Item 1. Business.
OVERVIEW AND NARRATIVE DESCRIPTION OF BUSINESS
General
Liz Claiborne, Inc. designs and markets a global portfolio of retail-based premium brands including KATE SPADE, JUICY COUTURE, LUCKY BRAND JEANS and MEXX. We also have a group of department store-based brands with strong consumer franchises including the LIZ CLAIBORNE and MONET families of brands, ENYCE and the licensed DKNY® JEANS and DKNY® ACTIVE brands. The Company also offers cosmetics and fragrances.
In 2007, we performed a review of our operations to assess options to best evolve our strategy on a sustainable, go-forward basis. The strategic realignment outlined below reflects a brand-centric approach, designed to optimize the operational coordination and resource allocation of our businesses across multiple functional areas including specialty retail, outlet, wholesale apparel, wholesale non-apparel, e-commerce and licensing.
As such, we have configured our operations into the following two reportable segments, each reflecting the different financial missions, cultural profiles and focal points appropriate for these two reportable segments:
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Direct Brands, which is comprised of the specialty retail, outlet, wholesale apparel, wholesale non-apparel (including accessories, jewelry, handbags and fragrances), e-commerce and licensing operations of our four retail-based brands: JUICY COUTURE, KATE SPADE, LUCKY BRAND and MEXX.
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Partnered Brands, which is comprised of the wholesale apparel, wholesale non-apparel, outlet and specialty retail, e-commerce and licensing operations of our wholesale-based brands including: AXCESS, CLAIBORNE (men’s), CONCEPTS BY CLAIBORNE, DANA BUCHMAN, ENYCE, KENSIE, LIZ & CO., LIZ CLAIBORNE, MAC & JAC, MARVELLA, MONET, NARCISO RODRIGUEZ, TRIFARI, VILLAGER, the Company’s licensed DKNY® JEANS and DKNY® ACTIVE brands, as well as the Company’s other non-Direct Brands fragrances including: CLAIBORNE, CURVE, LIZ CLAIBORNE and our licensed USHER fragrance.
With this new structure in place, in mid-2007 we began implementing the following strategic imperatives:
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Implementing and maintaining a more competitive cost structure. We have accelerated our structural realignment and other initiatives to achieve cost savings targets through staff reductions, closing and consolidations of distribution facilities and office space, discretionary expense cuts, process re-engineering and supply chain rationalization.
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Developing best-in-class retail capabilities and innovating in our supply chain. We are committed to accelerating the flow of goods in both the retail and wholesale formats, providing “fashion faster” in each.
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Narrowing our portfolio to a select group of brands. As such, we have conducted a strategic review of alternatives for 16 brands with the following outcome as of February 15, 2008:
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On October 4, 2007, we completed the sale of our EMMA JAMES, INTUITIONS, J.H. COLLECTIBLES and TAPEMEASURE brands. We also announced the consolidation of our TINT brand into LIZ & CO., STAMP 10 brand into AXCESS and the closure of our FIRST ISSUE brand.
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On January 8, 2008, we announced the sale of our C & C CALIFORNIA and LAUNDRY BY DESIGN brands in a single transaction (completed February 4, 2008), as well as the closure of SIGRID OLSEN and retention of the ENYCE brand. We expect to complete the closure of our SIGRID OLSEN brand in the first half of 2008.
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On January 17, 2008, we announced that we entered into an exclusive license agreement with Kohl’s Corporation (“Kohl’s”) naming Kohl’s as the exclusive retailer of our DANA BUCHMAN brand, under which we will design the product and Kohl’s will lead manufacturing, production, distribution and marketing. As a result, we expect to close our current DANA BUCHMAN operations in the first half of 2008 and that the launch of the DANA BUCHMAN line in Kohl’s stores will occur no later than the first quarter of 2009.
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On February 1, 2008, we announced that we had entered an agreement to sell substantially all of the assets and liabilities of our prAna brand to a group consisting of the prAna founders and Steelpoint Capital Partners. We expect the sale to close by the end of the first quarter of 2008.
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On February 14, 2008, we announced that we had entered into an agreement to sell substantially all of the assets and liabilities of our ELLEN TRACY brand to a group of investors, including Radius Partners, LLC. We expect the sale to close in the second quarter of 2008.
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The remaining brands under review are KENSIE and MAC & JAC. We expect the review of these brands to be completed by the end of the first quarter of 2008.
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Committing the necessary resources for marketing and capital expenditures.
For a discussion of these changes, see “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations - Overview; Competitive Profile,” below.
On May 18, 2007, we acquired 50 percent ownership of the entity that owns the rights to the “Narciso Rodriguez” name and trademarks. As part of this transaction, we entered into an exclusive license to operate NARCISO RODRIGUEZ worldwide, and formed a new company to operate the license and develop the NARCISO RODRIGUEZ brand globally. For a discussion of our recent acquisitions, see Note 2 of Notes to Consolidated Financial Statements.
International sales have come to represent an increasingly larger part of our total sales. As a percentage of our total sales, international sales have grown from approximately 23% in 2003 to 32% in 2007. The growth in our international business has been the result of the growth and continued expansion of MEXX Europe and MEXX Canada, the impact of currency fluctuation, as well as the introduction of certain of our United States based brands into Europe, Canada and, to a lesser extent, Asia.
We operate in global fashion markets that are intensely competitive. Our ability to continuously evaluate and respond to changing consumer demands and tastes across multiple markets, 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 on our results of operations. Other key aspects of competition include quality, brand image, market share, distribution methods, price, size and location of our retail stores and department store selling space, customer service and intellectual property protection (see “Competition” below).
In summary, the measure of our success in the future will depend on our ability to execute on our strategic vision, including attracting and retaining the management talent necessary for such execution, designing and delivering products that are acceptable to the marketplaces that we serve, sourcing the manufacture of our products on a competitive and efficient basis, and evolving our retail capabilities. For a discussion of certain risks relating to our business, see “Item 1A
Item 1A. Risk Factors.
The following risk factors should be read carefully in connection with evaluating our business and the forward-looking statements contained in this Annual Report on Form 10-K or in any other written or oral communication made by or with the approval of any of our authorized personnel. Any of the following risks could materially adversely affect us, our business, our operating results, our financial condition and the actual outcome of matters as to which forward-looking statements are made in this Report.
Risks Related to Our Business and Our Long-Term Growth Strategy
We cannot assure the successful implementation and results of the long-term strategic plan that we announced in July 2007.
Our ability to execute our long-term growth plan and achieve our projected results is subject to a variety of risks, including the following:
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In June 2007, we announced that we reorganized our Company into five operating segments that aggregate into two reportable segments, Direct Brands and Partnered Brands, and realigned our management structure around this new organization. There can be no assurances that such restructuring and realignment will improve our operations or our results.
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As part of our strategic plan, we designated 16 brands for strategic review, which included possible sale, licensing or closure. There can be no assurances that we appropriately identified the appropriate brands for strategic review or that we appropriately valued the assets which we have sold or licensed to third parties. Moreover, we have not closed the previously announced sales of our prAna and ELLEN TRACY brands, and such closings are subject to a variety of closing conditions; accordingly, there can be no assurances that those transactions will in fact close.
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Our strategic plan involves a significant expansion of our specialty retail business. The successful operation and expansion of our specialty retail business in our Direct Brands segment is subject to, among other things, our ability to successfully expand the specialty store base of our Direct Brands segment, our ability to successfully find appropriate sites, negotiate favorable leases, design and create appealing merchandise, appropriately manage inventory levels, install and operate effective retail systems, apply appropriate pricing strategies and integrate such stores into our overall business mix. There can be no assurances that we can be successful in this regard, and our inability to successfully expand our specialty retail business would have a material adverse effect on our results.
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We have announced a number of initiatives designed to achieve greater collaboration with our wholesale customers and to improve results of the Company’s wholesale-based Partnered Brands. These initiatives include design agreements with Isaac Mizrahi with respect to our LIZ CLAIBORNE brand and John Bartlett with respect to our CLAIBORNE (men’s) brand. Our wholesale customers have been seeking differentiated product and we believe that these design agreements will enable us to distinguish our product offering. However, there can be no assurances that these arrangements will result in improved product or that the resulting products will be acceptable to our wholesale customers or consumers.
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The successful implementation of our strategic plan will require us to evolve our supply chain system, including our product development, sourcing, logistics and technology functions, to reduce product cycle-time and costs and meet customer demands and the requirements of the projected growth of our retail-based Direct Brands segment. There can be no assurances that we can be successful in these efforts and our failure to evolve our supply chain capabilities and reduce costs in this area will have a material adverse impact on our business and results.
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We previously announced that our structural realignment and other initiatives would yield substantial cost savings, and that we expected such savings would drive operating margin expansion beginning in 2008. There can be no assurances that we can successfully implement the anticipated cost savings as announced on June 20, 2007.
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Our strategic plan focuses on building strong brands through increased marketing spending. Our ability to fund such efforts is critical to the success of our strategy. Our inability to fund marketing initiatives appropriate to support our strategic plan will have a material adverse impact on our ability to achieve the growth we project in our Direct Brands segment.
We cannot assure that we can attract and retain talented highly qualified executives, or maintain satisfactory relationships with our employees, both union and non-union.
Our success depends, to a significant extent, both upon the continued services of these individuals, as well as our ability to attract, hire, motivate and retain additional talented and highly qualified management in the future, including in the areas of design, merchandising, sales, supply chain, marketing, production and systems, as well as our ability to hire and train qualified retail management and associates. In addition, we will need to provide for the succession of senior management. The loss of key members of management and our failure to successfully plan for succession could disrupt our operations and our ability to successfully operate our business and execute our strategic plan.
At the 2007 fiscal year end, we had approximately 16,500 full-time employees worldwide. We are bound by a variety of collective bargaining agreements with two unions, covering approximately 1,480 employees, mostly in our warehouse and distribution facilities. We consider our relations with our non-union and union employees to be satisfactory and to date we have not experienced any interruption of our operations due to labor disputes. While our relations with the unions have historically been amicable, the Company cannot rule out the possibility of a labor dispute at one or more of its facilities, particularly in light of facility closings. Any such dispute could have a material adverse impact on our business.
The success of our business depends on our ability to respond to constantly changing consumer demands and tastes and fashion trends, across multiple product lines, shopping channels and geographies.
The apparel and accessories industries have historically been subject to rapidly changing consumer demands and tastes and fashion trends. We believe that our success is largely dependent on our ability to effectively anticipate, gauge and respond to changing consumer demands and taste, across multiple product lines, shopping channels and geographies, in the design, pricing, styling and production of our products and in the merchandising and pricing of products in our retail stores. Our products must appeal to a broad range of consumers whose preferences cannot be predicted with certainty and are subject to constant change. Also, we must maintain and enhance favorable brand recognition, which may be affected by consumer attitudes towards the desirability of fashion products bearing a “mega brand” label and which are widely available at a broad range of retail stores.
We attempt to schedule a substantial portion of our materials and manufacturing commitments relatively late in the production cycle; however, in order to secure necessary materials and manufacturing facilities, we must make substantial advance commitments, often as much as five months prior to the receipt of firm orders from customers for the items to be produced. We need to translate market trends into appropriate, saleable product offerings relatively far in advance, while minimizing excess inventory positions, and correctly balance the level of our fabric and/or merchandise commitments with actual customer orders. We cannot assure that we will be able to continue to develop appealing styles and brands or successfully meet changing customer and consumer demands in the future. In addition, we cannot assure any new products or brands that we introduce will be successfully received and supported by our wholesale customers or consumers. Our failure to gauge consumer needs and fashion trends and respond appropriately, and to appropriately forecast our ability to sell products, could adversely affect retail and consumer acceptance of our products and leave us with substantial outstanding fabric and/or manufacturing commitments, resulting in increases in unsold inventory or missed opportunities. If that occurs, we may need to employ markdowns or promotional sales to dispose of excess inventory, which may harm our business and results. At the same time, our focus on inventory management may result, from time to time, in our not having a sufficient supply of products to meet demand and cause us to lose potential sales.
Our business could suffer if we cannot adequately establish, defend and protect our trademarks and other proprietary rights.
We believe that our trademarks and other proprietary rights are significantly important to our success and competitive position. Accordingly, we devote substantial resources to the establishment and protection of our trademarks and anti-counterfeiting activities on a worldwide basis. Counterfeiting of our products, particularly our JUICY COUTURE, LUCKY BRAND and KATE SPADE brands, continues, however, and in the course of our international expansion we have experienced conflicts with various third parties that have acquired or claimed ownership rights in some of our trademarks or otherwise have contested our rights to our trademarks. We have, in the past, resolved certain of these conflicts through both legal action and negotiated settlements, none of which, we believe, has had a material impact on our financial condition and results of operations. There can be no assurances that the actions taken to establish and protect our trademarks and other proprietary rights will be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products as a violation of their trademarks and proprietary rights. Moreover, there can be no assurances that in certain countries others will not assert rights in, or ownership of, our trademarks and
other proprietary rights or that we will be able to successfully resolve such conflicts. In addition, the laws of certain foreign countries may not protect proprietary rights to the same extent as do the laws of the United States. The loss of such trademarks and other proprietary rights, or the loss of the exclusive use of such trademarks and other proprietary rights, could have a material adverse effect on us. Any litigation regarding our trademarks or other proprietary rights could be time consuming and costly.
Our success will depend on our ability to successfully develop or acquire new product lines or enter new markets or product categories.
We have in the past, and may, from time to time, acquire or develop new product lines and/or enter new markets or product categories, including through licensing arrangements. This would include our acquisition of KATE SPADE in 2006, our agreement with NARCISO RODRIGUEZ, the license of our DANA BUCHMAN brand to Kohl’s and the sale of our LIZ & CO. and CONCEPTS BY CLAIBORNE brands outside of better department stores. These activities are accompanied by a variety of risks inherent in any such new business venture, including the following:
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Our ability to identify appropriate business development opportunities, including new product lines and markets.
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New businesses, product lines or market activities may require methods of operations, investments and marketing and financial strategies different from those employed in our other businesses, and may also involve buyers, store customers and/or competitors different from our historical buyers, store customers and competitors.
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We may not be able to generate projected or satisfactory level of sales, profits and/or return on investment for a new business or product line, and may also encounter unanticipated events and unknown or uncertain liabilities that could materially impact our business.
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We may experience possible difficulties, delays and/or unanticipated costs in integrating the business, operations, personnel and/or systems of an acquired business and may also not be able to retain and appropriately motivate key personnel of an acquired business.
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We may not be able to maintain product licenses, which are subject to agreement with a variety of terms and conditions, or to enter into new licenses to enable us to launch new products and lines.
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With respect to a business where we act as licensee, such as our licensed DKNY JEANS® and DKNY ACTIVE® brands and our NARCISO RODRIGUEZ brand, there are a number of inherent risks, including, without limitation, 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 our control.
Our ability to continue to have the liquidity necessary, through cash flow from operations and financing, may be adversely impacted by a number of factors, including the downgrading of our credit rating.
Our primary ongoing cash requirements are to fund growth in working capital (primarily accounts receivable and inventory), to invest in our supply chain and information systems, to fund investment in marketing and capital expenditures, and to fund our anticipated retail store expansion, as well as expenditures for in-store merchandise shops and normal maintenance activities. We also require cash to fund potential acquisitions and payments related to earn-out provisions of existing acquisition agreements. In addition, we will require cash to fund any repurchase of Company stock under our previously announced share repurchase programs. 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).
We anticipate that cash flows from operations, our commercial paper program and bank and letter of credit facilities will be sufficient to fund our liquidity requirements for the next twelve months and that we will be able to adjust the amounts available under these facilities if necessary. Such sufficiency and availability may be adversely affected by a variety of factors, including, without limitation, our ability to execute our strategy, retailer and consumer acceptance of our products, which may impact our financial performance, maintenance of our investment-grade credit rating, maintenance of financial covenants (as amended) of our debt and credit facilities, as well as interest rate and exchange rate fluctuations. We can not be certain that any additional required financing, whether debt or equity, will be available in amounts needed or on terms acceptable to us, if at all.
On August 8, 2007 and September 10, 2007 Moody’s and Standard & Poor’s (“S&P”), respectively, completed a review of our credit rating. Moody’s lowered the senior unsecured debt rating to Baa3 from Baa2 and the commercial paper rating to Prime-3 from Prime-2. S&P affirmed our BBB unsecured debt rating and lowered the commercial paper rating to A-3 from A-2. On February 15, 2008, Moody’s placed our Baa3 senior unsecured and Prime-3 commercial paper ratings under review for possible downgrade. There can be no assurance that we will not be further downgraded by either Moody’s or S&P, and any such additional downgrade could adversely impact our ability to obtain financing in amounts needed or on terms acceptable to us, if at all.
Risks Associated With Competition and the Marketplace
The markets in which we operate are highly competitive, both within the United States and abroad.
We face intense competitive challenges from other domestic and foreign fashion apparel and accessories producers and retailers. Competition is based on a number of factors, including the following:
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Anticipating and responding to changing consumer demands in a timely manner;
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Establishing and maintaining favorable brand name and recognition;
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Product quality;
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Maintaining and growing market share;
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Developing quality and differentiated products that appeal to consumers;
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Establishing and maintaining acceptable relationships with our retail customers;
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Pricing products appropriately;
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Providing appropriate service and support to retailers;
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Optimizing our retail and supply chain capabilities;
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Size and location of our retail stores and department store selling space; and
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Protecting intellectual property.
Any increased competition, or our failure to adequately address these competitive factors, could result in reduced sales or prices, or both, which could have a material adverse effect on us. We also believe there is an increasing focus by the department stores to concentrate an increasing portion of their product assortments within their own private label products. These private label lines compete directly with our product lines and may receive prominent positioning on the retail floor by department stores.
Our wholesale business is largely dependent on sales to a limited number of large U. S. department store customers, and our business could suffer as a result of consolidations, restructurings and other ownership changes in the retail industry.
Our 100 largest customers from both our Direct and Partnered Brands segments accounted for approximately 82% of 2007 wholesale sales (before allowances) from continuing operations (or 67% of net sales from continuing operations).
See “Item 1 - Business-Sales and Marketing.” Many major department store groups make centralized buying decisions; accordingly, any material change in our relationship with any such group could have a material adverse effect on our operations. We expect that our largest customers will continue to account for a significant percentage of our sales.
Our dependence on sales to a limited number of large U.S. department store customers is subject to our ability to respond effectively to, among other things, (i) these customers’ buying patterns, including their purchase and retail floor space commitments for apparel in general (compared with other product categories they sell) and our products specifically (compared with products offered by our competitors, including with respect to customer and consumer acceptance, pricing and new product introductions); (ii) these customers’ strategic and operational initiatives, including their continued focus on further development of their “private label” initiatives; (iii) these customers’ desire to have the Company provide them with exclusive and/or differentiated designs and product mixes; (iv) these customers’ requirements for vendor margin support; (v) any credit risks presented by these customers, especially given the significant proportion of the Company’s accounts receivable they represent; and (vi) the effect of any potential consolidation among one or more of these larger customers, such as the merger between Macy’s Inc. and The May Department Store Company.
We do not enter into long-term agreements with any of our customers. Instead, we enter into a number of purchase order commitments with our customers for each of our lines every season. A decision by the controlling owner of a group of stores or any other significant customer, whether motivated by competitive conditions, financial difficulties or otherwise, to decrease or eliminate the amount of merchandise purchased from us or to change their manner of doing business with us could have a material adverse effect on our business or financial condition.
We sell our wholesale merchandise primarily to major department stores across the U.S. and Europe and extend credit based on an evaluation of each customer’s financial condition, usually without requiring collateral. However, the financial difficulties of a customer could cause us to curtail or eliminate business with that customer. We may also assume more credit risk relating to our receivables from that customer. Our inability to collect on our trade accounts receivable from any of our largest customers could have a material adverse effect on our business or financial condition.
Our reliance on independent manufacturers could cause delay and loss and damage our reputation and customer relationships.
We do not own any product manufacturing facilities; all of our products are manufactured in accordance with our specifications through arrangements with independent suppliers. Products produced in Asia represent a substantial majority of our sales. We also source product in the United States and other regions. During 2007, several hundred suppliers, located in approximately 46 countries, manufactured our products, with the largest finished goods supplier accounting for approximately 4% of the total of finished goods we purchased. A supplier’s failure to manufacture and deliver products to us in a timely manner or to meet our quality standards could cause us to miss the delivery date requirements of our customers for those items. The failure to make timely deliveries may drive customers to cancel orders, refuse to accept deliveries or demand reduced prices, any of which could have a material adverse effect on us and our reputation in the marketplace. Also, a manufacturer’s failure to comply with safety and content regulations and standards, including with respect to children’s product and fashion jewelry, could result in substantial liability and damage to our reputation. While we provide our manufacturers with standards and we employ independent testing for safety and content issues, there can be no assurances that we will be able to prevent or detect all failures of our manufacturers to comply with such standards and regulations.
We require our independent manufacturers (as well as our licensees) to operate in compliance with applicable laws and regulations. While our internal and vendor operating guidelines promote ethical business practices and our staff periodically visits and monitors the operations of our independent manufacturers, we do not control these manufacturers or their labor practices. The violation of labor or other laws by an independent manufacturer used by us (or any of our licensees), or the divergence of an independent manufacturer’s (or licensee’s) labor practices from those generally accepted as ethical in the U.S., could interrupt, or otherwise disrupt the shipment of finished products to us or damage our reputation. Any of these, in turn, could have a material adverse effect on our financial condition and results of operations.
Our arrangements with foreign suppliers are also subject generally to the risks of doing business abroad, including currency fluctuations and revaluations, restrictions on the transfer of funds, terrorist activities, pandemic disease and, in certain parts of the world, political, economic and currency instability. Our operations have not been materially affected by any such factors to date. However, due to the very substantial portion of our products that are produced abroad, any substantial disruption of our relationships with our foreign suppliers could adversely effect our operations.
Economic, Social, Political and Regulatory Risks
General economic conditions, including a downturn in the economy, may affect consumer purchases of discretionary items and fashion and retail products, which could adversely affect our sales.
The industries in which we operate have historically been subject to cyclical variations, recessions in the general economy and future economic outlook. Our results are dependent on a number of factors impacting consumer spending including but not limited to, general economic and business conditions; consumer confidence; wages and employment levels; the housing market; consumer debt levels; availability of consumer credit; credit and interest rates; fluctuations in foreign currency exchange rates; fuel and energy costs; energy shortages; the level of the stock market; taxes; general political conditions, both domestic and abroad; and the level of customer traffic within department stores, malls and other shopping and selling environments.
Consumer purchases of discretionary items, including our products, may decline during recessionary periods and at other times when disposable income is lower. A downturn or an uncertain outlook in the economies in which we sell our products may materially adversely effect our businesses and our revenues and profits. The domestic and international political situation also affects consumer confidence. The threat, outbreak or escalation of terrorism, military conflicts or other hostilities could lead to a decrease in consumer spending.
Fluctuations in the price, availability and quality of the fabrics or other raw materials used by us in our manufactured apparel and in the price of materials used to manufacture our footwear and accessories could have a material adverse effect on our cost of sales or our ability to meet our customers’ demands. The prices for such fabrics depend largely on the market prices for the raw materials used to produce them, particularly cotton, leather and synthetics. The price and availability of such raw materials may fluctuate significantly, depending on many factors, including crop yields and weather patterns. In the future, we may not be able to pass all or a portion of such higher raw materials prices on to our customers.
