Item 1A. For example, during the period between May 15, 2008 and February 18, 2011, the trading price of our Common Stock as reported on the New York Stock Exchange ranged from a low of $12.22 on November 21, 2008 to a high of $58.95 on December 17, 2010.
Increases in the prices of raw materials used to manufacture our products or increases in costs to produce or transport our products could materially increase our costs and decrease our profitability.
The principal fabrics used in our business are made from cotton, wool, silk, synthetic and cotton-synthetic blends. The costs of these fabrics are dependent on the market prices for the raw materials used to produce them, primarily cotton and chemical components of synthetic fabrics. These raw materials are subject to price volatility caused by weather, supply conditions, government regulations, energy costs, economic climate and other unpredictable factors. Fluctuations in petroleum prices may also influence the prices of related items such as chemicals, dyestuffs and polyester yarn as well as the costs we incur to transport products from our suppliers and costs we incur to distribute products to our customers. Any raw material price increase or increase in costs related to the transport of our products (primarily petroleum costs) could increase our cost of sales and decrease our profitability unless we are able to pass higher prices on to our customers. In addition, if one or more of our competitors is able to reduce its production costs by taking greater advantage of any reductions in raw material prices, favorable sourcing agreements or new manufacturing technologies (which enable manufacturers to produce goods on a more cost-effective basis) we may face pricing pressures from those competitors and may be forced to reduce our prices or face a decline in net sales, either of which could have an adverse effect on our business, results of operations or financial condition.
During the fourth quarter of Fiscal 2010, we experienced an increase in costs, including those for raw material, labor and freight, which we anticipate will continue in the fiscal year ending 2011. We expect to partially mitigate cost increases in 2011 and their effect on gross margins through a combination of sourcing initiatives, price increases, and continuing shifts in our business, favoring international and direct to consumer channels, which carry higher gross margins. There is no certainty that such measures will achieve their goal.
The apparel industry is subject to pricing pressures that may require us to lower the prices we charge for our products.
In addition to the product cost pressures discussed above, we and our competitors also face selling price pressure as a result of increases in sales through the mass and off-price retail channels of distribution (which retailers seek to sell their products at discounted prices) as well as consolidation in the retail industry (which could result in larger customers with greater negotiating leverage). To remain competitive, we must adjust our prices from time to time in response to these industry-wide pricing and cost pressures. In addition, certain of our customers seek allowances, incentives and other forms of economic support. Our profitability may be negatively affected by these pricing pressures if we are forced to reduce our prices but are unable to reduce our production or other operating costs.
We have foreign currency exposures relating to buying, selling and financing in currencies other than the U.S. dollar, our functional currency.
We have significant foreign currency exposure related to foreign denominated revenues and costs, which must be translated into U.S. dollars. Fluctuations in foreign currency exchange rates (particularly any strengthening of the U.S. dollar relative to the Euro, Canadian dollar, British pound, Korean won, Mexican peso, Brazilian real and Chinese yuan) may adversely affect our reported earnings and the comparability of period-to-period results of operations. In addition, while certain currencies (notably the Hong Kong dollar) are currently fixed or managed in value in relation to the U.S. dollar by foreign central banks or governmental entities, such conditions may change, thereby exposing us to various risks as a result.
Certain of our foreign operations purchase products from suppliers denominated in U.S. dollars and Euros, which may expose such operations to increases in cost of goods sold (thereby lowering profit margins) as a result of foreign currency fluctuations. Our exposures are primarily concentrated in the Euro, Canadian dollar, British pound, Korean won and Mexican peso. Changes in currency exchange rates may also affect the relative prices at which we and our foreign competitors purchase and sell products in the same market and the cost of certain items required in our operations. In addition, certain of our foreign operations have receivables or payables denominated in currencies other than their functional currencies, which exposes such operations to foreign exchange losses as a result of foreign currency fluctuations. We have instituted foreign currency hedging programs to mitigate the effect of foreign currency fluctuations on our operations. However, management of our foreign currency exposure may not sufficiently protect us from fluctuations in foreign currency exchange rates, which could have an adverse effect on our business, results of operations and financial condition.
The apparel industry is subject to constantly changing fashion trends and if we misjudge consumer preferences, the image of one or more of our brands may suffer and the demand for our products may decrease.
The apparel industry is subject to shifting consumer demands and evolving fashion trends both in domestic and overseas markets and our success is dependent upon our ability to anticipate and promptly respond to these changes. Failure to anticipate, identify or promptly react to changing trends, styles or brand preferences may result in decreased demand for our products, as well as excess inventories and markdowns, which could have an adverse effect on our results of operations. In addition, if we misjudge consumer preferences, the brand image of our products may be impaired, which would adversely affect our business.
The markets in which we operate are highly competitive and we may not be able to compete effectively.
The apparel industry is extremely competitive. We compete with many domestic and foreign apparel manufacturers and distributors, some of which are larger, more diversified and have greater financial and other resources than us. This competition could cause reduced unit sales or prices, or both, which could adversely affect us. We compete on the basis of a variety of factors, including:
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product quality;
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brand recognition;
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price;
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product differentiation (including product innovation);
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sourcing and distribution expertise and efficiency;
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marketing and advertising; and
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customer service.
Our ability to remain competitive in these areas will, in large part, determine our future success. Our failure to compete successfully could adversely affect our business.
Shortages in the supply of sourced goods, difficulties encountered by the third parties that source certain of our products, or interruptions in production facilities owned by our third party contractors or in our distribution operations could result in difficulty in procuring, producing and distributing our products.
We seek to secure and maintain favorable relationships with the companies that source our products and to ensure the proper operation of production facilities owned by third party contractors. We generally utilize multiple sources of supply. An unexpected interruption in the supply of our sourced products, including as a result of a disruption in operations at any of our production facilities owned by third party contractors or distribution facilities or at the facilities which source our products, our failure to secure or maintain favorable sourcing relationships, shortages of sourced goods or disruptions in shipping, could adversely affect our results of operations until alternate sources or facilities can be secured. In addition, any issues, problems relating to equipment, systems failures or difficulties with the Company’s transition to the use of its new consolidated distribution facility in the Netherlands could result in delays of shipments to our customers and additional costs to us. Any of the events noted above could result in difficulty in procuring or producing our products on a cost-effective basis or at all, which could have an adverse effect on our results of operations.
In addition, although we monitor the third-party facilities that produce our products to seek to ensure their continued human rights and labor compliance and adherence to all applicable laws and our own business partner manufacturing guidelines, we do not control these independent manufacturers. Accordingly, vendors may violate labor or other laws, or fail to adhere to our business partner manufacturing guidelines, including by engaging in business or labor practices that would generally be regarded as unethical in the U.S. In such case, our reputation may be damaged, our supply of sourced goods may be interrupted and we may terminate our relationship with such vendors, any of which could have an adverse effect on our business.
The failure of our suppliers or contractors to adhere to quality and production standards and the failure of our inspections to identify and correct such quality or production problems could have a material adverse effect on our business, financial condition and results of operations.
Concerns about the safety of our products, including but not limited to concerns about those products manufactured in developing countries, where a significant portion of our products are manufactured, may cause us to recall selected products, either voluntarily or at the direction of a foreign or domestic governmental authority. Product safety concerns, recalls, defects or errors in production could result in the rejection of our products by customers, damage to our reputation, lost sales, product liability litigation and increased costs, any of which could harm our business.
We depend on a limited number of customers for a significant portion of our sales, and our financial success is linked to the success of our customers, our customers’ commitment to our products and our ability to satisfy and/or maintain our customers.
Net revenues from our ten largest customers represented approximately 31.4%, 31.6% and 29.4% of our worldwide net revenues during Fiscal 2010, Fiscal 2009 and Fiscal 2008, respectively. No one customer accounted for 10% or more of our Fiscal 2010, Fiscal 2009 or Fiscal 2008 net revenues.
We do not have long-term contracts with any of our customers. Sales to customers are generally on an order-by-order basis. If we cannot fill customers’ orders on time, orders may be cancelled and relationships with customers may suffer, which could have an adverse effect on us, especially if the relationship is with a major customer. Furthermore, if any of our customers experiences a significant downturn in its business, or fails to remain committed to our programs or brands, the customer may reduce or discontinue purchases from us. The loss of a major customer or a reduction in the amount of our products purchased by our major customers could have an adverse effect on our results of operations.
During the past several years, various retailers, including some of our customers, have experienced significant changes and difficulties, including consolidation of ownership, restructurings, bankruptcies and liquidations. Consolidation of retailers or other events that eliminate our customers could result in fewer stores selling our products and could increase our reliance on a smaller group of customers. In addition, if our retailer customers experience significant problems in the future, including as a result of general weakness in the retail environment, our sales may be reduced and the risk of extending credit to these retailers may increase. A significant adverse change in a customer relationship or in a customer’s financial position could cause us to limit or discontinue business with that customer, require us to assume greater credit risk relating to that customer’s receivables or limit our ability to collect amounts related to previous purchases by that customer. These or other events related to our significant customers could have an adverse effect on our business, results of operations or financial condition.
Our success depends upon the continued protection of our trademarks and other intellectual property rights and we may be forced to incur substantial costs to maintain, defend, protect and enforce our intellectual property rights.
Our registered and common law trademarks, as well as certain of our licensed trademarks, have significant value and are instrumental to our ability to market our products. Third parties may assert claims against any such intellectual property and we may not be able to successfully resolve such claims. In addition, we may be required to assert legal claims or take other enforcement actions against third parties who infringe on our intellectual property rights. We may be required to incur substantial costs in defending such claims or in taking such actions. In addition, the laws of some foreign countries may not allow us to protect, defend or enforce our intellectual property rights to the same extent as the laws of the U.S. Our failure to successfully protect our intellectual property rights, or the substantial costs that we may incur in doing so, may have an adverse effect on our operations.
A significant portion of our operations is dependent on license agreements with third parties that allow us to design, produce, source and market our products.
As of January 1, 2011, approximately 64% of our revenue was derived from sales of products which we design, source and/or market pursuant to license agreements with third parties. The success of this portion of our business requires us to maintain favorable relationships with our licensors; deterioration in these relationships could impair our ability to market our brands and distribute our products.
Certain of our license agreements, including the license agreements with SIL, CKI and Polo Ralph Lauren, Inc require us to make minimum royalty payments, meet certain minimum sales thresholds, subject us to restrictive covenants, require us to provide certain services (such as design services) and may be terminated or not renewed if certain of these conditions are not met. We may not be able to continue to meet our obligations or fulfill the conditions under these agreements in the future. In addition, disputes or disagreements with our licensors in connection with the provisions of these license agreements could result in our recording additional expenses. The termination or non-renewal of certain of these license agreements could have an adverse effect on our business, results of operations or financial condition.
Our success depends on the reputation of our owned and licensed brand names, including, in particular, Calvin Klein.
The success of our business depends on the reputation and value of our owned and licensed brand names. The value of our brands could be diminished by actions taken by licensors or others who have interests in the brands for other products and/or territories. Because we cannot control the quality of other products produced and sold under such licensed brand names, if such products are of poor quality, the value of the brand name could be damaged, which could have an adverse effect on our sales. In addition, some of the brand names licensed to us reflect the names of living individuals, whose actions are outside our control. If the reputation of one of these individuals is significantly harmed, our products bearing such individual’s name may fall into disfavor, which could adversely affect our business. In addition, we may from time to time license our owned and licensed brand names to third parties. The actions of these licensees may diminish the reputation of the licensed brand, which could adversely affect our business.
The Calvin Klein brand name is significant to our business. Sales of 74% of our products are in large part tied to the success of the Calvin Klein brand name. In the event that consumer demand in the U.S. or overseas for the Calvin Klein brand declines, including as a result of changing fashion trends or an adverse change in the perception of the Calvin Klein brand image, our businesses which rely on the Calvin Klein brand name, including the businesses acquired in the CKJEA Acquisition, would be significantly harmed.
We are subject to local laws and regulations in the U.S. and abroad.
We are subject to U.S. federal, state and local laws and regulations affecting our business, including those promulgated under the Occupational Safety and Health Act, the Consumer Product Safety Act, the Flammable Fabrics Act, the Textile Fiber Product Identification Act, the rules and regulations of the Consumer Products Safety Commission, the Department of Homeland Security and various labor, workplace and related laws, as well as environmental laws and regulations. Our international businesses and the companies which source our products are subject to similar regulations in the countries where they operate. Our efforts to maintain compliance with local laws and regulations may require us to incur significant expenses, and our failure to comply with such laws may expose us to potential liability, which could have an adverse effect on our results of operations. Similarly, local laws could have an adverse effect on our sourcing vendors, which could affect our ability to procure our products.
We may have additional tax liabilities.
We are subject to income taxes in the U.S. and many foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. We regularly are under audit by tax authorities. Although we believe our tax estimates are reasonable, the final determination of our tax liabilities as a result of tax audits and any related litigation could be materially different from our historical income tax provisions and accruals. The results of an audit or litigation could have a material effect on our financial position, results of operations, or cash flows in the period or periods for which that determination is made. In addition, there have been proposals to reform U.S. tax laws that would significantly impact how U.S. multinational corporations are taxed on foreign earnings. We earn a substantial portion of our income in foreign countries. Although we cannot predict whether or in what form this proposed legislation will pass, if enacted it could have a material adverse impact on our tax expense and cash flow.
Changing international trade regulation may increase our costs and limit the amount of products or raw materials that we may import from or export to a given country.
Substantially all of our operations are subject to bilateral textile agreements. These agreements include free trade agreements and other preference agreements with and between various countries. Our non-compliance with, or changes associated with, such agreements and regulations may limit the amount of products that may be imported from a particular country or may impact our ability to obtain favorable duty rates, which could impair our ability to source our products on a cost-effective basis.
In addition, the countries in which our products are sourced or into which they are imported, may from time to time impose new quotas, duties, tariffs and requirements as to where raw materials must be purchased or additional workplace regulations or other restrictions, or may adversely modify existing restrictions. Changes in international trade regulation, including future trade agreements, could provide our competitors an advantage over us, or increase our costs, either of which could have an adverse effect on our business, results of operations or financial condition.
Our business outside of the U.S. exposes us to uncertain conditions in overseas markets.
Our foreign operations subject us to risks customarily associated with foreign operations. As of January 1, 2011, we sold our products throughout the world and had warehousing and distribution facilities in sixteen countries. We also source our products from third-party vendors substantially all of which are based in foreign countries. For Fiscal 2010, we had net revenues outside of the U.S. of $1,287.6 million, representing 56.1% of our total net revenues, with the majority of these sales in Europe and Asia. We are exposed to the risk of changes in social, political and economic conditions inherent in operating in foreign countries, including:
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currency fluctuations;
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import and export license requirements;
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trade restrictions;
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changes in quotas, tariffs, taxes and duties;
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restrictions on repatriating foreign profits back to the U.S.;
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foreign laws and regulations;
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international trade agreements;
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difficulties in staffing and managing international operations;
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economic conditions overseas;
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political or social unrest such as recent turmoil in the Middle East; and
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disruptions or delays in shipments.
In addition, transactions between our foreign subsidiaries and us may be subject to U.S. and foreign withholding taxes. Applicable tax rates in foreign jurisdictions differ from those of the U.S., and change periodically.
Our business depends on our senior management team and other key personnel.
Our success is, to a significant extent, dependent on our ability to attract, retain and motivate senior management and other key employees, including managerial, operational, design and sales personnel. Demand and competition for qualified personnel in our industry is intense, and we compete for personnel with companies which may have greater financial resources than we do. The unexpected loss of our current senior management or other key employees, or our inability to attract and retain such persons in the future, could harm our ability to operate our business, including our ability to effectively service our customers, generate new business or formulate and execute on our strategic initiatives.
We rely significantly on information technology. Any inadequacy, interruption, integration failure or security failure of that technology could harm our ability to effectively operate our business.
Our ability to effectively manage and operate our business depends significantly on our information technology systems. The failure of these systems to operate effectively, problems with transitioning to upgraded or replacement systems, difficulty in integrating new systems or systems of acquired businesses or a breach in security of any of our systems could adversely impact the operations of our business. Any such failure, problem, difficulty or breach could also require significant expenditures to remediate.
Fluctuations in the valuation of our pension plan’s investments and pension benefit obligation can have a negative effect on our financial condition and results of operations.
We maintain, among other plans, a defined benefit pension plan for certain U.S.-based employees, who completed service prior to January 1, 2003. The plan provides for specified payments after retirement. Under our direction, our U.S. pension plan invests in a variety of assets including marketable equity and debt securities, mutual funds and pooled investment accounts and limited partnerships. The value of these pension plan investments may fluctuate due to, among other things, changing economic conditions, interest rates and investment returns, and we cannot predict with certainty the value that any individual asset or investment will have in the future. Decreases in the value of U.S. pension plan investments can have a significant effect on our results of operations in the fourth quarter of each fiscal year because they increase our pension expense and our unfunded pension liability. Moreover, as a result of such decreases, we may be required to make larger cash contributions to the U.S. pension plan in the future, which could limit us from making investments in our business, reduce cash available to fund operations or service our indebtedness, or otherwise be detrimental to our results of operations and financial condition. In addition, a decrease in the discount rate that we use to calculate the pension benefit obligation, as described in Note 7 of Notes to Consolidated Financial Statements - Employee Retirement and Benefit Plans, would increase our pension expense.
Businesses that we may acquire may fail to perform to expectations. In addition, we may be unable to successfully integrate acquired businesses with our existing business.
From time to time, we evaluate potential acquisition opportunities to support and strengthen our business. We may not be able to realize all or a substantial portion of the anticipated benefits of acquisitions that we may consummate. Newly acquired businesses may not achieve expected results of operations, including expected levels of revenues, and may require unanticipated costs and expenditures. Acquired businesses may also subject us to liabilities that we were unable to discover in the course of our due diligence, and our rights to indemnification from the sellers of such businesses, even if obtained, may not be sufficient to offset the relevant liabilities. In addition, acquired businesses may be adversely affected by the risks described in this Item 1A, or other risks, including as a result of factors of which we are not currently aware.
In addition, the integration of newly acquired businesses and products may be expensive and time-consuming and may not be entirely successful. The success of integrating acquired businesses is dependent on our ability to, among other things, merge operational and financial systems, retain customers of acquired businesses, realize cost reduction synergies and retain key management and other personnel of the acquired companies. Integration of the acquired businesses may also place additional pressures on our systems of internal control over financial reporting. If we are unable to successfully integrate newly acquired businesses or if acquired businesses fail to produce targeted results, it could have an adverse effect on our results of operations or financial condition.
We are subject to certain risks as a result of our indebtedness.
As of January 1, 2011, we had total debt of approximately $32.2 million. In August 2008, we entered into a revolving credit agreement (the “2008 Credit Agreement”) and Warnaco of Canada Company, an indirect wholly-owned subsidiary of Warnaco, entered into a second revolving credit agreement (the “2008 Canadian Credit Agreement” and, together with the 2008 Credit Agreement, the “2008 Credit Agreements”), with lines of credit, initially totaling $300.0 million (see Note 12 of Notes to Consolidated Financial Statements). At January 1, 2011, there were no outstanding loans under the 2008 Credit Agreements, although the balance of outstanding loans may increase from time to time in the future in order to meet our cash flow needs. Our ability to service our indebtedness using cash flows from operations is dependent on our financial and operating performance, which is subject to prevailing economic and competitive industry conditions and to certain other factors beyond our control, including the factors described in this Item 1A. In the event that we are unable to satisfy our debt obligations as they come due, we may be forced to refinance our indebtedness, and there can be no assurance that we will be able to refinance our indebtedness on terms favorable to us, or at all. Our debt service obligations may also limit cash flow available for our operations and adversely affect our ability to obtain additional financing, if necessary. In addition, the 2008 Credit Agreements are subject to floating interest rates; accordingly, our results of operations may be adversely affected if market interest rates increase.
The terms of the agreements governing our indebtedness may also limit our operating and financial flexibility. The 2008 Credit Agreements each contain a number of significant restrictions and other covenants, including financial covenants (see Note 12 of Notes to Consolidated Financial Statements). In addition, in the event that we are unable to comply with these restrictions and other covenants and are not able to obtain waivers from our lenders, we would be in default under these agreements and, among other things, our debt may be accelerated by our lenders. In such case, we may not be able to repay our debt or borrow sufficient funds to refinance it on commercially reasonable terms, or terms that are acceptable to us, which could have an adverse effect on our financial condition.
The restructuring and disposition activities that we engage in may not be successfully implemented and may have an adverse effect on our results of operations or financial condition.
The Company periodically implements restructuring and disposition initiatives including, but not limited to, reductions in workforce, the closure, relocation or consolidation of facilities or the disposition or wind-down of businesses, brands or product lines, in order to streamline its operations and increase its profitability. Restructuring and disposition initiatives may be expensive and time consuming and may not achieve desired goals. In addition, certain restructuring and disposition initiatives, if not successfully implemented, may have an adverse effect on our results of operations or financial condition.
We may be required to recognize impairment charges for our long-lived assets.
At January 1, 2011, the net carrying value of long-lived assets (property, plant and equipment, goodwill and other intangible assets) totaled approximately $618 million. In accordance with generally accepted accounting principles, we periodically assess these assets to determine if they are impaired. Significant negative industry or economic trends, disruptions to our business, unexpected significant changes or planned changes in use of the assets, divestitures and market capitalization declines may result in impairments to goodwill and other long-lived assets. Future impairment charges could significantly affect our results of operations in the periods recognized. Impairment charges would also reduce our consolidated stockholders’ equity and increase our debt-to-total-capitalization ratio, which could negatively impact our credit rating and access to the public debt and equity markets.
We cannot predict with certainty the outcome of litigation matters and other contingencies and uncertainties.
We may be subject to legal proceedings and other disputes in the future arising out of the conduct of our business, including matters relating to commercial transactions, acquisitions and divestitures, and employment matters. Resolution of these matters can be prolonged and costly, and the ultimate resolutions are uncertain due to the inherent uncertainty in such proceedings. Moreover, our potential liabilities are subject to change over time due to new developments, changes in settlement strategy or the impact of evidentiary requirements. While we maintain insurance for certain risks, it is not possible to obtain insurance to protect against all our operational risks and liabilities. Accordingly, in certain instances, we may become subject to or be required to pay damage awards or settlements that could have a material adverse effect on our results of operations, cash flows and financial condition. Certain of these proceedings could also have a negative impact on the Company’s reputation or relations with its employees, customers or other third parties.
Ineffective disclosure controls and procedures or internal controls over financial reporting could impair our ability to provide timely and reliable financial information in the future and have a negative effect on our business and stock price.
Management has concluded that our internal controls were effective as of January 1, 2011 and January 2, 2010. However, there can be no assurance that in the future we will not suffer from ineffective disclosure controls and procedures or internal controls over financial reporting, which would impair our ability to provide reliable and timely financial reports. Moreover, because of the inherent limitations of any control system, material misstatements due to error or fraud may not be prevented or detected on a timely basis, or at all. If we are unable to provide reliable and timely financial reports, or if we are required to restate our financial statements, our business may be harmed, including as a result of adverse publicity, litigation, SEC proceedings, exchange delisting or consequences under (or the need for waivers of) our debt covenants. Failures in internal controls and restated financial statements may also cause investors to lose confidence in our financial reporting process, which could have a negative effect on the price of our Common Stock.
Item 1B.
Item 1B.
Unresolved Staff Comments.
None.
The Company’s principal executive offices are located at 501 Seventh Avenue, New York, New York, which the Company leases pursuant to a 13-year lease that commenced in May 2003 (expiring August 2016) and a second lease expiring in February 2020. In addition to the Company’s executive offices, the Company leases offices in California and Connecticut pursuant to leases that expire between 2015 and 2020.
