 10.2% to $24.3 million, reflecting the results of
losses in our LIZ CLAIBORNE Europe business and the incremental costs associated
with the creation of the multi-brand platform in Europe, and well as the reasons
described above, partially offset by the favorable impact of foreign exchange
rates of $2.9 million.
Net Other Expense
- -----------------
Net other expense in the first half of 2004 was $1.6 million compared to $0.6
million in the first half of 2003. In 2004 net other expense was comprised of
$2.0 million of minority interest expense (which relates to the 15% minority
interest in Lucky Brand Dungarees, Inc. and the 2.5% minority interest in
Segrets, Inc.), partially offset by other non-operating income. In 2003, net
other expense was principally comprised of $1.1 million of minority interest
expense.
Net Interest Expense
- --------------------
Net interest expense in the first half of 2004 was $14.5 million, compared to
$14.8 million in the first half of 2003, 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 half of 2004 decreased to 35.2% from 36.2% in
the prior year as a result of change to the European organizational structure
and the integration of our LIZ CLAIBORNE Europe and MEXX operations in nine
European countries.
31
Net Income
- ----------
Net income in the first half of 2004 increased to $119.3 million, or 5.6% of net
sales, from $108.7 million in the first half of 2003, or 5.3% of net sales.
Diluted earnings per common share ("EPS") increased 8.0% to $1.08 in 2004, from
$1.00 in 2003.
Average diluted shares outstanding increased by 2.0 million shares to 110.7
million in the first half of 2004 on a year-over-year basis, as a result of the
exercise of stock options and the effect of dilutive securities, partially
offset by the impact of shares repurchased during the second quarter of 2004.
FORWARD OUTLOOK
- ---------------
Retailers continue to be focused on inventory productivity to drive sales and
avoid excess inventory. This planned increase in productivity, the overall
negative retail sales trends in 2003 and the focus on brand differentiation have
resulted in very conservative planned retailer receipts in all sectors for 2004.
While improving sales trends for our brands drove our higher than planned sales
performance in the second quarter, we continue to take a conservative and
prudent approach in planning our business.
In light of our improving sales trends, for fiscal 2004, we have raised our
previous guidance, forecasting a net sales increase of 7 - 8% (including a 1.6%
sales increase due to the projected impact of foreign currency exchange rates),
an operating margin in the range of 11.1% - 11.3% and EPS in the range of $2.79
- - $2.83, including an approximate 4 cent impact from stock repurchases made year
to date.
o In our Wholesale Apparel segment, we expect fiscal 2004 net sales to
increase in the range of 4 - 5% (including a 1% sales increase due to the
projected impact of foreign currency exchange rates), primarily driven by
the inclusion of a full year's sales in our JUICY COUTURE and ENYCE
businesses, the launches of our REALITIES and INTUITIONS brands and
increases in our MEXX Europe, SIGRID OLSEN, licensed DKNY(R) Jeans, ELLEN
TRACY and LUCKY BRAND businesses, offset by a mid-teens decrease in our LIZ
CLAIBORNE business and an approximate 10% decrease in our Special Markets
business.
o In our Wholesale Non-Apparel segment, we expect fiscal 2004 net sales to
increase in the range of 5 - 7%, primarily driven by the introduction of
new products.
o In our Retail segment, we expect fiscal 2004 net sales to increase in the
range of 16 - 20% (including a 3% sales increase due to the projected
impact of foreign currency exchange rates), primarily driven by continued
growth in MEXX Europe with plans to open 12 new freestanding stores and 43
concessions, the continuation of the LUCKY BRAND roll-out with plans for an
additional 15 new stores, and plans for a total of 29 net new outlet stores
in various formats in Europe, Canada and the USA. We are proceeding with a
conservative rollout of the MEXX USA format with plans for 4 new stores. In
addition, we are also planning to open 19 new stores in the SIGRID OLSEN
format. Overall, we are planning a low single digit comp sales increase in
this segment.
o In our Corporate segment, we expect fiscal 2004 licensing revenue to
increase by 20% over 2003.