Our business is exposed to domestic and foreign currency fluctuations.
While we generally purchase our products in U.S. dollars, we source most of our products overseas. As a result, the cost of these products may be affected by changes in the value of the relevant currencies, including currency devaluations. Changes in currency exchange rates may also affect the U.S. dollar value of the foreign currency denominated prices at which our international businesses sell products. Furthermore, our international sales represented approximately 32% of our total sales in fiscal 2007, and such sales were derived from sales in foreign currencies, primarily the euro. Our international sales, as well as our international businesses’ inventory and accounts receivables levels, could be materially affected by currency fluctuations. Although we hedge some exposures to changes in foreign currency exchange rates arising in the ordinary course of business, we cannot assure that foreign currency fluctuations will not have a material adverse impact on our financial condition or results of operations.
Our international operations, including manufacturing, are subject to a variety of legal, regulatory, political and economic risks, including risks relating to the importation and exportation of product.
We source most of our products outside the U.S. through arrangements with independent suppliers in over 46 countries. There are a number of risks associated with importing our products, including but not limited to the following:
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Quotas imposed by bilateral textile agreements with China and non-WTO countries. These agreements limit the amount and type of goods that may be imported annually from these countries;
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Changes in social, political, legal and economic conditions or terrorist acts that could result in the disruption of trade from the countries in which our manufacturers or suppliers are located;
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The imposition of additional regulations relating to imports or exports;
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The imposition of additional duties, taxes and other charges on imports or exports;
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Risks of increased sourcing costs, including costs for materials and labor, including as a result of the elimination of quota on apparel products;
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Our ability to adapt to and compete effectively in the current quota environment, including changes in sourcing patterns resulting from the elimination of quota on apparel products, as well as lowered barriers to entry;
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Significant delays in the delivery of cargo due to security considerations;
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The imposition of antidumping or countervailing duty proceedings resulting in the potential assessment of special antidumping or countervailing duties; and
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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 (although China has agreed to safeguard quota on certain classes of apparel products through 2008 as a result of a surge in exports to the United States, political pressure will likely continue for restraint on importation of apparel).
Any one of these factors could have a material adverse effect on our financial condition, results of operations and current business practices.
Our ability to realize growth in new international markets and to maintain the current level of sales in our existing international markets is subject to risks associated with international operations. These include complying with a variety of foreign laws and regulations; unexpected changes in regulatory requirements; new tariffs or other barriers in some international markets; political instability and terrorist attacks; changes in diplomatic and trade relationships; and general economic fluctuations in specific countries or markets.
Item 1B.
Item 1B. Unresolved Staff Comments.
None.
Item 2.
Item 2. Properties.
Our distribution and administrative functions are conducted in both leased and owned facilities. We also lease space for our retail specialty, outlet and concession stores. We believe that our existing facilities are well maintained, in good operating condition and, upon occupancy of additional space, will be adequate for our present level of operations, although from time to time we use unaffiliated third parties to provide distribution services to meet our distribution requirements. See Note 11 of Notes to Consolidated Financial Statements.
Our principal executive offices and showrooms, as well as sales, merchandising and design staffs, are located at 1441 Broadway, New York, New York, where we lease approximately 305,000 square feet under a master lease which expires at the end of 2012 and contains certain renewal options and rights of first refusal for additional space. Most of our business segments use the 1441 Broadway facility. In addition, in North Bergen, New Jersey, we own and operate an approximately 300,000 square foot office complex, which houses operational staff. The following table sets forth information with respect to our other key properties:
Key Properties:
(a)
We also lease showroom, warehouse and office space in various other domestic and international locations.
(b)
This facility is on an 80-acre site, which we own.
(c)
In 2007, we completed the closure of our North Bergen, New Jersey apparel distribution center.
(d)
In 2008, we completed the closure of our Allentown, Pennsylvania distribution center.
(e)
These properties are used for our European operations.
Pursuant to financing obtained through an off-balance sheet arrangement commonly referred to as a synthetic lease, we have constructed the West Chester, Ohio and Lincoln, Rhode Island facilities. See “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations - Financial Position, Capital Resources and Liquidity” and Note 11 of Notes to Consolidated Financial Statements for a discussion of this arrangement. In 2006, we completed the sale of an approximately 290,000 square foot warehouse and distribution facility in Montgomery, Alabama. We still maintain ownership of 80 acres of land in Montgomery, Alabama, which we are seeking to sell. In the first quarter of 2007, we completed the sale of our approximately 270,000 square foot facility in Augusta, Georgia (located on a 98-acre site and previously used in connection with a dyeing and finishing joint venture). However, we retain certain obligations with respect to the site. See “Item 3.
Item 3. Legal Proceedings
The Company’s previously owned Augusta, Georgia facility became listed during 2004 on the State of Georgia’s Hazardous Site Inventory of environmentally impacted sites due to the detection of certain chemicals at the site. In November 2005, the Georgia Department of Natural Resources requested that we submit a compliance status report and compliance status certification regarding the site. The Company submitted the requested materials in the second quarter of 2006. In October 2006, the Company received a letter from the Department of Natural Resources requesting that we provide additional information and perform additional tests to complete the compliance status report, which was previously submitted. Additional testing was completed and the Company submitted
the results in the second quarter of 2007. The Georgia Department of Natural Resources has reviewed the Company’s submission and has requested certain modifications to the response and some minimal additional testing. The Company has submitted the modified response and additional testing results.
The Company is a party to several pending legal proceedings and claims. 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 financial position, results of operations, liquidity or cash flows. (See Notes 11 and 25 of Notes to Consolidated Financial Statements).
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders.
No matter was submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year covered by this report.
Executive Officers of the Registrant.
Information as to the executive officers of the Company, as of February 15, 2008, is set forth below:
Executive officers serve at the discretion of the Board of Directors.
Mr. McComb joined the Company as Chief Executive Officer and a member of the Board of Directors on November 6, 2006. Prior to joining the Company, Mr. McComb was a company group chairman at Johnson & Johnson. During his 14-year tenure with Johnson & Johnson, Mr. McComb oversaw some of the company’s largest consumer product businesses and brands, including Tylenol, Motrin and Clean & Clear. He also led the team that repositioned and restored growth to the Tylenol brand and oversaw the growth of J&J’s McNeil Consumer business with key brand licenses such as St. Joseph aspirin, where he implemented a strategy to grow the brand beyond the over-the-counter market by adding pediatric prescription drugs. Mr. McComb currently serves on the board of INROADS of Philadelphia and Technoserve, Inc., both not-for-profit organizations.
Mr. Warren joined the Company in July 2007. Prior to that, he had held numerous finance positions at General Electric over the prior 18 years, including Senior Vice President and CFO for NBC Cable from January 2002 to May 2004 and Executive Vice President and Chief Financial Officer for NBC Universal Television Group from May 2004 to May 2006. Most recently, he served as Senior Operations Leader, GE Audit Staff, from May 2006 to July 2007 where he helped lead the divestiture of GE’s Plastics division.
Mr. Scarpa joined the Company in 1983 as budget manager and served in various management positions thereafter. In 1991, Mr. Scarpa was promoted to Vice President - Divisional Controller and in 1995 he was promoted to Vice President - Financial Planning and Operations. Effective July 2000, he became Vice President - Chief Financial Officer, in July 2002 he became Senior Vice President - Chief Financial Officer, and in May 2005 he became Senior Vice President - Finance and Distribution and Chief Financial Officer. Effective January 31, 2007, Mr. Scarpa was appointed Chief Operating Officer.
Ms. Granoff joined the Company in September 2006 as Group President - Direct-to-Consumer and was promoted to Executive Vice President - Direct Brands in June 2007. Prior to joining the Company, Ms. Granoff was President and Chief Operating Officer of Victoria’s Secret Beauty (VSB), a subsidiary of Limited Brands, where she worked from April 1999 to April 2006. Prior to her role at
VSB, Ms. Granoff worked at The Estee Lauder Companies from 1990 to 1999, culminating in her role as Senior Vice President of Strategic Planning, Finance and Information Systems for Estee Lauder Inc.
Mr. McTague joined Liz Claiborne Inc. in August 2007 as Executive Vice President of Partnered Brands. Prior to joining the Company, he was President of Converse Apparel and Accessories at NIKE, Inc. from 2005 to 2007, where he was responsible for expanding the Converse brand into a global, lifestyle brand, including premium apparel and accessories for men and women. Before that, he was President of Global Apparel and Retail, Victorinox, Swiss Army Brands from 2004 to 2005, where he oversaw design, strategy, operations, production, sales, analytical planning, retail presentation and merchandising for the label. He also served as President of Tommy Hilfiger USA Menswear from 2000 to 2004.
Ms. Karp joined the Company in November 1986 as Legal Counsel and was promoted to Vice President, Corporate Counsel in 1988 and Vice President, General Counsel in 1992. Ms. Karp added Corporate Affairs to her responsibilities in 1996 and in 2000 she became Senior Vice President, Corporate Affairs and General Counsel. Ms. Karp assumed her current position as Senior Vice President, Business Development, Legal and Corporate Affairs in June 2007.
Mr. McClure joined the Company in 2000 as Senior Vice President - Human Resources. Prior to joining the Company, Mr. McClure served as Vice President, Human Resources of Dexter Corporation, a specialty materials company, from 1995.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters.
MARKET INFORMATION
Our Common Stock trades on the New York Stock Exchange (“NYSE”) under the symbol LIZ. The table below sets forth the high and low closing sale prices of the Common Stock (based on the NYSE composite tape) for the periods indicated.
RECORD HOLDERS
On February 15, 2008, the closing sale price of our Common Stock was $17.60. As of February 15, 2008, the approximate number of record holders of Common Stock was 5,212.
DIVIDENDS
We have paid regular quarterly cash dividends since May 1984. Quarterly dividends for the last two fiscal years were paid as follows:
We currently plan to continue paying quarterly cash dividends on our Common Stock. The amount of any such dividend will depend on our earnings, financial position, capital requirements and other relevant factors.
PERFORMANCE GRAPH
The line graph above compares the cumulative total stockholder return on the Company’s Common Stock over a 5-year period with the return on (i) the Standard & Poor’s 500 Stock Index (“S&P 500 Index”); (ii) an index comprised of the Company and the following 22 competitors comprising the peer group for which executive compensation practices are compared (the “LTTP Peer Group”): Abercrombie & Fitch; Ann Taylor Store Corporation; Coach, Inc.; Dillards, Inc.; The Gap, Inc.; Jones Apparel Group, Inc.; Kellwood Company (which was acquired by Sun Capital Securities Group in February 2008); Limited Brands, Inc.; Macy’s, Inc.; The May Department Stores Company (which was acquired by Federated Department Stores in August 2005); The Neiman Marcus Group, Inc. (which was acquired by Newton Acquisition Merger Sub Inc. in October 2005); NIKE, Inc.; Nordstrom, Inc; Philips Van-Heusen Corporation; Polo Ralph Lauren Corporation; Quicksilver; Russell Corporation (which was acquired by Berkshire Hathaway in August 2006); Saks Incorporated; The Talbots, Inc.; Tiffany & Co; Tommy Hilfiger Corporation (which was acquired by Apax Partners in May 2006); and VF Corporation; and (iii) an index comprised of the Company and the following 21 competitors comprising the peer group for the Growth Share program (the “G-Share Peer Group”): Ann Taylor Stores Corporation; The Gap, Inc.; Gucci Group N.V. (which was acquired by Pinault-Printemps-Redoute in May 2004); Guess, Inc.; Haggar Corp. (which was acquired by Infinity Associates in November 2005); Hartmarx Corporation; Jones Apparel Group, Inc.; Kellwood Company (which was acquired by Sun Capital Securities Group in February 2008); Limited Brands, Inc.; Oshkosh B’Gosh, Inc. (which was acquired by Carters Inc. in July 2005); Oxford Industries, Inc.; Phillips-Van Heusen Corporation; Polo Ralph Lauren Corporation; Quiksilver, Inc.; Russell Corporation (which was acquired by Berkshire Hathaway in August 2006); The Talbots, Inc.; Tarrant Apparel Group; Tommy Hilfiger Corporation (which was acquired by Apax Partners in May 2006); Tropical Sportswear Int’l Corporation (which was liquidated in February 2005); V.F. Corporation; and The Warnaco Group, Inc. Returns for companies in the G-Share Peer Group and the LTPP Peer Group that have been acquired or liquidated are reflected in the graph above through the end of the year of such acquisition.
In accordance with the SEC disclosure rules, the measurements are indexed to a value of $100 at December 28, 2002 (the last trading day before the beginning of the Company’s 2003 fiscal year) and assume that all dividends were reinvested.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table summarizes information about our purchases during the year ended December 29, 2007 of equity securities that are registered by the Company pursuant to Section 12 of the Securities Exchange Act of 1934:
(a)
Includes 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.
(b)
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 $2.275 billion. As of February 15, 2008, the Company had $28.7 million remaining in buyback authorization under its program.
(c)
On November 12, 2007, the Company’s Board of Directors authorized the Company to purchase up to an additional $100.0 million of its Common Stock for cash in open market purchases and privately negotiated transactions.
Item 6.
Item 6. Selected Financial Data.
The following table sets forth certain information regarding our operating results of operations and financial position, and is qualified in its entirety by the consolidated financial statements and notes thereto which appear elsewhere herein:
(All dollar amounts in thousands except per common share data)
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Business/Segments
In the second quarter of 2007, we revised our segment reporting structure to reflect the strategic realignment of our businesses and internal reporting. The strategic realignment reflects a brand-focused approach, designed to optimize the operational coordination and resource allocation of our businesses across multiple functional areas including specialty retail, retail outlets, concession, wholesale apparel, wholesale non-apparel, e-commerce and licensing. As such, we now report our operations in two reportable segments as follows:
•
The Direct Brands segment - consists of the specialty retail, outlet, wholesale apparel, wholesale non-apparel (including accessories, jewelry, handbags and fragrances), e-commerce and licensing operations of our four retail-based operating segments: JUICY COUTURE, KATE SPADE, LUCKY BRAND and MEXX; and
•
The Partnered Brands segment - consists of one operating segment including the wholesale apparel, wholesale non-apparel, outlet and specialty retail, e-commerce and licensing operations of our wholesale-based brands including: AXCESS, CLAIBORNE (men’s), CONCEPTS BY CLAIBORNE, DANA BUCHMAN(a), ELLEN TRACY(b), ENYCE, KENSIE, LIZ & CO., LIZ CLAIBORNE, MAC & JAC, MARVELLA, MONET, NARCISO RODRIGUEZ, SIGRID OLSEN(c), TRIFARI, VILLAGER, our licensed DKNY® JEANS and DKNY® ACTIVE brands, as well as our other non-Direct Brands fragrances including: CLAIBORNE, CURVE, ELLEN TRACY (b), LIZ CLAIBORNE and our licensed USHER fragrance.
In July 2007, we announced our long-term strategic plan, which included a strategic review and potential divestiture or closure of 16 of our brands. On October 4, 2007, we completed the first phase of such review by finalizing the disposal of certain assets of our former EMMA JAMES, INTUITIONS, J.H. COLLECTIBLES and TAPEMEASURE brands in a single transaction. We completed the second phase of such review by disposing of certain assets and liabilities of our C&C CALIFORNIA and LAUNDRY BY DESIGN on February 4, 2008, and by entering into a definitive agreement to sell assets and liabilities of our prAna brand. The transaction is expected to close in the first quarter of 2008. The results of these brands, previously included in the Partnered Brands Segment, have been segregated and reported as discontinued operations for all periods presented (see Note 3 of Notes to Consolidated Financial Statements).
We also present our results on a geographic basis based on selling location, between Domestic (wholesale customers, Company specialty retail and outlet stores located in the United States and e-commerce sites) and International (wholesale customers and Company specialty retail and outlet and concession stores located outside of the United States). We, as licensor, also license to third parties the right to produce and market products bearing certain Company-owned trademarks; the resulting royalty income is included within the results of the associated segment.
Competitive Profile
We operate in global fashion markets that are intensely competitive. Our ability to continuously evaluate and respond to changing consumer demands and tastes across multiple markets, distribution channels and geographies is critical to our success. Although our brand portfolio approach is aimed at mitigating our risks in this regard, misjudging shifts in consumer preferences could have a negative effect on our results of operations. Other key aspects of competition include quality, brand image, market share, distribution methods, price, size and location of our retail stores and department store selling space, customer service and intellectual property protection. We believe that our size and global operating capabilities can enable us to compete successfully by positioning us to take advantage of synergies in product design, development, sourcing and distribution of our products throughout the world.
Since 1999, we have acquired a number of brands in an effort to diversify our business across price points and channels and to decrease our dependence on the domestic department store channel. We have also diversified geographically, with our international operations representing 32.4% and 30.0% of total Company net sales for the years ended December 29, 2007 and December 30, 2006,
respectively. In addition, we expanded our own retail business by increasing the number of doors in a variety of formats. As we expanded our brand portfolio, our management structure was based on channel and category management, and our reliance on the domestic department store channel remained significant.
After the appointment of our CEO in November 2006, we initiated a review of our operations to assess options to best allocate our resources to those brands we believe have the maximum potential for sustainable growth in sales and earnings and to best evolve our brand-focused strategy on a going forward basis. On June 20, 2007, we announced the reconfiguration of our organization and on July 11, 2007, we announced the preliminary results of our review of operations. The major elements of our strategy are as follows:
Reconfiguring our organization into two new business segments:
•
Direct Brands (comprised of our JUICY COUTURE, KATE SPADE, LUCKY BRAND and MEXX retail-based lifestyle brands); and
•
Partnered Brands (comprised of LIZ CLAIBORNE and our other owned and licensed wholesale-based brands). The strategic realignment reflects a brand-focused approach, designed to optimize the operational coordination and resource allocation of our businesses across multiple functional areas including specialty retail, retail outlets, wholesale apparel, wholesale non-apparel, e-commerce and licensing.
The undertaking of our strategic review of 16 specific brands in our portfolio in an effort to narrow our brand offerings to a select group that we believe we can fully resource and develop into powerful, sustaining brands:
Implementing and maintaining a more competitive cost structure:
•
We have accelerated our structural realignment and other initiatives to achieve cost savings targets. Key actions taken included headcount reductions, the closing of three of our distribution centers, real estate rationalization and discretionary expense cuts.
•
We anticipate additional cost reductions to be realized through further staff reductions, consolidations of distribution facilities and office space, discretionary expense cuts, process re-engineering and supply chain cost rationalization.
Committing the resources, structure and marketing investment necessary to fully support and maximize the growth of our brands:
•
We estimate committing approximately $200 million to capital expenditures, including approximately $140 million to open new stores primarily within our Direct Brands segment in 2008;
•
We are honing our organizational structure to better support the unique opportunities within our reporting units; and
•
We anticipate spending approximately $100 million in 2008 in marketing activities in support of our growth initiatives.
Developing best-in-class, retail-centric capabilities, and initiating investments to optimize our supply chain activities and accelerate the flow of goods to our stores in both retail and wholesale formats.
Market Environment
Consumers have migrated, and are continuing to migrate, away from traditional department stores, turning instead to specialty retailers, national chains and off-price retailers. This factor, combined with the complexities and impacts of the ongoing retail industry consolidation and changes in the domestic department store business model, including the continued increase in their emphasis on private label offerings, has presented a multitude of challenges for us in the sector for a number of years. As our larger department store customers have been focusing on inventory productivity and product differentiation to gain competitive market share, improve natural margins, reduce their dependency on vendor margin support and improve cash flows, they have executed, and we believe will continue to execute, their buying activities very cautiously and conservatively, while aggressively growing their private label businesses. Over the past few years, this operating environment has adversely affected the results of our wholesale-based brands.
Apparel and non-apparel retailers, in general, including many of our major customers, have reported disappointing holiday season comparable store sales. Accordingly, we continue to be cautious about the near-term retail environment as evidenced by the slowdown in consumer spending, which reflects the recent deterioration in the macro-economic environment in the U.S., as well as abroad.
This uncertain environment has been a driver in our acceleration of our strategic reviews of the brands mentioned above and the ultimate outcomes for those brands as well as in our acceleration of our streamlining initiatives.
In summary, the measure of our success in the future will depend on our ability to navigate through a difficult macro-economic environment and challenging market conditions, execute on our strategic vision, including evolving our retail capabilities, attracting and retaining the management talent necessary for such execution, designing and delivering products that are acceptable to the marketplaces that we serve and sourcing the manufacture of and distributing our products on a competitive and efficient basis and evolving our retail capabilities.
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 Statements” and those set forth under the heading “Item 1A - Risk Factors.”
Operating Overview
Our 2007 results from continuing operations reflected the following pre-tax items:
•
Expenses associated with our streamlining initiatives and our strategic review of approximately $120.7 million and $41.4 million, respectively;
•
Non-cash charges associated with the impairment of our ELLEN TRACY trademark of approximately $36.3 million;
•
Non-cash charges associated with the impairment of goodwill in the Partnered Brands segment of approximately $450.8 million; and
•
Expenses associated with the elimination of certain cosmetics product offerings of approximately $34.4 million.
Additionally, disappointing results in our Partnered Brands segment reflected:
•
Increased retailer markdowns driven by significant promotional activity before year-end; and
•
Aggressive liquidation of excess inventories across all brands.
As a result of the sale or probable sale of brands under strategic review in our Partnered Brands segment and the decline in the actual and projected performance and cash flows of such segment, we determined that a goodwill impairment test was required to be performed as of December 29, 2007, in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.” In performing this evaluation, we considered declines in the Company’s market value, which began in the second half of 2007. As a result, we determined that the goodwill of our Partnered Brands segment, was impaired and recorded a pretax impairment charge of $450.8 million during the fourth quarter of 2007 (see Note 1 and Note 8 of Notes to Consolidated Financial Statements).
2007 Overall Results
Net Sales
Net sales in 2007 were $4.577 billion, a decrease of 1.4%, compared to 2006 net sales.
The sales results reflected decreased sales in the Partnered Brands Segment, primarily resulting from decreases in our LIZ CLAIBORNE, DANA BUCHMAN, SIGRID OLSEN, ELLEN TRACY and Men’s apparel businesses, partially offset by growth in certain regions in which our Direct Brands segment operates and the impact in 2007 of the recently acquired KATE SPADE and NARCISO RODRIGUEZ brands. The impact of foreign currency exchange rates, primarily as a result of the strengthening of the euro and Canadian dollar, in our international businesses, increased sales by approximately $115.7 million during 2007.
Gross Profit and (Loss) Income from Continuing Operations
Our gross profit decreased to 47.3% of net sales in 2007 as compared to 48.7% in 2006, reflecting decreased gross profit rates in our Partnered Brands segment primarily due to higher levels of retailer support, increased sales to the off-price channel and inventory markdowns in our cosmetics business, partially offset by an increased proportion of sales from our Direct Brands segment, which operates at a higher gross profit rate than the Company average. We recorded a net loss from continuing operations of $370.0 million in 2007 as compared to income from continuing operations of $220.9 million in 2006, reflecting the gross profit items noted herein, as well as an after-tax goodwill impairment charge of $343.1 million, after-tax expenses associated with our streamlining initiatives of $78.0 million, as well as the impact of decreased sales in our Partnered Brands Segment.