As of January 1, 2011, the Company owned or leased six primary domestic distribution and warehousing facilities located in California and Pennsylvania. In addition, the Company owned or leased six international, warehousing and distribution facilities in Canada (one), Mexico (one), the Netherlands (two), Italy (one), and Argentina (one). Some of the Company’s warehouse facilities are also used for administrative functions. The Company owns one of its domestic facilities. Eleven of the Company’s facilities are leased with terms expiring between 2011 and 2025, except for certain leases which operate on a month-to-month basis. In addition, in connection with the consolidation of its European operations, during Fiscal 2010 the Company entered into a 15-year lease for a distribution center in the Netherlands, which is included in the preceding discussion.
The Company leases sales offices in a number of major cities, including Los Angeles and New York in the U.S.; Rio Piedras, Puerto Rico, Buenas Aires, Argentina, Melbourne, Australia, Brussels, Belgium, Sao Paulo, Brazil, Copenhagen, Denmark, London, England; Madrid, Spain; Toronto, Canada; Paris and Toulouse, France; Dusseldorf, Germany; Shanghai, Guangzhou and Beijing, China; Hong Kong; Seoul, Korea, Singapore; Taipei, Taiwan; Capetown, South Africa; Florence and Milan, Italy; Santiago, Chile; Amersfoort, Netherlands; Mexico City, Mexico, Lima, Peru, and Zurich, Switzerland. The sales office leases expire between 2011 and 2020 and are generally renewable at the Company’s option. As of January 1, 2011, the Company leased 1,357 retail store sites in the U.S., Canada, Mexico, Central and South America, Europe, Australia and Asia. The retail store leases expire between 2011 and 2018 (except for one retail store lease which expires in 2028) and are generally renewable at the Company’s option.
All of the Company’s distribution and warehouse facilities are located in appropriately designed buildings, which are kept in good repair. All such facilities have well-maintained equipment and sufficient capacity to handle present and expected future volumes.
SEC Inquiry: As disclosed in its Annual Report on Form 10-K for Fiscal 2009, the SEC issued a formal order of investigation in September 2007 in connection with the matters associated with the Company’s restatement of its previously reported financial statements for the fourth quarter of 2005, the fiscal year ended 2005 and the first quarter of 2006. On September 20, 2010, the Company received notice that the SEC had completed its investigation and did not intend to recommend any enforcement action against the Company.
OP Litigation: On August 19, 2004, the Company acquired 100% of the outstanding common stock of Ocean Pacific Apparel Corp. (“OP”) from Doyle and certain minority shareholders of OP. The terms of the acquisition agreement required the Company to make certain contingent payments to the sellers of OP under certain circumstances. On November 6, 2006, the Company sold the OP business to a third party. On May 23, 2007, Doyle filed a demand against the Company for arbitration before Judicial Arbitration and Mediation Services (“JAMS”) in Orange County, California, alleging that certain contingent purchase price payments are due to them as a result of the Company’s sale of the OP business in November 2006. On February 7, 2011, the Company and Doyle entered into a settlement agreement and mutual release to the entire action described above. As a result, the entire action was dismissed by JAMS, with prejudice.
Lejaby Claims: As of January 1, 2011, the Company had receivables (comprised of a loan receivable and a receivable for working capital, recorded in Other Assets on the Company’s Consolidated Balance Sheets) totaling $16.9 million from Palmers related to the Company’s sale of its Lejaby business to Palmers on March 10, 2008. On August 18, 2009, Palmers filed an action against the Company in Le Tribunal de Commerce de Paris (The Paris Commercial Court), alleging that the Company made certain misrepresentations in the sale agreement, and seeking to declare the sale null and void, monetary damages in an unspecified amount and other relief (the “Palmers Suit”). In addition, the Company and Palmers have been unable to agree on certain post-closing adjustments to the purchase price, including adjustments for working capital. The dispute regarding the amount of post-closing adjustments is not a subject of the Palmers Suit. The Company believes that its receivables from Palmers are valid and collectible and that the Palmers’ lawsuit is without merit. The Company is defending itself vigorously in this matter.
Other: In addition, from time to time, the Company is involved in arbitrations or legal proceedings that arise in the ordinary course of its business. The Company cannot predict the timing or outcome of these claims and proceedings. Currently, the Company is not involved in any such arbitration and/or legal proceeding that it expects to have a material effect on its financial condition, results of operations or business.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
The Company’s Common Stock is traded on the New York Stock Exchange under the ticker symbol “WRC”. The table below sets forth the high and low sales prices of the Common Stock as reported on the New York Stock Exchange from January 1, 2009 through February 21, 2011:
As of February 18, 2011, there were 17,667 holders of the Common Stock, based upon the number of holders of record and the number of individual participants in certain security position listings.
The last reported sale price of the Common Stock as reported on the New York Stock Exchange Composite Tape on February 18, 2011 was $54.19 per share. In the event that available credit under the 2008 Credit Agreements (previously referred to as the New Credit Agreements) ($153.1 million at January 1, 2011) is less than 25% of the aggregate borrowing limit under the 2008 Credit Agreements ($56.5 million at January 1, 2011), the 2008 Credit Agreements place restrictions on the Company’s ability to pay dividends on the Common Stock and to repurchase shares of the Common Stock. The Company has not paid any dividends on the Common Stock (See Note 12 of Notes to Consolidated Financial Statements).
Repurchases of Shares
On May 12, 2010, the Company’s Board of Directors authorized a share repurchase program (the ''2010 Share Repurchase Program’’) for the repurchase of up to 5,000,000 shares of the Company’s common stock (“Common Stock”). During Fiscal 2010, the Company repurchased 939,158 shares in the open market for a total cost of $47.4 million (based on an average of $50.45 per share) under the 2010 Share Repurchase Program, leaving a balance of 4,060,842 shares, at January 1, 2011, to be repurchased. During January 2011, after the close of Fiscal 2010, the Company repurchased 560,842 shares of Common Stock under the 2010 Share Repurchase Program for $29.1 million (based on an average of $51.94 per share). All repurchases of shares under the 2010 Share Repurchase Program will be made consistent with the terms of the Company’s applicable debt instruments. The share repurchase program may be modified or terminated by the Company’s Board of Directors at any time.
In May 2007, the Company’s Board of Directors authorized a share repurchase program (the “2007 Share Repurchase Program”) for the repurchase of up to 3,000,000 shares of Common Stock. During Fiscal 2010, the Company repurchased the remaining 1,490,131 shares of its common stock allowed to be repurchased under the 2007 Share Repurchase Program in the open market at a total cost of approximately $69 million (an average cost of $46.31 per share). At January 1, 2011, the Company had cumulatively purchased 3,000,000 shares of Common Stock in the open market at a total cost of approximately $106.9 million (an average cost of $35.64 per share) under the 2007 Share Repurchase Program. Prior to Fiscal 2010, under the 2007 Share Repurchase Program the Company had repurchased no shares during Fiscal 2009, 943,000 shares during Fiscal 2008 and 566,869 shares during Fiscal 2007.
In addition, an aggregate of 76,148 shares were repurchased during Fiscal 2010 (of which 692 shares were repurchased during the fourth quarter of Fiscal 2010 and are included in the table below), which reflect the surrender of shares in connection with the vesting of certain restricted stock awarded by the Company to its employees. At the election of an employee, shares having an aggregate value on the vesting date equal to the employee’s withholding tax obligation may be surrendered to the Company in satisfaction thereof. The repurchase of these shares is not a part of the 2010 Share Repurchase Program or the 2007 Share Repurchase Program.
Repurchased shares are held in treasury pending use for general corporate purposes.
The following table summarizes repurchases of the Company’s Common Stock during the fourth quarter of 2010:
Item 6.
Item 6.
Selected Financial Data.
The following table sets forth the Company’s selected historical consolidated financial and operating data for Fiscal 2010, Fiscal 2009, Fiscal 2008, Fiscal 2007 and Fiscal 2006. All fiscal years for which financial information is set forth below had 52 weeks, except Fiscal 2008, which had 53 weeks.
For all periods presented, income from continuing operations excludes the results of the Company’s discontinued operations (i.e. Calvin Klein Golf, Calvin Klein Collection, Nautica, Michael Kors, Private Label, Lejaby, Anne Cole, Cole of California, Catalina, OP, JLO, Lejaby Rose, Axcelerate Activewear and its three Speedo retail outlet store businesses). The results of operations of these business units are presented separately in the following table.
The information set forth in the following table should be read in conjunction with Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The Company is subject to certain risks and uncertainties that could cause its future results of operations to differ materially from its historical results of operations and those expected in the future and that could affect the market value of the Company’s Common Stock. Except for the historical information contained herein, this Annual Report on Form 10-K, including the following discussion, contains forward-looking statements that involve risks and uncertainties. See “Statement Regarding Forward-Looking Disclosure” and Item 1A. Risk Factors.
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the consolidated financial statements and related notes thereto, which are included in this Annual Report on Form 10-K. References to “Calvin Klein Jeans” refer to jeans, accessories and “bridge” products. “Core Intimates” refer to the Intimate Apparel Group’s Warner’s, Olga and Body Nancy Ganz /Bodyslimmers brand names. References to “Retail” within each operating Group refer to the Company’s owned full price free standing stores, owned outlet stores, concession / “shop-in-shop” stores and on-line stores. Results related to stores operated by third parties under retail licenses or distributor agreements are included in “Wholesale” within each operating Group.
Overview
The Company designs, sources, markets, licenses and distributes intimate apparel, sportswear and swimwear worldwide through highly recognized brand names. The Company’s products are distributed domestically and internationally in over 100 countries, primarily to wholesale customers through various distribution channels, including major department stores, independent retailers, chain stores, membership clubs, specialty, off-price and other stores, mass merchandisers and, to retail customers, through the Company’s retail stores and the internet.
The Company’s mission is to become the premier global, branded apparel company. To accomplish its mission, the Company has identified the following key strategic objectives, which it successfully continued to implement during Fiscal 2010, as follows:
Overall, the Company’s net revenue increased $276.1 million, or 13.7%, to $2.3 billion for Fiscal 2010 compared to $2.0 billion for Fiscal 2009, reflecting increases of $159.2 million in the Sportswear Group, $110.8 million in the Intimate Apparel Group, and $6.1 million in the Swimwear Group compared to Fiscal 2009. The Company’s operating income increased $54.3 million, or 28.0%, to $247.8 million for Fiscal 2010 compared to $193.5 million for Fiscal 2009, reflecting increases of $27.0 million in the Sportswear Group, $19.8 million in the Intimate Apparel Group, $2.4 million in the Swimwear Group and $5.0 million in corporate allocations compared to Fiscal 2009. Operating income includes restructuring charges of $9.8 million and $12.1 million for Fiscal 2010 and Fiscal 2009, respectively, and pension expense of $2.6 million and $20.9 million for Fiscal 2010 and Fiscal 2009, respectively.
As noted above, more than 50% of the Company’s net revenue was generated from foreign operations, a majority of which are conducted in countries whose functional currencies are the Euro, Korean Won, Canadian Dollar, Brazilian Real, Mexican Peso, Chinese Yuan and British Pound. Consequently, both net revenues and operating income were affected by fluctuations in certain foreign currencies: net revenue includes an increase of $19.9 million for Fiscal 2010, while operating income includes an increase of $22.3 million for Fiscal 2010. The effects of fluctuations in foreign currencies are reflective of the following: (i) the translation of operating results for the current year period for entities reporting in currencies other than the U.S. dollar into U.S. dollars at the average exchange rates in effect during the comparable period of the prior year (rather than the actual exchange rates in effect during the current year period); (ii) as relates to entities who purchase inventory in currencies other than that entity’s reporting currency, the effect on cost of goods sold for the current year period compared to the prior year period as a result of differences in the exchange rates in effect at the time the related inventory was purchased and (iii) gains and losses recorded by the Company as a result of fluctuations in foreign currencies and related to the Company’s foreign currency hedge programs.
The Company’s income from continuing operations per diluted share increased for Fiscal 2010 compared to Fiscal 2009. On a GAAP (defined below) basis, income from continuing operations per diluted share increased 46% to $3.19 per diluted share (from $2.19 per diluted share), which includes positive effects of fluctuations in foreign currency exchange rates for Fiscal 2010 of approximately $0.27. On a non-GAAP basis (excluding restructuring expense, pension expense and certain other items (see Non-GAAP Measures, below), income from continuing operations per diluted share increased 27% to $3.57 per diluted share (from $2.82 per diluted share).
At January 1, 2011, the Company’s balance sheet included cash and cash equivalents of $191.2 million and total debt of $32.2 million. During Fiscal 2010, the Company redeemed from bondholders the remaining $160.9 million aggregate principal amount of its senior notes, which were set to mature on June 15, 2013 and which bore interest at 87/8% per annum payable semi-annually on December 15 and June 15 of each year (the “Senior Notes”), for a total consideration of $164.0 million (see Note 12 of Notes to Consolidated Financial Statements).
During Fiscal 2010, the Company completed all remaining share repurchases under its 2007 Share Repurchase Program (see Note 13 of Notes to Consolidated Financial Statements) by repurchasing 1,490,131 shares of Common Stock for a total of $69.0 million (based on an average of $46.31 per share). In May 2010, the Company’s Board of Directors approved the 2010 Share Repurchase Program (as defined above, see Part II. Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities), which allows the Company to repurchase up to 5.0 million shares of Common Stock. A total of 939,158 shares of Common Stock were repurchased during Fiscal 2010 for a total of $47.4 million (based on an average of $50.45 per share). During January 2011, after the close of Fiscal 2010, the Company repurchased 560,842 shares of Common Stock under the 2010 Share Repurchase Program for $29.1 million (based on an average of $51.94 per share).
In addition to the many near-term opportunities for growth and operational improvement referenced above, the Company acknowledges that there are a number of challenges and uncertainties relating to its businesses. See Item 1A. Risk Factors and Statement Regarding Forward-Looking Disclosure.
Non-GAAP Measures
The Company’s reported financial results are presented in accordance with U.S. generally accepted accounting principles (“GAAP”). The reported operating income, income from continuing operations and diluted earnings per share from continuing operations reflect certain items which affect the comparability of those reported results. Those financial results are also presented on a non-GAAP basis, as defined by Regulation S-K section 10(e) of the Securities and Exchange Commission (“SEC”), to exclude the effect of these items. The Company’s computation of these non-GAAP measures may vary from others in its industry. These non-GAAP financial measures are not intended to be, and should not be, considered separately from or as an alternative to the most directly comparable GAAP financial measure to which they are reconciled, as presented in the following table:
a)
This adjustment seeks to present operating income, income from continuing operations and diluted earnings per share from continuing operations the Fiscal 2010, Fiscal 2009 and Fiscal 2008, respectively, without the effects of restructuring charges and other exit costs as shown in the table above. The income tax rates used to compute the income tax effect related to this adjustment correspond to the local statutory tax rates of the reporting entities that incurred the restructuring and other exit costs.
b)
This adjustment seeks to present operating income, income from continuing operations and diluted earnings per share from continuing operations for Fiscal 2010, Fiscal 2009 and Fiscal 2008, respectively, without the effects of pension expense as shown in the table above. The income tax rates used to compute the income tax effect related to this adjustment correspond to the local statutory tax rates of the reporting entities that recognized pension income or incurred pension expense.
c)
This adjustment seeks to present operating income, income from continuing operations and diluted earnings per share from continuing operations without the effects of an additional charge related to an adjustment to the contingent consideration to be paid for the business acquired in Brazil in 2009 as shown in the table above for Fiscal 2010. The income tax rate used to compute the income tax effect related to this adjustment corresponds to the local statutory tax rate in Brazil.
d)
This adjustment seeks to present operating income, income from continuing operations and diluted earnings per share from continuing operations:
i)
excluding a charge as shown in the table above for certain franchise taxes recorded during Fiscal 2010 related to the correction of amounts recorded in prior periods. The amount was not material to any prior period. The income tax rates used to compute the income tax effect related to the above-mentioned charge for franchise taxes correspond to the statutory tax rates in the United States; and
ii)
excluding a charge as shown in the table above for Fiscal 2009 and Fiscal 2008, respectively, for amortization expense related to the correction of amounts recorded in prior periods in connection with the recapture of cancellation of indebtedness income which had been deferred in connection with the Company’s bankruptcy proceedings in 2003. The income tax rates used to compute the income tax effect related to the charge for the above-mentioned amortization expense correspond to the statutory tax rates in the United States.
e)
This adjustment seeks to present income from continuing operations and diluted earnings per share from continuing operations without the effect of a charge of $3,747 ($2,368 after tax) as shown in the table above related to the repurchase of a portion of the Company’s Senior Notes during Fiscal 2010. The income tax rates used to compute the income tax effect related to this adjustment correspond to the statutory tax rates in the United States.
f)
For Fiscal 2010, this adjustment seeks to present income from continuing operations and diluted earnings per share from continuing operations without the effects of certain tax adjustments related to errors or changes in estimates in prior period tax provisions (approximately $2,300) and adjustments for certain other discrete tax items (approximately $2,600). The adjustment related to prior period errors or estimate changes includes, among other items, a charge of approximately $2,300 recorded during Fiscal 2010 associated with the correction of an error in the 2006 through 2009 income tax provisions as a consequence of the loss of a credit related to prior year tax overpayments caused by the delayed filing of tax returns in a U.S. state taxing jurisdiction. This error was not material to any prior period. The adjustments for other discrete items reflect the federal, state and foreign tax effects related to: 1) direct and indirect income taxes associated with legal entity reorganizations and restructurings; 2) tax provision or benefit resulting from statute expirations or the finalization of income tax examinations; and 3) other adjustments not considered part of the Company’s core business activities.
For Fiscal 2009, this adjustment seeks to present income from continuing operations and diluted earnings per share from continuing operations without the effects of certain tax adjustments related to changes in estimates or errors in prior period tax provisions (approximately $2,300), adjustments for certain other discrete tax items (approximately $1,700) and an adjustment for the amount recorded to correct for an error in the Company’s 2006 income tax provision associated with the recapture of cancellation of indebtedness income which had been deferred in connection with the Company’s bankruptcy proceedings in 2003 (approximately $3,600). The adjustments for other discrete items reflect the federal, state and foreign tax effects related to: 1) the effect of changes in tax laws (in 2009) related to the opening balances for deferred tax assets and liabilities; 2) direct and indirect income taxes associated with legal entity reorganizations and restructurings; 3) tax provision or benefit resulting from statute expirations or the finalization of income tax examinations; and 4) other adjustments not considered part of the Company’s core business activities.
For Fiscal 2008, this adjustment seeks to present income from continuing operations and diluted earnings per share from continuing operations without the effects of a tax charge (approximately $14,600) related to the repatriation to the United States of the net proceeds received in connection with the sale of the Lejaby business and adjustments for certain other discrete tax items (approximately $5,800). The adjustments for other discrete items reflect the federal, state and foreign tax effects related to: 1) the effect of changes in tax laws (in 2008) related to the opening balances for deferred tax assets and liabilities; 2) direct and indirect income taxes associated with legal entity reorganizations and restructurings; 3) tax provision or benefit resulting from statute expirations or the finalization of income tax examinations: and 4) other adjustments not considered part of the Company’s core business activities.
The Company believes it is valuable for users of its financial statements to be made aware of the non-GAAP financial information, as such measures are used by management to evaluate the operating performance of the Company’s continuing businesses on a comparable basis and to make operating and strategic decisions. Such non-GAAP measures will also enhance users’ ability to analyze trends in the Company’s business. In addition, the Company uses performance targets based, in part, on non-GAAP operating income and diluted earnings per share as a component of the measurement of incentive compensation.
Furthermore, the Warnaco Group is a global company that reports financial information in U.S. dollars in accordance with GAAP. Foreign currency exchange rate fluctuations affect the amounts reported by the Company from translating its foreign revenues into U.S. dollars. These rate fluctuations can have a significant effect on reported operating results. As a supplement to its reported operating results, the Company presents constant currency financial information, which is a non-GAAP financial measure. The Company uses constant currency information to provide a framework to assess how its businesses performed excluding the effects of changes in foreign currency translation rates. Management believes this information is useful to investors to facilitate comparisons of operating results and better identify trends in the Company’s businesses.
To calculate the increase in segment revenues on a constant currency basis, operating results for the current year period for entities reporting in currencies other than the U.S. dollar are translated into U.S. dollars at the average exchange rates in effect during the comparable period of the prior year (rather than the actual exchange rates in effect during the current year period).
These constant currency performance measures should be viewed in addition to, and not in isolation from, or as a substitute to, the Company’s operating performance measures calculated in accordance with GAAP. The constant currency information presented in the following table may not be comparable to similarly titled measures reported by other companies.
NET REVENUES ON A CONSTANT CURRENCY BASIS
(Dollars in thousands)
Discussion of Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company to use judgment in making estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses in its consolidated financial statements and accompanying notes.
Critical accounting policies are those that are most important to the portrayal of the Company’s financial condition and results of operations and require difficult, subjective and complex judgments by management in order to make estimates about the effect of matters that are inherently uncertain. The Company’s most critical accounting policies pertain to revenue recognition, cost of goods sold, accounts receivable, inventories, long-lived assets, goodwill and other intangible assets, income taxes, pension plans, stock-based compensation and advertising costs. In applying such policies, management must record income and expense amounts that are based upon 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. Management is not aware of any reasonably likely events or circumstances which would result in different amounts being reported that would materially affect the Company’s financial condition or results of operations.
Use of Estimates The Company uses estimates and assumptions in the preparation of its financial statements which affect (i) the reported amounts of assets and liabilities at the date of the consolidated financial statements and (ii) the reported amounts of revenues and expenses. Actual results could materially differ from these estimates. The estimates the Company makes are based upon historical factors, current circumstances and the experience and judgment of the Company’s management. The Company evaluates its assumptions and estimates on an ongoing basis. The Company believes that the use of estimates affects the application of all of the Company’s significant accounting policies and procedures.
Revenue Recognition The Company recognizes revenue when goods are shipped to customers and title and risk of loss have passed, net of estimated customer returns, allowances and other discounts. The Company recognizes revenue from its retail stores when goods are sold to consumers, net of allowances for future returns. The determination of allowances and returns involves the use of significant judgment and estimates by the Company. The Company bases its estimates of allowance rates on past experience by product line and account, the financial stability of its customers, the expected rate of sales to the end customer, forecasts of demand for its products and general economic and retail forecasts. The Company also considers its accounts receivable collection rate and the nature and amount of customer deductions and requests for promotion assistance. The Company believes it is likely that its accrual rates will vary over time and could change materially if the Company’s mix of customers, channels of distribution or products change. Current rates of accrual for sales allowances, returns and discounts vary by customer. Revenues from the licensing or sub-licensing of certain trademarks are recognized when the underlying royalties are earned.
Cost of Goods Sold Cost of goods sold consists of the cost of products purchased and certain period costs related to the product procurement process. Product costs include: (i) cost of finished goods; (ii) duty, quota and related tariffs; (iii) in-bound freight and traffic costs, including inter-plant freight; (iv) procurement and material handling costs; (v) inspection, quality control and cost accounting and (vi) in-stocking costs in the Company’s warehouse (in-stocking costs may include but are not limited to costs to receive, unpack and stock product available for sale in its distribution centers). Period costs included in cost of goods sold include: (a) royalty; (b) design and merchandising; (c) prototype costs; (d) loss on seconds; (e) provisions for inventory losses (including provisions for shrinkage and losses on the disposition of excess and obsolete inventory); and (f) direct freight charges incurred to ship finished goods to customers. Costs incurred to store, pick, pack and ship inventory to customers (excluding direct freight charges) are included in shipping and handling costs and are classified in selling, general and administrative (“SG&A”) expenses. The Company’s gross profit and gross margin may not be directly comparable to those of its competitors, as income statement classifications of certain expenses may vary by company.
Accounts Receivable The Company maintains reserves for estimated amounts that the Company does not expect to collect from its trade customers. Accounts receivable reserves include amounts the Company expects its customers to deduct for returns, allowances, trade discounts, markdowns, amounts for accounts that go out of business or seek the protection of the Bankruptcy Code and amounts in dispute with customers. The Company’s estimate of the allowance amounts that are necessary includes amounts for specific deductions the Company has authorized and an amount for other estimated losses. Estimates of accruals for specific account allowances and negotiated settlements of customer deductions are recorded as deductions to revenue in the period the related revenue is recognized. The provision for accounts receivable allowances is affected by general economic conditions, the financial condition of the Company’s customers, the inventory position of the Company’s customers and many other factors. The determination of accounts receivable reserves is subject to significant levels of judgment and estimation by the Company’s management. If circumstances change or economic conditions deteriorate, the Company may need to increase the reserve significantly.