For the third quarter of 2004, we forecast a net sales increase of 9 - 10%
(including a 1.5% sales increase due to the projected impact of foreign currency
exchange rates), an operating margin in the range of 13.9% - 14.1% and EPS in
the range of $1.00 - $1.02.
o In our wholesale apparel segment, we expect third quarter 2004 net sales to
increase in the range of 6 - 7%, primarily driven by the acquisition of
ENYCE and increases in our Mexx Europe, Juicy Couture, licensed DKNY(R)
Jeans, Sigrid Olsen, and Lucky Brand businesses, partially offset by
decreases in our Liz Claiborne business.
o In our wholesale non-apparel segment, we expect third quarter 2004 net
sales to increase in the range of 14 - 17%, driven by increases in all
existing businesses and the introduction of new brands.
o In our retail segment, we expect third quarter 2004 net sales to increase
in the range of 16 - 18%, primarily driven by increases in our Lucky Brand,
Mexx Europe and Outlet businesses as well as the conservative rollout of
the Mexx USA and Sigrid Olsen formats which were introduced in the second
half of fiscal 2003.
o In our corporate segment, we expect third quarter 2004 licensing revenue to
increase by 25%.
All of these forward-looking statements exclude the impact of any future
acquisitions or additional stock repurchases. The foregoing 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.
32
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 August 5, 2004, the Company
had $101.5 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.
2004 vs. 2003
- -------------
Cash and Debt Balances. We ended the first half of 2004 with $271.6 million in
- ------------------------
cash and marketable securities, compared to $122.4 million at July 5, 2003 and
$343.9 million at January 3, 2004, and with $462.9 million of debt outstanding
compared to $433.9 million at July 5, 2003 and $459.2 million at January 3,
2004. The $120.2 million decrease in our net debt position on a year-over-year
basis is primarily attributable to cash flow from operations for the trailing
twelve months of $464.3 million partially offset by $116.8 million in share
repurchases, the $126.7 million payment made to acquire ENYCE and the effect of
foreign currency translation on our Eurobond, which added $27.8 million to our
debt balance. The increase in our net debt position from year-end of $76.0
million was attributable to timing of cash flows from operations, partially
offset by $116.8 million in share repurchases. We ended the half with $1.629
billion in stockholders' equity, giving us a total debt to total capital ratio
of 22.1% compared to $1.413 billion in stockholders' equity last year with a
debt to total capital ratio of 23.5% and $1.578 billion in stockholders' equity
at year end with a debt to total ratio of 22.5%. As of the end of the second
quarter, we had approximately $101.5 million remaining on our share repurchase
authorization.
Accounts Receivable increased $28.9 million, or 6.8%, at July 3, 2004 compared
- --------------------
to the end of first half 2003, primarily due to $13.5 million from our recently
acquired ENYCE business and the impact of foreign currency exchange rates of
$6.4 million, primarily related to the strengthening of the euro. Declines in
our some of our domestic wholesale businesses were partially offset by timing
differences of shipments during the half. Days' sales outstanding increased to
49.4 from 48.0 on a year over year basis. Accounts receivable increased $61.8
million, or 15.8%, at July 3, 2004 compared to January 3, 2004 due primarily to
volume increases and the timing of shipments in our domestic operations.
Inventories increased $9.7 million, or 1.8% at the end of first half 2004
- -----------
compared to the end of first half 2003, and increased $56.2 million, or 11.6% at
July 3, 2004 compared to January 3, 2004. The acquisitions of ENYCE as well as
other new business initiatives were responsible for $20.6 million of the
increase in inventory over July 5, 2003. Inventories in our comparable domestic
businesses declined by $58.5 million, while our international inventories grew
by $47.6 million, primarily due to an additional $35.0 million reflecting a
shift in timing of our new season and in-transit product and growth in our
international retail business. Approximately $10.4 million of the international
increase is related to the impact of currency exchange rates, primarily relating
to the strengthening of the euro. The increase of $56.2 million compared to
January 3, 2004 is primarily due to a shift in timing of our current season and
in-transit inventories within our domestic wholesale apparel businesses. Our
average inventory turnover rate decreased slightly to 4.5 times for the
twelve-month period ended July 3, 2004 as compared to 4.8 times for the
twelve-month period ended July 5, 2003 and 4.7 times for the twelve-month period
ended January 3, 2004,
33
reflecting an increased proportion of retail business in our mix. We continue to
take a conservative approach to inventory management in 2004.