Balance Sheet
We ended 2007 with a net debt position of $682.0 million as compared to $397.6 million at 2006 year-end. We generated $273.9 million in cash from operations during fiscal 2007 and increased our net debt position by $284.4 million, which enabled us to fund $48.3 million of acquisition-related payments, our 2007 share repurchase of $300.5 million and our capital expenditures of $181.0 million. The effect of foreign currency translation on our Eurobond increased our debt balance by $53.0 million.
International Operations
Revenues for the last five years are presented on a geographic basis as follows:
In 2007, sales from our international operations represented 32.4% of our net sales, compared to 23.1% in 2003, primarily due to growth of MEXX Europe and MEXX Canada and, to a lesser extent, expansion of the MONET brand. We expect our international sales to continue to represent a significant portion of our overall sales. Accordingly, our overall results can be greatly impacted by changes in foreign currency exchange rates. In 2007, the impact of foreign currency exchange rates represented $115.7 million of the increase in international sales compared to $28.0 million of the increase in international sales in 2006. 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.
Acquisitions
On May 18, 2007, we acquired 50 percent ownership of the entity that owns the rights to the NARCISO RODRIGUEZ name and trademarks, entered into an exclusive license to operate the Narciso Rodriguez business worldwide and formed a new company to operate the license and develop the NARCISO RODRIGUEZ brand worldwide. The purchase price totaled $13.9 million, which includes closing fees and certain post-closing adjustments. We believe the addition of NARCISO RODRIGUEZ provides an opportunity to build a broad business in the luxury designer category (a category in which we did not previously participate) that is sold in partnership-oriented, upscale retailers. We allocated $8.9 million of purchase price to the value of trademarks and trade names associated with the business, $0.3 million to the value of a non-compete agreement, $0.6 million to the value of a beneficial lease and $5.0 million to goodwill. The $5.0 million of goodwill that was included in the Partnered Brands segment was subsequently written off as part of our fourth quarter 2007 non-cash impairment charge and deducted for tax purposes. The value of trademarks and tradenames, the non-compete agreement and the beneficial lease are being amortized over 7 years, 3 years and 5 years, respectively. As we maintain control over the assets and activities of the NARCISO RODRIGUEZ brand, the related financial results have been consolidated from the date of acquisition. Unaudited pro forma information related to this acquisition is not included, as the impact of this transaction is not material to our consolidated results.
On December 13, 2006, we acquired 100 percent of the equity of Kate Spade LLC (“Kate Spade”). Based in New York City, Kate Spade is a designer, marketer, wholesaler and retailer of fashion accessories for women and men through its KATE SPADE® and
JACK SPADE® brands. We believe the KATE SPADE brand enjoys widespread consumer recognition in the accessible luxury category and provides considerable opportunity for growth in its direct-to-consumer business. The purchase price totaled approximately $124 million, plus $3.4 million in fees and for certain post-closing adjustments and assumption of liabilities that were accounted for as additional purchase price. We allocated $74.9 million of purchase price to the value of trademarks and trade names associated with the business, $6.5 million to the value of customer relationships, $2.6 million to the value of beneficial leases and $36.0 million to goodwill. The trademarks and tradenames are deemed to have indefinite lives and are subject to an annual impairment test. The value of customer relationships and beneficial leases are being amortized over 14 years and from 2 to 9 years, respectively. Unaudited pro forma information related to this acquisition is not included, as the impact of this transaction is not material to our consolidated results.
On January 26, 2006, we acquired 100 percent of the equity of Westcoast Contempo Fashions Limited and Mac & Jac Holdings Limited, which collectively design, market and sell the Mac & Jac, Kensie and Kensiegirl apparel lines (“Mac & Jac”), a privately held fashion apparel company. The purchase price totaled 26.2 million Canadian dollars (or $22.7 million), which includes the retirement of debt at closing and fees, but excludes contingent payments to be determined based upon a multiple of Mac & Jac’s earnings in fiscal years 2006, 2008, 2009 and 2010. There was no contingent payment made based on 2006 fiscal year earnings. We allocated $13.9 million of purchase price to the value of trademarks and trade names associated with the business and $5.6 million to the value of customer relationships. The trademarks and trade names are deemed to have indefinite lives and are subject to an annual test for impairment. The value of customer relationships is being amortized over 12 years. We currently estimate that the aggregate of the contingent payments will be in the range of approximately $10-12 million and will be accounted for as additional purchase price when paid. Unaudited pro forma information related to this acquisition is not included, as the impact of this transaction is not material to our consolidated results.
The prAna acquisition agreement requires us to make contingent payments to the former owners of prAna based on certain performance parameters of prAna over a pre-determined time frame. In connection with the sale of the prAna brand, we agreed to satisfy such contingent obligation for $18.4 million, which will be paid concurrently with the closing of the sale of the prAna brand and will be recorded as an expense within our Consolidated Statement of Operations in 2008.
On April 7, 2003, we acquired 100 percent of the equity of Juicy Couture, Inc. (formerly, Travis Jeans, Inc.) (“Juicy Couture”), a privately held fashion apparel company. The total purchase price consisted of: (i) a payment, including the assumption of debt and fees of $53.1 million and (ii) 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. In March of 2005, the contingent payment agreement was amended to include an advance option for the sellers providing that (i) if the 2005 measurement year is not selected, the sellers may elect to receive up to 70 percent of the estimated contingent payment based upon 2005 results; and (ii) if the 2005 and 2006 measurement years are not selected, the sellers are eligible to elect to receive up to 85 percent of the estimated contingent payment based on the 2006 measurement year net of any 2005 advances. In April 2006, the sellers elected to receive a 70 percent advance against the contingent purchase price and were paid $80.3 million on April 20, 2006. In May 2007, the sellers elected to receive an 85 percent advance against the contingent purchase price and were paid $19.9 million on May 23, 2007. These payments were accounted for as additional purchase price and as increases to goodwill. The 2008 payment of $72.9 million will be made in the first half of 2008 based on a multiple of Juicy Couture’s 2007 earnings, and has been accounted for as additional purchase price and an increase to goodwill.
On June 8, 1999, we acquired 85.0 percent of the equity of Lucky Brand Dungarees, Inc. (“Lucky Brand”), whose core business consists of the Lucky Brand Dungarees line of women and men’s denim-based sportswear. The total purchase price consisted of a cash payment made at the closing date of approximately $85.0 million and a payment made in April 2003 of $28.5 million. An additional payment of $12.7 million was made in 2000 for tax-related purchase price adjustments. On January 16, 2007, January 17, 2006 and January 28, 2005, we paid $10.0 million, $10.0 million and $35.0 million, respectively, for 1.5 percent, 1.9 percent and 8.25 percent, respectively, of the equity interest of Lucky Brand. On September 20, 2007, we entered into an agreement to acquire the remaining shares that were owned by the sellers of Lucky Brand, amending an agreement signed on January 28, 2005. We will acquire 0.4% in each of January of 2008, 2009 and 2010 of the equity interest in Lucky for payments of $5.0 million each. We recorded the present value of fixed amounts owed of $14.0 million in Accrued expenses and Other non-current liabilities. As of December 29, 2007, the excess of the liability recorded over the related amount of minority interest has been recorded as goodwill. The remaining 2.28% of the original shares outstanding will be settled for an aggregate purchase price composed of the following two installments: (i) the 2008 payment of $14.4 million that will be made in the first half of 2008 based on a multiple of Lucky Brand’s 2007 earnings, which we have accounted for as additional purchase price and (ii) the 2011 payment that will be based on a multiple of Lucky Brand’s 2010 earnings, net of the 2008 payment, which we estimate will be in the range of $9-12 million.
RESULTS OF OPERATIONS
We present our results based on the two reportable segments discussed in the Overview section, as well as on the following geographic basis based on selling location:
•
Domestic: wholesale customers, licensees, Company specialty retail and outlet stores located in the United States and our e-commerce sites; and
•
International: wholesale customers, licensees, Company specialty retail, outlet stores and concession stores located outside of the United States, primarily in our European and Canadian operations.
All data and discussion with respect to our segments included within this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is presented after applicable intercompany eliminations.
2007 vs. 2006
The following table sets forth our operating results for the year ended December 29, 2007 (52 weeks), compared to the year ended December 30, 2006 (52 weeks):
Net Sales
Net sales for 2007 were $4.577 billion, a decrease of 1.4%, as compared to net sales for 2006. The impact of foreign currency exchange rates, primarily as a result of the strengthening of the Canadian dollar and the euro, in our international businesses increased net sales by approximately $115.7 million during the year. Net sales data are provided below:
-
Sales productivity was $433 per average square foot as compared to $449 for fiscal 2006;
-
Comparable store sales in our MEXX Company-owned stores decreased by 2.0% overall, primarily due to a decrease in our MEXX Europe business, partly offset by an increase in our MEXX Canada business; and
-
A $98.7 million increase resulting from the impact of foreign currency exchange rates in our European and Canadian businesses.
Comparable Company-owned store sales are calculated as follows:
-
New stores become comparable after 14 full fiscal months of operations (on the 1st day of the 15th full fiscal month);
-
Except in unusual circumstances, closing stores become non-comparable one full fiscal month prior to the scheduled closing date;
-
A remodeled store will be changed to non-comparable when there is a 20% or more increase/decrease in its selling square footage (effective at the start of the fiscal month when construction begins). The store becomes comparable again after 14 full fiscal months from the re-open date;
-
A store that relocates becomes non-comparable when the new location is materially different from the original location (in respect to selling square footage and/or traffic patterns); and
-
Stores that are acquired are not comparable until they have been reflected in our results for a period of 12 months.
Net sales per average square foot is defined as net sales divided by the average of beginning and end of period gross square feet.
-
Our department store customers’ continued focus on inventory productivity and product differentiation to gain competitive market share and improve margins and cash flows, as they continue to execute their buying activities very cautiously, while aggressively growing their private label businesses. This operating environment continued to adversely affect our Partnered Brands segment, and contributed to reduced sales in 2007 for the following brands: LIZ CLAIBORNE, SIGRID OLSEN (closing in the first half of 2008), Cosmetics (due to reduced distribution and increased returns resulting from the closure of certain brands), CLAIBORNE, MONET, FIRST ISSUE (which closed in early 2008), ELLEN TRACY (which we have agreed to sell in a transaction that is expected to close in the second quarter of 2008), DANA BUCHMAN (licensed on an exclusive basis to Kohl’s in January 2008, with current operations expected to close in the first half of 2008 and the licensed offering expected to be launched no later than the first quarter of 2009), licensed DKNY® Jeans and ENYCE. The sales decline also reflects the elimination of our CITY UNLTD. and CRAZY HORSE brands, partially offset by the addition of our LIZ & CO. and CONCEPTS BY CLAIBORNE brands and the launch of our licensed USHER fragrance; and
-
The impact of fluctuations in foreign currency exchange rates, which increased sales by $15.9 million primarily related to our LIZ CLAIBORNE and MONET operations in Europe and Canada.
Viewed on a geographic basis, Domestic net sales decreased by $156.2 million or 4.8%, to $3.093 billion, reflecting decreases in our Partnered Brands segment, partially offset by increases in our Direct Brands segment primarily due to growth in JUICY COUTURE and the inclusion of KATE SPADE (acquired in December of 2006). International net sales increased $89.6 million or 6.4%, to $1.485 billion. The increase in international sales reflected the impact of fluctuations in foreign currency exchange rates, which increased sales by approximately $115.7 million, as well as increases in our MEXX Canada retail business partially offset by decreases in our MEXX Europe business.
Gross Profit
Gross profit in 2007 was $2.166 billion, a $94.5 million decrease as compared to 2006. Gross profit as a percentage of net sales decreased to 47.3% in 2007 as compared to 48.7% in 2006, reflecting decreased gross profit rates in our Partnered Brands segment due to higher levels of retailer support, the aggressive liquidation of excess inventories across all brands, as well as costs associated with the elimination of certain cosmetics product offerings, partially offset by an increased proportion of sales from our Direct Brands segment, which operates at a higher gross profit rate than the Company average. Gross profit increased approximately $67.1 million due to the impact of fluctuations in foreign currency exchange rates on our international businesses. Warehousing activities, including receiving, storing, picking, packing and general warehousing charges, are included in selling, general and administrative expenses (“SG&A”); accordingly, our gross profit may not be comparable to others who may include these expenses as a component of cost of goods sold.
Selling, General & Administrative Expenses
SG&A increased $225.7 million or 12.0%, to $2.104 billion in 2007 over 2006. The SG&A increase reflected the following:
•
The inclusion of $21.2 million of expenses related to our licensed USHER fragrance;
•
An $85.2 million increase primarily resulting from the retail expansion in our Direct Brands segment;
•
A $63.5 million increase due to the impact of changes in foreign currency exchange rates on our international operations;
•
A $50.0 million increase due to incremental costs associated with streamlining activities and the inclusion of expenses resulting from our strategic review in 2007; and
SG&A as a percent of net sales was 46.0% in 2007, compared to 40.5% in 2006, primarily reflecting an increased SG&A rate in our Partnered Brands segment resulting from the de-leveraging impact of decreased wholesale net sales, higher expenses associated with our streamlining activities, expenses associated with the strategic review of our brand portfolio as well as an increased proportion of expenses from our Direct Brands segment, which runs at a higher SG&A rate than the Company average.
Trademark Impairment
Non-cash charges totaling $36.3 million were recorded as a result of the impairment of the ELLEN TRACY trademark due to decreases in sales projections over the next few years.
Goodwill Impairment
A non-cash charge of $450.8 million was recorded in the Partnered Brands segment reflecting a decrease in its fair value below its carrying value due to declines in the actual and projected performance and cash flows in the segment.
Operating (Loss) Income
Operating loss for 2007 was $425.8 million, a decrease of $807.3 million as compared to 2006. This decrease includes the impact of the non-cash impairment charges discussed above of $487.1 million in the Partnered Brand Segment. Operating loss as a percent of net sales was (9.3%) in 2007 compared to income of 8.2% in 2006. The impact of changes in foreign currency exchange rates on our international operations added $3.6 million to operating income for the year. Operating income by segment is provided below:
•
The Partnered Brands operating loss for the year was $632.0 million ((27.2) % of net sales), compared to operating income of $175.9 million (6.4% of net sales) in 2006. This decrease is due to lower sales (primarily in brands under strategic review) and increased retailer support, expenses associated with the elimination of certain cosmetics product offerings, an increase in expenses associated with our streamlining initiatives, expenses associated with the strategic review of our brands, as well as the Partnered Brands goodwill and ELLEN TRACY trademark non-cash impairment charges.
On a geographic basis, Domestic recorded an operating loss of $476.8 million, a decrease of $783.0 million. The Domestic decrease predominantly reflected reduced income in our Partnered Brands segment and the impact of the non-cash impairment charges discussed above, partially offset by an increase in the domestic operations of our Direct Brands segment. International operating income decreased $24.3 million or 32.3% to $51.0 million. The International decrease primarily reflected reduced income in our Partnered Brands segment primarily from our LIZ CLAIBORNE and MONET European brands, as well as our Direct Brands European retail business, partially offset by the impact of $3.6 million of foreign currency exchange rates in our international businesses.
Other Income (Expense), Net
In 2007, other income (expense), net was $(4.4) million of expense compared to $5.4 million of income in 2006. In 2007, net other (expense) income was primarily comprised of $3.7 million of foreign currency transaction losses and $1.1 million of minority interest (see “Financial Position, Capital Resources and Liquidity - Commitments and Capital Expenditures,” below, for discussion of the purchase of the remaining Lucky Brand minority interest), partially offset by a $0.4 million realized gain from the sale of certain equity investments. In 2006, net other income (expense) was primarily comprised of a $3.6 million realized gain from the sale of certain equity investments and foreign currency transaction gains of $3.0 million, partially offset by $1.2 million of minority interest.
Interest Expense, Net
Net interest expense in 2007 was $42.2 million, compared to $34.9 million in 2006, both of which were principally related to borrowings incurred to finance our strategic initiatives, including share repurchases and acquisitions. Net interest expense includes $10.3 million and $4.4 million of interest income in 2007 and 2006, respectively.
(Benefit) Provision for Income Taxes
Income taxes in 2007 decreased by $233.5 million to an income tax benefit of $(102.4) million as compared to a tax expense of $131.1 million in 2006. Tax expense decreased by $107.7 million as a result of the goodwill impairment charge. The tax rate benefit resulting from the goodwill impairment charge was less than the statutory rate as a significant portion of the goodwill impairment charge is non-deductible. The resulting effective tax rate benefit on the pre-tax loss from continuing operations was 21.7% in 2007 as compared to 37.2% of pre-tax income in 2006.
(Loss) Income from Continuing Operations
Loss from continuing operations in 2007 was $(370.0) million and Income from continuing operations in 2006 was $220.9 million, or 4.8% of net sales. EPS from continuing operations decreased to $(3.71) in 2007 from diluted EPS of $2.13 in 2006. We incurred a loss from continuing operations in 2007, therefore outstanding stock options and restricted shares are anti-dilutive. Accordingly, basic and diluted weighted average shares outstanding are equal for such period.
Income from Discontinued Operations, Net of Tax
Income from discontinued operations in 2007 decreased to $4.5 million, from $33.8 million in 2006 due to (i) decreased performance of the brands comprising our discontinued operations in 2007 and (ii) the inclusion of the results of EMMA JAMES, INTUITIONS, J.H. COLLECTIBLES and TAPEMEASURE for nine months in 2007, but for the entire year in 2006 (these brands were disposed on October 4, 2007). EPS from discontinued operations decreased to $0.04 in 2007 from $0.33 in 2006.
Loss on Disposal of Discontinued Operations, Net of Tax
Loss on disposal of discontinued operations in 2007 was $7.3 million, or $(0.07) per common share reflecting the estimated difference between the carrying value of the assets sold and their estimated fair values less costs to dispose, including transaction costs.
Net (Loss) Income
The net loss recorded in 2007 was $(372.8) million as compared to net income of $254.7 million in 2006, or 5.5% of net sales. EPS decreased to $(3.74) in 2007, from $2.46 in 2006. These decreases primarily reflect the after-tax impact of the non-cash goodwill and trademark impairment charges of $365.1 million ($(3.66) per share) and the operating loss incurred in our Partnered Brands segment.
2006 vs. 2005
The following table sets forth our operating results for the year ended December 30, 2006 (52 weeks), compared to the year ended December 31, 2005 (52 weeks):
Net Sales
Net sales for 2006 were $4.644 billion, an increase of $57.7 million, or 1.3%, over net sales for 2005. The impact of fluctuations in foreign currency exchange rates on our international businesses increased net sales by approximately $28.0 million during the year. Net sales data are provided below:
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Net sales for MEXX were $1.162 billion, a 9.8% increase compared to 2005, primarily due to increases in our MEXX Europe retail and wholesale businesses (due to volume growth as a result of new specialty retail customers), as well as increases in our MEXX Canada retail business.
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A $231.9 million net decrease primarily reflecting our department store customers’ focus on inventory productivity and product differentiation to gain competitive market share and improve margins and cash flows, as they execute their buying activities very cautiously, while aggressively growing their private label businesses. This operating environment adversely affected our Partnered Brand segment and contributed to reduced sales for the following brands: LIZ CLAIBORNE, SIGRID OLSEN, ELLEN TRACY, CLAIBORNE, FIRST ISSUE, MONET, DANA BUCHMAN and AXCESS men’s. The sales decline also reflects the elimination of our CITY UNLTD. and CRAZY HORSE brands which is being replaced in 2007 by LIZ & CO., partly offset by growth in our licensed DKNY® Jeans (due to volume growth primarily due to additional points of sale, and ENYCE (due to increased demand);
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The impact of $35.2 million of sales from our acquisition of MAC & JAC;
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The inclusion in 2005 of a $12.3 million reimbursement from a customer of improperly collected markdown allowance; and
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Fluctuations in foreign currency exchange rates increased sales by $8.0 million primarily related to our LIZ CLAIBORNE operations in Europe and Canada.
Viewed on a geographic basis, Domestic net sales decreased by $75.5 million, or 2.3%, to $3.249 billion, reflecting declines in the domestic operations of our Partnered Brands segment partially offset by increases in our domestic Direct Brands segment. International net sales increased $133.2 million, or 10.6%, to $1.395 billion. The international increase reflected increases in our MEXX Europe and Canadian retail operations in our Direct Brand Segment. Fluctuations in foreign currency exchange rates increased international sales by approximately $28.0 million.
Gross Profit
Gross profit increased $60.3 million, or 2.7%, to $2.260 billion in 2006 over 2005. $16.1 million of the increase in gross profit is due to the impact of changes in foreign currency exchange rates on our international businesses. Gross profit as a percent of net sales increased to 48.7% in 2006 from 48.0% in 2005, reflecting the impact of a changing mix within our portfolio, partially offset by a decreased gross profit rate in our Partnered Brands segment and the impact of the $12.3 million (0.3% of net sales) reimbursement in 2005 from a customer of improperly collected markdown allowances. The change in mix primarily reflected an increased proportion of sales from our Direct Brands segment, which runs at a higher gross profit rate than the Company average, and a decreased proportion of sales from our Partnered Brands segment, which runs at a lower gross profit rate than the Company average. Warehousing activities including receiving, storing, picking, packing and general warehousing charges are included in SG&A; accordingly, our gross profit may not be comparable to others who may include these expenses as a component of cost of goods sold.
Selling, General & Administrative Expenses
SG&A increased $163.0 million, or 9.5%, to $1.879 billion in 2006 over 2005 and as a percent of net sales increased to 40.5% in 2006 from 37.4%. The SG&A increase reflected the following:
•
The inclusion of $18.4 million of expenses from our acquisitions of MAC & JAC and KATE SPADE;
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A $96.4 million increase primarily resulting from the retail expansion of our Direct Brands Segment;
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A $13.7 million increase due to the impact of fluctuations in foreign currency exchange rates on our international operations;
•
$81.6 million of expenses primarily consisting of employee severance costs, lease termination costs and fixed asset write-downs, offset by savings of $28.2 million associated with our streamlining initiatives;
•
$14.9 million of reinvestment in marketing and in-store activities of realized savings from our streamlining initiatives; and
•
A $33.8 million net decrease in Partnered brands and corporate expenses primarily reflecting reduced incentive compensation expense.
The increased SG&A rate primarily reflected net expenses associated with our business streamlining initiatives and the increased proportion of expenses related to our Direct Brands segment, which runs at a higher SG&A rate than the Company average, as described above, in addition to reduced expense leverage resulting from the decreased proportion of expenses related to our Partnered Brands segment, which runs at a lower SG&A rate than the Company average.
Operating Income
Operating income was $381.5 million (8.2% of net sales) in 2006 compared to $484.2 million (10.6% of net sales) in 2005. The decrease is primarily attributable to $81.6 million of expenses associated with our streamlining initiatives, the $12.3 million reimbursement in 2005 from a customer of improperly collected markdown allowances, as well as the impact of reduced wholesale apparel sales, partially offset by decreased wholesale and corporate expenses. Operating income increased by $2.3 million in 2006 due to the impact of changes in foreign currency exchange rates on our international businesses. Operating income by business segment is provided below:
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Direct Brands operating income was $205.6 million decreasing $37.1 million, or 15.3%, as a result of reduced income in our MEXX Europe retail and wholesale operations partially offset by growth in our LUCKY BRAND and MEXX Canada operations. The impact of foreign currency exchange rates in our international business increased operating income by $2.6 million.