Inventories The Company records purchases of inventory when it assumes title and the risk of loss. The Company values its inventories at the lower of cost, determined on a first-in, first-out basis, or market. The Company evaluates its inventories to determine excess units or slow-moving styles based upon quantities on hand, orders in house and expected future orders. For those items for which the Company believes it has an excess supply or for styles or colors that are obsolete, the Company estimates the net amount that it expects to realize from the sale of such items. The Company’s objective is to recognize projected inventory losses at the time the loss is evident rather than when the goods are ultimately sold. The Company’s calculation of the reduction in carrying value necessary for the disposition of excess inventory is highly dependent on its projections of future sales of those products and the prices it is able to obtain for such products. The Company reviews its inventory position monthly and adjusts its carrying value for excess or obsolete goods based on revised projections and current market conditions for the disposition of excess and obsolete inventory.
Long-Lived Assets Intangible assets primarily consist of licenses and trademarks. The majority of the Company’s license and trademark agreements cover extended periods of time, some in excess of forty years; others have indefinite lives. Warnaco Group, Warnaco Inc. (“Warnaco”), the principal operating subsidiary of Warnaco Group and certain of Warnaco’s subsidiaries were reorganized under Chapter 11 of the U.S. Bankruptcy Code, 11 U.S.C. Sections 101-1330, as amended, effective February 4, 2003 (the “Effective Date”). Long-lived assets (including property, plant and equipment) and intangible assets existing at the Effective Date are recorded at fair value based upon the appraised value of such assets, net of accumulated depreciation and amortization and net of any adjustments after the Effective Date for reductions in valuation allowances related to deferred tax assets arising before the Effective Date. Long-lived assets, including licenses and trademarks, acquired in business combinations after the Effective Date under the purchase method of accounting are recorded at their fair values, net of accumulated amortization since the acquisition date. Long-lived assets, including licenses and trademarks, acquired in the normal course of the Company’s operations are recorded at cost, net of accumulated amortization. Identifiable intangible assets with finite lives are amortized on a straight-line basis over the estimated useful lives of the assets. Assumptions relating to the expected future use of individual assets could affect the fair value of such assets and the depreciation expense recorded related to such assets in the future. Costs incurred to renew or extend the term of a recognized intangible asset are capitalized and amortized, where appropriate, through the extension or renewal period of the asset.
The Company determines the fair value of acquired assets based upon the planned future use of each asset or group of assets, quoted market prices where a market exists for such assets, the expected future revenue and profitability of the business unit utilizing such assets and the expected future life of such assets. In its determination of fair value, the Company also considers whether an asset will be sold either individually or with other assets and the proceeds the Company expects to receive from any such sale. Preliminary estimates of the fair value of acquired assets are based upon management’s estimates. Adjustments to the preliminary estimates of fair value that are made within one year of an acquisition date are recorded as adjustments to goodwill. Subsequent adjustments are recorded in earnings in the period of the adjustment.
The Company reviews its long-lived assets for possible impairment in the fourth quarter of each fiscal year or when events or circumstances indicate that the carrying value of the assets may not be recoverable. Such events may include (a) a significant adverse change in legal factors or the business climate; (b) an adverse action or assessment by a regulator; (c) unanticipated competition; (d) a loss of key personnel; (e) a more-likely-than-not expectation that a reporting unit, or a significant part of a reporting unit, will be sold or disposed of; (f) the determination of a lack of recoverability of a significant “asset group” within a reporting unit; (g) reporting a goodwill impairment loss by a subsidiary that is a component of a reporting unit; and (h) a significant decrease in the Company’s stock price.
In evaluating long-lived assets (finite-lived intangible assets and property, plant and equipment) for recoverability, the Company uses its best estimate of future cash flows expected to result from the use of the asset and its eventual disposition. To the extent that estimated future undiscounted net cash flows attributable to the asset are less than the carrying amount, an impairment loss is recognized equal to the difference between the carrying value of such asset and its fair value, which is determined based on discounted cash flows. Assets to be disposed of and for which there is a committed plan of disposal are reported at the lower of carrying value or fair value less costs to sell.
The Company conducted an annual evaluation of the long-lived assets of its retail stores for impairment during the fourth quarter of Fiscal 2010. The Company determined that the long-lived assets of 10 retail stores were impaired, based on the valuation methods described above. For retail stores that failed step one based on undiscounted cash flows, the fair value of the store assets was determined by using a factor of 14.5%, which is the Company’s weighted average cost of capital, to discount each store’s cash flows over its respective remaining lease term. The fair values thus determined are categorized as level 3 (significant unobservable inputs) within the fair value hierarchy (see Note 16 of Notes to Consolidated Financial Statements for a description of the levels in the fair value hierarchy). The aggregate carrying amount of $2.2 million of those retail store assets were written down to their aggregate fair value of $0.3 million, resulting in an impairment charge of $1.9 million, which was recorded in selling, general and administrative expense for Fiscal 2010. The portion of that impairment charge related to stores which management expects to close in 2011 was $1.6 million, which was recorded as restructuring and other exit costs within selling, general and administrative expense (see Note 4 of Notes to Consolidated Financial Statements -Restructuring Expense and Other Exit Costs). For Fiscal 2009, the Company recognized an impairment charge of $0.2 million, related to the long-lived assets of two stores in Mexico, which were closed early in 2010. There were no impairment charges for long-lived assets of retail stores in Fiscal 2008.
During the fourth quarter of Fiscal 2010, the Company conducted an annual evaluation of its finite-lived intangible assets for impairment. Recoverability of a finite-lived intangible asset is measured in the same manner as for property, plant and equipment, described above. For Fiscal 2010, Fiscal 2009 and Fiscal 2008, no impairment charges were recorded related to the Company’s finite-lived intangible assets.
Since the determination of future cash flows is an estimate of future performance, there may be future impairments to the carrying value of long-lived and intangible assets and impairment charges in future periods in the event that future cash flows do not meet expectations. In addition, depreciation and amortization expense is affected by the Company’s determination of the estimated useful lives of the related assets. The estimated useful lives of fixed assets and finite-lived intangible assets are based on their classification and expected usage, as determined by the Company.
Goodwill and Other Intangible Assets Goodwill represents the excess of purchase price over the fair value of net assets acquired in business combinations accounted for under the purchase method of accounting. Goodwill is not amortized and is subject to an annual impairment test which the Company performs in the fourth quarter of each fiscal year.
Goodwill impairment is determined using a two-step process. Goodwill is allocated to various reporting units, which are either the operating segment or one reporting level below the operating segment. As of January 1, 2011, the Company’s reporting units for purposes of applying the goodwill impairment test are: Core Intimate Apparel (consisting of the Warner’s® /Olga® /Body Nancy Ganz®/Bodyslimmers ® business units), Calvin Klein Underwear, Calvin Klein Jeans, Chaps® and Swimwear. The first step of the goodwill impairment test is to compare the fair value of each reporting unit to its carrying amount to determine if there is potential impairment. If the fair value of the reporting unit is less than its carrying value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss. The second step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. That is, the fair value of the reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the fair value was the purchase price paid to acquire the reporting unit.
Determining the fair value of a reporting unit under the first step of the goodwill impairment test and determining the fair value of individual assets and liabilities of a reporting unit (including unrecognized intangible assets) under the second step of the goodwill impairment test is judgmental in nature and often involves the use of significant estimates and assumptions. These estimates and assumptions could have a significant impact on whether or not an impairment charge is recognized and the magnitude of any such charge. Estimates of fair value are primarily determined using discounted cash flows, market multiples or appraised values, as appropriate. During the fourth quarter of Fiscal 2010, the Company determined the fair value of the assets and liabilities of its reporting units in the first step of the goodwill impairment test as the weighted average of both an income approach, based on discounted cash flows using the Company’s weighted average cost of capital of 14.5%, and a market approach, using inputs from a group of peer companies. The Company did not identify any reporting units that failed or are at risk of failing the first step of the goodwill impairment test (comparing fair value to carrying amount) during Fiscal 2010, Fiscal 2009 or Fiscal 2008.
Intangible assets with indefinite lives are not amortized and are subject to an annual impairment test which the Company performs in the fourth quarter of each fiscal year. The Company also reviews its indefinite-lived intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value of an indefinite-lived intangible asset exceeds its fair value, as for goodwill. If the carrying value of an indefinite-lived intangible asset exceeds its fair value (determined based on discounted cash flows), an impairment loss is recognized. The estimates and assumptions used in the determination of the fair value of indefinite-lived intangible assets will not have an effect on the Company’s future earnings unless a future evaluation of trademark or license value indicates that such asset is impaired. For Fiscal 2010, Fiscal 2009 and Fiscal 2008, no impairment charges were recorded related to the Company’s indefinite-lived intangible assets.
Income Taxes Deferred income taxes are determined using the asset and liability method. Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured by applying enacted tax rates and laws to taxable years in which such differences are expected to reverse. Realization of the Company’s deferred tax assets is dependent upon future earnings in specific tax jurisdictions, the timing and amount of which are uncertain. Management assesses the Company’s income tax positions and records tax benefits for all years subject to examination based upon an evaluation of the facts, circumstances, and information available at the reporting dates. In addition, valuation allowances are established when management determines that it is more-likely-than-not that some portion or all of a deferred tax asset will not be realized. Tax valuation allowances are analyzed periodically and adjusted as events occur, or circumstances change, that warrant adjustments to those balances.
The Company accounts for uncertainty in income taxes by considering whether a tax position is “more-likely-than-not” of being sustained upon audit, based solely on the technical merits of the position. If so, the Company recognizes the tax benefit. The Company measures the tax benefit by determining the largest amount that is greater than 50% likely of being realized upon settlement, presuming that the tax position is examined by the appropriate taxing authority that has full knowledge of all relevant information. These assessments can be complex and require significant judgment. To the extent that the Company’s estimates change or the final tax outcome of these matters is different than the amounts recorded, such differences will impact the income tax provision in the period in which such determinations are made. If the initial assessment fails to result in the recognition of a tax benefit, the Company regularly monitors its position and subsequently recognizes the tax benefit if (i) there are changes in tax law or analogous case law that sufficiently raise the likelihood of prevailing on the technical merits of the position to more-likely-than-not, (ii) the statute of limitations expires, or (iii) there is a completion of an audit resulting in a settlement of that tax year with the appropriate agency. Uncertain tax positions are classified as current only when the Company expects to pay cash within the next twelve months. Interest and penalties, if any, are recorded within the provision for income taxes in the Company’s consolidated statements of operations and are classified on the consolidated balance sheets with the related liability for unrecognized tax benefits.
Pension Plans The Company has a defined benefit pension plan covering certain full-time non-union domestic employees and certain domestic employees covered by a collective bargaining agreement who completed service prior to January 1, 2003 (the “Pension Plan”). The assumptions used, in particular the discount rate, can have a significant effect on the amount of pension liability recorded by the Company. The discount rate is used to estimate the present value of projected benefit obligations at each valuation date. The Company evaluates the discount rate annually and adjusts the rate based upon current market conditions. For the Pension Plan, the discount rate is estimated using a portfolio of high quality corporate bond yields (rated “Aa” or higher by Moody’s or Standard & Poor’s Investors Services) which matches the projected benefit payments and duration of obligations for participants in the Pension Plan. The discount rate that is developed considers the unique characteristics of the Pension Plan and the long-term nature of the projected benefit obligation. The Company believes that a discount rate of 5.8% for Fiscal 2010 reasonably reflects current market conditions and the characteristics of the Pension Plan. An increase or decrease of 1% in the discount rate would result in an increase/decrease of approximately $17 million in pension expense (decrease/increase in pension income) for Fiscal 2010. A 1% increase/decrease in the actual return earned on pension plan assets would result in a decrease/increase of approximately $1.2 million in pension expense (increase/decrease in pension income) for Fiscal 2010.
The investments of each plan are stated at fair value based upon quoted market prices, if available. The Pension Plan invests in certain funds or asset pools that are managed by investment managers for which no quoted market price is available. These investments are valued at estimated fair value as reported by each fund’s administrators to the Pension Plan trustee. The individual investment managers’ estimates of fair value are based upon the value of the underlying investments in the fund or asset pool. These amounts may differ significantly from the value that would have been reported had a quoted market price been available for each underlying investment or the individual asset pool in total.
Effective January 1, 2003, the Pension Plan was amended and, as a result, no future benefits accrue to participants in the Pension Plan. As a result of the amendment, the Company has not recorded pension expense related to current service for all periods presented and will not record pension expense for current service for any future period.
The Company uses a method that accelerates recognition of gains or losses which are a result of (i) changes in projected benefit obligations related to changes in assumptions and (ii) returns on plan assets that are above or below the projected asset return rate (currently 8% for the Pension Plan) (“Accelerated Method”) to account for its defined benefit pension plans. The Company has recorded pension obligations equal to the difference between the plans’ projected benefit obligations and the fair value of plan assets in each fiscal year since the adoption of the Accelerated Method. The Company believes the Accelerated Method is preferable because the pension liability using the Accelerated Method approximates fair value.
The Company recognizes one-quarter of its estimated annual pension expense (income) in each of its first three fiscal quarters. Estimated pension expense (income) consists of the interest cost on projected benefit obligations for the Pension Plan, offset by the expected return on pension plan assets. The Company records the effect of any changes in actuarial assumptions (including changes in the discount rate) and the difference between the assumed rate of return on plan assets and the actual return on plan assets in the fourth quarter of its fiscal year. The Company’s use of the Accelerated Method results in increased volatility in reported pension expense and therefore the Company reports pension income/expense on a separate line in its consolidated statement of operations. The Company recognizes the funded status of its pension and other post-retirement benefit plans in the statement of financial position.
The Company makes annual contributions to all of its defined benefit pension plans that are at least equal to the minimum required contributions and any other premiums due under the Employee Retirement Income Security Act of 1974, as amended, the U.S. Internal Revenue Code of 1986, as amended and the Pension Protection Act of 2006 (the “PPA”). The Company’s cash contribution to the Pension Plan during Fiscal 2010 was $5.7 million and is expected to be approximately $12.6 million in the fiscal year ending 2011. See Note 7 of Notes to Consolidated Financial Statements.
Stock-Based Compensation The Company uses the Black-Scholes-Merton model to calculate the fair value of stock option awards. The Black-Scholes-Merton model uses assumptions which involve estimating future uncertain events. The Company is required to make significant judgments regarding these assumptions, the most significant of which are the stock price volatility, the expected life of the option award and the risk-free rate of return.
•
In determining the stock price volatility assumption used, the Company considers the historical volatility of its stock price, based upon daily quoted market prices of Common Stock on the New York Stock Exchange and, prior to May 15, 2008, on the NASDAQ Stock Market LLC, over a period equal to the expected term of the related equity instruments. The Company relies only on historical volatility since it provides the most reliable indication of future volatility. Future volatility is expected to be consistent with historical; historical volatility is calculated using a simple average calculation method; historical data is available for the length of the option’s expected term and a sufficient number of price observations are used consistently. Since the Company’s stock options are not traded on a public market, the Company does not use implied volatility. A higher volatility input to the Black-Scholes-Merton model increases the resulting compensation expense.
•
During Fiscal 2009, the Company had accumulated sufficient historical data regarding stock option exercises and forfeitures to be able to rely on that data for the calculation of expected option life. Accordingly, for options granted during Fiscal 2010 and Fiscal 2009, the Company revised its method of calculating expected option life from the simplified method as described in the SEC’s Staff Accounting Bulletin No. 110 (“SAB 110”) (which yielded an expected term of 6 years) to the use of historical data (which yielded an expected life of 4.2 years and 3.72 years for Fiscal 2010 and Fiscal 2009, respectively). Historical data will be used for stock options granted in all future periods. The Company based its Fiscal 2008 estimate of the expected life of a stock option of six years upon the average of the sum of the vesting period of 36-42 months and the option term of ten years for issued and outstanding options in accordance with the simplified method as detailed in SAB 110. A shorter expected term would result in a lower compensation expense.
•
The Company’s risk-free rate of return assumption for options granted in Fiscal 2010, Fiscal 2009 and Fiscal 2008 was equal to the quoted yield for U.S. treasury bonds as of the date of grant.
Compensation expense related to stock option grants is determined based on the fair value of the stock option on the grant date and is recognized over the vesting period of the grants on a straight-line basis. Compensation expense related to restricted stock grants is determined based on the fair value of the underlying stock on the grant date and recognized over the vesting period of the grants on a straight-line basis (see below for additional factors related to recognition of compensation expense). The Company applies a forfeiture rate to the number of unvested awards in each reporting period in order to estimate the number of awards that are expected to vest. Estimated forfeiture rates are based upon historical data on vesting behavior of employees. The Company adjusts the total amount of compensation cost recognized for each award, in the period in which each award vests, to reflect the actual forfeitures related to that award. Changes in the Company’s estimated forfeiture rate will result in changes in the rate at which compensation cost for an award is recognized over its vesting period.
Beginning in March 2010, share-based compensation awards granted to certain of the Company’s executive officers under the 2005 Stock Incentive Plan included 75,750 performance-based restricted stock/restricted unit awards (“Performance Awards”) in addition to the service-based stock options and restricted stock awards of the types that had been granted in previous periods. See Note 13 of Notes to Consolidated Financial Statements. The Performance Awards cliff-vest three years after the grant date and are subject to the same vesting provisions as awards of the Company’s regular service-based restricted stock/restricted unit awards granted in March 2010. The final number of Performance Awards that will be earned, if any, at the end of the three-year vesting period will be the greatest number of shares based on the Company’s achievement of certain goals relating to cumulative earnings per share growth (a performance condition) or the Company’s relative total shareholder return (“TSR”) (change in closing price of the Company’s common stock on the New York Stock Exchange compared to that of a peer group of companies (“Peer Companies”)) (a market condition) measured from the beginning of Fiscal 2010 to the end of Fiscal 2012 (the “Measurement Period”). The total number of Performance Awards earned could equal up to 150% of the number of Performance Awards originally granted, depending on the level of achievement of those goals during the Measurement Period.
The Company records stock-based compensation expense related to the Performance Awards ratably over the requisite service period based on the greater of the estimated expense calculated under the performance condition or the grant date fair value calculated under the market condition. Stock-based compensation expense related to an award with a market condition is recognized over the requisite service period regardless of whether the market condition is satisfied, provided that the requisite service period has been completed. Under the performance condition, the estimated expense is based on the grant date fair value (the closing price of the Company’s Common Stock on the date of grant) and the Company’s current expectations of the probable number of Performance Awards that will ultimately be earned. The fair value of the Performance Awards under the market condition ($2.4 million for the March 2010 Performance Awards) is based upon a Monte Carlo simulation model, which encompasses TSR’s during the Measurement Period, including both the period from the beginning of Fiscal 2010 to March 3, 2010 (the grant date), for which actual TSR’s are calculated, and the period from the grant date to the end of Fiscal 2012, a total of 2.83 years (the “Remaining Measurement Period”), for which simulated TSR’s are calculated.
In calculating the fair value of the award under the market condition, the Monte Carlo simulation model utilizes multiple input variables over the Measurement Period in order to determine the probability of satisfying the market condition stipulated in the award. The Monte Carlo simulation model computed simulated TSR’s for the Company and Peer Companies during the Remaining Measurement Period with the following inputs: (i) stock price on the grant date (ii) expected volatility; (iii) risk-free interest rate; (iv) dividend yield and (v) correlations of historical common stock returns between the Company and the Peer Companies and among the Peer Companies. Expected volatilities utilized in the Monte Carlo model are based on historical volatility of the Company’s and the Peer Companies’ stock prices over a period equal in length to that of the Remaining Measurement Period. The risk-free interest rate is derived from the U.S. Treasury yield curve in effect at the time of grant with a term equal to the Measurement Period assumption at the time of grant.
In addition, for all employee stock-based compensation awards issued in March 2010 (and for similar types of future awards), the Company’s Compensation Committee approved the incorporation of a Retirement Eligibility feature such that an employee who has attained the age of 60 years with at least five years of continuous employment with the Company will be deemed to be “Retirement Eligible”. Awards granted to Retirement Eligible employees will continue to vest even if the employee’s employment with the Company is terminated prior to the award’s vesting date (other than for cause, and provided the employee does not engage in a competitive activity). As in previous years, awards granted to all other employees (i.e. those who are not Retirement Eligible) will cease vesting if the employee’s employment with the Company is terminated prior to the awards vesting date. Stock-based compensation expense is recognized over the requisite service period associated with the related equity award. For Retirement Eligible employees, the requisite service period is either the grant date or the period from the grant date to the Retirement-Eligibility date (in the case where the Retirement Eligibility date precedes the vesting date). For all other employees (i.e. those who are not Retirement Eligible), as in previous years, the requisite service period is the period from the grant date to the vesting date. The Retirement Eligibility feature was not applied to awards issued prior to March 2010. The increase in stock-based compensation expense recorded during Fiscal 2010 of approximately $8.1 million, from Fiscal 2009, primarily related to the Retirement Eligibility feature described above.
Advertising Costs Advertising costs are included in SG&A expenses and are expensed when the advertising or promotion is published or presented to consumers. Cooperative advertising expenses are charged to operations as incurred and are also included in SG&A expenses. The amounts charged to operations for advertising, marketing and promotion expenses (including cooperative advertising, marketing and promotion expenses) for Fiscal 2010, Fiscal 2009 and Fiscal 2008 were $126.5 million, $100.2 million and $118.8 million, respectively. Cooperative advertising expenses for Fiscal 2010, Fiscal 2009 and Fiscal 2008 were $27.9 million, $21.6 million and $24.6 million, respectively.
Acquisitions
See Note 2 of Notes to Consolidated Financial Statements.
Dispositions and Discontinued Operations
See Note 3 of Notes to Consolidated Financial Statements
Results of Operations
Statement of Operations (Selected Data)
The following tables summarize the historical results of operations of the Company for Fiscal 2010, Fiscal 2009 and Fiscal 2008. The results of the Company’s discontinued operations are included in “Loss from discontinued operations, net of taxes” for all periods presented.
Comparison of Fiscal 2010 to Fiscal 2009
Net Revenues
For Fiscal 2010 compared to Fiscal 2009, the amount of net revenues increased from both wholesale and retail channels of distribution. However, as a percentage of total Company net revenues, there was a significant increase in net revenues from retail channels, while there was a decrease in net revenues from wholesale channels from one period to the other. In addition, net revenues increased in all geographies, especially in Asia, Canada and Mexico and Central and South America, and in all Groups (segments), as presented in the following tables:
Net revenues by segment were as follows:
The effect of fluctuations in foreign currency exchange rates on net revenues was an increase of $19.9 million for Fiscal 2010 compared to Fiscal 2009. See Overview, above.
During Fiscal 2010, the Company’s top five customers accounted for $490.3 million (21.4%) of the Company’s net revenue as compared to $470.9 million (23.3%) for Fiscal 2009. During Fiscal 2010 and Fiscal 2009, no one customer accounted for 10% or more of the Company’s net revenues.
Sportswear Group
Sportswear Group net revenues were as follows:
Sportswear Group net revenues increased $159.2 million to $1.20 billion for Fiscal 2010 from $1.04 billion for Fiscal 2009. Sportswear Group net revenues from international operations increased $110.9 million and from domestic operations increased $48.3 million. The increase in international net revenues includes a $14.7 million increase due to the favorable effect of fluctuations in certain foreign currency exchange rates. See Overview, above.