Borrowings under our revolving credit facility and other credit facilities
- ----------
peaked at $48 million during the first half of 2004; at the end of the first
half of 2004, our borrowings under these facilities were $31.8 million.
Net cash provided by operating activities was $62.0 million in the first half of
- -----------------------------------------
2004, compared to $10.2 million used in operating activities in the first half
of 2003. This $72.2 million increase in cash flow was primarily due to a $121.5
million use of cash for working capital in 2004 compared to a $190.8 million use
of cash for working capital in 2003, driven primarily by year-over-year changes
in the accrued expenses due to payment of certain employment related obligations
in 2003 and in accounts payable due to timing of payments for inventory
purchases, partially offset by year-over-year changes in the accounts receivable
balances as described above.
Net cash used in investing activities was $70.9 million in the first half of
- ---------------------------------------
2004, compared to $143.0 million in 2003. Net cash used in the first half of
2004 primarily reflected $63.0 million for capital and in-store expenditures.
Net cash used in the first half of 2003 primarily reflected $95.8 million for
the additional payments made in connection with the acquisitions of JUICY
COUTURE, LUCKY BRAND DUNGAREES and MEXX Canada and $48.2 million in capital and
in-store expenditures.
Net cash used in financing activities was $88.8 million in the first half of
- ---------------------------------------
2004, compared to $21.4 million provided in the first half of 2003. The $110.2
million year-over-year decrease primarily reflected the purchase of common
stock.
Commitments and Capital Expenditures
- ------------------------------------
We may be required to make additional payments in 2004, 2005 and 2006 in
connection with our acquisitions of the LUCKY BRAND DUNGAREES, Segrets, MEXX
Canada and JUICY COUTURE businesses (see Note 2 of Notes to Condensed
Consolidated Financial Statements). These payments become due when triggered by
us or the seller, pursuant to provisions in the MEXX Canada and JUICY COUTURE
acquisition agreements that call for contingent purchase price payments, as well
as provisions contained in the LUCKY BRAND DUNGAREES and Segrets acquisition
agreements which could require us to purchase the minority interest shares in
these businesses.
We estimate that if the eligible payments for LUCKY BRAND DUNGAREES and Segrets
are triggered in 2004, they would fall in the range of $32 - 45 million and $2 -
4 million, respectively. These payments will be made in either cash or shares of
our common stock at the option of either the Company or the seller.
We estimate that, if the 2004 measurement year is selected, the MEXX Canada
contingent payment in 2005 would be in the range of 38 - 42 million Canadian
dollars (or $29 - 32 million based on the exchange rate in effect at July 3,
2004). This payment will be made in cash.
We estimate that, if the 2005 measurement year is selected, the JUICY COUTURE
contingent payment in 2006 would be in the range of $85 - 90 million. This
payment will be made in either cash or shares of our common stock at the option
of the Company.
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.
We note that with respect to the MEXX payment, the MEXX sellers have selected
the 2003 measurement year for the calculation of the contingent payment
triggered under the process provided for in the MEXX acquisition agreement.
Payment is expected to be made in cash in mid-August 2004. The contingent
payment will be approximately $192 million (160 million euro).
Our anticipated capital expenditures for 2004 are expected to approximate $125 -
130 million. These expenditures will consist primarily of the continued
technological upgrading and expansion of our management information systems and
distribution facilities (including certain building and equipment expenditures)
and the opening of retail stores and in-store merchandise shops. Capital
expenditures and working capital cash needs will be financed with net cash
provided by operating activities and our revolving credit and other credit
facilities.