Viewed on a geographic basis, Domestic operating income decreased by $70.5 million, or 18.7%, to $306.2 million predominantly reflecting the reduced income in our Partnered Brands segment and the expenses associated with our streamlining initiatives. International operating income decreased $32.2 million, or 30.0%, to $75.3 million. The international decrease reflected decreased profitability in our MEXX European retail business and expenses associated with our streamlining initiatives.
Other Income (Expense), Net
In 2006, Other income (expense), net was $5.4 million of income compared to $2.3 million of expense in 2005. In 2006, net other income (expense) was primarily comprised of a $3.6 million realized gain from the sale of certain equity investments and foreign currency transaction gains of $3.0 million, partially offset by $1.2 million of minority interest expense. (See “Financial Position, Capital Resources and Liquidity - Commitments and Capital Expenditures,” below, for discussion of the purchase of the remaining LUCKY BRAND minority interest). In 2005, Other income (expense), net was primarily comprised of $1.8 million of minority interest expense.
Interest Expense, Net
Net interest expense in 2006 was $34.9 million, compared to $31.8 million in 2005, both of which were principally related to borrowings incurred to finance our strategic initiatives, including acquisitions. Net interest includes $4.4 million and $2.6 million of interest income in 2006 and 2005, respectively.
Provision for Income Taxes
The income tax rate in 2006 increased to 37.2% from 35.2% in 2005. Taxes on earnings were affected by the impact of discrete tax events as well as a shift in earnings to jurisdictions with higher statutory tax rates.
Income from Continuing Operations
Income from continuing operations in 2006 decreased to $220.9 million, or 4.8% of net sales, from $291.8 million in 2005, or 6.4% of net sales. EPS from continuing operations decreased to $2.13 in 2006 from $2.70 in 2005.
Income from Discontinued Operations, Net of Tax
Income from discontinued operations in 2006 increased to $33.8 million, from $25.6 million in 2005. Diluted EPS from discontinued operations increased to $0.33 in 2006 from $0.24 in 2005.
Net Income
Net income decreased in 2006 to $254.7 million, or 5.5% of net sales, from $317.4 million in 2005, or 6.9% of net sales. EPS decreased to $2.46 in 2006, from $2.94 in 2005, a 16.3% decrease. The impact of the 2005 reimbursement from a customer of improperly collected markdown allowances was approximately $8.0 million, net of taxes, which increased EPS in 2006 by $0.07. Our average diluted shares outstanding decreased by 4.4 million shares in 2006 on a year-over-year basis to 103.5 million as a result of the repurchase of common shares, partially offset by the exercise of stock options and the effect of dilutive securities. Shares repurchased during 2006 increased EPS by approximately $0.03 in 2006.
FORWARD OUTLOOK
We remain confident that the strategies we outlined in July 2007 will drive sustained long-term improvement in operating performance, however, we have observed the significant recent deterioration in the macroeconomic environment in the U.S. and abroad, causing a notable slowdown in consumer spending. In this environment, department store traffic and profitability are more difficult to forecast.
Facing these challenges, we are planning our business conservatively, projecting fiscal 2008 EPS in the range of $1.50 - $1.70, which excludes the results of the following brands for which we have completed the strategic review: TAPEMEASURE, INTUITIONS, J.H. COLLECTIBLES, EMMA JAMES, FIRST ISSUE, C&C CALIFORNIA, LAUNDRY BY DESIGN and SIGRID OLSEN; expenses associated with expected additional streamlining initiatives in 2008; and the potential impact of any acquisition, additional divestiture or share repurchases. We will continue to monitor the environment closely as we progress through the year.
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 headings “STATEMENT REGARDING FORWARD-LOOKING STATEMENTS” and “Item 1A - Risk Factors.”
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 invest in our supply chain and information systems, to fund investment in marketing and capital expenditures and to fund our anticipated retail store expansion, as well as expenditures for in-store merchandise shops and normal maintenance activities. We also require cash to fund potential acquisitions and payments related to earn-out provisions of recent acquisition agreements. In addition, we will require cash to fund any repurchase of Company stock under our previously announced share repurchase programs. On November 12, 2007 and May 18, 2006, the Company’s Board of Directors authorized us to purchase up to an additional $100 million and $250 million, respectively, of our common stock for cash in open market purchases and privately negotiated transactions. As of February 15, 2008, we had $28.7 million remaining in buyback authorization under the share repurchase 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). We anticipate that cash flows from operations, our bank and letter of credit facilities will be sufficient to fund our liquidity requirements for the next twelve months 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, our ability to execute our strategy, retailer and consumer acceptance of our products, which may impact our financial performance, maintenance of our investment-grade credit rating, maintenance of financial covenants (as amended) of our debt and credit facilities, as well as interest rate and exchange rate fluctuations. On August 8, 2007 and September 10, 2007 Moody’s and Standard & Poor’s (“S&P”), respectively, completed a review of our credit rating. Moody’s lowered the senior unsecured debt rating to Baa3 from Baa2 and the commercial paper rating to Prime-3 from Prime-2. S&P affirmed our BBB unsecured debt rating and lowered the commercial paper rating to A-3 from A-2. On February 15, 2008, Moody’s placed our Baa3 senior unsecured and Prime-3 commercial paper ratings under review for possible downgrade.
2007 vs. 2006
Cash and Debt Balances. We ended 2007 with $205.7 million in cash and marketable securities, compared to $195.1 million at the end of 2006 and with $887.7 million of debt outstanding, compared to $592.7 million at the end of 2006. This $284.4 million increase in our net debt (total debt less cash and marketable securities) position on a year-over-year basis is primarily attributable to $300.5 million in share repurchases, $181.0 million in capital and in-store expenditures, $48.3 million in acquisition-related payments and the effect of foreign currency translation on our Eurobond (which increased our debt balance by $53.0 million), partially offset by cash flows from operations for the last twelve months of $273.9 million. We ended the year with $1.516 billion in stockholders’ equity, giving us a total debt to total capital ratio of 36.9% at the end of 2007, compared to $2.130 billion in stockholders’ equity at the end of 2006 with a total debt to capital ratio of 21.8%.
Accounts Receivable decreased $58.9 million, or 11.8%, at year-end 2007 compared to year-end 2006, primarily due to a $127.1 million reduction in receivables in our Partnered Brands segment due to reduced sales, and the impacts of brands sold, discontinued or classified as held for sale during 2007, as well as decreases in the fragrance operations of both our Direct Brands and Partnered Brands segments, partially offset by increases in our Direct Brands segment and the inclusion of an additional $3.9 million of receivables
from our acquired KATE SPADE and NARCISO RODRIGUEZ brands. The year-over-year change in foreign currency exchange rates primarily relates to the strengthening of the euro, which increased accounts receivable by $19.6 million.
Inventories decreased $52.6 million, or 8.9% at year-end 2007 compared to year-end 2006, primarily due to the impact of brands sold, discontinued, or classified as held for sale during 2007, as well as aggressive liquidation and write-downs resulting from our decision to exit certain cosmetics product offerings, partially offset by increases due to retail expansion in our Direct Brands segment and the increase in our LIZ & CO. and CONCEPTS BY CLAIBORNE brands. Foreign currency exchange rate fluctuations, primarily due to the strengthening of the euro, increased inventories by $20.2 million. Our average inventory turnover for 2007 was 3.9 times compared to 4.2 times in 2006. The reduction in inventory turnover is attributable to retail expansion in our Direct Brands Segment as retail inventories turnover at a slower rate.
Borrowings under our revolving credit facility and other credit facilities peaked at $473.7 million during 2007; at year-end 2007, our borrowings under these facilities were $348.0 million.
Net cash provided by operating activities was $273.9 million in 2007, compared to $394.0 million in 2006. This $120.1 million decrease was primarily due to reduced net income offset by changes in accounts receivable due to reduced shipments in our Partnered Brands segment as well as inventory reductions in our Partnered Brands segment.
Net cash used in investing activities was $219.9 million in 2007, compared to $435.4 million in 2006. Net cash used in 2007 primarily reflected $181.0 million for capital and in-store expenditures and $48.3 million in acquisition-related payments. Net cash used in 2006 primarily reflected $266.8 million in acquisition-related payments and $181.1 million for capital and in-store expenditures, partially offset by proceeds from the sale of equity investments and the sale of property and equipment.
Net cash used in financing activities was $37.2 million in 2007, compared to $89.8 million in 2006. The $52.6 million year-over-year decrease in use of cash primarily reflected a $359.9 million increase in proceeds from short-term borrowings, partly offset by a $126.4 million increase in cash used for stock repurchases, a $164.2 million decrease in proceeds from commercial paper and an $18.8 million decrease in proceeds from the exercise of stock options.
2006 vs. 2005
Cash and Debt Balances. We ended 2006 with $195.1 million in cash and marketable securities, compared to $343.2 million at year-end 2005 and with $592.7 million of debt outstanding, compared to $466.6 million at year-end 2005. This $274.2 million increase in our net debt position on a year-over-year basis is primarily attributable to $174.1 million in share repurchases, $182.4 million in capital and in-store expenditures, $266.8 million in acquisition-related payments and the effect of foreign currency translation on our Eurobond (which increased our debt balance by $48.5 million), partially offset by cash flow from operations for the last twelve months of $394.0 million. We ended the year with $2.130 billion in stockholders’ equity, giving us a total debt to total capital ratio of 21.8% at the end of 2006, compared to $2.003 billion in stockholders’ equity at the 2005 year-end with a total debt to total capital ratio of 18.9%.
Accounts receivable increased $83.2 million, or 20.0%, at year-end 2006 compared to year-end 2005, primarily due to increased shipments in our domestic non-apparel businesses of both our Direct Brands and Partnered Brands segments and the timing of shipments in the fourth quarter of 2006 and 2005, the inclusion of $13.0 million of receivables from our acquired prAna, MAC & JAC and KATE SPADE brands, the impact of foreign currency exchange rates of $15.3 million primarily related to the strengthening of the euro, partially offset by a $5.9 million reduction in receivables in our domestic Partnered Brands segment.
Inventories increased $57.1 million, or 10.7%, at year-end 2006 compared to year-end 2005, primarily due to a $35.2 million increase resulting from acquisitions, new business initiatives and the expansion of our Direct Brands retail business, net of Partnered Brands discontinued lines, a $14.8 million increase resulting from the impact of foreign currency exchange rate fluctuations, primarily due to the strengthening of the euro in our international businesses, partially offset by decreases in our domestic better woman’s apparel and domestic outlet operations in our Partnered Brands Segment. Our average inventory turnover rate for 2006 was 4.3 times compared to 4.4 times in 2005.
Borrowings under our revolving credit facility and other credit facilities peaked at $314.2 million during 2006; at year-end 2006, our borrowings under these facilities were $104.4 million.
Net cash provided by operating activities was $394.0 million in 2006, compared to $440.6 million in 2005. This $46.6 million decrease in cash flow was primarily due to reduced net income resulting from the impact of our streamlining initiatives, as well as changes in accounts receivable due to timing of shipments in our Domestic Partnered Brands segment, partially offset by changes in
accounts payable due to the timing of payments and changes in accrued expenses primarily as a result of accruals relating to our streamlining initiatives, as well as increases in depreciation and amortization mostly due to retail expansion in our Direct Brands Segment.
Net cash used in investing activities was $435.4 million in 2006, compared to $298.8 million in 2005. Net cash used in 2006 primarily reflected $266.8 million in acquisition-related payments and $181.1 million for capital and in-store expenditures, partially offset by proceeds from the sale of certain equity investments and the sale of our former distribution center in Alabama. Net cash used in 2005 reflected payments of $157.7 million for capital and in-store expenditures, $37.1 million to complete the acquisition of MEXX Canada, $35.0 million for the acquisition of the additional 8.25 percent of minority interest in LUCKY BRAND and payments of $29.3 million for the acquisition of C & C CALIFORNIA and $32.4 million for the acquisition of prAna.
Net cash used in financing activities was $89.8 million in 2006, compared to $199.5 million provided in 2005. The $109.7 million year-over-year decrease was primarily due to commercial paper outstanding at year-end, increased proceeds from exercise of stock options and decreased common stock repurchases.
Commitments and Capital Expenditures
We may be required to make the following additional payments in connection with our acquisitions. If paid in cash, these payments will be funded with cash provided by operating activities, our revolving credit and other credit facilities and/or the issuance of debt:
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The prAna acquisition agreement requires us to make contingent payments to the former owners of prAna based on certain performance parameters of prAna over a pre-determined time frame. In connection with the sale of the prAna brand, we agreed to satisfy such contingent obligation for $18.4 million, which will be paid concurrently with the closing of the sale of the prAna brand and will be recorded as an expense within our Consolidated Statement of Operations in 2008.
We lease retail stores under leases with terms that are typically five or ten years. We amortize leasehold improvements, as well as rental abatements, construction allowances and other rental concessions classified as deferred rent, on a straight-line basis over the initial term of the lease or estimated useful lives of the assets, whichever is less. The initial lease term can include one renewal under limited circumstances if the renewal is reasonably assured, based on consideration of all of the following factors: (i) a written renewal at the Company’s option or an automatic renewal, (ii) there is no minimum sales requirement that could impair our ability to renew, (iii) failure to renew would subject us to a substantial penalty and (iv) there is an established history of renewals in the format or location.
Our capital expenditures for 2008 are expected to approximate $200 million. These expenditures primarily relate to our retail expansion strategy including our plan to open 110 - 125 specialty retail stores globally, with the majority of the store openings focused on the JUICY COUTURE, LUCKY BRAND, MEXX and KATE SPADE formats, and the continued technological upgrading and expansion of our management information systems and distribution facilities (including certain building and equipment expenditures). 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.
The following table summarizes as of December 29, 2007 our contractual cash obligations by future period (see Notes 2, 4, 11 and 12 of Notes to the Consolidated Financial Statements):
*
The table above does not include amounts recorded in accordance with Financial Accounting Standards Board Interpretation No. 48 “Accounting for Uncertainty in Income Taxes.” We cannot estimate the amounts or timing of payments related to uncertain tax positions as we have not yet entered into substantive settlement discussions with taxing authorities.
(a)
Interest on the 5% Notes is fixed at 5% per annum and assumes an exchange rate of 1.4683 U.S. dollars per euro.
(b)
Interest on all of these borrowings is estimated at a rate of 5.65%, or approximately $33.9 million.
On October 13, 2004, we entered into a $750 million, five-year revolving credit agreement (the “Agreement”). A portion of the funds available under the Agreement not in excess of $250 million is available for the issuance of letters of credit. Additionally, at our request, the amount of funds available under the Agreement may be increased at any time or from time to time by an aggregate principal amount of up to $250 million with only the consent of the lenders (which may include new lenders) participating in such increase. The Agreement includes a $150 million multi-currency revolving credit line, which permits us to borrow in U.S. dollars, Canadian dollars and euro. The Agreement has two borrowing options, an “Alternative Base Rate” option, as defined in the Agreement and a Eurocurrency rate option with a spread based on our long-term credit rating. The Agreement contains certain customary covenants, including financial covenants requiring us to maintain specified debt leverage and fixed charge coverage ratios and covenants restricting our ability to, among other things, incur indebtedness, grant liens, make investments and acquisitions and sell assets. The funds available under the Agreement may be used to refinance existing debt, to provide working capital and for our general corporate purposes, including, without limitation, the repurchase of capital stock and the support of our $750 million commercial paper program. On February 29, 2008, we entered into an amendment to our revolving credit facility, whereby the fixed charge coverage ratio was modified and certain definitions were revised so that certain cash restructuring charges are excluded from the revised calculation. We were also provided a waiver of any potential prior defaults for failure to be in compliance with the fixed charge coverage ratio provided that we were in compliance with the amended fixed charge coverage ratio as of the end of fiscal 2007. As of December 29, 2007, we were in compliance with such covenants, as amended. A copy of such amendment was filed on Form 8-K, dated February 29, 2008. Both S&P and Moody’s credit rating services placed our ratings under review in May 2007 based on the 2007 outlook provided as part of our first quarter 2007 earnings release. During the third quarter of 2007, Moody’s completed its review and lowered our senior unsecured debt rating to Baa3 from Baa2 and our commercial paper rating to Prime-3 from Prime-2. Also during the third quarter of 2007, S&P completed its review, affirmed our BBB unsecured debt rating and lowered our commercial paper rating to A-3 from A-2. On February 15, 2008, Moody’s placed our Baa3 senior unsecured and Prime-3 commercial paper ratings under review for possible downgrade.
On July 6, 2006, we completed the issuance of 350 million euro (or $446.9 million based on the exchange rate in effect on such date) 5% Notes (the “Notes”) due July 8, 2013. The net proceeds of the offering were used to refinance our outstanding 350 million euro 6.625% Notes due August 7, 2006, which were originally issued on August 7, 2001. The Notes bear interest from and including July
6, 2006, payable annually in arrears on July 8 of each year beginning on July 8, 2007. The Notes have been listed on the Luxembourg Stock Exchange and received a credit rating of BBB from Standard & Poor’s and Baa2 from Moody’s Investor Services. During the third quarter of 2007, Moody’s lowered the rating to Baa3 and S&P affirmed the BBB rating. These Notes are designated as a hedge of our net investment in a foreign subsidiary.
On November 21, 2006, we entered into a seven year capital lease with a financial institution totaling $30.6 million. The purpose of the lease was to finance the equipment associated with our distribution facilities in Ohio and Rhode Island, which had been previously financed through our 2001 synthetic lease, which matured in 2006 (see Note 11 of Notes to Consolidated Financial Statements).
As of December 29, 2007, the revolving credit facility and commercial paper program, letter of credit facilities and other borrowing facilities available to us were as follows:
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 totaling $63.7 million. The synthetic lease expired on November 22, 2006. On November 21, 2006, we entered into a new synthetic lease with a financial institution for a five-year period, totaling $32.8 million to refinance the land and buildings referred to above. The lessor is a wholly owned subsidiary of a publicly traded corporation. The lessor is a sole member, whose ownership interest is without limitation as to profits, losses and distribution of the lessor’s assets. Our lease represents less than 1% of the lessor’s assets. The leases include our guarantees for a substantial portion of the financing and options to purchase the facilities at original cost; the maximum guarantee is approximately $27 million. The lessor’s risk included an initial capital investment in excess of 10% of the total value of the lease, which is at risk during the entire term of the lease. The equipment portion of the original synthetic lease was sold to another financial institution and leased back to us through a seven-year capital lease totaling $30.6 million. The lessor does not meet the definition of a variable interest entity under Financial Accounting Standards Board (“FASB”) Interpretation No. 46R, “Consolidation of Variable Interest Entities” and therefore consolidation is not required.
Hedging Activities
At December 29, 2007, we had various Canadian currency collars outstanding with a notional amount of $7.5 million, maturing through September 2008 and with contract rates ranging between 0.96 and 1.09 Canadian dollars per U.S. dollar. We had $8.7 million and 45.3 million Hong Kong dollars in Canadian currency collars and 23.3 million Hong Kong dollars in euro currency collars at December 30, 2006. At December 29, 2007, we also had forward contracts maturing through December 2008 to sell 14.4 million Canadian dollars for $14.3 million, to sell 24.2 million Canadian dollars for 185.1 million Hong Kong dollars and to sell 68.7 million euro for 736.3 million Hong Kong dollars. The notional value of the foreign exchange forward contracts at December 29, 2007 was $132.3 million, as compared with $97.5 million at December 30, 2006. Unrealized losses for outstanding foreign exchange forward contracts and currency options were $7.1 million at December 29, 2007 and $1.6 million at December 30, 2006. The ineffective portion of these trades is recognized currently in earnings and was $(1.6) million for the twelve months ended December 29, 2007. The ineffective portion of such trades was not material for the years ended December 30, 2006 and December 31,2005. In addition, for the years ended December 29, 2007, December 30, 2006, and December 31, 2005, we recorded approximately $1.0 million, $1.0 million and $0.5 million, respectively, as expense for derivative instruments that no longer qualified for hedge accounting treatment. Approximately $6.5 million in Accumulated other comprehensive loss relating to cash flow hedges will be reclassified into earnings in the next twelve months as the inventory is sold.
In connection with the variable rate financing under the 2001 synthetic lease agreement, we entered into two interest rate swap agreements with an aggregate notional amount of $40.0 million that began in January 2003 and terminated in May 2006, in order to fix the interest component of rent expense at a rate of 5.56%. We entered into these arrangements to hedge against potential future interest rate increases. The ineffective portion of these swaps recognized in earnings was not material during 2006 or 2005.
We hedge our net investment position in euro functional subsidiaries by designating the 350 million euro-denominated bonds as the hedging instrument in a net investment hedge. As a result, the foreign currency transaction gains and losses that are recognized on the
euro-denominated bonds in accordance with SFAS No. 52, “Foreign Currency Translation,” are accounted for as a component of accumulated other comprehensive loss rather than recognized currently in income. The unrealized losses recorded to Cumulative translation adjustment were $53.0 million and $48.5 million for the years ended December 29, 2007 and December 30, 2006, respectively.
On February 11, 2004, we entered into interest rate swap agreements for the notional amount of 175 million euro in connection with its 350 million Eurobonds that matured on August 7, 2006. This converted a portion of the fixed rate Eurobonds interest expense to floating rate at a spread over six month EURIBOR. This was designated as a fair value hedge. The first interest rate setting occurred on August 7, 2004 and was reset each six-month period thereafter until maturity. Interest accrued related to these swaps was not material for the periods presented.
In May 2006, we entered into multiple forward starting swaps to lock the underlying interest rate on the notional amount of 175 million euro in connection with the July 6, 2006 issuance of the Notes (see Note 12 of Notes to Consolidated Financial Statements). These swaps were terminated on June 29, 2006 and we subsequently received payment of 1.0 million euro. This amount, net of tax, was recorded in Accumulated other comprehensive loss and will continue to be reclassified into earnings over the seven year term of the Notes. The amount reclassified out of Accumulated other comprehensive loss was not significant for the years ended December 29, 2007 and December 30, 2006.
USE OF ESTIMATES AND CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 financial statements. These estimates and assumptions also affect the reported amounts of revenues and expenses. Significant accounting policies employed by the Company, including the use of estimates, are presented in the Notes to Consolidated Financial Statements in this Annual Report on Form 10-K.
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, derivative instruments and share-based compensation. 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.
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.
For accounts receivable, we estimate the net collectibility, considering both historical and anticipated trends as well as an evaluation of economic conditions and the financial positions of our customers. For inventory, we review the aging and salability of our inventory and estimate the amount of inventory that we will not be able to sell in the normal course of business. This distressed inventory is written down to the expected recovery value to be realized through off-price channels. If we incorrectly anticipate these trends or unexpected events occur, our results of operations could be materially affected. We utilize various valuation methods to determine the fair value of acquired tangible and intangible assets. For inventory, the method uses the expected selling prices of finished goods and intangible assets acquired are valued using a discounted cash flow model. 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. The significant reductions in the carrying values of certain of our intangible assets were the result of the impairment testing we performed at year-end (See Note 8 of Notes to Consolidated Financial Statements). 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 is recognized from our wholesale, retail and licensing operations. 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 historical 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 sales tax collected from customers is excluded from revenue. Proceeds received from the sale of gift cards are recorded as a liability and recognized as sales when redeemed by the holder. Licensing revenues are recorded based upon contractually guaranteed minimum levels and adjusted as actual sales data is received from licensees.