Net revenues from Calvin Klein Jeans increased $119.1 million. Wholesale sales increased $39.0 million (including increases of $39.4 million in Mexico, Central and South America, $10.9 million in the U.S., $9.0 million in Asia and $3.6 million in Canada, partially offset by a decrease of $23.9 million in Europe). The increase in worldwide wholesale net revenues was primarily due (in constant currency) to the following:
(i)
an increase in sales in Mexico and Central and South America to department stores, membership clubs (primarily due to the introduction of new styles) and specialty stores, including an increase in new customers and an expansion of locations of existing customers;
(ii)
an increase in the U.S. primarily due to increased sales to the off-price channel, due primarily to additional product offerings, partially offset by a decrease in sales to department stores and clubs;
(iii)
an increase in Asia primarily due to (a) the expansion of the distribution network in the People’s Republic of China and other regions of Asia, partially offset by the conversion of a portion of the Company’s wholesale businesses in the People’s Republic of China and Singapore to retail businesses, as a result of the acquisition of distributors’ businesses in those regions in the second quarter of 2010, and (b) a decrease in sales to the off-price channel primarily due to lower levels of excess inventory;
(iv)
in Canada, an increase in net revenues from sales to department stores and independent retailers, which was partially offset by a decline in net revenues from sales in the off-price channel; partially offset by
(v)
a decrease in wholesale net revenue in Europe primarily due to decreased sales of Calvin Klein Jeans to department, specialty and independent stores, due in part to the acquisition of the Company’s Italian distributor of Calvin Klein products in the fourth quarter of Fiscal 2010, partially offset by an increase in sales of accessories.
Net revenues from Calvin Klein Jeans retail sales increased $80.1 million (including increases of $37.2 million in Asia, $28.6 million in Europe and $12.8 million in Mexico, Central and South America). The change in retail net revenues was primarily due (in constant currency) to a 6.5% increase in comparable store sales, coupled with the addition of new stores opened by the Company and new stores acquired by the Company (including stores acquired in Brazil in the fourth quarter of 2009 and stores acquired in the People’s Republic of China, Singapore and Italy during Fiscal 2010).
Net revenues from Chaps increased $40.0 million. The increase primarily reflects an increase in sales in the U.S. to chain stores, department stores and customers in the off-price channel due to additional product offerings.
Intimate Apparel Group
Intimate Apparel Group net revenues were as follows:
Intimate Apparel Group net revenues increased $110.8 million to $834.0 million for Fiscal 2010 from $723.2 million for Fiscal 2009. Intimate Apparel Group net revenues from international operations increased $68.1 million and from domestic operations increased $42.7 million. The increase in international net revenues includes a $3.3 million increase due to the favorable effect of fluctuations in foreign currency exchange rates. See Overview, above.
Net revenues from Calvin Klein Underwear increased $89.6 million. Wholesale sales increased $58.1 million (including increases of $24.7 million in the U.S., $10.8 million in Mexico, Central and South America, $11.6 million in Europe, $5.0 million in Asia and $6.0 million in Canada). The increase in worldwide wholesale net revenue was, primarily due (in constant currency) to the following: (i) increases in all geographies in the department store channel, which benefitted from the launch of the Calvin Klein X men’s product line and the Calvin Klein Envy women’s product line, primarily in Europe and Asia; (ii) an increase in the U.S., which primarily resulted from an increase in sales to the off-price channel due primarily to additional product offerings; (iii) an increase in Mexico, Central and South America, primarily due to increased sales to membership clubs (primarily due to the introduction of new styles) and specialty stores, including an increase in new customers and an expansion of locations of existing customers; (iv) in Asia, an increase primarily due to (a) the expansion of the Company’s distribution networks in the People’s Republic of China and other regions of Asia, partially offset by the conversion of a portion of the Company’s wholesale businesses in the People’s Republic of China and Singapore to retail businesses, as a result of the acquisition of distributors’ businesses in those regions in the second quarter of 2010 and (b) a decrease in sales to the off-price channel primarily due to lower levels of excess inventory and (v) in Canada, an increase primarily in the department store and membership club channels of distribution.
Net revenues from Calvin Klein Underwear retail sales increased $31.5 million (including increases of $16.9 million in Asia, $8.0 million in Europe, $3.6 million in Mexico and Central and South America, and $2.9 million in Canada). The increase in net revenues was primarily due (in constant currency) to the addition of new stores opened by the Company and acquired by the Company (including the stores acquired in Brazil in the fourth quarter of 2009 and stores acquired in the People’s Republic of China, Singapore and Italy in Fiscal 2010) and to a 4.4% increase in comparable store sales. In addition, the increase reflects the successful launch of the Calvin Klein X men’s product line in all geographies and the Calvin Klein Envy women’s product line, primarily in Europe and Asia, during Fiscal 2010.
Net revenues from Core Intimates increased $21.2 million. The increase primarily reflects an increase in sales in the U.S. to the mass merchandisers channel primarily due to new product launches and a new customer in Fiscal 2010, and increases in sales of Olga and Warner’s brand products across other channels of distribution primarily due to new product launches. Net revenues also increased in Mexico and Central and South America due primarily to increased sales of Warner’s products to department stores and the introduction of new product lines in membership clubs.
Swimwear Group
Swimwear Group net revenues were as follows:
Swimwear Group net revenues increased $6.2 million to $257.7 million for Fiscal 2010 from $251.5 million Fiscal 2009. Swimwear Group net revenues from international operations increased $5.7 million and from domestic operations increased $0.5 million. The increase in international net revenues includes a $1.9 million increase due to the favorable effect of fluctuations in foreign currency exchange rates. See Overview, above. Comparable store sales declined 2.2% for Fiscal 2010 compared to Fiscal 2009 in the Swimwear Group.
Net revenues from Speedo increased $2.4 million, which primarily represented an increase of $3.6 million in sales to membership clubs and sporting goods stores in Canada, partially offset by a decrease in net revenues of $1.9 million in the U.S. primarily due to decreased sales to membership clubs, which was partially offset by increased sales to mass merchandisers, specialty stores and department stores in the U.S.
Net revenues from Calvin Klein swimwear increased $3.8 million, mainly in wholesale sales, primarily due, in the U.S., to improved delivery to department and specialty stores and the introduction of sales to membership clubs in 2010, and, in Europe, to increased sales to department stores and independent retailers. Retail sales were substantially unchanged.
Gross Profit
Gross profit was as follows:
(a)
reflects the reclassification of approximately $27.8 million of gross profit related to certain sales of Calvin Klein underwear, previously reported in the Sportswear Group, to the Intimate Apparel Group for Fiscal 2009 in order to conform to the Fiscal 2010 presentation.
(b)
Reflects a charge of $3.6 million during Fiscal 2009 related to the write down of inventory associated with the Company’s LZR Racer and other similar racing swimsuits. The Company recorded the write down as a result of FINA’s ruling during Fiscal 2009 which banned the use of these types of suits in competitive swim events.
Gross profit was $1.02 billion, or 44.4% of net revenues, for Fiscal 2010 compared to $864.3 million, or 42.8% of net revenues, for Fiscal 2009. The 160 basis point increase in gross margin and the increase in gross profit are primarily reflective of a favorable sales mix due to an increase in retail sales compared to wholesale as a percentage of total sales, increased sales volume and the favorable effects of fluctuations in foreign currency exchange rates. Gross profit for Fiscal 2010 includes an increase of $22.9 million due to the favorable effects of foreign currency fluctuations.
During the fourth quarter of Fiscal 2010, the increase in gross margin due to those factors was partially offset by an increase in costs, including those for raw material, labor and freight, which the Company anticipates will continue in the fiscal year ending 2011. The Company expects to partially mitigate cost increases in 2011 and their effect on gross margins through a combination of sourcing initiatives, price increases, and continuing shifts in its business, favoring international and direct to consumer channels, which carry higher gross margins.
Sportswear Group gross profit increased $83.4 million, and gross margin increased 150 basis points, for Fiscal 2010 compared to Fiscal 2009, reflecting a $79.9 million increase in international operations (primarily due to an increase in sales volume and a favorable sales mix in all geographies, and the favorable effect of fluctuations in exchange rates of foreign currencies), and a $3.5 million increase in the domestic business (primarily reflecting increased sales, partially offset by an increase in freight costs and customer allowances).
Intimate Apparel Group gross profit increased $66.2 million and gross margin increased 150 basis points for Fiscal 2010 compared to Fiscal 2009 reflecting a $53.9 million increase in international operations (primarily related to the favorable effect of fluctuations in exchange rates of foreign currencies, increased sales volume and a favorable sales mix), and a $12.3 million increase in the domestic business. The increase in the domestic business primarily reflects increased sales volume and a favorable product mix, partially offset by increases in freight and raw material costs in Fiscal 2010.
Swimwear Group gross profit increased $6.0 million and gross margin increased 150 basis points for Fiscal 2010 compared to Fiscal 2009 reflecting a $5.0 million increase in international operations (primarily related to the favorable effect of fluctuations in exchange rates of certain foreign currencies and a favorable sales mix) and a $1.0 million increase in the domestic business (primarily reflecting a charge in the third quarter of 2009, not repeated in 2010, related to the write-down of inventory associated with the Company’s LZR Racer and other similar racing suits which were banned by FINA during Fiscal 2009, partially offset by a decrease in sales volume and an unfavorable product mix).
Selling, General and Administrative Expenses
Selling, general & administrative (“SG&A”) expenses increased $119.2 million to $758.1 million (33.0% of net revenues) for Fiscal 2010 compared to $638.9 million (31.6% of net revenues) for Fiscal 2009. The increase in SG&A expenses includes:
(i)
an increase of $72.1 million in selling and distribution expenses primarily associated with the opening and acquisition of additional retail stores in Europe, Asia, Canada and Mexico and Central and South America and duplicative costs associated with consolidation of the distribution centers in Europe, partially offset by decreases due to cost savings resulting from restructuring activities which occurred in Fiscal 2009;
(ii)
an increase of $26.3 million in marketing expenses, including the launch of the Calvin Klein X product line of men’s underwear and the launch of Calvin Klein Envy product line of women’s underwear; and
(iii)
an increase in administrative expenses of $21.6 million, primarily including an increase due to amounts accrued for performance-based employee compensation as well as an increase in stock-based compensation expense primarily as a result in the change in terms of equity awards granted to employees in March 2010 (see Discussion of Critical Accounting Policies -Stock-Based Compensation Expense and Note 13 of Notes to Consolidated Financial Statements) and also including increases in acquisition expenses of $2.4 million (related to the acquisition of certain of the Company’s distributors of Calvin Klein products in Italy, Singapore and the People’s Republic of China) (see Note 2 of Notes to Consolidated Financial Statements) and franchise taxes.
The effect of fluctuations in the U.S. dollar relative to certain functional currencies where the Company conducts certain of its operations for Fiscal 2010 compared to Fiscal, 2009 resulted in a $0.5 million increase in SG&A.
Amortization of Intangible Assets
Amortization of intangible assets was $11.5 million for Fiscal 2010 compared to $11.0 million for Fiscal 2009 (see Note 10 of Notes to Consolidated Financial Statements - Intangible Assets and Goodwill).
Pension Income / Expense
Pension expense was $2.6 million for Fiscal 2010 compared to pension expense of $20.9 million for Fiscal 2009. The decrease in pension expense is primarily related to a higher asset base in Fiscal 2010 due to returns earned on the Plan’s assets during Fiscal 2010, partially offset by interest cost on the Company’s projected benefit obligation resulting from a decrease in the discount/interest rate to 5.8% in Fiscal 2010 from 6.1% in Fiscal 2009. See Note 7 of Notes to Consolidated Financial Statements.
Operating Income
The following table presents operating income by group:
(a)
reflects a charge of $3.6 million during Fiscal 2009 related to the write down of inventory associated with the Company’s LZR Racer and other similar racing swimsuits. The Company recorded the write down as a result of FINA’s ruling during Fiscal 2009 which banned the use of these types of suits in competitive swim events.
(b)
the decrease in unallocated corporate expenses for Fiscal 2010 compared to Fiscal 2009 was primarily related to a reduction in pension expense (see Note 7 of Notes to Consolidated Financial Statements) and foreign currency exchange-related losses, partially offset by an increase in amounts accrued for performance-based employee compensation and other employee compensation and benefits and an increase in share-based compensation expense due primarily to the addition of Retirement Eligibility provisions in the Fiscal 2010 awards (see Note 13 of Notes to Consolidated Financial Statements).
(c)
includes approximately $9.8 million and $12.1 million for Fiscal 2010 and Fiscal 2009, respectively, related to restructuring expenses. See Note 4 of Notes to Consolidated Financial Statements.
The following table presents operating income by region and channel:
Operating income for Fiscal 2010 includes an increase of $22.3 million related to the favorable effects of fluctuations in exchange rates of foreign currencies. See Overview, above.
Sportswear Group
Sportswear Group operating income was as follows:
Sportswear Group operating income increased $27.0 million, or 21.9%, reflecting increases of $16.7 million, $5.7 million and $4.6 million in the Calvin Klein Jeans wholesale, Calvin Klein Jeans retail and Chaps businesses, respectively. The increase in Sportswear operating income reflects an $83.4 million increase in gross profit, partially offset by a $56.4 million increase in SG&A (including amortization of intangible assets) expenses. The increase in SG&A expenses primarily reflects increases in Europe, Asia and Mexico and Central and South America due to store openings, increased distribution costs related to increased sales volume and the unfavorable effects of foreign currency fluctuations.
Intimate Apparel Group
Intimate Apparel Group operating income was as follows:
Intimate Apparel Group operating income for Fiscal 2010 increased $19.8 million, or 16.7%, reflecting increases of $10.9 million Calvin Klein Underwear wholesale, $3.3 million in Calvin Klein Underwear retail and $5.6 million in Core Intimates. The increase in Intimate Apparel operating income reflects a $66.2 million increase in gross profit, partially offset by a $46.4 million increase in SG&A expenses (including amortization of intangible assets). The increase in SG&A expense primarily reflects incremental marketing investments behind the launch of the Calvin Klein X product line of men’s underwear and the launch of the Calvin Klein Envy product line of women’s underwear, an increase related to retail store openings in Europe, Asia, Canada and South America and the unfavorable effect of fluctuations in foreign currency exchange rates.
Swimwear Group
Swimwear Group operating income was as follows:
Swimwear Group operating income for Fiscal 2010 increased $2.3 million, or 15.3%, reflecting a $0.9 million increase in Speedo wholesale and a $1.4 million increase in Calvin Klein wholesale. Swimwear retail operating income was substantially unchanged. The increase in Swimwear operating income reflects a $6.0 million increase in gross profit, partially offset by a $3.7 million increase in SG&A expenses (including amortization of intangible assets).
Other Loss
Other loss of $6.2 million for Fiscal 2010 primarily reflects a loss of $3.7 million related to the redemption of $160.9 million of Senior Notes during Fiscal 2010 (see Note 12 of Notes to Consolidated Financial Statements), a loss of $5.1 million on the current portion of inter-company loans denominated in currency other than that of the foreign subsidiaries’ functional currency, partially offset by a gain of $2.6 million on foreign currency exchange contracts designed as economic hedges (see Note 17 to Notes to Consolidated Financial Statements). Other loss of $1.9 million for Fiscal 2009 primarily reflects $3.9 million of net losses related to foreign currency exchange contracts designed as economic hedges (see Note 17 to Notes to Consolidated Financial Statements), partially offset by net gains of $2.0 million on the current portion of inter-company loans denominated in currency other than that of the foreign subsidiaries’ functional currency.
Interest Expense
Interest expense decreased $9.4 million to $14.5 million for Fiscal 2010 from $23.9 million for Fiscal 2009. The decrease primarily relates to the redemption of the full outstanding balance of $160.9 million of the Senior Notes by June 15, 2010, which were repaid prior to their date of maturity in June 2013, a decrease in the outstanding balances related to the CKJEA Notes payable and the 2008 Credit Agreements (previously referred to as the New Credit Agreements), partially offset by an increase in the balance of the Italian Note, which was entered into in Fiscal 2010 (see Note 12 of Notes to Consolidated Financial Statements). In addition, interest expense increased due to the accretion of the liability for the contingent payments to the Sellers in the acquisitions in Brazil in the fourth quarter of 2009 (see Note 2 of Notes to Consolidated Financial Statements).
Interest Income
Interest income increased $1.6 million to $2.8 million for Fiscal 2010 from $1.2 million for Fiscal 2009. The increase in interest income was due primarily to an increase in the average of the Company’s cash balance during Fiscal 2010.
Income Taxes
The effective tax rates for Fiscal 2010 and Fiscal 2009 were 35.7% and 38.0%, respectively. The decrease in the effective tax rate reflects the effect of a reduction in the level of foreign income subject to taxation in the U.S., a shift in earnings from higher to lower taxing jurisdictions, as well as the net effect of certain discrete items. In addition, the tax provision for Fiscal 2010 includes a tax charge of approximately $2.7 million associated with the correction of an error in the 2006 through 2009 income tax provisions as a consequence of the loss of a credit related to prior year tax overpayments caused by the delayed filing of tax returns in a U.S. state taxing jurisdiction, while the tax provision for Fiscal 2009 includes a non-cash tax charge of approximately $3.6 million recorded in the U.S. associated with the correction of an error in the 2006 income tax provision related to the recapture of cancellation of indebtedness income which had been deferred in connection with the Company’s bankruptcy proceedings in 2003. The abovementioned errors were not material to any prior period.
Discontinued Operations
Loss from discontinued operations, net of taxes, was $9.2 million for Fiscal 2010 compared to a loss of $6.2 million for Fiscal 2009, primarily related to the Company’s Ocean Pacific Apparel, Lejaby and Calvin Klein Collection discontinued businesses. See Note 3 of Notes to Consolidated Financial Statements.
Comparison of Fiscal 2009 to Fiscal 2008
Net Revenues
Net revenues by segment were as follows:
The decreases in net revenues for the Sportswear, Intimate Apparel and Swimwear Groups for Fiscal 2009 relative to Fiscal 2008 reflect:
•
a decrease in domestic net revenues of $25.5 million and a decline in international net revenues of $17.7 million; the decline in international net revenues includes an $85.0 million decrease due to the unfavorable effect of fluctuations in foreign currency exchange rates in countries where the Company conducts certain of its operations (primarily the Euro, Korean Won, Canadian Dollar and Mexican Peso);
•
the negative effect of the downturn in the worldwide economy, tightening of credit and erosion in consumer spending primarily from the fourth quarter of 2008, which contributed to the decline domestically and limited the international increase in net revenues expressed in local currency in Fiscal 2009, and;
Total Company net revenues from comparable store sales increased 3.0% for Fiscal 2009.
The Company’s products are widely distributed through virtually all channels of distribution and geographies. The following tables summarize the Company’s net revenues by channel of distribution, by geography and by wholesale/retail split for Fiscal 2009 and Fiscal 2008:
Sportswear Group
Sportswear Group net revenues were as follows:
Sportswear Group net revenues decreased $6.4 million to $1,044.9 million for Fiscal 2009 from $1,051.3 million for Fiscal 2008, comprised of a decrease of $27.9 million in Sportswear wholesale and an increase of $21.5 million in Sportswear retail. Sportswear Group net revenues include a $48.1 million decrease due to the negative effect of fluctuations in foreign currency exchange rates. Sportswear Group net revenues from international operations increased $1.9 million and from domestic operations declined $8.3 million. Sportswear Group net revenues from comparable store sales increased 4.0% for Fiscal 2009.
The decrease in Sportswear wholesale primarily reflects:
Calvin Klein Jeans:
•
a decline in net revenues to department stores and membership clubs in the U.S., Mexico, Canada and Europe, partially offset by:
•
an increase in sales in the U.S. and Europe to the off-price channel;
•
an increase in net revenues in Asia due to increased sales in Korea, primarily due to the sale of off-season merchandise and promotional events and discounts and an increase in the number of distributors in the People’s Republic of China.
Chaps:
•
a decline in the U.S., Mexico and Canada in the department store and membership club channels, partially offset by:
•
an increase in sales in the U.S. to the off-price and chain store channels.
The increase in Sportswear retail primarily reflects:
•
increases in Europe, primarily related to volume increases in comparable outlet stores and the effect of new outlet, full price and concession store openings;
•
an increase in Brazil, due to the addition of sixteen new stores, including the eight stores acquired in the fourth quarter of Fiscal 2009;
•
increases in comparable store sales and new store openings in the People’s Republic of China, Korea and Australia.
Intimate Apparel Group
Intimate Apparel Group net revenues were as follows:
Intimate Apparel Group net revenues decreased $28.3 million to $723.2 million for Fiscal 2009 from $751.5 million for Fiscal 2008, comprised of a decrease of $39.3 million in Intimate Apparel wholesale and an increase of $11.0 million in Calvin Klein Underwear retail. Intimate Apparel Group net revenues include a $32.0 million decrease due to the negative effect of fluctuations in foreign currency exchange rates. Intimate Apparel Group net revenues from international operations declined $15.5 million and from domestic operations declined $12.8 million. Intimate Apparel Group net revenues from comparable store sales increased 2.0% for Fiscal 2009.
The decrease in Intimate Apparel wholesale primarily reflects:
Calvin Klein Underwear:
•
decreases in net revenues in all geographies in the department store channel;
•
a reduction in the off-price channel in the U.S, which the Company attributes to lower excess and obsolete inventory in line with its global initiative to reduce inventory levels, partially offset by:
•
an increase in net revenues in the U.S., Canada and Mexico to membership clubs;
•
an increase in net revenues in Asia related to the expansion of the Company’s distribution network in the People’s Republic of China.
Core Intimates:
•
decreases in net revenues in all geographies in the department store channel, partially offset by:
•
an increase in sales in the U.S. in the off-price channel;
•
an increase in sales of the Olga line, primarily related to strong sales of new styles.
The increase in Calvin Klein retail primarily reflects:
•
the opening of new retail stores and increased net revenues in existing stores in Canada, Hong Kong, the People’s Republic of China, Europe, Mexico, Central and South America, partially offset by:
•
a decrease in the U.S., which reflects a decline in e-commerce sales on the Company’s website and the Soho store.
Swimwear Group
Swimwear Group net revenues were as follows:
Swimwear Group net revenues decreased $8.5 million to $251.5 million for Fiscal 2009 from $260.0 million for Fiscal 2008, comprised of a decrease of $6.9 million in Swimwear wholesale and a decrease of $1.6 million in Swimwear retail. Swimwear Group net revenues include a $4.8 million decrease due to the negative effect of fluctuations in foreign currency exchange rates. Swimwear Group net revenues from international operations declined $4.1 million and from domestic operations declined $4.4 million. Swimwear Group net revenues from comparable store sales increased 1.6% for Fiscal 2009.
The decrease in Swimwear wholesale net revenues reflects:
Speedo:
•
a decline in sales in the U.S., reflecting decreased net revenues to specialty and sporting goods stores and discounters, partially offset by increased sales volume to membership clubs and team dealers;
•
a decrease in net revenues in specialty stores in Mexico.
Calvin Klein:
•
a decline in the U.S. and in Europe, due primarily to cancellations of orders related to late deliveries in 2009.
The decrease in Swimwear retail reflects:
•
volume decreases and price decreases at the online Speedo store in the U.S. due to promotional sales, partially offset by:
•
an increase in sales volume of Calvin Klein swimwear at outlet stores in Europe.
Gross Profit
Gross profit was as follows:
Gross profit was $864.3 million, or 42.8% of net revenues, for Fiscal 2009 compared to $920.8 million, or 44.6% of net revenues, for Fiscal 2008. The $56.5 million decrease in gross profit was due to decreases in the Sportswear Group ($11.5 million), Intimate Apparel Group ($31.9 million) and the Swimwear Group ($13.1 million). The 180 basis point reduction in gross margin is primarily reflective of an increase in the ratio of customer allowances and discounts to net revenues (which the Company believes is due to an increase in promotional activity in response to recent weakness in the global economy), the write down of inventory in response to FINA’s ruling regarding the LZR Racer and other similar swimsuits, an unfavorable sales mix as the Company experienced an increase in off-price (and other less profitable channels) net revenues as a proportion of total net revenues and the negative effects of fluctuations in foreign currency exchange rates. Gross profit for Fiscal 2009 includes a decrease of $72.4 million due to foreign currency fluctuations. In addition, gross profit for Fiscal 2008 benefitted by an extra week of operations when compared to Fiscal 2009.