34
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 in 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.
On October 21, 2002, we entered into a $750 million credit agreement (the
"Agreement") consisting of a $375 million, 364-day unsecured financing
commitment under a bank revolving credit facility, replacing a $500 million,
364-day unsecured credit facility scheduled to mature in November 2002, and a
$375 million, three-year bank revolving credit facility, replacing an existing
$250 million bank revolving credit facility which was scheduled to mature in
November 2003. 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. The three-year facility includes a $75 million multi-currency
revolving credit line, which permits us to borrow in U.S. dollars, Canadian
dollars and euro. Repayment of outstanding balances of the 364-day facility can
be extended for one year after the maturity date. 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 Agreement
may be directly drawn upon, or used, to support our $750 million commercial
paper program, which is used from time to time to fund working capital and other
general corporate requirements. Our 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 3, 2004, we had no
borrowings outstanding under the Agreement.
As of July 3, 2004, January 3, 2004 and July 5, 2003, we had lines of credit
aggregating $543 million, $487 million and $466 million, respectively, which
were primarily available to cover trade letters of credit. At July 3, 2004,
January 3, 2004 and July 5, 2003, we had outstanding trade letters of credit of
$360 million, $254 million and $328 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 $112.6 million (based on the exchange rates as of July 3, 2004),
which is included in the aforementioned $543 million available lines of credit.
As of July 3, 2004, a total of $31.8 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 2004 and 2005. These lines are guaranteed by
the Company. With the exception of the Eurobonds, which mature in 2006,
substantially all of our debt will mature in less than one year and will be
refinanced under existing credit lines.
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, which 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 $54 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 the Company or any of its employees, directors or affiliates,
and the Company's 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 Condensed Consolidated
Statements of Income.
35
In December 2003, the 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.
Hedging Activities
- ------------------
At July 3, 2004, we had forward contracts maturing through May 2005 to sell 66
million euro for $76 million, 3.5 million Pounds Sterling for 5.2 million euro
and 1 million Canadian dollars for $760,000. The notional value of the foreign
exchange forward contracts at the end of the second quarter of 2004 was
approximately $83 million, as compared with approximately $76 million at
year-end 2003 and approximately $30 million at the end of the second quarter of
2003. At the end of the second quarter of 2004, we had no euro currency collars
outstanding as compared to $42 million in euro currency collars at year-end 2003
and $48 million in euro currency collars at the end of the second quarter of
2003. Unrealized losses for outstanding foreign exchange forward contracts were
approximately $4.5 million at the end of the second quarter of 2004, $11.8
million at year-end 2003 and approximately $8.9 million at the end of the second
quarter of 2003. The ineffective portion of these contracts was approximately
$700,000 and was expensed in 2004.
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 this arrangement to provide protection
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 half ended July 3, 2004.
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 half ended July 3, 2004.
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 the Company, including the
use of estimates, are presented in the Notes to Consolidated Financial
Statements in our 2003 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
36
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. 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 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
Condensed 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.
37
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 determined based on historical sales trends for
the category of inventory involved, 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 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 12 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 July 3, 2004, there were no adjustments to the carrying values of any
long-lived assets resulting from these evaluations.
38
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 floating interest
rate debt for fixed rate debt in connection with the synthetic lease as well as
the swapping of 175 million euro of fixed rate debt to floating rate debt in
connection with our 350 million Eurobonds. These instruments are designated as
cash flow and fair value hedges and, in accordance with SFAS No. 133, to the
extent the hedges are highly effective, 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 portions of the cash flow and fair value hedges, if any, are
recognized in current-period earnings. 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. Under SFAS No. 133, changes in the
fair value of these instruments are immediately recognized in foreign currency
translation, a component of Accumulated Other Comprehensive Income (Loss), to
offset the change in the value of the net investment being hedged.
Occasionally, we purchase short-term foreign currency contracts and options to
hedge 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 recognized in current period
earnings. No gains or losses were incurred during the quarter.