Income Taxes
Income taxes are accounted for under SFAS No. 109, “Accounting for Income Taxes.” In accordance with SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as measured by enacted tax rates that are expected to be in effect in the periods when the deferred tax assets and liabilities are expected to be realized or settled. Significant judgment is required in determining the worldwide provision for income taxes. Changes in estimates may create volatility in our effective tax rate in future periods due to settlements with various tax authorities, either favorable or unfavorable, the expiration of the statute of limitations on some tax positions or obtaining new information about particular tax positions that may cause management to change its estimates. In the ordinary course of a global business, the ultimate tax outcome is uncertain for many transactions. It is our policy to recognize, at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority, the impact of an uncertain income tax position on its income tax return. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. We establish the provisions based upon our 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 quarterly) and adjustments are made as events occur that warrant adjustments to those provisions. We record interest expense and penalties payable to relevant tax authorities as income tax expense. In fiscal 2007, a 1% increase in the effective tax rate would have impacted Loss from Continuing Operations by $4.7 million.
Accounts Receivable - Trade, Net
In the normal course of business, we extend credit to customers that satisfy pre-defined credit criteria. Accounts receivable - trade, net, as shown on the Consolidated Balance Sheets, is net of allowances and anticipated discounts. An allowance for doubtful accounts is determined through analysis of the aging of accounts receivable at the date of the financial statements, assessments of collectibility based on an evaluation of historical 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 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 historical 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 our provisions. Our historical estimates of these costs have not differed materially from actual results.
Inventories, Net
Inventories for seasonal merchandise are recorded at actual average cost. Inventories for replenishment and on-going merchandise are recorded at lower of cost (using the first-in, first-out method) or market value. We continually evaluate the composition of our inventories assessing slow-turning, ongoing product as well as prior seasons’ fashion product. Market value of distressed inventory is valued based on historical sales trends for this category of inventory of our individual product lines, the impact of market trends and economic conditions and the value of current orders in-house relating to the future sales of this type of inventory. Estimates may differ from actual results due to quantity, quality and mix of products in inventory, consumer and retailer preferences and market conditions. We review our inventory position on a monthly basis and adjust our estimates based on revised projections and current market conditions. If economic conditions worsen, we incorrectly anticipate trends or unexpected events occur, our estimates could be proven overly optimistic and required adjustments could materially adversely affect future results of operations. Our historical estimates of these costs and our provisions have not differed materially from actual results.
Goodwill and Other Intangibles, Net
In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill and intangible assets with indefinite lives are not amortized, but rather tested for impairment at least annually.
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. 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 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 reporting 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 based on their fair value and determining the fair value of the impaired reporting unit’s goodwill based upon the residual of the summed identified tangible and intangible assets.
We completed our annual goodwill impairment tests as of the first day of the third quarter of fiscal 2007. No impairment of goodwill was recognized at that date as a result of such tests.
However, as a result of the sale or probable sale of brands under strategic review in our Partnered Brands segment and the decline in the actual and projected performance and cash flows of such segment, we determined that a goodwill impairment test was required to be performed as of December 29, 2007, in accordance with SFAS No. 142. In performing this evaluation, we considered declines in the Company's market value, which began in the second half of 2007 and reconciled the sum of the estimated fair values of our five reporting units to the Company's market value (based on its stock price), plus an estimated control premium.
Accordingly, this assessment compared the carrying value of each of our reporting units with its estimated fair value using discounted cash flow models and market approaches. As a result, we determined that the goodwill of our Partnered Brands segment, which is a reporting unit, was impaired and recorded a pretax impairment charge of $450.8 million ($343.1 million, after tax) during the fourth quarter of 2007.
Owned trademarks that have been determined to have indefinite lives are also not subject to amortization and are reviewed at least annually for potential impairment in accordance with SFAS No. 142, as mentioned above. The fair value of purchased intangible assets with indefinite lives, primarily trademarks and trade names, are estimated and compared to their carrying value. We estimate the fair value of these intangible assets based on an income approach using the relief-from-royalty method. This methodology assumes that, in lieu of ownership, a third party 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, royalty rates in the category of intellectual property, discount 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.
As a result of the impairment analysis performed in connection with our purchased trademarks with indefinite lives, we determined that the carrying value of such intangible asset related to our ELLEN TRACY brand exceeded its estimated fair value. Accordingly, during 2007, we recorded pre-tax charges of $36.3 million ($22.0 million after-tax) to reduce the value of the ELLEN TRACY trademark to its estimated fair value. This impairment resulted from a decline in future anticipated cash flows of the ELLEN TRACY brand.
Intangible assets with finite lives are 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.”
Trademarks having finite lives are amortized over their estimated useful lives. Acquired trademarks are valued using the relief-from-royalty method. Trademarks that are licensed by us 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 3 to 4 years. Customer relationships are amortized assuming gradual attrition over time. Existing relationships are amortized over periods ranging from 5 to 25 years.
The recoverability of the carrying values of all long-lived assets with finite lives is re-evaluated 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 brand.
Accrued Expenses
Accrued expenses for employee insurance, workers’ compensation, profit sharing, contracted advertising, professional fees and other outstanding 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 Consolidated Balance Sheets 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 (Loss) Income from Continuing Operations or Accumulated other comprehensive income (loss), depending on whether the derivative qualifies for hedge accounting treatment. Hedge accounting requires that we test each derivative for effectiveness at inception of each hedge and at the end of each reporting period.
We use foreign currency forward contracts and options for the purpose of hedging the specific exposure to variability in forecasted cash flows associated primarily with inventory purchases mainly by our European and Canadian entities. These instruments are designated as cash flow hedges. To the extent the hedges are highly effective, the effective portion of the changes in fair value is included are Accumulated other comprehensive income (loss), net of related tax effects, with the corresponding asset or liability recorded in the Consolidated Balance Sheets. The ineffective portion of the cash flow hedge is recognized primarily as a component of Cost of goods sold in current period earnings or, in the case of the swaps, if any, within SG&A expenses. Amounts recorded in Accumulated other comprehensive income (loss) are reflected in current period earnings when the hedged transaction affects earnings. If fluctuations in the relative value of the currencies involved in the hedging activities were to move dramatically, such movement could have a significant impact on 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 our 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 also involves an estimation of the probability of the occurrence of transactions for cash flow hedges. The use of different assumptions and changing market conditions may impact the results of the effectiveness assessment and ultimately the timing of when changes in derivative fair values and underlying hedged items are recorded in earnings.
We hedge our net investment position in euro functional subsidiaries by borrowing directly in foreign currency and designating a portion of foreign currency debt as a hedge of net investments. The foreign currency transaction gain or loss recognized for a foreign currency denominated debt instrument that is designated as the hedging instrument in a net investment hedge is recorded as a translation adjustment. We also use derivative instruments to hedge the changes in the fair value of debt due to interest rates with the change in fair value recognized currently in Interest expense, net together with the change in fair value of the hedged item attributable to interest rates.
Occasionally, we purchase short-term foreign currency contracts and options outside of the cash flow hedging program to neutralize quarter-end balance sheet and other expected exposures. These derivative instruments do not qualify as cash flow hedges under SFAS No. 133 and are recorded at fair value with all gains or losses, which have not been significant, recognized as a component of SG&A expenses in current period earnings.
Share-Based Compensation
On July 3, 2005, we adopted SFAS No. 123(R) “Share-Based Payment,” requiring the recognition of compensation expense in the Consolidated Statements of Operations related to the fair value of employee share-based awards, including stock options and restricted stock. Determining the fair value of options at the grant date requires judgment, including estimating the expected term that stock options will be outstanding prior to exercise, the associated volatility and the expected dividends. Prior to adopting SFAS No. 123(R), we applied Accounting Principles Board (“APB”) Opinion No. 25 and related Interpretations, in accounting for its share-based compensation plans. All employee stock options were granted at or above the grant date market price. Accordingly, no compensation cost was recognized for share-based awards prior to July 3, 2005. In accordance with SFAS No. 123(R), judgment is required in
estimating the amount of share-based awards expected to be forfeited prior to vesting. If actual forfeitures differ significantly from these estimates, share-based compensation expense could be materially impacted.
Inflation
The rate of inflation over the past few years has not had a significant impact on our sales or profitability.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements.” SFAS No. 160 amends Accounting Research Bulletin No. 51, “Consolidated Financial Statements” and requires (i) classification of noncontrolling interests, commonly referred to as minority interests, within stockholders’ equity, (ii) net income to include the net income attributable to the noncontrolling interest and (iii) enhanced disclosure of activity related to noncontrolling interests. Currently, we classify noncontrolling interests as liabilities and exclude net income attributable to noncontrolling interests from net income. SFAS No. 160 is effective for fiscal years beginning after December 15, 2008. We are currently assessing the impact of SFAS No. 160 on our consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141 (Revised), “Business Combinations,” which provides revised guidance for how an acquirer in a business combination recognizes and measures in its financial statements (i) identifiable assets acquired, (ii) liabilities assumed, (iii) noncontrolling interests in the acquiree and (iv) goodwill or a gain from a bargain purchase. SFAS No. 141(R) also sets forth the disclosures required to be made in the financial statements related to effects of a business combination. SFAS No. 141(R) applies to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. We will adopt the provisions of SFAS No. 141(R) as required.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115.” SFAS No. 159 allows companies the choice to measure financial instruments and certain other items at fair value. This allows the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We do not believe adopting the provisions of SFAS No. 159 will have a significant impact on our consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We do not believe adopting the provisions of SFAS No. 157 will have a significant impact on our consolidated financial statements.
On July 13, 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109,” which clarifies the accounting for uncertainty in tax positions. This interpretation requires recognition in the financial statements of the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. We adopted the provisions of FIN 48 on December 31, 2006, the first day of the 2007 fiscal year, as required, and recorded a cumulative effect charge to retained earnings of $10.5 million.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have exposure to interest rate volatility primarily relating to interest rate changes applicable to our revolving credit facility and other credit facilities. These loans bear interest at rates that vary with changes in prevailing market rates.
We do not speculate on the future direction of interest rates. As of December 29, 2007 and December 30, 2006, our exposure to changing market rates was as follows:
A ten percent change in the average interest rates of the variable debt would have resulted in a $1.6 million change in interest expense during 2007.
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 revolving credit facility, bank lines and commercial paper program expose us to market risk for changes in interest rates. As of December 29, 2007, we have not employed interest rate hedging to mitigate such risks with respect to our floating rate facilities. We believe that our Eurobond offering, which is a fixed rate obligation, partially mitigates the risks with respect to our variable rate financing.
MEXX transacts business in multiple currencies, resulting in exposure to exchange rate fluctuations. We mitigate the risks associated with changes in foreign currency rates through the use of foreign exchange forward contracts and collars to hedge transactions denominated in foreign currencies for periods of generally less than one year and to hedge expected payment of intercompany transactions with our non-U.S. subsidiaries. Gains and losses on contracts which hedge specific foreign currency denominated commitments are recognized in the period in which the underlying hedged item affects earnings.
At December 29, 2007 and December 30, 2006, we had outstanding foreign currency collars with net notional amounts aggregating $7.5 million and $17.5 million, respectively. We had forward contracts aggregating to $132.3 million at December 29, 2007 and $97.5 million at December 30, 2006. Unrealized losses for outstanding foreign currency options and foreign exchange forward contracts were approximately $7.1 million at December 29, 2007 and $1.6 million at December 30, 2006. A sensitivity analysis to changes in the foreign currencies when measured against the U.S. dollar indicates that if the U.S. dollar uniformly weakened by 10% against all of the hedged currency exposures, the fair value of instruments would decrease by $14.9 million. Conversely, if the U.S. dollar uniformly strengthened by 10% against all of the hedged currency exposures, the fair value of these instruments would increase by $13.8 million. Any resulting changes in the fair value of the hedged instruments would be partially offset by changes in the underlying balance sheet positions. The sensitivity analysis assumes a parallel shift in foreign currency exchange rates. The assumption that exchange rates change in a parallel fashion may overstate the impact of changing exchange rates on assets and liabilities denominated in foreign currency. We do not hedge all transactions denominated in foreign currency.
The table below presents the amount of contracts outstanding, the contract rate and unrealized gain or (loss), as of December 29, 2007:
The table below presents the amount of contracts outstanding, the contract rate and unrealized gain or (loss), as of December 30, 2006:
Item 8.
Item 8. Financial Statements and Supplementary Data.
See the “Index to Consolidated Financial Statements and Schedule” appearing at the end of this Annual Report on Form 10-K for information required under this Item 8.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated our disclosure controls and procedures at the end of each of our fiscal quarters. Our Chief Executive Officer and Chief Financial Officer concluded that, as of December 29, 2007, our disclosure controls and procedures were effective to ensure that all information required to be disclosed is recorded, processed, summarized and reported within the time periods specified, and that information required to be filed in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, to allow timely decisions regarding required disclosure. There were no changes in our internal control over financial reporting that have materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
No change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended December 29, 2007 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
See “Index to Consolidated Financial Statements and Schedule” appearing at the end of this Annual Report on Form 10-K for Management’s Report on Internal Control Over Financial Reporting.
Item 9B.
Item 9B. Other Information.
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant.
With respect to our Executive Officers, see “Executive Officers of the Registrant” in Part I of this Annual Report on Form 10-K.
Information regarding Section 16 (a) compliance, the Audit Committee (including membership and Audit Committee Financial Experts but excluding the “Audit Committee Report”), our code of ethics and background of our Directors appearing under the captions “Section 16 (a) Beneficial Ownership Reporting Compliance”, “Corporate Governance”, “Additional Information-Company Code of Ethics and Business Practices” and “Election of Directors” in our Proxy Statement for the 2008 Annual Meeting of Shareholders (the “2008 Proxy Statement”) is hereby incorporated by reference.
Item 11.
Item 11. Executive Compensation.
Information called for by this Item 11 is incorporated by reference to the information set forth under the headings “Compensation Discussion and Analysis” and “Executive Compensation” (other than the Board Compensation Committee Report) in the 2008 Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
EQUITY COMPENSATION
The following table summarizes information about the stockholder approved Liz Claiborne, Inc. Outside Directors’ 1991 Stock Ownership Plan (the “Outside Directors’ Plan”); Liz Claiborne, Inc. 1992 Stock Incentive Plan; Liz Claiborne, Inc. 2000 Stock Incentive Plan (the “2000 Plan”); Liz Claiborne, Inc. 2002 Stock Incentive Plan (the “2002 Plan”); and Liz Claiborne, Inc. 2005 Stock Incentive Plan (the “2005 Plan”), which together comprise all of our existing equity compensation plans, as of December 29, 2007. In January 2006, we adopted the Liz Claiborne, Inc. Outside Directors’ Deferral Plan, which amended and restated the Outside Directors’ Plan by eliminating equity grants under the Outside Directors’ Plan, including the annual grant of shares of Common Stock. The last grant under the Outside Directors’ Plan was on January 10, 2006.
Security ownership information of certain beneficial owners and management as called for by this Item 12 is incorporated by reference to the information set forth under the heading “Security Ownership of Certain Beneficial Owners and Management” in the 2008 Proxy Statement.
Item 13.
Item 13. Certain Relationships and Related Transactions.
Information called for by this Item 13 is incorporated by reference to the information set forth under the headings “Certain Relationships and Related Transactions” in the 2008 Proxy Statement.
Item 14.
Item 14. Principal Accounting Fees and Services.
Information called for by this Item 14 is incorporated by reference to the information set forth under the heading “Ratification of the Appointment of the Independent Registered Public Accounting Firm” in the 2008 Proxy Statement.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules.
(a) 1. Financial Statements.
NOTE: Schedules other than those referred to above and parent company condensed financial statements have been omitted as inapplicable or not required under the instructions contained in Regulation S-X or the information is included elsewhere in the financial statements or the notes thereto.
3. Exhibits.
+
Compensation plan or arrangement required to be noted as provided in Item 14(a)(3).
*
Filed herewith.
+
Compensation plan or arrangement required to be noted as provided in Item 14(a)(3).
+
Compensation plan or arrangement required to be noted as provided in Item 14(a)(3).
+
Compensation plan or arrangement required to be noted as provided in Item 14(a)(3).
*
Filed herewith.
#
A signed original of this written statement required by Section 906 has been provided by the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, on March 13, 2008.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed below by the following persons on behalf of the registrant and in the capacities indicated, on March 13, 2008.
LIZ CLAIBORNE, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a - 15(f) under the Securities and Exchange Act of 1934. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. The Company’s system of internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Management has evaluated the effectiveness of the Company’s internal control over financial reporting as of December 29, 2007 based upon criteria for effective internal control over financial reporting described in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (''COSO’’). Based on our evaluation, management determined that the Company’s internal control over financial reporting was effective as of December 29, 2007 based on the criteria in Internal Control - Integrated Framework issued by COSO.
The Company’s internal control over financial reporting as of December 29, 2007 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their attestation report which appears herein.
Dated March 13, 2008
MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL STATEMENTS
The management of Liz Claiborne, Inc. is responsible for the preparation, objectivity and integrity of the consolidated financial statements and other information contained in this Annual Report. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States and include some amounts that are based on management’s informed judgments and best estimates.
Deloitte & Touche LLP, an independent registered public accounting firm, has audited these consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States) and has expressed herein their unqualified opinion on those financial statements.
The Audit Committee of the Board of Directors, which oversees all of the Company’s financial reporting process on behalf of the Board of Directors, consists solely of independent directors, meets with the independent registered public accounting firm, internal auditors and management periodically to review their respective activities and the discharge of their respective responsibilities. Both the independent registered public accounting firm and the internal auditors have unrestricted access to the Audit Committee, with or without management, to discuss the scope and results of their audits and any recommendations regarding the system of internal controls.
/s/ William L. McComb
/s/ Andrew Warren
William L. McComb
Chief Executive Officer
Andrew Warren
Chief Financial Officer
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Liz Claiborne, Inc.:
We have audited the internal control over financial reporting of Liz Claiborne, Inc. and subsidiaries (the “Company”) as of December 29, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 29, 2007, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended December 29, 2007 of the Company and our report dated March 13, 2008 expressed an unqualified opinion on those financial statements and financial statement schedule and included an explanatory paragraph regarding the Company’s adoption of Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement 109,” effective December 31, 2006.
/s/ DELOITTE & TOUCHE LLP
New York, New York
March 13, 2008
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Liz Claiborne, Inc.:
We have audited the accompanying consolidated balance sheets of Liz Claiborne, Inc. and subsidiaries (the “Company”) as of December 29, 2007 and December 30, 2006, and the related consolidated statements of operations, retained earnings, comprehensive loss and changes in capital accounts, and cash flows for each of the three years in the period ended December 29, 2007. Our audits also included the financial statement schedule listed in the Index at Item 15(a)2. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Liz Claiborne, Inc. and subsidiaries as of December 29, 2007 and December 30, 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 29, 2007, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed in Note 1 to the consolidated financial statements, the Company adopted Financial Accounting Standards Board Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement 109,” effective December 31, 2006.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) the Company’s internal control over financial reporting as of December 29, 2007, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 13, 2008 expressed an unqualified opinion on the Company’s internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
New York, New York
March 13, 2008
CONSOLIDATED BALANCE SHEETS
Liz Claiborne, Inc. and Subsidiaries
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
Liz Claiborne, Inc. and Subsidiaries
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
CONSOLIDATED STATEMENTS OF RETAINED EARNINGS, COMPREHENSIVE LOSS AND CHANGES IN CAPITAL ACCOUNTS
Liz Claiborne, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF RETAINED EARNINGS, COMPREHENSIVE LOSS AND CHANGES IN CAPITAL ACCOUNTS (continued)
Liz Claiborne, Inc. and Subsidiaries
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Liz Claiborne, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Liz Claiborne, Inc. and Subsidiaries
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
NOTE 1: BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
Liz Claiborne, Inc. and its wholly owned and majority owned subsidiaries (the “Company”) are engaged primarily in the design and marketing of a broad range of apparel, accessories and fragrances. In the second quarter of 2007, the Company revised its segment reporting structure to reflect the strategic realignment of its businesses and internal reporting. The strategic realignment reflects a brand-focused approach, designed to optimize the operational coordination and resource allocation of the Company’s businesses across multiple functional areas including specialty retail, retail outlets, wholesale apparel, wholesale non-apparel, e-commerce and licensing. Prior periods have been conformed to the current period’s presentation. The two reportable segments described below represent the Company’s brand based activities for which separate financial information is available and which is utilized on a regular basis by its chief operating decision maker (“CODM”) to evaluate performance and allocate resources. In identifying its reportable segments, the Company considers economic characteristics, as well as products, customers, sales growth potential and long-term profitability. The Company aggregates its five operating segments to form reportable segments, where applicable. As such, the Company now reports its operations in two reportable segments as follows:
•
The Direct Brands segment - consists of the specialty retail, outlet, wholesale apparel, wholesale non-apparel (including accessories, jewelry, handbags and fragrances), e-commerce and licensing operations of the Company’s four retail-based operating segments: JUICY COUTURE, KATE SPADE, LUCKY BRAND and MEXX; and
•
The Partnered Brands segment - consists of one operating segment including the wholesale apparel, wholesale non-apparel, outlet and specialty retail, e-commerce and licensing operations of the Company’s wholesale-based brands including: AXCESS, CLAIBORNE (men’s), CONCEPTS BY CLAIBORNE, DANA BUCHMAN, ELLEN TRACY, ENYCE, KENSIE, LIZ & CO., LIZ CLAIBORNE, MAC & JAC, MARVELLA, MONET, NARCISO RODRIGUEZ, SIGRID OLSEN, TRIFARI, VILLAGER, the Company’s licensed DKNY® JEANS and DKNY® ACTIVE brands as well as the Company’s other non-Direct Brands fragrances including: CLAIBORNE, CURVE, ELLEN TRACY, LIZ CLAIBORNE and our licensed USHER fragrance.
In July 2007, the Company announced its long-term strategic plan, which included a strategic review and potential divestiture or closure of 16 of its brands. On October 4, 2007, the Company completed the first phase of such review by finalizing the disposal of certain assets of its former EMMA JAMES, INTUITIONS, J.H. COLLECTIBLES and TAPEMEASURE brands in a single transaction. The Company completed the second phase of such review by disposing of certain assets and liabilities of its C&C CALIFORNIA and LAUNDRY BY DESIGN brands on February 4, 2008 and by entering into a definitive agreement on February 1, 2008 to dispose of substantially all of the assets and liabilities of its prAna brand, which is expected to close in the first quarter of 2008. Also in 2007, the Company closed a distribution center and implemented a plan to sell the building, land and other assets associated with such facility. Pursuant to Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” certain assets and liabilities of the C&C CALIFORNIA, LAUNDRY BY DESIGN and prAna brands, as well as the assets associated with the Company’s closed distribution center, have been segregated and reported as held for sale as of December 29, 2007. The activities of these brands, as well as those of EMMA JAMES, INTUITIONS, J.H. COLLECTIBLES and TAPEMEASURE brands, have been segregated and reported as discontinued operations for all periods presented. Summarized financial data for the aforementioned brands are provided in Note 3 - Discontinued Operations. During 2007, the Company decided to close the SIGRID OLSEN brand, which is expected to occur in the first half of 2008.