Sportswear Group gross profit decreased $11.5 million and gross margin decreased 80 basis points for Fiscal 2009 compared to Fiscal 2008 reflecting an $11.1 million decrease in the international business (primarily related to the negative effect of fluctuations in exchange rates of foreign currencies, an unfavorable sales mix in the wholesale channels in Europe and Asia, and the effect of an extra week of operations during Fiscal 2008, partially offset by increased retail sales worldwide in Fiscal 2009) and a $0.4 million decrease in the domestic business (due primarily to lower net revenues and an unfavorable sales mix, partially offset by lower product costs).
Intimate Apparel Group gross profit decreased $31.9 million and gross margin decreased 240 basis points for Fiscal 2009 compared to Fiscal 2008 reflecting a $30.0 million decline in the international business (primarily related to the negative effect of fluctuations in exchange rates of foreign currencies, an unfavorable sales mix, lower net sales and the effect of an extra week of operations during Fiscal 2008) and a $1.9 million decrease in the domestic business. The decrease in the domestic business primarily reflects decreased net revenues in the Core Intimate and Calvin Klein underwear businesses, an unfavorable sales mix in the Core Intimate business and a restructuring expense increase in those businesses, partially offset by a favorable sales mix and lower freight costs in the Calvin Klein underwear business.
Swimwear Group gross profit decreased $13.1 million and gross margin decreased 400 basis points for Fiscal 2009 compared to Fiscal 2008. The decrease in gross profit and gross margin primarily reflects a $6.2 million decrease in Speedo (primarily related to the inventory write down associated with the LZR Racer and other similar racing swimsuits and declines in net revenues), a $5.7 million decline in Calvin Klein swimwear wholesale gross profit (due primarily to decrease net revenues coupled with an unfavorable sales mix in the U.S., a decrease in net sales in Europe and the unfavorable effect of foreign currency fluctuation in Europe) and a decrease of $1.2 million in Swimwear retail (due primarily to a decline in net revenue in the U.S. SpeedoUSA.com internet site). The decrease in gross margin also reflects the effect of an extra week of operations during Fiscal 2008.
Selling, General and Administrative Expenses
SG&A expenses decreased $99.3 million to $638.9 million (31.6% of net revenues) for Fiscal 2009 compared to $738.2 million (35.8% of net revenues) for Fiscal 2008. The decrease in SG&A expenses primarily reflects the effects of the Company’s cost cutting initiatives (which include, among other things, reductions in its workforce, reductions in discretionary marketing costs, and reductions in professional fees and travel costs), reductions related to the effects of, and losses associated with, fluctuations in foreign currency exchange rates (see below), lower restructuring charges and the effect of an extra week of operations in Fiscal 2008. This was partially offset by an increase of $5.9 million in selling expenses associated with the opening of additional retail stores in Fiscal 2009 The U.S. dollar strengthened during Fiscal 2009 relative to the functional currencies where the Company conducts certain of its operations compared to Fiscal 2008 resulting in a $32.7 million decrease in SG&A. The Company also experienced a $27.2 million reduction in foreign currency exchange losses (primarily associated with U.S. dollar denominated trade liabilities in certain of its foreign subsidiaries) which management believes is attributable to the implementation (during the fourth quarter of 2008) of strategies designed to minimize losses associated with certain exposures the Company has to fluctuations in foreign currency exchange rates. The reduction in restructuring charges (from $35.3 million in Fiscal 2008 to $12.1 million in Fiscal 2009) primarily related to a reduction in the Company’s workforce in response to the downturn in the economy and consolidation of the Company’s European operations, while charges for Fiscal 2008 related primarily to the Collection License Company Charge of $18.5 million, discussed previously, as well as activities to increase productivity and profitability in the Swimwear segment (see Note 4 of Notes to Consolidated Financial Statements).
Amortization of Intangible Assets
Amortization of intangible assets was $11.0 million for Fiscal 2009 compared to $9.4 million for Fiscal 2008. The increase primarily relates to the correction of certain intangible assets recorded at the Effective Date, partially offset by the unfavorable effect of foreign currency fluctuations on the Euro-denominated and Korean Won-denominated carrying amounts of Calvin Klein licenses acquired in January 2006 and January 2008 and the write-off of the Calvin Klein Golf license in Fiscal 2009.
Pension Income / Expense
Pension expense was $20.9 million in Fiscal 2009 compared to pension expense of $31.6 million in Fiscal 2008. The decrease in pension expense is primarily related to a higher asset base in 2009 due to positive returns earned on the Plan’s assets during Fiscal 2009, partially offset by an increase in pension liability resulting from application of a discount rate of 6.1% in Fiscal 2009 compared to 8.0% in Fiscal 2008. See Note 7 of Notes to the Consolidated Condensed Financial Statements.
Operating Income
The following table presents operating income by group:
Operating income was $193.5 million (9.6% of net revenues) for Fiscal 2009 compared to $141.4 million (6.9% of net revenues) for Fiscal 2008. Included in operating income for Fiscal 2009 are pension expense of $20.9 million and restructuring charges of $12.1 million. Included in operating income for Fiscal 2008 are pension expense of $31.6 million and restructuring charges of $35.3 million, of which $18.5 million relates to the Collection License Company Charge and the remainder relates to contract termination, employee severance and other costs. Operating income for Fiscal 2009 includes a decrease of $40.5 million related to the adverse effects of fluctuations in exchange rates of foreign currencies. In addition, operating income in Fiscal 2008 was favorably affected by the additional week of operations.
Sportswear Group
Sportswear Group operating income was as follows:
(a)
Includes restructuring charges of $3.2 million for Fiscal 2009, primarily related to the reduction in workforce and consolidation of the Company’s European operations and $27.8 million for Fiscal 2008, primarily related to the Collection License Company Charge of $18.5 million related to the transfer of the Collection License Company to PVH as well as contract termination and employee termination costs.
(b)
Reflects the reclassification of approximately $1.8 million and $0.4 million of operating income related to certain sales of Calvin Klein underwear previously reported in the Sportswear Group to the Intimate Apparel Group for Fiscal 2009 and Fiscal 2008, respectively, in order to conform to the presentation for Fiscal 2010.
(c)
Includes an allocation of shared services expenses by brand as detailed below:
Sportswear Group operating income increased $33.8 million, or 37.8%, primarily reflecting increases of $27.2 million, $1.8 million and $4.8 million in the Calvin Klein Jeans wholesale, Chaps and Calvin Klein Jeans retail businesses, respectively. The increase in Sportswear operating income primarily reflects an $11.5 million decrease in gross profit and a $45.3 million decrease in SG&A (including amortization of intangible assets) expenses. SG&A expenses as a percentage of net sales decreased 4.1 percentage points. The decrease in SG&A expenses primarily reflects a $24.5 million decrease in restructuring charges (see Note 4 of Notes to Consolidated Financial Statements), the effects of foreign currency fluctuations and savings as a result of cost cutting initiatives, partially offset by increases in Europe, Asia and Brazil due to store openings and the benefit of an extra week of operations in 2008.
Intimate Apparel Group
Intimate Apparel Group operating income was as follows:
Intimate Apparel Group operating income for Fiscal 2009 decreased $7.6 million, or 6.0%, over the prior year reflecting a $6.2 million decrease in Calvin Klein Underwear wholesale, a $1.1 million increase in Calvin Klein Underwear retail and a $2.5 million decrease in Core Intimates. The decrease in Intimate Apparel operating income primarily reflects a $31.9 million decrease in gross profit, partially offset by a $24.3 million decrease in SG&A (including amortization of intangible assets) expenses. SG&A expenses as a percentage of net sales decreased 2.0 percentage points. The decrease in SG&A expense primarily reflects the Company’s initiative to reduce costs and the effect of fluctuations in foreign currency exchange rates and the benefit of an extra week in 2008, partially offset by an increase related to retail store openings in Europe and Asia.
Swimwear Group
Swimwear Group operating income (loss) was as follows:
(c)
Includes restructuring charges of $3.0 million for Fiscal 2009, primarily related to the reduction in workforce and $3.9 million for Fiscal 2008, primarily related to contract termination and employee termination costs.
(d)
Includes an allocation of shared services expenses by brand in the following table:
Swimwear Group operating income for Fiscal 2009 increased $4.0 million, or 34.8%, reflecting an $11.3 million increase in Speedo wholesale, partially offset by a $5.1 million decrease in Calvin Klein wholesale and a decline of $2.2 million in Swimwear retail. Operating income for Fiscal 2009 and Fiscal 2008 includes restructuring expenses of $3.0 million and $3.9 million, respectively, primarily related to the reduction in the Company’s workforce in response to the downturn in the economy as well as the rationalization of the Swimwear Group warehouse and distribution function in California (see Note 4 of Notes to Consolidated Financial Statements). The increase in Swimwear operating income primarily reflects a $13.1 million decrease in gross profit, more than offset by a $17.1 million decrease in SG&A (including amortization of intangible assets) expenses. SG&A expenses as a percentage of net sales decreased 5.7 percentage points. The decrease in SG&A expense primarily relates to the Company’s initiative to reduce costs, marketing expenses related to the Beijing Olympics in 2008 and the benefit of the extra week of operations in Fiscal 2008.
Other (Income) Loss
Loss of $1.9 million for Fiscal 2009 primarily reflects $3.9 million of net losses related to foreign currency exchange contracts designed as economic hedges (see Note 17 to Notes to Consolidated Financial Statements), partially offset by net gains of $2.0 million on the current portion of inter-company loans denominated in currency other than that of the foreign subsidiaries’ functional currency. Loss of $1.9 million for Fiscal 2008 primarily reflects net gains of $1.5 million on the current portion of inter-company loans denominated in currency other than that of the foreign subsidiaries’ functional currency, a $2.2 million gain related to foreign currency exchange contracts designed as economic hedges, a write-off of $2.2 million of deferred financing charges related to the extinguishment of the Amended and Restated Credit Agreement in August 2008 (see below), and a premium paid of $3.2 million (which includes the write-off of approximately $1.1 million of deferred financing costs) related to the repurchase of $44.1 million aggregate principal amount of Senior Notes (defined below) for a total consideration of $46.2 million. See Capital Resources and Liquidity - Financing Arrangements, below.
Interest Expense
Interest expense decreased $5.6 million to $23.9 million for Fiscal 2009 from $29.5 million for Fiscal 2008. The decrease primarily relates to a decline in interest associated with the Term B Note, which was fully repaid in the third quarter of Fiscal 2008, with the Senior Notes in the U.S., which were partially repaid in the first quarter of Fiscal 2008, to the decrease in the outstanding balance and interest rates related to the CKJEA short term notes payable and the amortization of the premium on the interest rate swaps which were terminated in Fiscal 2009. Those decreases were partially offset by an increase in interest on balances of the 2008 Credit Agreements (previously referred to as the New Credit Agreements), which were entered into in August 2008.
Interest Income
Interest income decreased $1.9 million to $1.2 million for Fiscal 2009 from $3.1 million for Fiscal 2008. The decrease in interest income was due primarily to lower interest rates despite higher outstanding cash balances.
Income Taxes
The effective tax rates for Fiscal 2009 and Fiscal 2008 were 38.0% and 53.7% respectively. The lower effective tax rate for Fiscal 2009 primarily relates to a non-cash tax charge of approximately $14.6 million recorded during Fiscal 2008 associated with the repatriation of the Lejaby sale proceeds (see Note 3 to the Consolidated Financial Statements), partially offset by a tax charge of approximately $3.6 million in the U.S. recorded during Fiscal 2009 and a shift in earnings from lower to higher taxing jurisdictions included in the effective tax rate for Fiscal 2009. The tax charge of approximately $3.6 million recorded during Fiscal 2009 related to the correction of an error in the 2006 income tax provision associated with the recapture of cancellation of indebtedness income which had been deferred in connection with the Company’s bankruptcy proceedings in 2003. See Note 6 of Notes to Consolidated Financial Statements.
Discontinued Operations
Loss from discontinued operations, net of taxes, was $6.2 million and $3.8 million for Fiscal 2009 and Fiscal 2008, respectively. See Note 3 of Notes to Consolidated Financial Statements.
Capital Resources and Liquidity
The Company’s principal source of cash is from sales of its merchandise to both wholesale and retail customers. During Fiscal 2010, sales of the Company’s products increased in constant currencies compared to Fiscal 2009. Since more than 50% of those sales arose from the Company’s operations outside the U.S., fluctuations in foreign currencies (see Overview, above) relative to the U.S. Dollar had a significant effect on the Company’s cash inflows, expressed in U.S. Dollars. As a result, the increase in sales in constant currencies was further increased by the favorable effect of fluctuations in foreign currencies, which was reflected in an increase in net revenues of 13.7% during Fiscal 2010 compared to Fiscal 2009 (see Results of Operations - Net Revenues, above).
During the fourth quarter of Fiscal 2010, the Company experienced an increase in costs, including those for raw material, labor and freight, which the Company anticipates will continue in the fiscal year ending 2011. The Company expects to partially mitigate cost increases in 2011 and their effect on gross margins through a combination of sourcing initiatives, price increases, and continuing shifts in its business, favoring international and direct to consumer channels, which carry higher gross margins.
The Company believes that, at January 1, 2011, cash on hand, cash available under the 2008 Credit Agreements (previously referred to as the New Credit Agreements), the CKJEA Notes and other short-term debt (see Note 12 of Notes to Consolidated Financial Statements) and cash to be generated from future operating activities will be sufficient to fund its operations, including contractual obligations (see Note 15 to Notes to Consolidated Financial Statements, above) and capital expenditures (see below) for the next 12 months.
As of January 1, 2011, the Company had working capital (current assets less current liabilities) of $509.2 million. Included in working capital as of January 1, 2011 were (among other items) cash and cash equivalents of $191.2 million and short-term debt of $32.2 million, including, $18.4 million under the CKJEA Notes, $13.4 million under a new short-term loan entered into by one of the Company’s Italian subsidiaries in September 2010 in connection with the Company’s acquisition of the business of one of its distributors in Italy (the “Italian Note”) (see Notes 2 and 12 of Notes to Consolidated Financial Statements) and $0.4 million of other short-term debt.
As of January 1, 2011, under the 2008 Credit Agreement, the Company had no loans and $72.8 million in letters of credit outstanding, leaving approximately $131.1 million of availability, and, under the 2008 Canadian Credit Agreement, no loans and no letters of credit, leaving approximately $22.0 million of availability (see Note 12 of Notes to Consolidated Financial Statements).
The revolving credit facilities under the 2008 Credit Agreements reflect funding commitments by a syndicate of banks, including Bank of America N.A., JPMorgan Chase, N.A., Deutsche Bank, HSBC, Royal Bank of Scotland and The Bank of Nova Scotia. The ability of any one or more of those banks to meet its commitment to provide the Company with funding up to the maximum of available credit is dependent on the fair value of the bank’s assets and its legal lending ratio relative to those assets (amount the bank is allowed to lend). The Company believes that the ability of those banks to make loans during Fiscal 2010 has increased relative to Fiscal 2009. However, the Company continues to monitor the creditworthiness of the syndicated banks.
The 2008 Credit Agreements contain covenants limiting the Company’s ability to (i) incur additional indebtedness and liens, (ii) make significant corporate changes including mergers and acquisitions with third parties, (iii) make investments, (iv) make loans, advances and guarantees to or for the benefit of third parties, (v) enter into hedge agreements, (vi) make restricted payments (including dividends and stock repurchases), and (vii) enter into transactions with affiliates. The 2008 Credit Agreements also include certain other restrictive covenants. In addition, if Available Credit (as defined in the 2008 Credit Agreements) is less than a threshold amount (as specified in the 2008 Credit Agreements) the Company’s Fixed Charge Coverage ratio (as defined in the 2008 Credit Agreements) must be at least 1.1 to 1.0. The Company was in compliance with the covenants of its 2008 Credit Agreements as of January 1, 2011 and January 2, 2010, and of its Senior Notes as of January 2, 2010.
During Fiscal 2010, the Company was able to borrow funds, from time to time, under the 2008 Credit Agreement for seasonal and other cash flow requirements, including repurchase of Common Stock (see Note 13 of Notes to Consolidated Financial Statements) and redemption of the Senior Notes (see below). During Fiscal 2009, the Company was also able to borrow funds as needed. As of January 1, 2011, the Company expects that it will continue to be able to obtain needed funds under the 2008 Credit Agreements when requested. However, in the event that such funds are not available, the Company may have to delay certain capital expenditures or plans to expand its business, to scale back operations and/or to raise capital through the sale of its equity or debt securities. There can be no assurance that the Company would be able to sell its equity or debt securities on terms that are satisfactory.
On January 5, 2010, the Company redeemed from bondholders $50.0 million aggregate principal amount of the outstanding Senior Notes for a total consideration of $51.5 million and on June 15, 2010, the Company redeemed from bondholders the remaining $110.9 million aggregate principal amount of outstanding Senior Notes for a total consideration of $112.5 million. The Company funded the redemption of the Senior Notes on January 5, 2010 and June 15, 2010 with available cash on hand in the U.S. and borrowings under its 2008 Credit Agreement (see Note 12 of Notes to Consolidated Financial Statements).
The Company’s corporate or family credit ratings and outlooks at January 1, 2011, are summarized below:
(a)
ratings on individual debt instruments can be different from the Company’s corporate or family credit ratings depending on the priority position of creditors holding such debt, collateral related to such debt and other factors. The Company’s 2008 Credit Agreements are rated Baa2 (an investment-grade rating) by Moody’s.
In August 2010, S&P raised the Company’s corporate credit rating to BBB- (an investment-grade rating) and changed its outlook to “stable”. At the same time, S&P withdrew its BBB rating on the Company’s 2008 Credit Agreements because S&P does not assign ratings on secured credit when a company’s corporate credit rating is investment grade.
The Company’s credit ratings contribute to its ability to access the credit markets. Factors that can affect the Company’s credit ratings include changes in its operating performance, the economic environment, conditions in the apparel industry, the Company’s financial position, and changes in the Company’s business or financial strategy. If a downgrade of the Company’s credit ratings were to occur, it could adversely affect, among other things, the Company’s future borrowing costs and access to capital markets. The current state of the economy creates greater uncertainty than in the past with regard to financing opportunities and the cost of such financing. Given the Company’s capital structure and its projections for future profitability and cash flow, the Company believes it is well positioned to obtain additional financing, if necessary, to refinance its debt, or, if opportunities present themselves, to make future acquisitions. However, there can be no assurance that such financing, if needed, can be obtained on terms satisfactory to the Company or at such time as a specific need may arise.
During Fiscal 2010, the Company leased approximately 115,000 square feet of new retail store space worldwide, which resulted in capital expenditures of approximately $25.0 million. The Company has targeted an additional 120,000 square feet of new retail space for the fiscal year ending 2011, excluding any amounts from retail stores acquired in business combinations, if any, which the Company expects will result in additional capital expenditures of approximately $33 million. During Fiscal 2010, capital expenditures related to material handling equipment and other leasehold improvements at the Company’s new distribution center in the Netherlands was approximately $12.5 million. The distribution center began operations during May 2010.
During Fiscal 2010, the Company made $4.0 million in cash severance payments to employees for current year job eliminations, including those in connection with consolidation of its European operations. The Company also paid $4.8 million related to other restructuring and exit activities, including contract termination costs. See Note 4 of Notes to Consolidated Financial Statements for additional information on restructuring and other exit activities. In the fiscal year ending 2011, the Company expects to incur between $15 million and $19 million of expenses primarily related to the consolidation and restructuring of certain international operations.
During the fourth quarter of Fiscal 2009, the Company acquired the remaining 49% equity interest in WBR, its subsidiary in Brazil. In addition to the initial cash payment made upon acquisition, the consideration also includes three annual contingent payments through March 31, 2012. During Fiscal 2010, the Company made the first such payment, amounting to 6 million Brazilian Real (approximately $3.4 million), based upon the operating results achieved by WBR in the fourth quarter of Fiscal 2009. The Company expects to make the second contingent payment of $11.1 million during the first quarter of the fiscal year ending 2011, based upon the operating results of WBR for Fiscal 2010. See Note 2 of Notes to Consolidated Financial Statements.
During Fiscal 2010, the Company acquired the businesses of certain of its distributors of its Calvin Klein Jeans products and Calvin Klein Underwear products in Singapore and the People’s Republic of China for total cash consideration of $8.6 million. In addition, on October 4, 2010, the Company acquired the business of a distributor of its Calvin Klein products in Italy for cash consideration of approximately $22.4 million. These acquisitions are expected to increase the Company’s operating margins in Europe and Asia. On January 3, 2011, after the close of Fiscal 2010, the Company acquired certain assets, including inventory and leasehold improvements, and acquired the leases, of the retail stores from its Calvin Klein distributor in Taiwan for cash consideration of $1.4 million. See Note 2 of Notes to Consolidated Financial Statements.
During Fiscal 2010, the Company completed repurchases under its 2007 Share Repurchase Program by repurchasing the 1,490,131 shares of common stock available for repurchase for a total of $69.0 million (based on an average of $46.31 per share). The Company also repurchased 939,158 shares of common stock under its 2010 Share Repurchase Program (see Part II. Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities, above) for a total of $47.4 million (based on an average of $50.45 per share. During January, 2011, after the close of Fiscal 2010, the Company repurchased 560,842 shares of its common stock under the 2010 Share Repurchase Program for a total of $29.1 million (based on an average of $51.94 per share). In addition, the Company repurchased 76,148 shares of common stock for a total of $3.4 million (based on an average of $44.94 per share) related to the surrender of shares for the payment of minimum income tax due upon vesting of certain restricted stock awarded by the Company to its employees (see Note 13 of Notes to Consolidated Financial Statements and Part II. Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities, above). Repurchased shares are held in treasury pending use for general corporate purposes.
During Fiscal 2010, some of the Company’s foreign subsidiaries with functional currencies other than the U.S. dollar made purchases of inventory, paid minimum royalty and advertising costs and /or had intercompany payables denominated in U.S. dollars. During Fiscal 2010 compared to Fiscal 2009, the U.S. Dollar was weaker relative to the foreign currencies noted above, other than the Euro, against which the U.S. Dollar was stronger. The cash flows of those subsidiaries were, therefore, affected by the fluctuations of those foreign currencies relative to the U.S. dollar. In order to minimize the effects of fluctuations in foreign currency exchange rates of those transactions, the Company uses derivative financial instruments, primarily foreign currency exchange forward contracts (see Note 17 of Notes to Consolidated Financial Statements).
The Company carries its derivative financial instruments at fair value on the Consolidated Balance Sheets. The Company utilizes the market approach to measure fair value for financial assets and liabilities. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. At January 1, 2011, the Company’s hedging programs included $79.2 million of future inventory purchases, $21.6 million of future minimum royalty and advertising payments and $51.0 million of intercompany payables and loans denominated in non-functional currencies, primarily the U.S. dollar.
The Company classifies its financial instruments under a fair value hierarchy that is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy is based on inputs to valuation techniques that are used to measure fair value that are either observable or unobservable. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources while unobservable inputs reflect a reporting entity’s pricing based upon their own market assumptions. The fair value hierarchy consists of the following three levels:
Level 1 -
Inputs are quoted prices in active markets for identical assets or liabilities.
Level 2 -
Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable and market-corroborated inputs which are derived principally from or corroborated by observable market data.
Level 3 -
Inputs are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable.
The fair value of foreign currency exchange forward contracts was determined as the net unrealized gains or losses on those contracts, which is the net difference between (i) the U.S. dollars to be received or paid at the contracts’ settlement date and (ii) the U.S. dollar value of the foreign currency to be sold or purchased at the current forward exchange rate. The fair value of these foreign currency exchange contracts is based on exchange-quoted prices which are adjusted by a forward yield curve and, therefore, meets the definition of level 2 in the fair value hierarchy, as defined above.