RECENT ACCOUNTING PRONOUNCEMENTS
- --------------------------------
In March 2004, the FASB published an Exposure Draft, "Share-Based Payment," an
amendment of FASB Statements No. 123 and 95. Under this FASB proposal, all forms
of share-based payment to employees, including employee stock options, would be
treated as compensation and recognized in the income statement. This proposed
statement would be effective for fiscal years beginning after December 15, 2004.
The Company currently accounts for stock options under APB No. 25. The pro-forma
impact of expensing options is disclosed in Note 1 of Notes to Condensed
Consolidated Financial Statements.
In December 2003, the 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
39
identify variable interest entities and the criteria that requires the
consolidation of such entities. This statement did not have an impact on the
Company's Condensed Consolidated Financial Statements.
In March 2004, the Emerging Issues Task Force ("EITF") reached a consensus on
recognition and measurement guidance previously discussed under EITF 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 115, "Accounting for Certain Investments in Debt and
Equity Securities," and investments accounted for under the cost method or the
equity method. The recognition and measurement guidance for which the consensus
was reached is to be applied to other-than-temporary impairment evaluations in
reporting periods beginning after June 15, 2004. The implementation of this EITF
consensus in the third quarter of 2004 is not expected to have a material impact
on our results of operations or financial condition.
STATEMENT REGARDING FORWARD-LOOKING DISCLOSURE
- ----------------------------------------------
Statements contained herein and in future filings by the Company with the
Securities and Exchange Commission (the "S.E.C."), 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 2004, any fiscal quarter of 2004 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 current 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 financial condition of, and consolidations, restructurings and other
ownership changes in, the apparel (and related products) industry and the
retail industry;
o Risks associated with the Company's dependence on sales to a limited number
of large department store customers, including risks related to customer
requirements for vendor margin support, and those related to extending
credit to customers, risks relating to retailers' buying patterns and
purchase commitments for apparel products in general and the Company's
products specifically;
o The Company's ability to respond to the strategic and operational
initiatives of its largest customers, as well as to the introduction of new
products or pricing changes by its competitors; and
o The Company's ability to obtain sufficient retail floor space and to
effectively present products at retail.
40
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;
o Any significant disruption in the Company's relationships with its
suppliers, manufacturers and employees, including its union employees;
o Work stoppages by any Company suppliers or service providers or by the
Company's union employees;
o The impact of the anticipated elimination of quota for apparel products in
2005;
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:
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;
o Certain new businesses may be lower margin businesses and may require the
Company to achieve significant cost efficiencies. In addition, these
businesses may involve buyers, store customers and/or competitors different
from the Company's historical buyers, 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; 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.
41
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 July 3,
2004, January 3, 2004 and July 5, 2003 our exposure to changing market rates was
as follows:
Dollars in millions July 3, 2004 January 3, 2004 July 5, 2003
- --------------------------------------------------------------------------------
Floating rate debt $31.8 $18.9 $33.8
Average interest rate 2.8% 2.8% 2.1%
Notional amount of interest rate $215.0 -- --
swap
Current implied interest rate 5.707% -- --
A ten percent change in the average rate would have resulted in a $0.6 million
change in interest expense during the first half of 2004.
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.
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 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 July 3, 2004, we had forward contracts maturing through May 2005 to sell 66
million euro for $76 million, 3.5 million Pounds Sterling for 5.2 million euro
and 1 million Canadian dollars for $760,000. The notional value of the foreign
exchange forward contracts at the end of the second quarter of 2004 was
approximately $83 million, as compared with approximately $76 million at
year-end 2003 and approximately $30 million at the end of the second quarter of
2003. At the end of the second quarter of 2004, we had no euro currency collars
outstanding as compared to $42 million in euro currency collars at year-end 2003
and $48 million in euro currency collars at the end of the second quarter of
2003. Unrealized losses for outstanding foreign exchange forward contracts were
approximately $4.5 million at the end of the second quarter of 2004, $11.8
million at year-end 2003 and approximately $8.9 million at the end of the second
quarter of 2003. The ineffective portion of these contracts was approximately
$700,000 and was expensed in 2004.