On January 17, 2008, the Company announced that it entered into an exclusive license agreement with Kohl’s, whereby Kohl’s will source and sell products under the DANA BUCHMAN brand, and on February 14, 2008, the Company announced an agreement to sell substantially all of the assets and liabilities of ELLEN TRACY (see Note 26 - Subsequent Events).
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company. All intercompany balances and transactions have been eliminated in consolidation.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
FISCAL YEAR
The Company’s fiscal year ends on the Saturday closest to December 31. The 2007, 2006 and 2005 fiscal years each reflected a 52-week period.
USE OF ESTIMATES AND CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 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, derivative instruments and share-based compensation. 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 is recognized from its wholesale, retail and licensing operations. 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 historical 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 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; sales tax collected from customers is excluded from revenue. Proceeds received from the sale of gift cards are recorded as a liability and recognized as sales when redeemed by the holder. Licensing revenues, which amounted to $55.8 million, $45.4 million and $41.0 million during 2007, 2006 and 2005, respectively, 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 realized or settled. Significant judgment is required in determining the worldwide provision for income taxes. Changes in estimates may create volatility in the Company’s effective tax rate in future periods due to settlements with various tax authorities, either favorable or unfavorable, the expiration of the statute of limitations on some tax positions or obtaining new information about particular tax positions that may cause management to change its estimates. In the ordinary course of a global business, the ultimate tax outcome is uncertain for many transactions. It is the Company’s policy to recognize, at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority, the impact of an uncertain income tax position on its income tax return. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. 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 quarterly) and adjustments are made as events occur that warrant adjustments to those provisions. The Company records interest expense and penalties payable to relevant tax authorities as income tax expense.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
Accounts Receivable - Trade, Net
In the normal course of business, the Company extends credit to customers that satisfy pre-defined credit criteria. Accounts receivable - trade, net, as shown on the Consolidated Balance Sheets, is net of allowances and anticipated discounts. An allowance for doubtful accounts is determined through analysis of the aging of accounts receivable at the date of the financial statements, assessments of collectibility based on an evaluation of historical 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 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 historical 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 for seasonal merchandise are recorded at actual average cost. Inventories for replenishment and on-going merchandise are recorded at lower of cost (using the first-in, first-out method) or market value. The Company continually evaluates the composition of its inventories assessing slow-turning, ongoing product as well as prior seasons’ fashion product. Market value of distressed inventory is valued based on historical sales trends for this category of inventory of the Company’s individual product lines, the impact of market trends and economic conditions, and the value of current orders in-house relating to the future sales of this type of inventory. Estimates may differ from actual results due to quantity, quality and mix of products in inventory, consumer and retailer preferences and market conditions. The Company’s historical estimates of these costs and its provisions have not differed materially from actual results.
Goodwill and Other Intangibles, Net
In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill and intangible assets with indefinite lives are not amortized, but rather tested for impairment at least annually.
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 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 in the production process. Under this approach, the Company estimates 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 reporting 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 based on their fair value and determining the fair value of the impaired reporting unit’s goodwill based upon the residual of the summed identified tangible and intangible assets.
The Company completed its annual goodwill impairment tests as of the first day of the third quarter of fiscal 2007. No impairment of goodwill was recognized at that date as a result of such tests.
However, in accordance with SFAS No. 142, the Company performed an additional goodwill impairment test as of December 29, 2007 and recorded a pretax impairment charge of $450.8 million related to goodwill previously recorded in its Partnered Brands segment, which is a reporting unit (see Note 8 - Goodwill and Intangible Assets).
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
Owned trademarks that have been determined to have indefinite lives are also not subject to amortization and are reviewed at least annually for potential impairment in accordance with SFAS No. 142, as mentioned above. The fair value of purchased intangible assets with indefinite lives, primarily trademarks and trade names, are estimated and compared to their carrying value. The Company estimates the fair value of these intangible assets based on an income approach using the relief-from-royalty method. This methodology assumes that, in lieu of ownership, a third party 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, royalty rates in the category of intellectual property, discount 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.
As a result of the impairment analysis performed in connection with the Company’s purchased trademarks with indefinite lives, the Company determined that the carrying value of such intangible asset related to the Company’s ELLEN TRACY brand exceeded its estimated fair value. Accordingly, during 2007, the Company recorded pre-tax charges of $36.3 million ($22.0 million after-tax) to reduce the value of the ELLEN TRACY trademark to its estimated fair value. This impairment resulted from a decline in future anticipated cash flows of the ELLEN TRACY brand.
Intangible assets with finite lives are 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.”
Trademarks having finite lives are amortized over their estimated useful lives. Acquired trademarks are valued using the relief-from-royalty method. Trademarks that are licensed by the Company from third parties are amortized over the individual terms of the respective license agreements, which range from 5 to 15 years. Intangible merchandising rights are amortized over a period of 3 to 4 years. Customer relationships are amortized assuming gradual attrition over time. Existing relationships are amortized over periods ranging from 5 to 25 years.
The recoverability of the carrying values of all long-lived assets with finite lives is re-evaluated 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 brand.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
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 Consolidated Balance Sheets 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 (Loss) Income from Continuing Operations or Accumulated other comprehensive income (loss), depending on whether the derivative qualifies for hedge accounting treatment. Hedge accounting requires the Company to test each derivative for effectiveness at inception of each hedge and at the end of each reporting period.
The Company uses foreign currency forward contracts and options for the purpose of hedging the specific exposure to variability in forecasted cash flows associated primarily with inventory purchases mainly by the Company’s European and Canadian entities. These instruments are designated as cash flow hedges. To the extent the hedges are highly effective, the effective portion of the changes in fair value are included in Accumulated other comprehensive income (loss), net of related tax effects, with the corresponding asset or liability recorded in the Consolidated Balance Sheets. The ineffective portion of the cash flow hedge is recognized primarily as a component of Cost of goods sold 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.
The Company hedges its net investment position in euro functional subsidiaries by borrowing directly in foreign currency and designating a portion of foreign currency debt as a hedge of net investments. The foreign currency transaction gain or loss recognized for a foreign currency denominated debt instrument that is designated as the hedging instrument in a net investment hedge is recorded as a translation adjustment. The Company also uses derivative instruments to hedge the changes in the fair value of the debt due to interest rates, with the change in fair value recognized currently in Interest expense, net together with the change in fair value of the hedged item attributable to interest rates.
Occasionally, the Company purchases short-term foreign currency contracts and options outside of the cash flow hedging program to neutralize quarter-end balance sheet and other expected exposures. These derivative instruments do not qualify as cash flow hedges under SFAS No. 133 and are recorded at fair value with all gains or losses, which have not been significant, recognized as a component of SG&A expenses in current period earnings.
Share-Based Compensation
On July 3, 2005, the Company adopted SFAS No. 123(R) “Share-Based Payment” requiring the recognition of compensation expense in the Consolidated Statements of Operations related to the fair value of employee share-based awards, including stock options and restricted stock. Determining the fair value of options at the grant date requires judgment, including estimating the expected term that stock options will be outstanding prior to exercise, the associated volatility and the expected dividends. Prior to adopting SFAS No. 123(R), the Company applied Accounting Principles Board (“APB”) Opinion No. 25 “Accounting for Stock Issued to Employees”, and related Interpretations, in accounting for its share-based compensation plans. All employee stock options were granted at or above the grant date market price. Accordingly, no compensation cost was recognized for share-based awards prior to July 3, 2005. In accordance with SFAS No. 123(R), judgment is required in estimating the amount of share-based awards expected to be forfeited prior to vesting. If actual forfeitures differ significantly from these estimates, share-based compensation expense could be materially impacted.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
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 values due to the short-term nature of these instruments. The fair value of variable rate long-term debt instruments approximates the carrying value and is estimated based on the current rates offered to the Company for debt of similar maturities. Fixed-rate long-term debt is carried at its value on date of issuance. Fair values for derivatives are either obtained from counter parties or developed using dealer quotes or cash flow models.
Cash and Cash Equivalents
All highly liquid investments with an original maturity of three months or less at the date of purchase are classified as cash equivalents.
Marketable Securities
Investments are stated at market. The estimated fair value of the marketable securities is based on quoted prices in an active market. Gains and losses on investment transactions are determined using the specific identification method and are recognized in income based on settlement dates. Unrealized gains and losses on securities available-for-sale are included in Accumulated other comprehensive loss until realized. Interest is recognized when earned. All marketable securities are considered available-for-sale. Management evaluates securities held with unrealized losses for other-than-temporary impairment at least on a quarterly basis. Consideration is given to (a) the length of time and the extent to which the fair value has been less than cost; (b) the financial condition and near-term prospects of the issuer; and (c) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
Property and Equipment, Net
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. Improvements are capitalized and depreciated in accordance with the Company’s policies; costs for maintenance and repairs are expensed as incurred. Leased property meeting certain capital lease criteria is capitalized and the present value of the related lease payments is recorded as a liability. Amortization of capitalized leased assets is computed on the straight-line method over the shorter of the estimated useful life or the initial lease term. The Company recognizes a liability for the fair value of a conditional asset retirement obligation (“ARO”) if the fair value can be reasonably estimated. The Company’s ARO’s are primarily associated with the removal and disposal of leasehold improvements at the end of a lease term when the Company is contractually obligated to restore the facility back to a condition specified in the lease agreement. Amortization of ARO’s is recorded on a straight-line basis over the life of the lease term.
The Company capitalizes the costs of software developed or obtained for internal use in accordance with Statement of Position No. 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” Capitalization of software developed or obtained for internal use commences during the development phase of the project. The Company amortizes software developed or obtained for internal use on a straight-line basis over five years, when such software is substantially ready for use.
The Company evaluates the recoverability of property and equipment if circumstances indicate an impairment may have occurred, pursuant to SFAS No. 144. This analysis is performed by comparing the respective carrying values of the assets to the current and expected future cash flows, on an undiscounted basis, to be generated from such assets. Property and equipment is evaluated separately within each brand. If such analysis indicates that the carrying value of these assets is not recoverable, the carrying value of such assets is reduced to fair value through a charge to the Company’s Consolidated Statements of Operations. As a result of an impairment analysis performed on property and equipment of the Company’s SIGRID OLSEN brand, the Company determined that the carrying value of such assets exceeded their fair value. Accordingly, during the fourth quarter of 2007, the Company recorded a pre-tax charge of $14.9 million within SG&A on the accompanying Consolidated Statement of
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
Operations in order to reduce the carrying value of such assets to their estimated fair value. The impairment resulted from a decline in future anticipated cash flows of Sigrid Olsen retail stores due to various factors, including the Company’s decision to close the SIGRID OLSEN brand.
Operating Leases
The Company leases office space, retail stores and distribution facilities. Many of these operating leases provide for tenant improvement allowances, rent increases and/or contingent rent provisions. Rental expense is recognized on a straight-line basis commencing with the possession date of the property which is typically the earlier of the lease commencement date or the date when the company takes possession of the property. Certain store leases include contingent rents that are based on a percentage of retail sales over stated thresholds. The current portion of the tenant allowances is included in accrued liabilities, while the long-term portion is recorded as a deferred lease credit. These allowances are amortized on a straight-line basis over the life of the lease as a reduction of rent expense and are included in SG&A expense.
Foreign Currency Translation
Assets and liabilities of non-U.S. subsidiaries have been translated at year-end exchange rates. Revenues and expenses have been translated at average rates of exchange in effect during the year. Resulting translation adjustments have been included in Accumulated other comprehensive loss. Gains and losses on translation of intercompany loans with foreign subsidiaries of a long-term investment nature are also included in this component of Stockholders’ Equity.
Foreign Currency Transactions
Outstanding balances in foreign currencies are translated at the end of period exchange rates. Revenues and expenses for each month are translated using that month’s average exchange rate and then are combined for the period totals. The resulting exchange differences are recorded in the statement of operations or other comprehensive income, as appropriate.
Cost of Goods Sold
Cost of goods sold for wholesale operations include the expenses incurred to acquire and produce inventory for sale, including product costs, freight-in, import costs, third-party inspection activities, buying agent commissions and provisions for shrinkage. For retail operations, in-bound freight from the Company’s warehouse to its own retail stores is also included. Warehousing activities including receiving, storing, picking, packing and general warehousing charges are included in SG&A and, as such, the Company’s gross profit may not be comparable to others who may include these expenses as a component of Cost of goods sold.
Advertising, Promotion and Marketing
All costs associated with advertising, promoting and marketing of Company products are expensed during the periods when the activities take place. Costs associated with cooperative advertising programs involving agreements with customers, whereby customers are required to provide documentary evidence of specific performance and when the amount of consideration paid by the Company for these services are at or below fair value, are charged to SG&A. Costs associated with customer cooperative advertising allowances without specific performance guidelines are reflected as a reduction of sales revenue. Cooperative advertising expenses with specific agreements with customers were $51.8 million in 2007, $40.4 million in 2006 and $31.4 million in 2005. Advertising and promotion expenses were $146.9 million in 2007, $130.7 million in 2006 and $122.9 million in 2005. Marketing expenses, including in-store and other Company-sponsored activities, were $64.4 million in 2007, $55.4 million in 2006 and $53.7 million in 2005.
Shipping and Handling Costs
Shipping and handling costs, which are mostly comprised of warehousing activities, are included as a component of SG&A in the Consolidated Statements of Operations. In fiscal years 2007, 2006 and 2005, shipping and handling costs approximated $259.6 million, $232.2 million and $219.0 million, respectively.
Cash Dividend and Common Stock Repurchase
On January 23, 2008, 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 March 17, 2008 to stockholders of record at the close of business on February 22, 2008. On November 12, 2007, the Company’s Board of Directors authorized the Company to purchase up to an additional $100 million of its common stock for cash in open market purchases and privately negotiated transactions. As of December 29, 2007, the Company had $28.7 million remaining in buyback authorization under its share repurchase program.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
NOTE 2: ACQUISITIONS
On May 18, 2007, the Company acquired 50 percent ownership of the entity that owns the rights to the NARCISO RODRIGUEZ name and trademarks, entered into an exclusive license to operate the NARCISO RODRIGUEZ business worldwide and formed a new company to operate the license and develop the NARCISO RODRIGUEZ brand worldwide. The purchase price totaled $13.9 million, which includes closing fees and certain post-closing adjustments. The Company believes the addition of Narciso Rodriguez provides an opportunity to build a broad business in the luxury designer category (a category in which the Company did not previously participate) that is sold in partnership-oriented, upscale retailers. The Company allocated $8.9 million of purchase price to the value of trademarks and trade names associated with the business, $0.3 million to the value of a non-compete agreement, $0.6 million to the value of a beneficial lease and $5.0 million to goodwill. The $5.0 million of goodwill that was included in the Partnered Brands segment was subsequently written off as part of our fourth quarter 2007 non-cash impairment charge and deducted for tax purposes. The value of trademarks and tradenames, the non-compete agreement and the beneficial lease are being amortized over 7 years, 3 years and 5 years, respectively. As the Company maintains control over the assets and activities of the NARCISO RODRIGUEZ brand, the related financial results have been consolidated from the date of acquisition. Unaudited pro forma information related to this acquisition is not included, as the impact of this transaction is not material to the Company’s consolidated results.
On December 13, 2006, the Company acquired 100 percent of the equity of Kate Spade LLC (“Kate Spade”). Based in New York City, Kate Spade is a designer, marketer, wholesaler and retailer of fashion accessories for women and men through its KATE SPADE® and JACK SPADE® brands. The Company believes the KATE SPADE brand enjoys widespread consumer recognition in the accessible luxury category and provides an opportunity for growth in its direct-to-consumer business. The purchase price totaled approximately $124 million, plus $3.4 million in fees and for certain post-closing adjustments and assumption of liabilities that were accounted for as additional purchase price. The Company allocated $74.9 million of purchase price to the value of trademarks and trade names associated with the business, $6.5 million to the value of customer relationships, $2.6 million to the value of beneficial leases and $36.0 million to goodwill. The trademarks and tradenames are deemed to have indefinite lives and are subject to an annual impairment test. The value of customer relationships and beneficial leases are being amortized over 14 years and from 2 to 9 years, respectively. Unaudited pro forma information related to this acquisition is not included, as the impact of this transaction is not material to the Company’s consolidated results.
On January 26, 2006, the Company acquired 100 percent of the equity of Westcoast Contempo Fashions Limited and Mac & Jac Holdings Limited, which collectively design, market and sell the Mac & Jac, Kensie and Kensiegirl apparel lines (“Mac & Jac”), a privately held fashion apparel company. The purchase price totaled 26.2 million Canadian dollars (or $22.7 million), which includes the retirement of debt at closing and fees, but excludes contingent payments to be determined based upon a multiple of Mac & Jac’s earnings in fiscal years 2006, 2008, 2009 and 2010. There was no contingent payment made based on 2006 fiscal year earnings. The Company allocated $13.9 million of purchase price to the value of trademarks and trade names associated with the business and $5.6 million to the value of customer relationships. The trademarks and trade names are deemed to have indefinite lives and are subject to an annual test for impairment. The value of customer relationships is being amortized over 12 years. The Company currently estimates that the aggregate of the contingent payments will be in the range of approximately $10-12 million and will be accounted for as additional purchase price when paid. Unaudited pro forma information related to this acquisition is not included, as the impact of this transaction is not material to the Company’s consolidated results.
The prAna acquisition agreement requires the Company to make contingent payments to the former owners of prAna based on certain performance parameters of prAna over a pre-determined time frame. In connection with the sale of the prAna brand, the Company agreed to satisfy such contingent obligation for $18.4 million, which will be paid concurrently with the closing of the sale of the prAna brand and will be recorded as an expense within the Company’s Consolidated Statement of Operations in 2008.
On April 7, 2003, the Company acquired 100 percent of the equity of Juicy Couture, Inc. (formerly, Travis Jeans, Inc.) (“Juicy Couture”), a privately held fashion apparel company. The total purchase price consisted of: (i) a payment, including the assumption of debt and fees of $53.1 million and (ii) 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. In March of 2005, the contingent payment agreement was amended to include an advance option for the sellers providing that (i) if the 2005 measurement year is not selected, the sellers may elect to receive up to 70 percent of the estimated contingent payment based upon 2005 results; and (ii) if the 2005 and 2006 measurement years are not selected, the sellers are eligible to elect to receive up to 85 percent of the estimated contingent payment based on the 2006 measurement year
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
net of any 2005 advances. In April 2006, the sellers elected to receive a 70 percent advance against the contingent purchase price and were paid $80.3 million on April 20, 2006. In May 2007, the sellers elected to receive an 85 percent advance against the contingent purchase price and were paid $19.9 million on May 23, 2007. These payments were accounted for as additional purchase price and as increases to goodwill. The 2008 payment of $72.9 million will be made in the first half of 2008 based on a multiple of Juicy Couture’s 2007 earnings, which has been accounted for as additional purchase price and an increase to goodwill.
On June 8, 1999, the Company acquired 85.0 percent of the equity of Lucky Brand Dungarees, Inc. (“Lucky Brand”), whose core business consists of the Lucky Brand Dungarees line of women and men’s denim-based sportswear. The total purchase price consisted of a cash payment made at the closing date of approximately $85.0 million and a payment made in April 2003 of $28.5 million. An additional payment of $12.7 million was made in 2000 for tax-related purchase price adjustments.
On January 16, 2007, January 17, 2006 and January 28, 2005, the Company paid $10.0 million, $10.0 million and $35.0 million, respectively, for 1.5 percent, 1.9 percent and 8.25 percent, respectively, of the equity interest of Lucky Brand. On September 20, 2007, the Company entered into an agreement to acquire the remaining shares that were owned by the sellers of Lucky Brand, amending an agreement signed on January 28, 2005. The Company will acquire 0.4% in each of January of 2008, 2009 and 2010 of the equity interest in Lucky for payments of $5.0 million each. The Company recorded the present value of fixed amounts owed of $14.0 million in Accrued expenses and Other Non-Current Liabilities. As of December 29, 2007, the excess of the liability recorded over the related amount of minority interest has been recorded as goodwill. The remaining 2.28% of the original shares outstanding will be settled for an aggregate purchase price composed of the following two installments: (i) the 2008 payment of $14.4 million that will be made in the first half of 2008 based on a multiple of Lucky Brand’s 2007 earnings, which the Company has accounted for as additional purchase price and (ii) the 2011 payment that will be based on a multiple of Lucky Brand’s 2010 earnings, net of the 2008 payment, which the Company estimates will be in the range of $9-12 million.
NOTE 3: DISCONTINUED OPERATIONS
On October 4, 2007, the Company completed the sale of its former EMMA JAMES, INTUITIONS, J.H. COLLECTIBLES and TAPEMEASURE brands in a single transaction. Consideration for the sale was represented by a note that matured in February 2008 and was issued to the Company from the buyer. The Company has agreed to provide transition services to the buyer through the first quarter of 2008, to ensure a smooth transition for retailers, vendors and employees.
On January 7, 2008, the Company entered into a definitive agreement to dispose of certain assets and liabilities of its C & C CALIFORNIA and LAUNDRY BY DESIGN brands in a single transaction, which closed on February 4, 2008. Also, on February 1, 2008, the Company entered into a definitive agreement to dispose of substantially all of the assets and liabilities of its prAna brand.
During 2007, the Company recorded a pre-tax non-cash charge of $11.8 million ($7.3 million net of tax), to reflect the estimated difference between the carrying value of the assets sold and their estimated fair value, less costs to dispose, including estimated transaction costs.
Assets held for sale on the accompanying consolidated balance sheet for the period ended December 29, 2007 include the following:
Liabilities held for sale consist of accounts payable and accrued expenses.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
Summarized statement of operations data for discontinued operations are as follows:
NOTE 4: LICENSING COMMITMENTS
The Company has an exclusive license agreement for the USHER and USHER RAYMOND trademarks to design, produce, market and sell men’s and women’s fragrances in the US, Canada, Mexico, Europe and Japan. Under the agreement, the Company is obligated to pay a royalty equal to a percentage of net sales of the USHER and USHER RAYMOND products. The initial term of the agreement runs through December 29, 2012.
The Company has an exclusive license agreement with an affiliate of Donna Karan International, Inc. to design, produce, market and sell men’s and women’s sportswear, jeanswear and activewear products in the Western Hemisphere under the “DKNY® Jeans” and “DKNY® Active” marks and logos. Under the agreement, the Company is obligated to pay a royalty equal to a percentage of net sales of the “DKNY® Jeans” and “DKNY® Active” products. The initial term of the license agreement runs through December 31, 2012; the Company has an option to renew for an additional 15-year period if certain sales thresholds are met.
In December 2002, the Company consummated an exclusive license agreement with Kenneth Cole Productions, Inc. to design, manufacture, market and distribute women’s jewelry in the United States under the trademarks “Kenneth Cole New York” and “Reaction Kenneth Cole.” Under the agreement, the Company was obligated to pay a royalty equal to a percentage of net sales of licensed products. The license agreement terminated in January 2008.