The PPA revised the basis and methodology for determining defined benefit plan minimum funding requirements as well as maximum contributions to and benefits paid from tax-qualified plans. The PPA may ultimately require the Company to make additional contributions to its domestic plan. During Fiscal 2010, the Company contributed $5.7 million to the domestic pension plan. Contributions for the fiscal year ending 2011 are expected to be $12.6 million and for the following four years are expected to be in the range of $5.7 million and $9.6 million. Actual later year contributions could exceed the Company’s current projections, and may be influenced by future changes in government requirements. Additionally, the Company’s projections concerning timing of the PPA funding requirements are subject to change and may be influenced by factors such as general market conditions affecting trust asset performance, interest rates, and the Company’s future decisions regarding certain elective provisions of the PPA. See Note 7 of Notes to Consolidated Financial Statements for additional information on the Company’s pension plan.
Accounts receivable increased $27.4 million to $318.1 million at January 1, 2011 from $290.7 million at January 2, 2010, due primarily to increased sales volume in December 2010 compared to December 2009. The balance of accounts receivable at January 1, 2011 includes a decrease of $0.6 million, due to fluctuations in exchange rates in the U.S. dollar relative to foreign currencies in connection with transactions in countries where the Company conducts certain of its operations (principally the Euro, Korean won, Canadian dollar, Brazilian real and Mexican peso), at that date compared to January 2, 2010.
Inventories increased $57.1 million to $310.5 million at January 1, 2011 from $253.4 million at January 2, 2010. The inventory increase is consistent with the Company’s growth expectations for the fiscal year ending 2011 and reflects the growth in the Company’s direct to consumer platform from acquired and newly-opened stores, growth in its overall wholesale business, the need for sufficient inventory to provide higher service levels to its customers and certain early purchases intended to partially mitigate the effect of product price increases. The balance of inventories at January 1, 2011 includes a decrease of $2.4 million, due to fluctuations in exchange rates in the U.S. dollar relative to foreign currencies in connection with transactions in countries where the Company conducts certain of its operations at that date compared to January 2, 2010.
Cash Flows
The following table summarizes the cash flows from the Company’s operating, investing and financing activities for Fiscal 2010, Fiscal 2009 and Fiscal 2008.
For Fiscal 2010, cash provided by operating activities from continuing operations was $225.4 million compared to $263.9 million in Fiscal 2009 and $153.4 million in Fiscal 2008. The $38.5 million decrease in cash provided from Fiscal 2009 compared to Fiscal 2010 was due to a $64.2 million increase in net income, net of non-cash charges, offset by an increase in outflows related to changes in working capital, as described below. Working capital changes for Fiscal 2010 included cash outflows of $33.1 million related to accounts receivable (due to increased sales in December 2010 compared to December 2009 and the timing of payments), $62.5 million related to inventory (to support the Company’s growth expectations for the fiscal year ending 2011 and for certain early purchases of product) and $22.1 million related to prepaid expenses and other assets (primarily related to prepaid advertising and royalty expenses), partially offset by cash inflows of $55.2 million related to accounts payable, accrued expenses and other liabilities (due to the timing of payments for purchases of inventory) and $20.9 million related to accrued income taxes.
Working capital changes for Fiscal 2009 included cash inflows of $67.5 million related to inventory (due to the Company’s initiative to reduce inventory balances in light of the downturn in the economy), $17.1 million related to accrued income taxes and $9.9 million related to prepaid expenses and other assets ), partially offset by cash outflows of $27.9 million related to accounts receivable (due to increased sales in 2009 and the timing of payments) and $5.1 million related to accounts payable, accrued expenses and other liabilities (due to the timing of payments for purchases of inventory.
The Company experienced a $24.5 million increase in non-cash charges in Fiscal 2010, compared to Fiscal 2009 primarily reflecting increases in foreign exchange losses, depreciation and amortization, compensation expense related to share-based awards and loss on repurchase of the Senior Notes during Fiscal 2010 and loss from discontinued operations, partially offset by decreases in provision for bad debts and inventory write-down (primarily related to the Company’s Swimwear Group).
Cash provided by operating activities increased $110.5 million from Fiscal 2008 to Fiscal 2009, primarily due to a $49.9 million increase in net income, net of non-cash charges, partially offset by an increase in outflows related to changes in working capital. Working capital changes for Fiscal 2008 included cash outflows of $6.5 million related to accounts receivable, $42.4 million related to inventory, $33.8 million related to prepaid expenses and other assets, which were partially offset by cash inflows of $67.2 million related to accounts payable and accrued expenses and $4.9 million related to accrued income taxes (including an accrual during Fiscal 2008 of approximately $14.6 million associated with the repatriation, to the U.S., of the proceeds related to the sale of the Lejaby business, net of adjustments for working capital).
The Company experienced an $11.6 million decrease in non-cash charges in Fiscal 2009 compared to Fiscal 2008 primarily reflecting decreases in foreign exchange losses, provision for trade and other bad debts, inventory write-downs (primarily related to the Company’s Swimwear group), amortization of deferred charges and loss on repurchase of Senior Notes and refinancing of the 2008 Credit Agreements in 2008, partially offset by increases in loss from discontinued operations in 2009 and provision for deferred income tax.
For Fiscal, 2010 net cash used in investing activities from continuing operations was $72.6 million, including $44.4 million attributable to purchases of property, plant and equipment, primarily related to the Company’s new distribution center in the Netherlands and the opening of new retail stores, and $29.9 million related to acquisitions of businesses in Europe and Asia. For Fiscal 2009, cash used in investing activities from continuing operations was $52.6 million, mainly attributable to purchases of property, plant and equipment of $43.4 million, the acquisition of retail stores in Chile and Peru of $2.5 million and acquisitions in Brazil of $7.0 million (see Note 2 to Notes to Consolidated Financial Statements). For Fiscal 2008, cash used in investing activities from continuing operations was $44.3 million, mainly attributable to purchases of property, plant and equipment of $42.3 million and cash used for business acquisitions, net of cash acquired of $2.4 million, mainly related to the acquisition of a business which operates 11 retail stores in the People’s Republic of China and purchase of intangible assets of $26.7 million, mainly related to 2008 CKI Licenses acquired from PVH on January 30, 2008 (see Note 2 of Notes to the Consolidated Financial Statements). Those amounts were partially offset by a net amount of $26.8 million received from the sale of the Lejaby business, which closed on March 10, 2008 (see Note 3 of Notes to the Consolidated Financial Statements).
Net cash used in financing activities for Fiscal 2010 was $283.1 million, which primarily reflects net cash used of $164.0 million related to the repurchase of Senior Notes, $119.8 million related to the repurchase of treasury stock (in connection with the 2007 Share Repurchase Program, the 2010 Share Repurchase Program and the surrender of shares for the payment of minimum income tax due upon vesting of certain restricted stock awarded by the Company to its employees), $3.4 million related to a contingent payment in connection with the acquisition of the equity interest in WBR in the fourth quarter of Fiscal 2009, which was accounted for as an equity transaction and a decrease of $13.3 million related to reduced balances of short-term notes payable, partially offset by cash provided of $16.7 million related to the exercise of employee stock options.
Net cash used in financing activities for Fiscal 2009 was $40.9 million, which primarily reflects a decrease of $24.0 million related to short-term notes payable, a decrease of $11.8 million due to repayment of amounts borrowed under the 2008 Credit Agreements, a decrease of $4.0 million related to the dividend paid in connection with the acquisitions in Brazil in Fiscal 2010, a decrease of $5.3 million related to the acquisition of the equity interest in the Brazilian non-controlling interest, which was accounted for as an equity transaction, and a payment of $1.5 million related to the repurchase of treasury stock (in connection with the surrender of shares for the payment of the minimum employee withholding tax due upon vesting of certain restricted stock awarded by the Company to its employees), partially offset by $4.0 million received from the exercise of employee stock options and an increase of $2.2 million of cash received upon the cancellation of the 2003 and 2004 interest rate swap agreements (see Note 12 to notes to Consolidated Financial Statements).
Net cash used in financing activities in Fiscal 2008 was $120.7 million, which primarily reflects the repayments of the Term B note of $107.3 million (see Note 12 of Notes to Consolidated Financial Statements), repurchase of $46.2 million of Senior Notes, repurchase of treasury stock of $20.5 million (related to the 2007 Share Repurchase Program and surrender of shares in connection with the vesting of certain restricted stock awarded by the Company to its employees) and the payment of deferred financing costs of $3.9 million. Those amounts were partially offset by $12.0 million received under the 2008 Credit Agreements, $28.5 million received from the exercise of employee stock options and $16.6 million related to an increase in short-term notes payable. Net cash used in financing activities in 2007 was $121.7 million, which primarily reflects $61.8 million used for the repayment of the Term B Note and $57.7 million for treasury stock purchases (primarily related to the Company’s stock repurchase programs).
Cash in operating accounts primarily represents cash held in domestic cash collateral accounts, lockbox receipts not yet cleared or available to the Company, cash held by foreign subsidiaries and compensating balances required under various trade, credit and other arrangements.
Contractual Obligations
The following table summarizes the Company’s contractual commitments as of January 1, 2011:
(a)
The 2008 Credit Agreements mature on August 26, 2013. See Note 12 of Notes to Consolidated Financial Statements.
(b)
Includes the CKJEA Notes and the Italian Note. All of the CKJEA Notes were renewed for additional one-year terms during Fiscal 2010. The balance of $13.4 million under the Italian Note at January 1, 2011 will be repaid by the end of the fiscal year ending 2011.
(c)
See Note 15 of Notes to Consolidated Financial Statements. The fiscal year ending 2011 includes $2,506 for operating leases, which represents the maximum amount the Company expects to pay upon early closure of retail stores in Canada. See Note 1 of Notes to Consolidated Financial Statements -Long-Lived Assets.
(d)
Reflects expected interest obligations after considering required minimum repayments of the related debt. Interest on variable rate debt instruments is estimated based upon rates in effect at January 1, 2011. See Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk.
The Company is exposed to market risk primarily related to changes in hypothetical investment values under certain of the Company’s employee benefit plans, interest rates and foreign currency exchange rates. The Company does not use derivative financial instruments for speculation or for trading purposes.
Market Risk
The Company’s pension plan invests in marketable equity and debt securities, mutual funds, limited partnerships and cash accounts. These investments are subject to changes in the market value of individual securities and interest rates as well as changes in the overall economy. Investments are stated at fair value, except as disclosed below, based upon quoted market prices. Investments in limited partnerships are valued based on estimated fair value by the management of the limited partnerships in the absence of readily ascertainable market values. These estimated fair values are based upon the underlying investments of the limited partnerships. Because of the inherent uncertainty of valuation, those estimated values may differ significantly from the values that would have been used had a ready market for the securities existed, and the differences could be material. The limited partnerships utilize a “fund of funds” approach resulting in diversified multi-strategy, multi-manager investments. The limited partnerships invest capital in a diversified group of investment entities, generally hedge funds, private investment companies, portfolio funds and pooled investment vehicles which engage in a variety of investment strategies, managed by investment managers. Fair value is determined by the administrators of each underlying investment, in consultation with the investment managers. The Company’s pension plan has reduced its investment in limited partnerships from $12.9 million at January 2, 2010 to $9.6 million at January 1, 2011.
During Fiscal 2010, the fair value of the debt and equity securities and other investments held in the pension plan’s investment portfolio increased compared to Fiscal 2009. Changes in the fair value of the pension plan’s investment portfolio are directly reflected in the Company’s Consolidated Statement of Operations through pension expense or pension income and in the Company’s Consolidated Balance Sheet as a component of accrued pension liability. The Company records the effect of any changes in actuarial assumptions (including changes in the discount rate) and the difference between the assumed rate of return on plan assets and the actual return on plan assets in the fourth quarter of its fiscal year. The total value of the pension plan’s investment portfolio was $127.7 million at January 1, 2011 and $118.3 million at January 2, 2010. A hypothetical 10% increase/decrease in the value of the Company’s pension plan investment portfolio would have resulted in a decrease/increase in pension expense of $12.8 million and $11.8 million for Fiscal 2010 and Fiscal 2009, respectively. Based on historical appreciation in the Company’s pension plan investment portfolio, the Company, during the first three quarters of Fiscal 2010, estimated pension expense on an interim basis assuming a long-term rate of return on pension plan investments of 8%, net of pension plan expenses. A 1% decrease/increase in the actual return earned on pension plan assets (a decrease in the return on plan assets from 8% to 7% or an increase in the return on plan assets from 8% to 9%) would result in an increase/decrease of approximately $1.2 million in pension expense (decrease/increase in pension income) for Fiscal 2010. During Fiscal 2010, the return on pension plan assets, net of pension plan expenses, actually increased by approximately 10.5%. However, the Company reduced the discount rate used to determine benefit obligations from 6.1% in Fiscal 2009 to 5.8% in Fiscal 2010, which increased the benefit obligation. As a result, the Company recognized approximately $3.1 million of pension expense in the fourth quarter of Fiscal 2010. Based upon results for Fiscal 2010, a 0.1% increase (decrease) in the discount rate would decrease (increase) pension expense by approximately $1.7 million. See Note 7 of Notes to Consolidated Financial Statements.
Interest Rate Risk
The Company has market risk from exposure to changes in interest rates, at January 1, 2011, on $18.4 million under the CKJEA Notes and $13.4 million under the Italian Note and, at January 2, 2010, on $0.2 million under the 2008 Credit Agreements and $47.7 million under the CKJEA Notes. A hypothetical 10% increase in interest rates for the loans outstanding under the CKJEA Notes, Italian Note and 2008 Credit Agreements would have had a negligible unfavorable effect in Fiscal 2010 and in Fiscal 2009 on the Company’s income from continuing operations before provision for income taxes or cash flows. See Note 12 of Notes to Consolidated Financial Statements.
Foreign Exchange Risk
The Company is exposed to foreign exchange risk related to foreign denominated revenues and costs, which must be translated into U.S. dollars. Fluctuations in foreign currency exchange rates (particularly any strengthening of the U.S. dollar relative to the Euro, Canadian dollar, British pound, Korean won, Mexican peso, Brazilian real and Chinese yuan) may adversely affect the Company’s reported earnings and the comparability of period-to-period results of operations. The Company’s foreign exchange risk includes its U.S. dollar-denominated purchases of inventory, payment of minimum royalty and advertising costs and intercompany loans and payables where the functional currencies of the subsidiaries that are party to these transactions are the Euro, Canadian Dollar, Korean Won, Mexican Peso, or British Pound. The foreign currency derivative instruments that the Company uses to partially offset its foreign exchange risk are forward purchase contracts. See Note 17 of Notes to the Consolidated Financial Statements for further details on the derivative instruments and hedged transactions. These exposures have created significant foreign currency fluctuation risk and have had a significant positive impact on the Company’s earnings during Fiscal 2010, compared to Fiscal 2009, due to the weakening of the U.S. dollar against those foreign currencies, except for the Euro, against which the U.S. dollar strengthened. The Company’s European, Asian, Canadian and Mexican and Central and South American operations accounted for approximately 56.1% of the Company’s total net revenues for Fiscal 2010. These foreign operations of the Company purchase products from suppliers denominated in U.S. dollars. Total purchases of products made by foreign subsidiaries denominated in U.S. dollars amounted to approximately $250.6 million for Fiscal 2010. A hypothetical decrease of 10% in the value of these foreign currencies relative to the U.S. dollar would have increased cost of goods sold (which would decrease operating income) by $25.1 million for Fiscal 2010.
The fair value of foreign currency exchange forward contracts was determined as the net unrealized gains or losses on those contracts, which is the net difference between (i) the U.S. dollars to be received or paid at the contracts’ settlement date and (ii) the U.S. dollar value of the foreign currency to be sold or purchased at the current forward exchange rate.
The following table summarizes the effect on earnings for Fiscal 2010 of a hypothetical 10% adverse change in foreign exchange rates on the Company’s foreign currency exchange forward contracts:
(a)
USD = U.S. dollar, KRW = Korean won, CAD = Canadian dollar, MXN = Mexican peso, GBP = British pound
(b)
The Company expects that these hypothetical gains and losses would be offset by gains and losses on the related underlying transactions.
Item 8.
Item 8.
Financial Statements and Supplementary Data.
The information required by this Item 8 of Part II is incorporated by reference to the Consolidated Financial Statements filed with this Annual Report on Form 10-K. See Item 15. Exhibits, Financial Statement Schedules.
Item 9.
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A.
Controls and Procedures.
Evaluation of Disclosure Controls and Procedures.
The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Annual Report on Form 10-K. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective.
Management’s Annual Report on Internal Control Over Financial Reporting.
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. Internal Control over financial reporting is defined in Rule 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended, as a process designed by or under the supervision of, the Company’s principal executive and principal financial officers 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 and includes those policies and procedures that:
•
pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;
•
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
•
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 assessed the effectiveness of the Company’s internal control over financial reporting as of January 1, 2011. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.
Based on this assessment, management concluded that, as of January 1, 2011, the Company’s internal control over financial reporting was effective.
Deloitte & Touche LLP, the Company’s independent registered public accounting firm, has audited the Company’s internal control over financial reporting as of January 1, 2011, and its report thereon is included herein.
Changes in Internal Control Over Financial Reporting
There were no changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fourth quarter of 2010 that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Limitations on the Effectiveness of Controls
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
The Warnaco Group, Inc.
New York, New York
We have audited the internal control over financial reporting of The Warnaco Group, Inc. and subsidiaries (the “Company”) as of January 1, 2011, based on the 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 Annual Report on Internal Control Over Financial Reporting on page 66. 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 January 1, 2011, 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 January 1, 2011 of the Company and our report dated February 28, 2011 expressed an unqualified opinion on those financial statements and financial statement schedule.
/s/ DELOITTE & TOUCHE LLP
New York, New York
February 28, 2011
None.
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance.
The information required by this Item 10 of Part III is incorporated by reference from Item 1. Business - Executive Officers of the Registrant and from the Proxy Statement of the Warnaco Group, relating to the 2011 Annual Meeting of Stockholders, to be filed with the SEC within 120 days of the Fiscal 2010 year end.
The information required by this Item 11
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information required by this Item 12 of Part III is incorporated by reference from the Proxy Statement of the Warnaco Group, relating to the 2011 Annual Meeting of Stockholders, to be filed with the SEC within 120 days of the Fiscal 2010 year end.
Item 13.
Item 13.
Certain Relationships and Related Transactions and Director Independence.
The information required by this Item 13 of Part III is incorporated by reference from the Proxy Statement of the Warnaco Group, relating to the 2011 Annual Meeting of Stockholders, to be filed with the SEC within 120 days of the Fiscal 2010 year end.
Item 14.
Item 14.
Principal Accountant Fees and Services.
The information required by this Item 14 of Part III is incorporated by reference from the Proxy Statement of the Warnaco Group, relating to the 2011 Annual Meeting of Stockholders, to be filed with the SEC within 120 days of the Fiscal 2010 year end.
PART IV
Item 15.
Item 15.
Exhibits, Financial Statement Schedules.
All other schedules for which provision is made in the applicable accounting regulations of the SEC which are not included with this additional financial data have been omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or Notes thereto.
3. List of Exhibits.
The agreements contain representations and warranties by each of the parties to the applicable agreement. These representations and warranties were made solely for the benefit of the other parties to the applicable agreement and:
•
were not intended to be treated as categorical statements of fact, but rather as a way of allocating the risk to one of the parties if those statements prove to be inaccurate;
•
may have been qualified in such agreements by disclosures that were made to the other party in connection with the negotiation of the applicable agreement;
•
may apply contract standards of “materiality” that are different from “materiality” under the applicable security laws; and
•
were made only as of the date of the applicable agreement or such other date or dates as may be specified in the agreement.
The Company acknowledges that notwithstanding the inclusion of the foregoing cautionary statements, it is responsible for considering whether additional specific disclosures of material information regarding material contractual provisions are required to make the statements in this Form 10-K not misleading. Additional information about the Warnaco Group may be found elsewhere in this Annual Report on Form 10-K and the Warnaco Group’s other public filings, which are available without charge through the SEC’s website at http://www.sec.gov. See “Website Access to Reports” under Item 1 of Part I.
*
Previously filed.
**
The schedules to this agreement have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The Company will furnish copies of any of the schedules to the Securities and Exchange Commission upon request.

Filed herewith.
#
Certain portions of this exhibit omitted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment.
##
Certain portions of this exhibit omitted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment, which request was granted.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on this 28th day of February 2011.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of The Warnaco Group, Inc.
New York, New York
We have audited the accompanying Consolidated Balance Sheets of The Warnaco, Group Inc. and subsidiaries (the “Company”) as of January 1, 2011 and January 2, 2010, and the related Consolidated Statements of Operations, Stockholders’ Equity, and Cash Flows for each of the three years in the period ended January 1, 2011. Our audits also included the financial statement schedule listed in the Index at Item 15. 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 The Warnaco Group, Inc. as of January 1, 2011 and January 2, 2010, and the results of their operations and their cash flows for each of the three years in the period ended January 1, 2011, 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.
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 January 1, 2011, 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 February 28, 2011 expressed an unqualified opinion on the Company’s internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
New York, New York
February 28, 2011
THE WARNACO GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, excluding per share data)
See Notes to Consolidated Financial Statements.
THE WARNACO GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, excluding per share amounts)
See Notes to Consolidated Financial Statements.
THE WARNACO GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
AND COMPREHENSIVE INCOME
(Dollars in thousands)
See Notes to Consolidated Financial Statements.
THE WARNACO GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
See Notes to Consolidated Financial Statements
THE WARNACO GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
(Dollars in thousands)
See Notes to Consolidated Financial Statements.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
Note 1-Nature of Operations and Summary of Significant Accounting Policies
Organization: The Warnaco Group, Inc. (“Warnaco Group” and, collectively with its subsidiaries, the “Company”) was incorporated in Delaware on March 14, 1986 and, on May 10, 1986, acquired substantially all of the outstanding shares of Warnaco Inc. (“Warnaco”). Warnaco is the principal operating subsidiary of Warnaco Group. Warnaco Group, Warnaco and certain of Warnaco’s subsidiaries were reorganized under Chapter 11 of the U.S. Bankruptcy Code, 11 U.S.C. Sections 101-1330, as amended, effective February 4, 2003 (the “Effective Date”).
Nature of Operations: The Company designs, sources, markets and licenses a broad line of (i) sportswear for men, women and juniors (including jeanswear, knit and woven shirts, tops and outerwear); (ii) intimate apparel (including bras, panties, sleepwear, loungewear, shapewear and daywear for women and underwear and sleepwear for men); and (iii) swimwear for men, women, juniors and children (including swim accessories and fitness and active apparel). The Company’s products are sold under a number of highly recognized owned and licensed brand names. The Company offers a diversified portfolio of brands across multiple distribution channels to a wide range of customers. The Company distributes its products to customers, both domestically and internationally, through a variety of channels, including department and specialty stores, independent retailers, chain stores, membership clubs, mass merchandisers, off-price stores and the internet. In addition, as of January 1, 2011, the Company operated: (i) 1,360 Calvin Klein retail stores worldwide (consisting of 189 full price free-standing stores, 118 outlet free-standing stores, 1,050 shop-in-shop/concession stores) and (ii) in the U.S., three on-line stores: SpeedoUSA.com, Calvinkleinjeans.com, and CKU.com. As of January 1, 2011, there were also 619 Calvin Klein retail stores operated by third parties under retail licenses or franchise and distributor agreements.
Basis of Consolidation and Presentation: The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The consolidated financial statements include the accounts of Warnaco Group and its subsidiaries. Non-controlling interest represents minority shareholders’ proportionate share of the equity in the Company’s consolidated subsidiary WBR Industria e Comercio de Vestuario S.A. (“WBR”). During the fourth quarter of Fiscal 2009, the Company purchased the remaining 49% of the equity of WBR, increasing its ownership of the equity of WBR to 100% and, accordingly, at January 1, 2011 and January 2, 2010, there were no minority shareholders of WBR (see Note 2 to Notes to Consolidated Financial Statements).