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:
Euro $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)
42
The table below presents the amount of contracts outstanding, the contract rate
and unrealized gain or (loss), as of January 3, 2004:
U.S. Dollar Contract Unrealized
Currency in thousands Amount Rate Gain (Loss)
- ------------------------------------------------------------------------------------------------------------------
Forward Contracts:
Euro $64,000 1.0670 to 1.1450 $(6,715)
Canadian Dollars 12,066 0.7254 to 0.7622 (298)
Foreign Exchange Collar Contracts:
Euro $42,000 1.0500 to 1.1400 $(4,793)
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 3, 2004, 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 half of
fiscal 2004 that has materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting.
43
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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
material adverse effect on the Company's results of operations or financial
position. Please refer to Note 10 and Note 24 of Notes to Consolidated Financial
Statements in our 2003 Annual Report on Form 10-K.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
The following table summarizes information about purchases by the Company during
the six months ended July 3, 2004 of equity securities that are registered by
the Company pursuant to Section 12 of the Exchange Act:
(d) Maximum
(a) Total (c) Total Number of Approximate Dollar
Number of Shares Purchased as Value of Shares that May
Shares (b) Average Part of Publicly Yet Be Purchased Under
Purchased Price Paid Per Announced Plans or the Plans or Programs
Period (in thousands) Share Programs (in thousands) (2)
- ------------------------------------------------------------------------------------------------------------------------
January 4, 2004 - January 31, 2004 5.7 (1) $ 34.97 -- $ 218,334
February 1, 2004 - March 6, 2004 -- -- -- $ 218,334
March 7, 2004 - April 3, 2004 67.1 (1) $ 36.48 -- $ 218,334
April 4, 2004 - May 1, 2004 -- -- -- $ 218,334
May 2, 2004 - June 5, 2004 1,963.8 $ 33.78 1,963,800 $ 151,995
June 6, 2004 - July 3, 2004 1,447.7 $ 34.87 1,447,700 $ 101,516
---------- -----------
Total six months 3,484.3 $ 34.29 3,411,500
(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. Excludes the
forfeiture of an aggregate of 5,000 restricted shares.
(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 July 3, 2004, the Company had $101.5 million
remaining in buyback authorization under its program.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Company's 2004 Annual Meeting of Stockholders held on May 20, 2004, the
stockholders of the Company (i) approved the ratification of the appointment of
Deloitte & Touche LLP as the Company's independent auditors for fiscal 2004 (the
number of affirmative votes cast was 95,090,644, the number of negative votes
cast was 5,251,933 and the number of abstentions was 830,080); and (ii) elected
the following nominees to the Company's Board of Directors, to serve until the
2007 annual meeting of stockholders and until their respective successors are
duly elected and qualified.
Votes
Nominee For Withheld
- -------------------------------------------------------------------------------
Raul J. Fernandez 96,118,290 5,058,357
Mary Kay Haben 100,423,100 753,557
Kenneth P. Kopelman 95,676,887 5,499,770
Arthur C. Martinez 98,450,861 2,725,796
44
ITEM 5. OTHER INFORMATION
During the quarterly period covered by this filing, the Audit Committee of the
Company's Board of Directors approved the engagement of the Company's external
auditors to perform certain audit related and tax planning services.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) 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.
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.
(b) Current Reports on Form 8-K.
A Current Report on Form 8-K was filed with the S.E.C. on April 29, 2004 by
the Company relating to the results of operations for the three-month
period ended April 3, 2004.
A Current Report on Form 8-K was filed with the S.E.C. on May 20, 2004 by
the Company relating to the stockholder approval of the Company's nominees
to the Board of Directors and ratification of the appointment of Deloitte &
Touche LLP as the Company's independent auditors for the 2004 fiscal year.
A Current Report on Form 8-K was filed with the S.E.C. on July 29, 2004 by
the Company relating to the results of operations for the three and
six-month periods ended July 3, 2004.
* 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.
45
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: August 9, 2004
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)