The above licenses are subject to minimum guarantees totaling $68.5 million and running through 2012; there is no maximum limit on the license fees paid by the Company.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
NOTE 5: MARKETABLE SECURITIES
In May 2007, the Company sold 69,419 shares of an equity index mutual fund, which was previously considered available-for-sale. In March 2006, the Company sold 341,246 shares of certain equity investments, which were previously considered available-for-sale. There were no sales of investments previously considered available-for-sale for the period ended December 31, 2005.
Total proceeds from sales of investment instruments previously classified as available-for-sale were $9.6 million and $8.1 million for the years ended December 29, 2007 and December 30, 2006, respectively. Realized gains of $0.4 million and $3.6 million, previously recognized in Accumulated other comprehensive loss, were reclassified to Other income (expense), net upon the sale of the securities for the years ended December 29, 2007 and December 30, 2006.
Unrealized holding gains on available-for-sale securities, net of tax, for the years ended December 29, 2007 and December 30, 2006 were $0.3 million and $1.7 million, respectively, which were included in Accumulated other comprehensive loss.
The following is a summary of available-for-sale marketable securities at December 29, 2007 and December 30, 2006:
NOTE 6: INVENTORIES, NET
Inventories, net consist of the following:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
NOTE 7: PROPERTY AND EQUIPMENT, NET
Property and equipment, net consist of the following:
Depreciation and amortization expense on property and equipment for the years ended December 29, 2007, December 30, 2006 and December 31, 2005, was $141.5 million, $117.5 million and $106.9 million, respectively, which includes depreciation for property and equipment under capital leases of $7.2 million, $5.6 million and $5.3 million, respectively. Machinery and equipment under capital leases was $53.1 million and $50.7 million as of December 29, 2007 and December 30, 2006, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
NOTE 8: GOODWILL AND INTANGIBLES, NET
The following tables disclose the carrying value of all the intangible assets:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
Amortization expense of intangible assets was $18.3 million, $16.5 million and $16.3 million for the years ended December 29, 2007, December 30, 2006 and December 31, 2005, respectively. The Company reclassified its segment goodwill to conform with its new segment reporting structure, which is discussed in Note 1 - Basis of Presentation and Significant Accounting Policies.
The estimated amortization expense of intangible assets for the next five years is as follows:
The changes in carrying amount of goodwill for the year ended December 29, 2007 are as follows:
As a result of the sale or probable sale of brands under strategic review in the Company’s Partnered Brands segment and the decline in the actual and projected performance and cash flows of such segment, the Company determined that a goodwill impairment test was required to be preformed as of December 29, 2007, in accordance with SFAS No. 142. In performing this evaluation, the Company considered declines in its market value, which began in the second half of 2007 and reconciled the sum of the estimated fair values of its five reporting units to the Company’s market value (based on its stock price), plus an estimated control premium.
Accordingly, this assessment compared the carrying value of each of the Company’s reporting units with its estimated fair value using discounted cash flow models and market approaches. As a result, the Company determined that the goodwill of its Partnered Brands segment, which is a reporting unit, was impaired and recorded a pretax impairment charge of $450.8 million ($343.1 million, after tax) during the fourth quarter of 2007.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
NOTE 9: ACCRUED EXPENSES
Accrued expenses consisted of the following:
NOTE 10: INCOME TAXES
(Loss) Income before Provision for Income Taxes consisted of the following:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
The (benefit) provision for income taxes are as follows:
Liz Claiborne, Inc. and its U.S. subsidiaries file a consolidated federal income tax return. Deferred income tax benefits and deferred income tax liabilities represent the tax effects of revenues, costs and expenses, which are recognized for tax purposes in different periods from those used for financial statement purposes.
The effective income tax rate differs from the statutory federal income tax rate as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
The components of net deferred taxes arising from temporary differences as of December 29, 2007 and December 30, 2006 are as follows:
As of December 29, 2007, the Company and its domestic subsidiaries had net operating loss carryforwards for state income tax purposes that will reduce future state taxable income. A deferred tax asset of $11.5 million has been established however, a valuation allowance of $1.2 million has reduced the deferred tax asset recorded for certain state net operating loss carryforwards because management believes it is not more likely than not that these assets will be realized. The remaining $10.3 million net deferred tax asset expires between the years 2012 and 2028.
As of December 29, 2007, foreign subsidiaries had net operating loss carryforwards of approximately $106.7 million available to reduce future foreign taxable income. A deferred tax asset has been established however, a valuation allowance of $7.1 million has reduced the deferred tax assets because it is more likely than not that certain of these assets will not be realized. These net operating loss carryforwards expire in the years 2013, 2016 and 2023.
As of December 30, 2006, foreign subsidiaries had net operating loss carryforwards of approximately $76.5 million available to reduce future foreign taxable income. A deferred tax asset has been established. No valuation allowance is needed because it is more likely than not that these assets will be realized.
Foreign unremitted earnings have been retained indefinitely by subsidiary companies for reinvestment. As of December 29, 2007 and December 30, 2006, the amounts were $450.6 million and $481.6 million, respectively. It is not practicable to determine the amount of income taxes payable in the event all such foreign earnings are repatriated.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
The income tax rate in 2007 decreased to 21.7% from 37.2% in 2006. Taxes on earnings were affected by the impact of valuation allowances, goodwill impairment and discrete tax events.
On July 13, 2006, the FASB issued FIN 48, which clarifies the accounting for uncertainty in income taxes recognized by an entity’s financial statements in accordance with SFAS No. 109 and prescribes recognition threshold and measurement attributes for financial statement disclosure of tax positions on the income tax return. Additionally, FIN 48 provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company adopted the provisions of FIN 48 on December 31, 2006 (the first day of the 2007 fiscal year) and recorded a cumulative effect charge to retained earnings of $10.5 million. Changes in the amounts of unrecognized tax benefits for the fiscal year ended December 29, 2007 are summarized as follows:
(a)
Included within Income taxes payable and Other non-current liabilities on the accompanying Consolidated Balance Sheets.
The Company recognized interest and penalties related to unrecognized tax benefits as a component of provision for income taxes. As of December 30, 2006, the last day of the 2006 fiscal year, the Company accrued interest and penalties related to uncertain tax positions in taxes payable and provision for income taxes of approximately $2.7 million for open tax years in U.S. Federal, state, local and foreign jurisdictions. Upon adoption of FIN 48, the Company increased its accrual for interest and penalties to $6.4 million and $2.7 million, respectively. For the year ended December 29, 2007, the Company increased its accrual for interest and penalties by $16.0 million and $1.5 million, respectively. At December 29, 2007, the accrual for interest and penalties was $22.4 million and $4.2 million, respectively.
The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate within the next twelve months is $50.8 million.
The Company files tax returns in the U.S. Federal jurisdiction and various state and foreign jurisdictions. A number of years may elapse before an uncertain tax position, for which the Company has unrecognized tax benefits, is audited and finally resolved. While it is difficult to predict the final outcome or the timing of resolution of any particular uncertain tax position, the Company believes that the unrecognized tax benefits reflect the most likely outcome. We adjust these unrecognized tax benefits, as well as the related interest, in light of changing facts and circumstances. Favorable resolution would be recognized as a reduction to the effective tax rate in the period of resolution.
The number of years with open tax audits vary depending upon the tax jurisdiction. The major tax jurisdictions include the U.S. and the Netherlands. The Company is no longer subject to U.S. Federal examination by the Internal Revenue Service for the years before 2003 and, with a few exceptions, this also applies to tax examinations by state
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
authorities for the years before 2004. The Company is no longer subject to income tax examination by the Dutch tax authorities for the years before 2005. The U.S. and the Netherlands audit issues typically involve the timing of deductions and transfer pricing.
The Company expects a reduction in the liability for unrecognized tax benefits of approximately $52.8 million within the next twelve months due to the expiration of the statute of limitations and various accounting method changes. In addition, other current assets on the accompanying Consolidated Balance Sheet include approximately $81.0 million of taxes receivable from certain state, local and foreign taxing authorities as of December 29, 2007.
NOTE 11: COMMITMENTS, CONTINGENCIES AND OTHER MATTERS
The Company leases office, showroom, warehouse/distribution, retail space and computers and other equipment under various noncancelable operating lease agreements, which expire through 2025. Rental expense for 2007, 2006 and 2005 was approximately $222.7 million, $193.8 million and $157.5 million, respectively, excluding certain costs such as real estate taxes and common area maintenance.
The Company leases retail stores under leases with terms that are typically five or ten years. The Company amortizes leasehold improvements as well as rental abatements, construction allowances and other rental concessions classified as deferred rent, on a straight-line basis over the initial term of the lease or estimated useful lives of the assets, whichever is less. The initial lease term can include one renewal under limited circumstances if the renewal is reasonably assured, based on consideration of all of the following factors: (i) a written renewal at the Company’s option or an automatic renewal, (ii) there is no minimum sales requirement that could impair the Company’s ability to renew, (iii) failure to renew would subject the Company to a substantial penalty, and (iv) there is an established history of renewals in the format or location.
At December 29, 2007, minimum aggregate rental commitments under non-cancelable operating and capital leases are as follows:
Certain rental commitments have renewal options extending through the fiscal year 2037. Some of these renewals are subject to adjustments in future periods. Many of the leases call for additional charges, some of which are based upon various escalations, and, in the case of retail leases, the gross sales of the individual stores above base levels. The Company has no material sublease arrangements.
At December 29, 2007, the Company had entered into short-term commitments for the purchase of raw materials and for the production of finished goods totaling approximately $405.6 million.
Macy’s, Inc., Kohl’s Corporation and J.C. Penney Company, Inc. accounted for approximately 14 percent, 5 percent and 4 percent, respectively, of net sales from continuing operations in 2007.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
Macy’s, Inc. Kohl’s Corporation and Nordstrom, Inc. accounted for approximately 17 percent, 5 percent and 5 percent, respectively, of net sales from continuing operations in 2006. Macy’s, Inc. Dillard’s Inc. and Kohl’s Corporation accounted for approximately 19 percent, 5 percent and 5 percent, respectively, of net sales from continuing operations in 2005. The Company does not believe that this concentration of sales and credit risk represents a material risk of loss with respect to its financial position as of December 29, 2007.
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 totaling $63.7 million. The synthetic lease expired on November 22, 2006. On November 21, 2006, the Company entered into a new synthetic lease with a financial institution for a five-year period, totaling $32.8 million to refinance the land and buildings referred to above. The lessor is a wholly owned subsidiary of a publicly traded corporation. The lessor is a sole member, whose ownership interest is without limitation as to profits, losses and distribution of the lessor’s assets. The Company’s lease represents less than 1% of the lessor’s assets. 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 $27 million. The lessor’s risk included an initial capital investment in excess of 10% of the total value of the lease, which is at risk during the entire term of the lease. The equipment portion of the original synthetic lease was sold to another financial institution and leased back to the Company through a seven-year capital lease totaling $30.6 million. The lessor does not meet the definition of a variable interest entity under FASB Interpretation No. 46R, “Consolidation of Variable Interest Entities” and therefore consolidation by the Company is not required.
See Note 2 - Acquisitions for information regarding contingent payments related to acquisitions made by the Company.
The Company is a party to several pending legal proceedings and claims. 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 financial position, results of operations, liquidity or cash flows (see Note 25 - Legal Proceedings).
NOTE 12: DEBT AND LINES OF CREDIT
Long-term debt consists of the following:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
On October 13, 2004, the Company entered into a $750 million, five-year revolving credit agreement (the “Agreement”). A portion of the funds available under the Agreement not in excess of $250 million is available for the issuance of letters of credit. Additionally, at the request of the Company, the amount of funds available under the Agreement may be increased at any time or from time to time by an aggregate principal amount of up to $250 million with only the consent of the lenders (which may include new lenders) participating in such increase. The Agreement includes a $150 million multi-currency revolving credit line, which permits the Company to borrow in U.S. dollars, Canadian dollars and euros. The Agreement has two borrowing options, an “Alternative Base Rate” option, as defined in the Agreement and a Eurocurrency rate option with a spread based on the Company’s long-term credit rating. The Agreement contains certain customary covenants, including financial covenants requiring the Company to maintain specified debt leverage and fixed charge coverage ratios and covenants restricting the Company’s ability to, among other things, incur indebtedness, grant liens, make investments and acquisitions and sell assets. The funds available under the Agreement may be used to refinance existing debt, to provide working capital and for general corporate purposes of the Company, including, without limitation, the repurchase of capital stock and the support of the Company’s $750 million commercial paper program. On February 29, 2008, the Company entered into an amendment to its revolving credit facility, whereby the fixed charge coverage ratio was modified and certain definitions were revised so that certain cash restructuring charges are excluded from the revised calculation. The Company was also provided a waiver of any potential prior defaults for failure to be in compliance with the fixed charge coverage ratio provided that the Company was in compliance with the amended fixed charge coverage ratio as of the end of fiscal 2007. As of December 29, 2007, the Company was in compliance with such covenants, as amended. A copy of such amendment was filed on Form 8-K, dated February 29, 2008. Both Standard & Poor’s (“S&P”) and Moody’s credit rating services placed the Company’s ratings under review in May 2007 based on the 2007 outlook provided as part of its first quarter 2007 earnings release. During the third quarter of 2007, Moody’s completed its review and lowered the Company’s senior unsecured debt rating to Baa3 from Baa2 and its commercial paper rating to Prime-3 from Prime-2. Also during the third quarter of 2007, S&P completed its review and affirmed the Company’s BBB unsecured debt rating and lowered the Company’s commercial paper rating to A-3 from A-2. On February 15, 2008, Moody’s placed the Company's Baa3 senior unsecured and Prime-3 commercial paper ratings under review for possible downgrade.
On July 6, 2006, the Company completed the issuance of 350 million euro (or $446.9 million based on the exchange rate in effect on such date) 5% Notes (the “Notes”) due July 8, 2013. The net proceeds of the offering were used to refinance the Company’s outstanding 350 million euro 6.625% Notes due August 7, 2006, which were originally issued on August 7, 2001. The Notes bear interest from and including July 6, 2006, payable annually in arrears on July 8 of each year beginning on July 8, 2007. The Notes have been listed on the Luxembourg Stock Exchange and received a credit rating of BBB from Standard & Poor’s and Baa2 from Moody’s Investor Services. During the third quarter of 2007, Moody’s lowered the rating to Baa3 and S&P affirmed the BBB rating. These Notes are designated as a hedge of the Company’s net investment in a foreign subsidiary.
On November 21, 2006, the Company entered into a seven year capital lease with a financial institution totaling $30.6 million. The purpose of the lease was to finance the equipment associated with its distribution facilities in Ohio and Rhode Island, which had been previously financed through the Company’s 2001 synthetic lease, which matured in 2006 (see Note 11 - Commitments and Contingencies).
As of December 29, 2007, the revolving credit facility and commercial paper program, letter of credit facilities and other borrowing facilities available to the Company were as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
NOTE 13: DERIVATIVE INSTRUMENTS
At December 29, 2007, the Company had various Canadian currency collars outstanding with a notional amount of $7.5 million, maturing through September 2008 and with contract rates ranging between 0.96 and 1.09 Canadian dollars per U.S. dollar. The Company had $8.7 million and 45.3 million Hong Kong dollars in Canadian currency collars and 23.3 million Hong Kong dollars in euro currency collars at December 30, 2006. At December 29, 2007, the Company also had forward contracts maturing through December 2008 to sell 14.4 million Canadian dollars for $14.3 million, to sell 24.2 million Canadian dollars for 185.1 million Hong Kong dollars and to sell 68.7 million euro for 736.3 million Hong Kong dollars. The notional value of the foreign exchange forward contracts at December 29, 2007 was $132.3 million, as compared with $97.5 million at December 30, 2006. Unrealized losses for outstanding foreign exchange forward contracts and currency options were $7.1 million at December 29, 2007 and $1.6 million at December 30, 2006. The ineffective portion of these trades is recognized currently in earnings and was $(1.6) million for the twelve months ended December 29, 2007. Approximately $6.5 million in Accumulated other comprehensive loss relating to cash flow hedges will be reclassified into earnings in the next twelve months as the inventory is sold.
In connection with the variable rate financing under the 2001 synthetic lease agreement, the Company entered into two interest rate swap agreements with an aggregate notional amount of $40.0 million that began in January 2003 and terminated in May 2006, in order to fix the interest component of rent expense at a rate of 5.56%. The Company entered into these arrangements to hedge against potential future interest rate increases. The ineffective portion of these swaps recognized in earnings was not material during 2006 or 2005.
The Company hedges its net investment position in euro functional subsidiaries by designating the 350 million euro-denominated bonds as the hedging instrument in a net investment hedge. As a result, the foreign currency transaction gains and losses that are recognized on the euro-denominated bonds in accordance with SFAS No. 52, “Foreign Currency Translation,” are accounted for as a component of accumulated other comprehensive loss rather than recognized currently in income. The unrealized losses recorded to Cumulative translation adjustment were $53.0 million and $48.5 million for the years ended December 29, 2007 and December 30, 2006, respectively.
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 that matured on August 7, 2006. This converted a portion of the fixed rate Eurobonds interest expense to floating rate at a spread over six month EURIBOR. This was designated as a fair value hedge. The first interest rate setting occurred on August 7, 2004 and was reset each six-month period thereafter until maturity. Interest accrued related to these swaps was not material for the periods presented.
In May 2006, the Company entered into multiple forward starting swaps to lock the underlying interest rate on the notional amount of 175 million euro in connection with the July 6, 2006 issuance of the Notes (see Note 12 - Debt and Lines of Credit). These swaps were terminated on June 29, 2006 and the Company subsequently received payment of 1.0 million euro. This amount, net of tax, was recorded in Accumulated other comprehensive loss and will continue to be reclassified into earnings over the seven year term of the Notes. The amount reclassified out of Accumulated other comprehensive loss was not significant for the years ended December 29, 2007 and December 30, 2006.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
NOTE 14: STREAMLINING INITIATIVES
Actions
On July 11, 2007, the Company provided details of its long-term strategic plan. The major elements of the Company’s strategy include the following:
-
Realigning its organization into two new reporting segments: Direct Brands (comprised of our JUICY COUTURE, KATE SPADE, LUCKY BRAND and MEXX retail-based lifestyle brands) and Partnered Brands (comprised of LIZ CLAIBORNE and other Company-owned and licensed wholesale-based brands). The strategic realignment reflects a brand-focused approach, designed to optimize the operational coordination and resource allocation of the Company’s businesses across multiple functional areas including specialty retail, retail outlets, wholesale apparel, wholesale non-apparel, e-commerce and licensing;
-
Conducting a review of strategic alternatives, including possible divestiture, discontinuation or licensing of sixteen of the Company’s brands:
-
Implementing and maintaining a more competitive cost structure: the Company has accelerated its structural realignment and other initiatives to achieve cost savings targets through staff reductions, closing and consolidations of distribution facilities and office space, discretionary expense cuts, process re-engineering and supply chain cost rationalization.
The above mentioned announcements followed the Company’s streamlining activities announced in 2006.
Actions
In February 2006 and October 2006, the Company announced initiatives to streamline its operations to increase efficiency and more closely align its businesses with customer and consumer needs. These efforts included the redeployment of resources in order to better capitalize on compelling growth opportunities across a number of our brands.
For the period ended December 29, 2007, the Company recorded $120.7 million ($78.0 million after-tax) related to this initiative, including $49.8 million of payroll and related costs, $20.7 million of lease termination costs, $44.0 million of fixed asset write-downs and disposals and $6.1 million of other costs. Approximately $44.7 million of these charges were non-cash. The Company expects to pay substantially all accrued streamlining costs by the end of the first half of 2008. For the year ended December 30, 2006, the Company recorded $81.6 million ($51.3 million after-tax) related to this initiative, including $41.9 million of payroll and related costs, $10.2
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
million of lease termination costs, $22.6 million of fixed asset write-downs and disposals and $7.0 million of other costs. Approximately $22.6 million of these charges were non-cash.
For the years ended December 29, 2007 and December 30, 2006, these expenses, primarily recorded in SG&A in the Consolidated Statements of Operations, impacted business segments as follows:
A summary rollforward of streamlining initiatives is as follows:
NOTE 15: OTHER INCOME (EXPENSE), NET
Other income (expense), net consists of the following:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
NOTE 16: SHARE-BASED COMPENSATION
On July 3, 2005, the Company adopted the provisions of SFAS No. 123(R) and since that time has recognized the cost of all employee share-based awards on a straight-line attribution basis over their respective vesting periods, net of estimated forfeitures. The Company selected the modified prospective method of transition; accordingly, prior periods have not been restated. Prior to adopting SFAS No. 123(R), the Company applied APB Opinion No. 25 and related Interpretations in accounting for its share-based compensation plans; all employee stock options were granted at or above the grant date market price; accordingly, no compensation cost was recognized for fixed stock option grants in prior to the adoption of SFAS No.123(R).
The Company issues stock options and restricted shares as well as shares with performance features to employees under share-based compensation plans. Stock options are issued at the current market price, have a three-year vesting period and a contractual term of 7-10 years. As of December 29, 2007, the Company has not changed the terms of any outstanding awards.
Compensation expense for restricted stock awards is measured at fair value on the date of grant based on the number of shares granted and the quoted market price of the Company’s common stock. Such value is recognized as expense over the vesting period of the award, net of estimated forfeitures.
The following table details the effect on net income and earnings per share “as reported” as if compensation expense had been recorded for the period of January 2, 2005 through July 3, 2005 based on the fair value method under SFAS No. 123, “Accounting for Stock-Based Compensation” (“pro forma”). The reported and pro forma net income and earnings per share for the years ended December 29, 2007 and December 30, 2006 are the same since share-based compensation expense is calculated under the provisions of SFAS No. 123(R) for such fiscal years.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
Total share-based compensation expense was $19.4 million, $22.7 million and $23.7 million for the fiscal years ended December 29, 2007, December 30, 2006 and December 31, 2005, respectively, and $11.8 million, $14.2 million and $15.3 million net of tax for the fiscal years ended December 29, 2007, December 30, 2006 and December 31, 2005, respectively. All share-based compensation expense is inclusive of amounts related to discontinued operations, which are insignificant for all periods presented.
The Company utilizes the Binomial lattice pricing model to estimate the fair value of options granted. The Company believes this model provides the best estimate of fair value due to its ability to incorporate inputs that change over time, such as volatility and interest rates, and to allow for actual exercise behavior of option holders.
Expected volatilities are based on a term structure of implied volatility, which assumes changes in volatility over the life of an option. The Company utilizes historical optionee behavioral data to estimate the option exercise and termination rates that are used in the valuation model. The expected term represents an estimate of the period of time options are expected to remain outstanding. The expected term provided in the above table represents an option weighted-average expected term based on the estimated behavior of distinct groups of employees who received options in 2007, 2006 and 2005. The range of risk-free rates is based on a forward curve of interest rates at the time of option grant.