The Company operates on a fiscal year basis ending on the Saturday closest to December 31. The period January 3, 2010 to January 1, 2011 (“Fiscal 2010”) and January 4, 2009 to January 2, 2010 (“Fiscal 2009”) each contained fifty-two weeks of operations. The period December 30, 2007 to January 3, 2009 (“Fiscal 2008”) contained fifty-three weeks of operations.
All inter-company accounts and transactions have been eliminated in consolidation.
Reclassifications: Amounts related to certain sales of Calvin Klein underwear in regions managed by the Sportswear Group, previously included in net revenues and operating income of the Sportswear Group, have been reclassified to the Intimate Apparel Group for Fiscal 2009 and Fiscal 2008 to conform to the presentation for Fiscal 2010. See Note 5 of Notes to Consolidated Financial Statements.
Use of Estimates: The Company uses estimates and assumptions in the preparation of its financial statements which affect (i) the reported amounts of assets and liabilities at the date of the consolidated financial statements and (ii) the reported amounts of revenues and expenses. Actual results could materially differ from these estimates. The estimates the Company makes are based upon historical factors, current circumstances and the experience and judgment of the Company’s management. The Company evaluates its assumptions and estimates on an ongoing basis. The Company believes that the use of estimates affects the application of all of the Company’s significant accounting policies and procedures.
Concentration of Credit Risk: Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash, cash equivalents, receivables and derivative financial instruments. The Company invests its excess cash in demand deposits and investments in short-term marketable securities that are classified as cash equivalents. The Company has established guidelines that relate to credit quality, diversification and maturity and that limit exposure to any one issue of securities. The Company holds no collateral for these financial instruments. The Company performs ongoing credit evaluations of its customers’ financial condition and, generally, requires no collateral from its customers. During Fiscal 2010, Fiscal 2009 and Fiscal 2008, no one customer represented more than 10% of net revenues. During Fiscal 2010, Fiscal 2009 and Fiscal 2008, the Company’s top five customers accounted for $490,343 (21.4%), $470,861 (23.3%) and $465,818 (22.6%), respectively, of the Company’s net revenues.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
Revenue Recognition: The Company recognizes revenue when goods are shipped to customers and title and risk of loss have passed, net of estimated customer returns, allowances and other discounts. The Company recognizes revenue from its retail stores when goods are sold to consumers, net of allowances for future returns. The determination of allowances and returns involves the use of significant judgment and estimates by the Company. The Company bases its estimates of allowance rates on past experience by product line and account, the financial stability of its customers, the expected rate of retail sales and general economic and retail forecasts. The Company reviews and adjusts its accrual rates each month based on its current experience. During the Company’s monthly review, the Company also considers its accounts receivable collection rate and the nature and amount of customer deductions and requests for promotion assistance. The Company believes it is likely that its accrual rates will vary over time and could change materially if the Company’s mix of customers, channels of distribution or products change. Current rates of accrual for sales allowances, returns and discounts vary by customer. Revenues from the licensing or sub-licensing of certain trademarks are recognized when the underlying royalties are earned.
Cost of Goods Sold: Cost of goods sold consists of the cost of products purchased and certain period costs related to the product procurement process. Product costs include: (i) cost of finished goods; (ii) duty, quota and related tariffs; (iii) in-bound freight and traffic costs, including inter-plant freight; (iv) procurement and material handling costs; (v) inspection, quality control and cost accounting and (vi) in-stocking costs in the Company’s warehouse (in-stocking costs may include but are not limited to costs to receive, unpack and stock product available for sale in its distribution centers). Period costs included in cost of goods sold include: (a) royalty; (b) design and merchandising; (c) prototype costs; (d) loss on seconds; (e) provisions for inventory losses (including provisions for shrinkage and losses on the disposition of excess and obsolete inventory); and (f) direct freight charges incurred to ship finished goods to customers. Costs incurred to store, pick, pack and ship inventory to customers (excluding direct freight charges) are included in shipping and handling costs and are classified in selling, general and administrative (“SG&A”) expenses. The Company’s gross profit and gross margin may not be directly comparable to those of its competitors, as income statement classifications of certain expenses may vary by company.
Cash and Cash Equivalents: Cash and cash equivalents include cash in banks, demand deposits and investments in short-term marketable securities with maturities of 90 days or less.
Accounts Receivable: The Company maintains reserves for estimated amounts that the Company does not expect to collect from its trade customers. Accounts receivable reserves include amounts the Company expects its customers to deduct for returns, allowances, trade discounts, markdowns, amounts for accounts that go out of business or seek the protection of the Bankruptcy Code and amounts in dispute with customers. The Company’s estimate of the allowance amounts that are necessary includes amounts for specific deductions the Company has authorized and an amount for other estimated losses. Estimates of accruals for specific account allowances and negotiated settlements of customer deductions are recorded as deductions to revenue in the period the related revenue is recognized. The provision for accounts receivable allowances is affected by general economic conditions, the financial condition of the Company’s customers, the inventory position of the Company’s customers and many other factors. The determination of accounts receivable reserves is subject to significant levels of judgment and estimation by the Company’s management. If circumstances change or economic conditions deteriorate, the Company may need to increase the reserve significantly.
Inventories: The Company records purchases of inventory when it assumes title and the risk of loss. The Company values its inventories at the lower of cost, determined on a first-in, first-out basis, or market. The Company evaluates its inventories to determine excess units or slow-moving styles based upon quantities on hand, orders in house and expected future orders. For those items for which the Company believes it has an excess supply or for styles or colors that are obsolete, the Company estimates the net amount that it expects to realize from the sale of such items. The Company’s objective is to recognize projected inventory losses at the time the loss is evident rather than when the goods are ultimately sold. The Company’s calculation of the reduction in carrying value necessary for the disposition of excess inventory is highly dependent on its projections of future sales of those products and the prices it is able to obtain for such products. The Company reviews its inventory position monthly and adjusts its carrying value for excess or obsolete goods based on revised projections and current market conditions for the disposition of excess and obsolete inventory.
Long-Lived Assets: Intangible assets primarily consist of licenses and trademarks. The majority of the Company’s license and trademark agreements cover extended periods of time, some in excess of forty years; others have indefinite lives. Long-lived assets (including property, plant and equipment) and intangible assets existing at the Effective Date are recorded at fair value based upon the appraised value of such assets, net of accumulated depreciation and amortization and net of any adjustments after the Effective Date for reductions in valuation allowances related to deferred tax assets arising before the Effective Date. Long-lived assets, including licenses and trademarks, acquired in business combinations after the Effective Date under the purchase method of accounting are recorded at their fair values, net of accumulated amortization since the acquisition date. Long-lived assets, including licenses and trademarks, acquired in the normal course of the Company’s operations are recorded at cost, net of accumulated amortization. Identifiable intangible assets with finite lives are amortized on a straight-line basis over the estimated useful lives of the assets. Assumptions relating to the expected future use of individual assets could affect the fair value of such assets and the depreciation expense recorded related to such assets in the future. Costs incurred to renew or extend the term of a recognized intangible asset are capitalized and amortized, where appropriate, through the extension or renewal period of the asset.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
The Company determines the fair value of acquired assets based upon the planned future use of each asset or group of assets, quoted market prices where a market exists for such assets, the expected future revenue and profitability of the business unit utilizing such assets and the expected future life of such assets. In its determination of fair value, the Company also considers whether an asset will be sold either individually or with other assets and the proceeds the Company expects to receive from any such sale. Preliminary estimates of the fair value of acquired assets are based upon management’s estimates. Adjustments to the preliminary estimates of fair value that are made within one year of an acquisition date are recorded as adjustments to goodwill. Subsequent adjustments are recorded in earnings in the period of the adjustment.
The Company reviews its long-lived assets for possible impairment in the fourth quarter of each fiscal year or when events or circumstances indicate that the carrying value of the assets may not be recoverable. Such events may include (a) a significant adverse change in legal factors or the business climate; (b) an adverse action or assessment by a regulator; (c) unanticipated competition; (d) a loss of key personnel; (e) a more-likely-than-not expectation that a reporting unit, or a significant part of a reporting unit, will be sold or disposed of; (f) the determination of a lack of recoverability of a significant “asset group” within a reporting unit; (g) reporting a goodwill impairment loss by a subsidiary that is a component of a reporting unit; and (h) a significant decrease in the Company’s stock price.
In evaluating long-lived assets (finite-lived intangible assets and property, plant and equipment) for recoverability, the Company uses its best estimate of future cash flows expected to result from the use of the asset and its eventual disposition. To the extent that estimated future undiscounted net cash flows attributable to the asset are less than the carrying amount, an impairment loss is recognized equal to the difference between the carrying value of such asset and its fair value, which is determined based on discounted cash flows. Assets to be disposed of and for which there is a committed plan of disposal are reported at the lower of carrying value or fair value less costs to sell.
The Company conducted an annual evaluation of the long-lived assets of its retail stores for impairment during the fourth quarter of Fiscal 2010. The Company determined that the long-lived assets of 10 retail stores were impaired, based on the valuation methods described above. For retail stores that failed step one based on undiscounted cash flows, the fair value of the store assets was determined by using a factor of 14.5%, which is the Company’s weighted average cost of capital, to discount each store’s cash flows over its respective remaining lease term. The fair values thus determined are categorized as level 3 (significant unobservable inputs) within the fair value hierarchy (see Note 16 of Notes to Consolidated Financial Statements for a description of the levels in the fair value hierarchy). The aggregate carrying amount of $2,182 of those retail store assets were written down to their aggregate fair value of $249, resulting in an impairment charge of $1,933, which was recorded in selling, general and administrative expense for Fiscal 2010. The portion of that impairment charge related to stores which management expects to close in 2011 was $1,621, which was recorded as restructuring expense and other exit costs, within selling, general and administrative expense. For Fiscal 2009, the Company recognized an impairment charge of $160, related to the long-lived assets of two stores in Mexico, which were closed early in 2010. There were no impairment charges for long-lived assets of retail stores in Fiscal 2008.
During the fourth quarter of Fiscal 2010, the Company conducted an annual evaluation of its finite-lived intangible assets for impairment. Recoverability of a finite-lived intangible asset is measured in the same manner as for property, plan and equipment, described above. For Fiscal 2010, Fiscal 2009 and Fiscal 2008, no impairment charges were recorded related to the Company’s finite-lived intangible assets.
Since the determination of future cash flows is an estimate of future performance, there may be future impairments to the carrying value of long-lived and intangible assets and impairment charges in future periods in the event that future cash flows do not meet expectations. In addition, depreciation and amortization expense is affected by the Company’s determination of the estimated useful lives of the related assets. The estimated useful lives of fixed assets and finite-lived intangible assets are based on their classification and expected usage, as determined by the Company.
Goodwill and Other Intangible Assets: Goodwill represents the excess of purchase price over the fair value of net assets acquired in business combinations accounted for under the purchase method of accounting. Goodwill is not amortized and is subject to an annual impairment test which the Company performs in the fourth quarter of each fiscal year.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
Goodwill impairment is determined using a two-step process. Goodwill is allocated to various reporting units, which are either the operating segment or one reporting level below the operating segment. As of January 1, 2011, the Company’s reporting units for purposes of applying the goodwill impairment test are: Core Intimate Apparel (consisting of the Warner’s® /Olga® /Body Nancy Ganz®/Bodyslimmers ® business units), Calvin Klein Underwear, Calvin Klein Jeans, Chaps® and Swimwear. The first step of the goodwill impairment test is to compare the fair value of each reporting unit to its carrying amount to determine if there is potential impairment. If the fair value of the reporting unit is less than its carrying value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss. The second step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. That is, the fair value of the reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the fair value was the purchase price paid to acquire the reporting unit.
Determining the fair value of a reporting unit under the first step of the goodwill impairment test and determining the fair value of individual assets and liabilities of a reporting unit (including unrecognized intangible assets) under the second step of the goodwill impairment test is judgmental in nature and often involves the use of significant estimates and assumptions. These estimates and assumptions could have a significant impact on whether or not an impairment charge is recognized and the magnitude of any such charge. Estimates of fair value are primarily determined using discounted cash flows, market multiples or appraised values, as appropriate. During the fourth quarter of Fiscal 2010, the Company determined the fair value of the assets and liabilities of its reporting units in the first step of the goodwill impairment test as the weighted average of both an income approach, based on discounted cash flows using the Company’s weighted average cost of capital of 14.5%, and a market approach, using inputs from a group of peer companies. The Company did not identify any reporting units that failed or are at risk of failing the first step of the goodwill impairment test (comparing fair value to carrying amount).
Intangible assets with indefinite lives are not amortized and are subject to an annual impairment test which the Company performs in the fourth quarter of each fiscal year. The Company also reviews its indefinite-lived intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value of an indefinite-lived intangible asset exceeds its fair value, as for goodwill. If the carrying value of an indefinite-lived intangible asset exceeds its fair value (determined based on discounted cash flows), an impairment loss is recognized. The estimates and assumptions used in the determination of the fair value of indefinite-lived intangible assets will not have an effect on the Company’s future earnings unless a future evaluation of trademark or license value indicates that such asset is impaired. For Fiscal 2010, Fiscal 2009 and Fiscal 2008, no impairment charges were recorded related to the Company’s indefinite-lived intangible assets.
Property, Plant and Equipment: Property, plant and equipment as of January 1, 2011 and January 2, 2010 is stated at estimated fair value, net of accumulated depreciation, for the assets in existence at February 4, 2003 and at historical costs, net of accumulated depreciation, for additions after February 4, 2003. The estimated useful lives of property, plant and equipment are summarized below:
Depreciation and amortization expense is based on the estimated useful lives of depreciable assets and is provided using the straight line method. Leasehold improvements are amortized over the lesser of the useful lives of the assets or the lease term; or the lease term plus renewal options if renewal of the lease is reasonably assured.
Computer Software Costs: Internal and external costs incurred in developing or obtaining computer software for internal use are capitalized in property, plant and equipment and are amortized on a straight-line basis, over the estimated useful life of the software (3 to 7 years). Interest costs related to developing or obtaining computer software that could have been avoided if expenditures for the asset had not been made, if any, are capitalized to the cost of the asset. General and administrative costs related to developing or obtaining such software are expensed as incurred.
Income Taxes: Deferred income taxes are determined using the asset and liability method. Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured by applying enacted tax rates and laws to taxable years in which such differences are expected to reverse. Realization of the Company’s deferred tax assets is dependent upon future earnings in specific tax jurisdictions, the timing and amount of which are uncertain. Management assesses the Company’s income tax positions and records tax benefits for all years subject to examination based upon an evaluation of the facts, circumstances, and information available at the reporting dates. In addition, valuation allowances are established when management determines that it is more-likely-than-not that some portion or all of a deferred tax asset will not be realized. Tax valuation allowances are analyzed periodically and adjusted as events occur, or circumstances change, that warrant adjustments to those balances.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
The Company accounts for uncertainty in income taxes in accordance with Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) Topic 740-10. If the Company considers that a tax position is “more-likely-than-not” of being sustained upon audit, based solely on the technical merits of the position, it recognizes the tax benefit. The Company measures the tax benefit by determining the largest amount that is greater than 50% likely of being realized upon settlement, presuming that the tax position is examined by the appropriate taxing authority that has full knowledge of all relevant information. These assessments can be complex and require significant judgment. To the extent that the Company’s estimates change or the final tax outcome of these matters is different than the amounts recorded, such differences will impact the income tax provision in the period in which such determinations are made. If the initial assessment fails to result in the recognition of a tax benefit, the Company regularly monitors its position and subsequently recognizes the tax benefit if (i) there are changes in tax law or analogous case law that sufficiently raise the likelihood of prevailing on the technical merits of the position to more-likely-than-not, (ii) the statute of limitations expires, or (iii) there is a completion of an audit resulting in a settlement of that tax year with the appropriate agency. Uncertain tax positions are classified as current only when the Company expects to pay cash within the next twelve months. Interest and penalties, if any, are recorded within the provision for income taxes in the Company’s Consolidated Statements of Operations and are classified on the Consolidated Balance Sheets with the related liability for unrecognized tax benefits.
Pension Plans: The Company has a defined benefit pension plan covering certain full-time non-union domestic employees and certain domestic employees covered by a collective bargaining agreement that had completed service prior to January 1, 2003 (the “Pension Plan”). The measurement date used to determine benefit information is the Company’s fiscal year end.
The assumptions used, in particular the discount rate, can have a significant effect on the amount of pension liability recorded by the Company. The discount rate is used to estimate the present value of projected benefit obligations at each valuation date. The Company evaluates the discount rate annually and adjusts the rate based upon current market conditions. For the Pension Plan, the discount rate is estimated using a portfolio of high quality corporate bond yields (rated “Aa” or higher by Moody’s or Standard & Poors Investors Services) which matches the projected benefit payments and duration of obligations for participants in the Pension Plan. The discount rate that is developed considers the unique characteristics of the Pension Plan and the long-term nature of the projected benefit obligation. The Company believes that a discount rate of 5.80% for Fiscal 2010 reasonably reflects current market conditions and the characteristics of the Pension Plan.
The investments of each plan are stated at fair value based upon quoted market prices, if available. The Pension Plan invests in certain funds or asset pools that are managed by investment managers for which no quoted market price is available. These investments are valued at estimated fair value as reported by each fund’s administrators to the Pension Plan trustee. The individual investment managers’ estimates of fair value are based upon the value of the underlying investments in the fund or asset pool. These amounts may differ significantly from the value that would have been reported had a quoted market price been available for each underlying investment or the individual asset pool in total.
Effective January 1, 2003, the Pension Plan was amended and, as a result, no future benefits accrue to participants in the Pension Plan. As a result of the amendment, the Company has not recorded pension expense related to current service for all periods presented and will not record pension expense for current service for any future period.
The Company uses a method that accelerates recognition of gains or losses which are a result of (i) changes in projected benefit obligations related to changes in assumptions and (ii) returns on plan assets that are above or below the projected asset return rate (currently 8% for the Pension Plan) (“Accelerated Method”) to account for its defined benefit pension plans. The Company has recorded pension obligations equal to the difference between the plans’ projected benefit obligations and the fair value of plan assets in each fiscal year since the adoption of the Accelerated Method. The Company believes the Accelerated Method is preferable because the pension liability using the Accelerated Method approximates fair value.
The Company recognizes one-quarter of its estimated annual pension expense (income) in each of its first three fiscal quarters. Estimated pension expense (income) consists of the interest cost on projected benefit obligations for the Pension Plan, offset by the expected return on pension plan assets. The Company records the effect of any changes in actuarial assumptions (including changes in the discount rate) and the difference between the assumed rate of return on plan assets and the actual return on plan assets in the fourth quarter of its fiscal year. The Company’s use of the Accelerated Method results in increased volatility in reported pension expense and therefore the Company reports pension income/expense on a separate line in its Consolidated Statement of Operations. The Company recognizes the funded status of its pension and other post-retirement benefit plans in the Consolidated Balance Sheets.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
The Company makes annual contributions to all of its defined benefit pension plans that are at least equal to the minimum required contributions and any other premiums due under the Employee Retirement Income Security Act of 1974, as amended, the Pension Protection Act of 2006 and the U.S. Internal Revenue Code of 1986, as amended. The Company’s cash contribution to the Pension Plan for Fiscal 2010 was $5,682 and is expected to be approximately $12,600 in the fiscal year ending 2011. See Note 7 of Notes to Consolidated Financial Statements.
Stock-Based Compensation: In accounting for equity-based compensation awards, the Company uses the Black-Scholes-Merton model to calculate the fair value of stock option awards. The Black-Scholes-Merton model uses assumptions which involve estimating future uncertain events. The Company is required to make significant judgments regarding these assumptions, the most significant of which are the stock price volatility, the expected life of the option award and the risk-free rate of return.
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In determining the stock price volatility assumption used, the Company considers the historical volatility of its own stock price, based upon daily quoted market prices of the Company’s common stock on the New York Stock Exchange and, prior to May 15, 2008, on the NASDAQ Stock Market LLC, over a period equal to the expected term of the related equity instruments. The Company relies only on historical volatility since it provides the most reliable indication of future volatility. Future volatility is expected to be consistent with historical; historical volatility is calculated using a simple average calculation method; historical data is available for the length of the option’s expected term and a sufficient number of price observations are used consistently. Since the Company’s stock options are not traded on a public market, the Company does not use implied volatility. A higher volatility input to the Black-Scholes-Merton model increases the resulting compensation expense.
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During Fiscal 2009, the Company had accumulated sufficient historical data regarding stock option exercises and forfeitures to be able to rely on that data for the calculation of expected option life. Accordingly, for options granted during Fiscal 2010 and Fiscal 2009, the Company revised its method of calculating expected option life from the simplified method as described in the SEC’s Staff Accounting Bulletin No. 110 (“SAB 110”) (which yielded an expected term of six years) to the use of historical data (which yielded an expected life of 4.2 years and 3.72 years for Fiscal 2010 and Fiscal 2009, respectively). Historical data will be used for stock options granted in all future periods. The Company based its Fiscal 2008 estimates of the expected life of a stock option of six years upon the average of the sum of the vesting period of 36-42 months and the option term of ten years for issued and outstanding options in accordance with the simplified method as detailed in SAB 110. A shorter expected term would result in a lower compensation expense.
Compensation expense related to stock option grants is determined based on the fair value of the stock option on the grant date and is recognized over the vesting period of the grants on a straight-line basis. Compensation expense related to restricted stock grants is determined based on the fair value of the underlying stock on the grant date and recognized over the vesting period of the grants on a straight-line basis (see below for additional factors related to recognition of compensation expense). The Company applies a forfeiture rate to the number of unvested awards in each reporting period in order to estimate the number of awards that are expected to vest. Estimated forfeiture rates are based upon historical data on vesting behavior of employees. The Company adjusts the total amount of compensation cost recognized for each award, in the period in which each award vests, to reflect the actual forfeitures related to that award. Changes in the Company’s estimated forfeiture rate will result in changes in the rate at which compensation cost for an award is recognized over its vesting period.
Beginning in March 2010, share-based compensation awards granted to certain of the Company’s executive officers under the 2005 Stock Incentive Plan (defined below) included 75,750 performance-based restricted stock/restricted unit awards (“Performance Awards”) in addition to the service-based stock options and restricted stock awards of the types that had been granted in previous periods. The Performance Awards cliff-vest three years after the grant date and are subject to the same vesting provisions as awards of the Company’s regular service-based restricted stock/restricted unit awards granted in March 2010. The final number of Performance Awards that will be earned, if any, at the end of the three-year vesting period will be the greatest number of shares based on the Company’s achievement of certain goals relating to cumulative earnings per share growth (a performance condition) or the Company’s relative total shareholder return (“TSR”) (change in closing price of the Company’s common stock on the New York Stock Exchange compared to that of a peer group of companies (“Peer Companies”)) (a market condition) measured from the beginning of Fiscal 2010 to the end of Fiscal 2012 (the “Measurement Period”). The total number of Performance Awards earned could equal up to 150% of the number of Performance Awards originally granted, depending on the level of achievement of those goals during the Measurement Period.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
The Company records stock-based compensation expense related to the Performance Awards ratably over the requisite service period based on the greater of the estimated expense calculated under the performance condition or the grant date fair value calculated under the market condition. Stock-based compensation expense related to an award with a market condition is recognized over the requisite service period regardless of whether the market condition is satisfied, provided that the requisite service period has been completed. Under the performance condition, the estimated expense is based on the grant date fair value (the closing price of the Company’s common stock on the date of grant) and the Company’s current expectations of the probable number of Performance Awards that will ultimately be earned. The fair value of the Performance Awards under the market condition ($2,432) is based upon a Monte Carlo simulation model, which encompasses TSR’s during the Measurement Period, including both the period from the beginning of Fiscal 2010 to March 3, 2010 (the grant date), for which actual TSR’s are calculated, and the period from the grant date to the end of Fiscal 2012, a total of 2.83 years (the “Remaining Measurement Period”), for which simulated TSR’s are calculated.