Stock Plans
In March 1992, March 2000, March 2002 and March 2005, the Company adopted the “1992 Plan,” the “2000 Plan,” the “2002 Plan” and the “2005 Plan” respectively, under which options (both nonqualified options and incentive stock options) to acquire shares of common stock may be granted to officers, other key employees, consultants and, in the case of the 1992, 2000 and 2005 plans, outside directors, in each case as selected by the Company’s Compensation Committee (the “Committee”). Payment by option holders upon exercise of an option may be made in cash or, with the consent of the Committee, by delivering previously acquired shares of Company common stock or any other method approved by the Committee. If previously acquired shares are tendered as payment, the shares are subject to a six-month holding period, as well as specific authorization by the Committee. To date, this type of exercise has not been approved or transacted. The Committee has the authority under all of the plans to allow for a cashless exercise option, commonly referred to as a “broker-assisted exercise.” Under this method of exercise, participating employees must make a valid exercise of their stock options through a designated broker. Based on the exercise and information provided by the Company, the broker sells the shares on the open market. The employees receive cash upon settlement, some of which is used to pay the purchase price. Neither the stock-for-stock nor broker-assisted cashless exercise option are generally available to executive officers or directors of the Company. Although there are none currently outstanding, stock appreciation rights may be granted in connection with all or any part of any option granted under the plans, and may also be granted without a grant of a stock option. Vesting schedules will be accelerated upon a change of control of the Company. Options and stock appreciation rights generally may not be transferred during the lifetime of a holder.
Awards under the 2000, 2002 and 2005 Plans may also be made in the form of stock options, dividend equivalent rights, restricted stock, unrestricted stock and performance shares, and in the case of the 2005 Plan, restricted stock units. Exercise prices for awards under the 2000, 2002 and 2005 Plans are determined by the Committee; to date, all stock options have been granted at an exercise price not less than the closing market value of the underlying shares on the date of grant.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
The 2000 Plan provides for the issuance of up to 10,000,000 shares of common stock with respect to options, stock appreciation rights and other awards. No incentive stock options may be granted under the 2000 Plan after March 9, 2010. Upon shareholder approval of the 2000 Plan in May 2000, the Company ceased issuing grants under the 1992 Plan; awards made there under prior to its termination remain in effect in accordance with their terms. The 2002 Plan provides for the issuance of up to 9,000,000 shares of common stock with respect to options, stock appreciation rights and other awards. The 2002 plan expires in 2012. The 2005 Plan provides for the issuance of up to 5,000,000 shares of common stock with respect to options, stock appreciation rights and other awards. The 2005 plan expires in 2015, but no performance-based awards may be granted after the fifth anniversary of the 2005 Plan’s adoption. As of December 29, 2007, 7,876,532 shares were available for future grant under the 2000, 2002 and 2005 Plans.
The Company delivers treasury shares upon the exercise of stock options. The difference between the cost of the treasury shares, on a first-in, first-out basis, and the exercise price of the options has been reflected in Stockholders’ Equity. If the exercise price of the options is higher than the cost of the treasury shares, the amount is reflected in Capital in excess of par value. If the exercise price of the options is lower than the cost of the treasury shares, the amount is reflected in Retained earnings.
Stock Options
Changes in common shares under option for the fiscal year ended December 29, 2007 are summarized as follows:
The total intrinsic value of options exercised during the fiscal years ended December 29, 2007, December 30, 2006 and December 31, 2005 was $22.6 million, $29.1 million, and $19.1 million, respectively.
As of December 29, 2007, there was $8.1 million of total unrecognized compensation cost related to nonvested stock options granted under the Company’s stock option plans. That cost is expected to be recognized over a weighted average period of 2.1 years. The total fair value of shares vested for the years ended December 29, 2007, December 30, 2006 and December 31, 2005 was $19.0 million, $21.8 million and $28.0 million, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
Restricted Stock
From 2001 through 2004, the Committee granted a total of 233,966 shares of restricted stock under the 2000 Plan to a group of key executives. In 2005, the committee granted an additional 10,000 shares under the 2002 Plan to a key executive. As of December 29, 2007, 10,000 of these shares remained outstanding. These shares are subject to restrictions on transfer and risk of forfeiture until earned by continued service and vest as follows: 20 percent on each of the third, fourth and fifth grant date anniversary, and the remaining 40 percent on the sixth grant date anniversary, with acceleration of vesting upon the achievement of certain financial and non-financial goals. The unearned compensation is being amortized over a period equal to the anticipated vesting period.
The Company’s former CEO retired at the end of 2006 when his contract expired. Upon his retirement, all restricted shares previously awarded vested as of December 30, 2006 and were released, net of shares withheld for taxes, at that time. Additionally, in January 2007, 119,391 shares were released, net of shares withheld for taxes, based on the Committee’s assessment of the extent to which the performance targets related to previously granted restricted shares were achieved. These net shares issued, as well as all options outstanding, continue to be subject to certain holding requirements.
In November 2006, pursuant to the terms of his employment agreement, the Company’s CEO and member of its Board of Directors, William L. McComb, was granted by the Committee: (a) options to purchase 185,200 shares of the Company’s common stock that will vest 25% on the first anniversary of the grant date, 25% on the second anniversary and 50% on the third anniversary; (b) “premium priced” options (options with an exercise price equal to 120% of the closing price on the date of grant) to purchase 63,150 shares of the Company’s common stock that will vest 25% on the first anniversary of the grant date, 25% on the second anniversary and 50% on the third anniversary; (c) 76,355 restricted shares, which vest in three equal installments on the first three anniversaries of grant; and (d) 62,500 restricted shares which shares vested in full on the fifth anniversary of grant. The shares received upon exercise of the options, as well as the other restricted shares, are subject to certain transfer restrictions that will lapse in full on December 31, 2010.
The Company’s non-employee Directors receive an annual grant of shares of Common Stock with a value of $100,000 as part of their annual retainer for serving on the Board of Directors. Retainer share grants to non-employee Directors are made pursuant to the 2000 Plan, the 2002 Plan or the 2005 Plan. Retainer shares are non-transferable until the first anniversary of the grant, with 25 percent becoming transferable on each of the first and second anniversary of the grant and 50 percent becoming transferable on the third anniversary, subject to certain exceptions.
In 2004, the Committee granted 724,000 restricted shares to a group of key executives. As of December 29, 2007, 227,500 of these shares remained outstanding. These shares are subject to restrictions on transfer and subject to risk of forfeiture until earned by continued employment. The restrictions expire in January 2010. The expiration of restrictions may be accelerated if the total return on the Company’s common stock exceeds that of a predetermined group of competitors or upon the occurrence of certain other events. The unearned compensation is being amortized over a period equal to the anticipated vesting period.
In January 2006, the Committee granted 166,500 shares of restricted stock to a group of key executives. As of December 29, 2007, 27,800 shares remained outstanding and 122,550 shares have vested. Shares vest in equal installments based upon achievement of certain financial performance metrics during the third and fourth quarters of 2006, with one-half of the shares vesting on or before March 31, 2007 and one-half vesting on January 1, 2008, subject to continued employment with the Company and confirmation by the Committee that the performance metrics were achieved.
In July 2007, the Committee approved the issuance of Performance Share Awards to certain of its employees, including the Company’s executive officers. Performance Shares are earned based on the achievement of certain profit generation, profitability and return on capital targets aligned with the Company’s strategy, for performance through fiscal year 2009, with the number of shares earned ranging from 0 to 150% of the target amount, or 190,000 shares.
In fiscal years 2007, 2006 and 2005, the Committee granted a total of 1,702,500 restricted shares to a group of domestic and international employees who, in previous years, would have been entitled to a grant of stock options. As of December 29, 2007, 954,610 of these shares remained outstanding. These shares are subject to
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
restrictions on transfer and subject to risk of forfeiture until earned by continued employment and vest 50 percent on each of the second and third grant date anniversary. The unearned compensation is being amortized over a period equal to the anticipated vesting period.
The change in restricted shares for the year ended December 29, 2007 is summarized as follows:
The weighted average grant date fair value of restricted shares granted in the years ended December 29, 2007, December 30, 2006 and December 31, 2005 was $40.36, $38.89 and $40.72, respectively.
As of December 29, 2007, there was $23.2 million of total unrecognized compensation cost related to nonvested restricted share awards granted under the restricted stock plans. That cost is expected to be recognized over a weighted average period of 1.9 years. The total fair value of shares vested during the years ended December 29, 2007, December 30, 2006 and December 31, 2005 was $20.2 million, $5.8 million and $0.7 million, respectively.
NOTE 17: PROFIT-SHARING RETIREMENT, SAVINGS AND DEFERRED COMPENSATION PLANS
The Company maintains a qualified defined contribution plan (the “401(k)/Profit Sharing Plan”) for eligible U.S. employees of the Company and adopting affiliates, which has two component parts: a cash or deferred arrangement under section 401(k) of the Internal Revenue Code, and employee matching contributions including a discretionary profit sharing component. To be eligible to participate in either component of the 401(k)/Profit Sharing Plan, employees must be at least age 21 and not covered by a collective bargaining agreement. There are additional eligibility and vesting rules for each of the 401(k)/Profit Sharing Plan components. Full-time employees may begin to make pre-tax contributions and receive employer-matching contributions to the 401(k) component of the 401(k)/Profit Sharing Plan after six months of employment with the Company, while part-time employees must complete a 12-month period in which they are credited with 1,000 hours of service. An employee becomes eligible for the profit sharing component upon completion of 12 months and 1,000 hours of service. Once eligible, a participant must be credited with 1,000 hours of service during a plan year and be employed by the Company, or one of its affiliates, on the last day of the calendar year to share in the profit sharing contribution for that year.
The Company’s aggregate 401(k)/Profit Sharing Plan contribution expense for 2007, 2006 and 2005, which is included in SG&A expenses, was $4.4 million, $7.0 million and $11.0 million, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
The Company has a non-qualified supplemental retirement plan for certain employees whose benefits under the 401(k)/Profit Sharing Plan are expected to be constrained by the operation of certain Internal Revenue Code limitations. The supplemental plan provides a benefit equal to the difference between the contribution that would be made for an employee under the tax-qualified plan absent such limitations and the actual contribution under that plan. The supplemental plan also allows certain employees to defer up to 50 percent of their base salary and up to 100 percent of their annual bonus. The Company established an irrevocable “rabbi” trust to which the Company made periodic contributions to provide a source of funds to assist in meeting its obligations under the supplemental plan. The principal of the trust and earnings thereon, are to be used exclusively for the participants under the plan, subject to the claims of the Company’s general creditors.
NOTE 18: STOCKHOLDER RIGHTS PLAN
In December 1998, the Company adopted a new Stockholder Rights Plan to replace the then expiring plan originally adopted in December 1988. Under the new Plan, one preferred stock purchase right is attached to each share of common stock outstanding. The rights are nominally exercisable under certain circumstances, to buy 1/100 share of a newly created Series A Junior Participating Preferred Stock for $150. If any person or group (referred to as an “Acquiring Person”) becomes the beneficial owner of 15 percent or more of the Company’s common stock (20 percent or more in the case of certain acquisitions by institutional investors), each right, other than rights held by the Acquiring Person which become void, will become exercisable for common stock having a market value of twice the exercise price of the right. If anyone becomes an Acquiring Person and afterwards the Company or 50 percent or more of its assets is acquired in a merger, sale or other business combination, each right (other than voided rights) will become exercisable for common stock of the acquirer having a market value of twice the exercise price of the right. The rights, which expire on December 21, 2008, do not have voting rights and may be amended by the Company’s Board of Directors and redeemed by the Company at $0.01 per right at any time before any person or group becomes an Acquiring Person.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
NOTE 19: EARNINGS PER COMMON SHARE
The following is an analysis of basic and diluted (loss) earnings per common share (“EPS”) in accordance with SFAS No. 128, “Earnings per Share.”
(a)
Because the Company incurred a loss from continuing operations in 2007, outstanding stock options and restricted shares are anti-dilutive. Accordingly, basic and diluted weighted average shares outstanding are equal for such period.
(b)
Options to purchase 63,000 and 2,957,000 shares of common stock were outstanding as for fiscal years 2006 and 2005, respectively, but were not included in the computation of diluted EPS for the years then ended because such options were anti-dilutive.
(c)
Excludes restricted stock for which the performance period has not yet lapsed and criteria have not yet been achieved.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
NOTE 20: CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTARY DISCLOSURES
During fiscal 2007, 2006 and 2005, the Company made income tax payments of approximately $63.7 million, $141.0 million and $174.2 million, respectively. The Company made interest payments of approximately $49.6 million, $36.7 million and $33.0 million in 2007, 2006 and 2005, respectively. On November 21, 2006, the Company entered into a seven year capital lease with a financial institution totaling $30.6 million. The purpose of the lease was to finance the equipment associated with its distribution facilities in Ohio and Rhode Island, which had been previously financed through our 2001 synthetic lease, which matured in 2006. There were no other non-cash activities in the years ended December 29, 2007, December 30, 2006 or December 31, 2005.
NOTE 21: SEGMENT REPORTING
In the second quarter of 2007, the Company revised its segment reporting structure to reflect the strategic realignment of its businesses and internal reporting. The strategic realignment reflects a brand-focused approach, designed to optimize the operational coordination and resource allocation of the Company’s businesses across multiple functional areas including specialty retail, retail outlets, wholesale apparel, wholesale non-apparel, e-commerce and licensing. Prior periods have been conformed to the current period’s presentation. The two reportable segments described below represent the Company’s brand based activities for which separate financial information is available and which is utilized on a regular basis by its CODM to evaluate performance and allocate resources. In identifying its segments, the Company considers economic characteristics, as well as products, customers, sales growth potential and long-term profitability. The Company aggregates its operating segments to form reportable segments, where applicable. As such, the Company reports its operations in two reportable segments as follows:
•
The Direct Brands segment - consists of the specialty retail, outlet, wholesale apparel, wholesale non-apparel (including accessories, jewelry, handbags and fragrances), e-commerce and licensing operations of the Company’s four retail-based brands: JUICY COUTURE, KATE SPADE, LUCKY BRAND and MEXX; and
•
The Partnered Brands segment - consists of the wholesale apparel, wholesale non-apparel, outlet and specialty retail, e-commerce and licensing operations of the Company’s wholesale-based brands including: AXCESS, CLAIBORNE (men’s), CONCEPTS BY CLAIBORNE, DANA BUCHMAN, ELLEN TRACY, ENYCE, KENSIE, LIZ & CO., LIZ CLAIBORNE, MAC & JAC, MARVELLA, MONET, NARCISO RODRIGUEZ, SIGRID OLSEN, TRIFARI, VILLAGER, the Company’s licensed DKNY® JEANS and DKNY® ACTIVE brands as well as the Company’s other non-Direct Brands fragrances including: CLAIBORNE, CURVE, ELLEN TRACY, LIZ CLAIBORNE and our licensed USHER fragrance.
As discussed in Note 1 - Basis of Presentation and Significant Accounting Policies, certain assets and liabilities of the C & C CALIFORNIA, LAUNDRY BY DESIGN and prAna brands, as well as the assets associated with the Company’s closed distribution center, have been segregated and reported as held for sale as of December 29, 2007. The activities of these brands, as well as those of EMMA JAMES, INTUITIONS, J.H. COLLECTIBLES and TAPEMEASURE, previously included in the Partnered Brands Segment, have been segregated and reported as discontinued operations for all periods presented. Summarized financial data for the aforementioned brands are provided in Note 3 - Discontinued Operations.
The Company also announced the consolidation of its STAMP 10 and TINT brands into its AXCESS and LIZ & CO. brands, respectively, and the closure of its FIRST ISSUE brand, which occurred in early 2008.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
The Company’s Chief Executive Officer has been identified as the CODM. The CODM evaluates performance and allocates resources based primarily on operating income of each reportable segment. The accounting policies of the Company’s reportable segments are the same as those described in Note 1 - Basis of Presentation and Significant Accounting Policies. There are no inter-segment sales or transfers. The Company also presents its results on a geographic basis based on selling location, between Domestic (wholesale customers, Company specialty retail and outlet stores located in the United States and e-commerce sites) 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 resulting royalty income is included within the results of the associated segment.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
GEOGRAPHIC DATA
(a)
The Domestic operating loss includes pre-tax, non-cash impairment charges of (i) $36.3 million related to the Company’s ELLEN TRACY trademark, (ii) $14.9 million related to property and equipment of the Company’s SIGRID OLSEN brand and (iii) $450.8 million related to the impairment of goodwill (see Note 1 - Basis of Presentation and Summary of Significant Accounting Policies).
In connection with the realignment of its segment reporting structure, the Company reclassified its segment assets as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
NOTE 22: ACCUMULATED OTHER COMPREHENSIVE LOSS
Accumulated other comprehensive loss is comprised of the effects of foreign currency translation and changes in unrealized gains and losses on securities, as detailed below:
The losses on cash flow hedging derivatives are reclassified to current year gain or loss each year due to the short lives of these instruments.
As discussed in Note 13-Derivative Instruments, the Company hedges its net investment position in euro functional subsidiaries by designating the 350 million euro-denominated bonds as the hedging instrument in a net investment hedge. As a result, the foreign currency transaction gains and losses that are recognized on the euro-denominated bonds in accordance with SFAS No. 52 are accounted for as a component of accumulated other comprehensive loss. As of December 29, 2007, the Company recorded a tax benefit of $19.4 million related to such foreign currency transaction gains and losses in the cumulative translation adjustment account in other comprehensive loss (a component of shareholders’ equity). This tax benefit reduced taxes payable, the current year comprehensive loss and accumulated comprehensive loss by an equal amount. Tax benefits related to the cumulative translation account were not reflected in the reported amounts for prior periods, and, as a result, accumulated comprehensive loss and taxes payable at December 30, 2006 were overstated by approximately $16.2 million. The Company’s results of operations and cash flows were not affected by this adjustment for the periods presented.
NOTE 23: RECENT ACCOUNTING PRONOUNCEMENTS
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements.” SFAS No. 160 amends Accounting Research Bulletin No. 51, “Consolidated Financial Statements” and requires (i) classification of noncontrolling interests, commonly referred to as minority interests, within stockholders’ equity, (ii) net income to include the net income attributable to the noncontrolling interest and (iii) enhanced disclosure of activity related to noncontrolling interests. Currently, the Company classifies noncontrolling interests as liabilities and excludes net income attributable to noncontrolling interests from net income. SFAS No. 160 is effective for fiscal years beginning after December 15, 2008. The Company is currently assessing the impact of SFAS No. 160 on its consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141 (Revised), “Business Combinations,” which provides revised guidance for how an acquirer in a business combination recognizes and measures in its financial statements (i) identifiable assets acquired, (ii) liabilities assumed, (iii) noncontrolling interests in the acquiree and (iv) goodwill or a gain from a bargain purchase. SFAS No. 141(R) also sets forth the disclosures required to be made in the financial statements related to effects of a business combination. SFAS No. 141(R) applies to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company will adopt the provisions of SFAS No. 141(R) as required.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115.” SFAS No. 159 allows companies the choice to measure financial instruments and certain other items at fair value. This allows the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company does not believe adopting the provisions of SFAS No. 159 will have a significant impact on its consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company does not believe adopting the provisions of SFAS No. 157 will have a significant impact on its consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
NOTE 24: RELATED PARTY TRANSACTIONS
During 2007, 2006 and 2005, the Company paid the law firm, Kramer, Levin, Naftalis & Frankel LLP, of which Kenneth P. Kopelman (a Director of the Company) is a partner, approximately $0.8 million, $2.0 million and $3.9 million, respectively, for fees incurred in connection with legal services provided to the Company. The 2007 amount represents less than one percent of such firm’s 2007 fee revenue. The foregoing transactions between the Company and this entity were effected on an arm’s-length basis, with services provided at fair market value.
During 2007, 2006 and 2005, the Company leased a certain office facility from Amex Property B.V. (“Amex”), a company whose principal owner is Rattan Chadha, former President and Chief Executive Officer of Mexx, under a 20-year lease agreement, which commenced in 2001. The space houses the principal headquarters of Mexx Group B.V. in Voorschoten, Netherlands. The rental paid to Amex during fiscal years 2007, 2006 and 2005 was $0.7 million, $0.7 million and $0.7 million, respectively, excluding a $1.6 million charge to terminate the lease in 2007.
The Company believes that each of the transactions described above was effected on terms no less favorable to the Company than those that would have been realized in transactions with unaffiliated entities or individuals.
NOTE 25: LEGAL PROCEEDINGS
The Company's previously owned Augusta, Georgia facility became listed during 2004 on the State of Georgia’s Hazardous Site Inventory of environmentally impacted sites due to the detection of certain chemicals at the site. In November 2005, the Georgia Department of Natural Resources requested that the Company submit a compliance status report and compliance status certification regarding the site. The Company submitted the requested materials in the second quarter of 2006. In October 2006, the Company received a letter from the Department of Natural Resources requesting that the Company provide additional information and perform additional tests to complete the compliance status report, which was previously submitted. Additional testing was completed and the Company submitted the results in the second quarter of 2007. The Georgia Department of Natural Resources has reviewed the Company’s submission and has requested certain modifications to the response and some minimal additional testing. The Company has submitted the modified response and additional testing results.
The Company is a party to several pending legal proceedings and claims. 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 financial position, results of operations, liquidity or cash flows.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
NOTE 26: SUBSEQUENT EVENTS
On January 17, 2008, the Company entered into an exclusive license agreement with Kohl’s, naming Kohl’s as the exclusive retailer for the DANA BUCHMAN brand. Under the arrangement, the DANA BUCHMAN brand will be designed by the Company, and Kohl’s will lead the manufacturing, production, distribution and marketing of the brand. As a result, the Company expects to close our current DANA BUCHMAN operations in the first half of 2008 and that the launch of the DANA BUCHMAN line in Kohl’s stores will occur no later than the first quarter of 2009.
On February 1, 2008, the Company entered a definitive agreement to sell substantially all of the assets and liabilities of its prAna brand to the former owners of prAna and Steelpoint Capital Partners for consideration of $36.5 million and a contingent payment of up to $4.0 million based on 2008 EBITDA. In connection with the disposition, the Company will settle the contingent earn out obligation resulting from its 2005 acquisition of prAna with an $18.4 million payment to the prAna founders.
On February 4, 2008, the Company completed the sale of substantially all of the assets and liabilities of its former C&C CALIFORNIA and LAUNDRY brands for net cash proceeds of $33.1 million.
Also, on February 14, 2008, the Company entered a definitive agreement to sell substantially all of the assets and liabilities of its ELLEN TRACY brand to a group of investors, including Radius Partners, LLC, for consideration of $27.3 million, subject to adjustment, and a contingent cash payment of up to $15.0 million based on performance from 2008 through 2012.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
NOTE 27: UNAUDITED QUARTERLY RESULTS
Unaudited quarterly financial information for 2007 and 2006 is set forth in the table below. Certain amounts relating to the first and second quarters of 2007 and 2006 have been revised from those previously reported in the Company’s quarterly filings on Form 10-Q in order to present the C&C CALIFORNIA, LAUNDRY BY DESIGN, prAna, EMMA JAMES, INTUITIONS, J.H. COLLECTIBLES and TAPEMEASURE brands as discontinued operations. Certain amounts relating to the third quarter of 2007 and 2006 have been revised from those previously reported in the Company’s quarterly filings on Form 10-Q in order to present the C&C CALIFORNIA, LAUNDRY BY DESIGN and prAna brands as discontinued operations. See Note 3 - Discontinued Operations.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liz Claiborne, Inc. and Subsidiaries
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Liz Claiborne, Inc. and Subsidiaries
(A)
Uncollectible accounts written off, less recoveries.