In calculating the fair value of the award under the market condition, the Monte Carlo simulation model utilizes multiple input variables over the Measurement Period in order to determine the probability of satisfying the market condition stipulated in the award. The Monte Carlo simulation model computed simulated TSR’s for the Company and Peer Companies during the Remaining Measurement Period with the following inputs: (i) stock price on the grant date (ii) expected volatility; (iii) risk-free interest rate; (iv) dividend yield and (v) correlations of historical common stock returns between the Company and the Peer Companies and among the Peer Companies. Expected volatilities utilized in the Monte Carlo model are based on historical volatility of the Company’s and the Peer Companies’ stock prices over a period equal in length to that of the Remaining Measurement Period. The risk-free interest rate is derived from the U.S. Treasury yield curve in effect at the time of grant with a term equal to the Measurement Period assumption at the time of grant.
For all employee stock-based compensation awards issued beginning in March 2010 (and for similar types of future awards), the Company’s Compensation Committee approved the incorporation of a Retirement Eligibility feature such that an employee who has attained the age of 60 years with at least five years of continuous employment with the Company will be deemed to be “Retirement Eligible”. Awards granted to Retirement Eligible employees will continue to vest even if the employee’s employment with the Company is terminated prior to the award’s vesting date (other than for cause, and provided the employee does not engage in a competitive activity). As in previous years, awards granted to all other employees (i.e. those who are not Retirement Eligible) will cease vesting if the employee’s employment with the Company is terminated prior to the awards vesting date. Stock-based compensation expense is recognized over the requisite service period associated with the related equity award. For Retirement Eligible employees, the requisite service period is either the grant date or the period from the grant date to the Retirement Eligibility date (in the case where the Retirement Eligibility date precedes the vesting date). For all other employees (i.e. those who are not Retirement Eligible), as in previous years, the requisite service period is the period from the grant date to the vesting date. The Retirement Eligibility feature was not applied to awards issued prior to March 2010. The increase in stock-based compensation expense recorded during Fiscal 2010 of approximately $8,100, from Fiscal 2009, primarily related to the Retirement Eligibility feature described above.
Advertising Costs: Advertising costs are included in SG&A expenses and are expensed when the advertising or promotion is published or presented to consumers. Cooperative advertising expenses are charged to operations as incurred and are also included in SG&A expenses. The amounts charged to operations for advertising, marketing and promotion expenses (including cooperative advertising, marketing and promotion expenses) for Fiscal 2010, Fiscal 2009 and Fiscal 2008 were $126,465, $100,188 and $118,814, respectively. Cooperative advertising expenses for Fiscal 2010, Fiscal 2009 and Fiscal 2008 were $27,936, $21,583 and $24,646, respectively.
Shipping and Handling Costs: Costs to store, pick and pack merchandise and costs related to warehousing and distribution activities (with the exception of freight charges incurred to ship finished goods to customers) are expensed as incurred and are classified in SG&A expenses. Direct freight charges incurred to ship merchandise to customers are expensed as incurred and are classified in cost of goods sold. The amounts charged to SG&A for shipping and handling costs for Fiscal 2010, Fiscal 2009 and Fiscal 2008 were $61,190, $52,260 and $56,393, respectively.
Leases: The Company recognizes rent expense for operating leases on a straight-line basis (including the effect of reduced or free rent and rent escalations) over the life of the lease beginning on the date the Company takes possession of the property. At lease inception, the Company determines the lease term by assuming the exercise of those renewal options that are reasonably assured because of the significant economic penalty that exists for not exercising those options. The exercise of renewal options is at the Company’s sole discretion. The expected lease term is used to determine whether a lease is operating or capital and is used to calculate the straight-line rent expense. The difference between the cash paid to the landlord and the amount recognized as rent expense on a straight-line basis is included in deferred rent and classified within other long-term liabilities. Cash reimbursements received from landlords for leasehold improvements and other cash payments received from landlords as lease incentives are recorded as deferred rent and classified as other long-term liabilities. Deferred rent related to landlord incentives is amortized using the straight-line method over the lease term as an offset to rent expense.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
Deferred Financing Costs: Deferred financing costs represent legal, other professional and bank underwriting fees incurred in connection with the issuance of debt. Such fees are amortized over the life of the related debt using the interest method. Amortization of deferred financing costs is included in interest expense, net.
Derivative Financial Instruments: The Company is exposed to foreign exchange risk primarily related to fluctuations in foreign exchange rates between the U.S. Dollar and the Euro, Canadian Dollar, Korean Won, Mexican Peso, Brazilian real, Chinese Yuan and British Pound. The Company’s foreign exchange risk includes U.S. dollar-denominated purchases of inventory, payment of minimum royalty and advertising costs and intercompany loans and payables by subsidiaries whose functional currencies are the Euro, Canadian Dollar, Korean Won, Mexican Peso or British Pound. The Company or its foreign subsidiaries enter into foreign exchange forward contracts and zero-cost collar option contracts, to offset its foreign exchange risk. The Company does not use derivative financial instruments for speculative or trading purposes.
The Company accounts for its derivative instruments as either assets or liabilities and carries them at fair value. The Company designates foreign exchange forward contracts, that are entered into by the Company’s subsidiaries, related to the purchase of inventory or the payment of minimum royalties and advertising costs as cash flow hedges, with gains and losses accumulated on the Balance Sheet in Other Comprehensive Income and recognized in Cost of Goods Sold (“COGS”) in the Statement of Operations during the periods in which the underlying transactions occur. Foreign exchange forward contracts, entered into by foreign subsidiaries that do not qualify for hedge accounting, and those entered into by Warnaco on behalf of a subsidiary, related to inventory purchases, payment of minimum royalties and advertising costs and zero-cost collars or forward contracts related to intercompany loans or payables are considered to be economic hedges for accounting purposes. Gain or loss on the underlying foreign-denominated balance or future obligation would be offset by the loss or gain on the forward contract. Accordingly, changes in the fair value of these economic hedges are recognized in earnings during the period of change.
Gains and losses on economic hedges that are forward contracts are recorded in Other loss (income) in the Consolidated Statements of Operations. Gains and losses on zero cost collars that are used to hedge changes in intercompany loans and payables are included in Other loss (income) or selling, general and administrative expense, respectively, on the Consolidated Statements of Operations.
The Company designates foreign currency forward contracts related to purchase of inventory or payment of minimum royalty and advertising costs as cash flow hedges if the following requirements are met: (i) at the inception of the hedge there is formal documentation of the hedging relationship, the entity’s risk management objective and strategy for undertaking the hedge, the specific identification of the hedging instrument, the hedged transaction and how the hedging instruments effectiveness in hedging exposure to the hedged transactions variability in cash flows attributable to the hedged risk will be assessed; (ii) the hedge transaction is expected to be highly effective in achieving offsetting cash flows attributable to the hedged risk and (iii) the occurrence of the forecasted transaction is probable.
The Company formally assesses, both at the cash flow hedge’s inception and on an ongoing basis, whether the derivatives used in hedging transactions have been highly effective in offsetting changes in the cash flows of hedged items and whether those derivatives may be expected to remain highly effective in future periods. Effectiveness for cash flow hedges is assessed based on forward rates using the Dollar-Offset Analysis, which compares (a) the cumulative changes since inception of the amount of dollars maturing under that dollar forward purchase contract to (b) the cumulative changes since inception of the contract in the amount required for hedged transaction. Changes in the time value (difference between spot and forward rates) are not excluded from the assessment of effectiveness.
Changes in the fair values of foreign exchange contracts that are designated as cash flow hedges, to the extent that they are effective, are deferred and recorded as a component of other comprehensive income until the underlying transaction being hedged is settled, at which time the deferred gains or losses are recorded in cost of goods sold in the Statements of Operations. The ineffective portion of a cash flow hedge, if any, is recognized in Other loss (income) in the current period. Commissions and fees related to foreign currency exchange contracts, if any, are expensed as incurred. Cash flows from the Company’s derivative instruments are classified in the Consolidated Statements of Cash Flows in the same category as the items being hedged.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
The Company discontinues hedge accounting prospectively when it is determined that (i) a derivative is not, or has ceased to be, highly effective as a hedge, (ii) when a derivative expires or is terminated or (iii) whenever it is probable that the original forecasted transactions will not occur by the end of the originally specified time period or within an additional two-month period of time thereafter. When the Company discontinues hedge accounting because it is no longer probable that the forecasted transaction will occur in the originally expected period, the gain or loss on the derivative remains in accumulated other comprehensive income and is reclassified to net income when the forecasted transaction affects net income. However, if it is probable that a forecasted transaction will not occur by the end of the originally specified time period or within a two-month period of time thereafter, the gains and losses that were accumulated in other comprehensive income will be recognized immediately in net income.
Prior to July 2009, the Company also utilized interest rate swaps to convert a portion of the interest obligation related to its long-term debt from a fixed rate to floating rates. See Note 12 of Notes to Consolidated Financial Statements. A number of international financial institutions are counterparties to the Company’s outstanding foreign exchange contracts. The Company monitors its positions with, and the credit quality of, these counterparty financial institutions and does not anticipate nonperformance by these counterparties. Management believes that the Company would not suffer a material loss in the event of nonperformance by these counterparties.
Translation of Foreign Currencies: Cumulative translation adjustments arise primarily from consolidating the net assets and liabilities of the Company’s foreign operations at current rates of exchange. Assets and liabilities of the Company’s foreign operations are recorded at current rates of exchange at the balance sheet date and translation adjustments are applied directly to stockholders’ equity and are included as part of accumulated other comprehensive income. Gains and losses related to the translation of current amounts due from foreign subsidiaries are included in Other loss (income) or selling, general and administrative expense, as appropriate, and are recognized in the period incurred. Translation gains and losses related to long-term and permanently invested inter-company balances are recorded in accumulated other comprehensive income. Income and expense items for the Company’s foreign operations are translated using monthly average exchange rates.
Subsequent Events: The Company has evaluated events and transactions occurring after January 1, 2011 for potential recognition or disclosure in the Consolidated Financial Statements. See Note 2 of Notes to Consolidated Financial Statements - Acquisitions, Note 3 of Notes to Consolidated Financial Statements - Dispositions and Discontinued Operations, Note 13 of Notes to Consolidated Financial Statements - Stockholders’ Equity -Share Repurchase Programs and Note 19 of Notes to Consolidated Financial Statements - Legal Matters.
Recent Accounting Pronouncements:
There were no new accounting pronouncements issued or effective during Fiscal 2010 that had or are expected to have a material impact on the Company’s Consolidated Financial Statements.
Note 2-Acquisitions
Acquisition of Business in Asia
On January 3, 2011, after the close of Fiscal 2010, the Company acquired certain assets, including inventory and leasehold improvements, and acquired the leases, of the retail stores from its Calvin Klein distributor in Taiwan for cash consideration of approximately $1,420. The acquisition was accounted for as a business combination and its results will be consolidated into the Company’s operations and financial statements from its acquisition date. The Taiwan acquisition was deemed not to be material for accounting purposes from a financial reporting perspective.
Acquisition of Businesses in Europe and Asia
On October 4, 2010, the Company acquired the business of a distributor of its Calvin Klein products in Italy, for which total cash consideration was approximately 16,200 ($22,400). On April 29, 2010 and June 1, 2010, the Company acquired the businesses of distributors of its Calvin Klein Jeans and Calvin Klein Underwear products in Singapore and the People’s Republic of China, respectively, for total cash consideration of $8,600. The acquisitions in Italy, Singapore and the People’s Republic of China were accounted for as business combinations and their results were consolidated into the Company’s operations and financial statements from their respective acquisition dates.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
The abovementioned acquisitions were deemed not to be material for accounting purposes from a financial disclosure perspective, either individually or in the aggregate.
Acquisition of Remaining Non-controlling Interest and Retail Stores in Brazil
During the fourth quarter of 2009, the Company finalized agreements, effective October 1, 2009, to acquire the remaining 49% of the equity (the “Equity Purchase”) in its Brazilian subsidiary WBR Industria e Comercio de Vestuario S.A. (“WBR”) from the minority shareholders (the “Sellers”). As a result, the Company’s interest in the outstanding equity of WBR increased to 100%. Concurrent with the Equity Purchase, the Company finalized agreements, effective October 1, 2009, to acquire the business of eight retail stores in Brazil that sell Calvin Klein products (including jeans wear and underwear) (the “Asset Purchase”) from the Sellers. The consummation of the Equity Purchase and the Asset Purchase continues the Company’s strategy of expansion of its operations in South America, as part of its strategic goal of international expansion of its direct to consumer business.
Prior to the consummation of the Equity Purchase, WBR paid a dividend in the amount of 7,000 Brazilian Real ($4,000), which amount represented a distribution to the Sellers of their portion of WBR’s accumulated earnings through September 30, 2009. The Company made an initial cash payment of 21,000 Brazilian Real ($12,000 based on the exchange rate on the acquisition date) in connection with both the Equity Purchase and the Asset Purchase.
In addition to the initial cash payment, the Company is required to make three additional payments, each of which is contingent upon the achievement of a threshold of profitability of WBR (including the eight retail stores), within a defined range, for the fourth quarter of Fiscal 2009 and each of fiscal years 2010 and 2011, respectively. The contingent consideration is payable on March 31, 2010, 2011 and 2012. On the date of acquisition, the Company recorded a liability of 35,000 Brazilian Real ($20,000), which amount represented its estimate, at that time, of the present value of the future contingent payments (totaling 40,000 Brazilian Real) it would be required to pay. During Fiscal 2010, the Company increased, by approximately 3,000 Brazilian Real, (approximately $1,700), its estimate of the total of three additional future annual payments, which are contingent on the operating activity of the subsidiary through December 31, 2011, from the initial estimate of 40,000 Brazilian Real to 43,000 Brazilian Real (approximately $24,000). The Company is recognizing the difference between the present value of the future contingent payments and the nominal value of future contingent payments as interest expense in its Consolidated Statements of Operations during the period over which the contingent payments are made. The Company recorded an expense of 2,669 Brazilian Real (approximately $1,500), representing the present value of the increase to its initial estimate of the contingent consideration, as an adjustment to earnings in its Consolidated Statement of Operations (part of selling, general and administrative expenses (“SG&A”)) and an increase to Other long-term liabilities in its Consolidated Balance Sheet in Fiscal 2010. Based upon the operating results achieved by WBR during the fourth quarter of Fiscal 2009, a payment of 6,000 Brazilian Real ($3,500) was paid by March 31, 2010. The Company will make the second contingent payment of 18,500 Brazilian Real (approximately $11,100), based on the operating results of WBR for Fiscal 2010, by March 31, 2011 and expects that the third contingent payment will be 18,500 Brazilian Real (approximately $11,100), based on the anticipated operating results of WBR for the fiscal year ending 2011, which will be paid by March 31, 2012.
The Equity Purchase was accounted for as an equity transaction since the Company maintained control of WBR both before and after the transaction. The Company has determined, based on its preliminary estimates of the relative fair values of the acquired retail stores business and the 49% interest of WBR (without the acquired retail stores), that the portion of the total consideration due the Sellers that related to the Equity Purchase was 44,100 Brazilian Real ($25,000), resulting in the reduction of Additional Paid in Capital by that amount. In addition, in connection with the Equity Purchase, the Company recorded a deferred tax asset of 14,200 Brazilian Real (approximately $8,000), which was offset by an increase in Additional Paid in Capital.
The Asset Purchase was accounted for as a business combination, which was not deemed to be material for accounting purposes from a financial disclosure perspective. The Company determined that the portion of the total consideration due the Sellers that related to the Asset Purchase was 12,400 Brazilian Real ($7,000).
During Fiscal 2010, the Company completed the accounting for the Equity Purchase and the Asset Purchase, including the acquisition of certain store assets, which had been recorded as intangible assets of $3,592 on the date of acquisition. During Fiscal 2010, the Company reclassified those assets as prepaid rent (included in Other assets on the Company’s Consolidated Balance Sheet), which will be amortized as rent expense over the expected term of the respective leases. The Company did not adjust prior period balance sheets to give effect to the change in classification as it considers the adjustment to be immaterial. See Note 10 of Notes to Consolidated Financial Statements for details of intangible assets and goodwill resulting from these acquisitions.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
The following table describes the effect of changes in the Company’s ownership interest in WBR on the Company’s equity:
(a)
includes $451 of transaction costs related to the acquisition of WBR.
Businesses in Chile and Peru: On June 10, 2009, the Company acquired from Fashion Company S.A. (formerly Clemente Eblen S.A.) and Battery S.A. (collectively, “Eblen”), for cash consideration of $2,475, businesses relating to distribution and sale at wholesale and retail of jeanswear and underwear products bearing the Calvin Klein trademarks in Chile and Peru, including the transfer and assignment to the Company by Eblen of the right to operate and conduct business at three retail locations in Chile and one retail location in Peru. The Company acquired these businesses in order to increase its presence in South America.
2008 CK Licenses: In connection with the consummation of the January 31, 2006 acquisition of 100% of the shares of the companies (“the CKJEA Business”) that operate the wholesale and retail businesses of Calvin Klein jeanswear and accessories in Europe and Asia and the CK /Calvin Klein “bridge” line of sportswear and accessories in Europe, the Company became obligated to acquire from the seller of the CKJEA Business, for no additional consideration and subject to certain conditions which were ministerial in nature, 100% of the shares of the company (the “Collection License Company”) that operates the license (the “Collection License”) for the Calvin Klein men’s and women’s Collection apparel and accessories worldwide. The Company acquired the Collection License Company on January 28, 2008. The Collection License was scheduled to expire in December 2013. However, pursuant to an agreement (the “Transfer Agreement”) entered into on January 30, 2008, the Company transferred the Collection License Company to Phillips-Van Heusen Corporation (“PVH”), the parent company of Calvin Klein, Inc. (“CKI”). In connection therewith, the Company paid approximately $43,000 (including final working capital adjustments) to, or on behalf of, PVH and entered into certain new, and amended certain existing, Calvin Klein licenses (collectively, the “2008 CK Licenses”).
The rights acquired by the Company pursuant to the 2008 CK Licenses include: (i) rights to operate Calvin Klein Jeanswear Accessories Stores in Europe, Eastern Europe, Middle East, Africa and Asia, as defined; (ii) rights to operate Calvin Klein Jeanswear Accessories Stores in Central and South America (excluding Canada and Mexico, which is otherwise included in the underlying grant of rights to the company to operate Calvin Klein Jeanswear retail stores in Central and South America); (iii) rights to operate CK/Calvin Klein Bridge Accessories Stores in Europe, Eastern Europe, Middle East and Africa, as defined; (iv) rights to operate CK/Calvin Klein Bridge Accessories Stores in Central and South America (excluding Canada and Mexico, which is otherwise included in the underlying grant of rights to the Company to operate Calvin Klein Bridge Accessories Stores in Central and South America); and (v) e-commerce rights in the Americas, Europe and Asia for Calvin Klein Jeans and for Calvin Klein jeans accessories. Each of the 2008 CK Licenses are long-term arrangements. In addition, pursuant to the Transfer Agreement, the Company had entered into negotiations with respect to a grant of rights to sublicense and distribute Calvin Klein Golf apparel and golf related accessories. During Fiscal 2008, the Company recorded $24,700 of intangible assets related to the 2008 CK Licenses and Calvin Klein Golf license and recorded a restructuring charge (included in selling, general and administrative expenses) of $18,535 (the “Collection License Company Charge”) related to the transfer of the Collection License Company to PVH. During the third quarter of Fiscal 2009, the Company decided to discontinue its Calvin Klein Golf business (see Note 3 of Notes to Consolidated Financial Statements).
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
Note 3-Dispositions and Discontinued Operations
Calvin Klein Golf and Calvin Klein Collection businesses: During the third quarter of Fiscal 2009, the Company discontinued its Calvin Klein Golf (“Golf”) business and classified as available for sale, its Calvin Klein Collection (“Collection”) business, both of which operated in Korea. As a result, those business units have been classified as discontinued operations for all periods presented. During the third quarter of Fiscal 2009, the Company wrote off the carrying value of the Golf license of $792. In addition, the Company reclassified, as discontinued operations, net revenues of $155 and expenses of $353 for Fiscal 2009 in connection with the shut down of the Golf business. The Company’s Collection business had operated as a distributor of Calvin Klein Collection merchandise at retail locations in Korea both before and subsequent to the transfer of the Collection License Company to PVH. During Fiscal 2010 and Fiscal 2009, the Company reclassified, as discontinued operations, net revenues of $1,754 and $2,305 and expenses of $2,372 and $3,062, respectively, in connection with the shut down of the Collection business. The Collection business was sold to a third party during Fiscal 2010.
Designer Swimwear brands (except for Calvin Klein): During Fiscal 2007, the Company disposed of its OP women’s and junior swimwear, Catalina, Anne Cole and Cole of California businesses. As a result, the OP women’s and junior’s, Catalina, Anne Cole and Cole of California business units have been classified as discontinued operations as of January 1, 2011 and January 2, 2010. The Company had operated the OP women’s and junior swimwear business under a license it was granted in connection with the Company’s sale of its OP business including the associated trademarks and goodwill in 2006. During February 2011, the Company and Doyle & Bossiere Fund I LLC (“Doyle”) reached a settlement agreement and mutual release related to the OP Action (defined below) (see Note 19 of Notes to Consolidated Financial Statements - Legal Matters). As a result, as part of the finalization of its financial statements for Fiscal 2010, the Company recorded a pre-tax charge of $8,000 in the Loss from discontinued operations line item in its Consolidated Statement of Operations for Fiscal 2010 (bringing the Company’s total accrual in relation to the OP Action to $15,000 as of January 1, 2011). On February 16, 2011, the Company paid this amount ($15,000) in full and final settlement of the action in accordance with the terms of the settlement agreement and mutual release.
The Company sold its Catalina, Anne Cole and Cole of California businesses to In Mocean Group, LLC (“InMocean”) for a total consideration of approximately $25,300 (subject to adjustments for working capital) of which $20,600 was received in cash on December 28, 2007. The remaining portion relates to raw material and work-in-process acquired at December 28, 2007. Cash related to raw material and work in process at the sale date is collected by drawing on letters of credit as the related finished goods are shipped. The Company recorded a loss of $2,338 related to the sale of the Catalina, Anne Cole and Cole of California businesses. During Fiscal 2008, the Company recorded charges of approximately $6,864, primarily related to working capital adjustments associated with the disposition of these brands. In addition, through June 30, 2008, the Company was obligated to provide certain transition services to InMocean for which the Company has been reimbursed.
In addition, during Fiscal 2008, the Company ceased operations of its Nautica, Michael Kors and private label swimwear businesses. As a result, these business units have been classified as discontinued operations for financial reporting purposes. During Fiscal 2009 and Fiscal 2008, the Company recognized gains of $304 and losses of $2,035, respectively, (as part of “Loss from discontinued operations, net of taxes”) related to the discontinuation of the Nautica, Michael Kors and private label swimwear businesses.
Lejaby Sale: On February 14, 2008, the Company entered into a stock and asset purchase agreement with Palmers Textil AG (''Palmers’’) whereby, effective March 10, 2008, Palmers acquired the Lejaby business for a base purchase price of 32,500 (approximately $47,400) payable in cash and 12,500 (approximately $18,200) evidenced by an interest free promissory note (payable on December 31, 2013), subject to certain adjustments, including adjustments for working capital. Pursuant to the transition services agreement (“TSA”) with Palmers, the Company operated the Canadian portion of the Lejaby business through December 31, 2008, the term of the TSA. As a result, the Lejaby business (including the Company’s Canadian Lejaby division) has been classified as a discontinued operation for financial reporting purposes. During March 2008, the Company recorded a gain (as part of “Loss from discontinued operations, net of taxes”) of $3,392 related to the sale of Lejaby. In addition, during Fiscal 2008, the Company repatriated, in the form of a dividend to the U.S., the net proceeds received in connection with the Lejaby sale. The repatriation of the proceeds from the Lejaby sale, net of adjustments for working capital, resulted in an income tax charge of approximately $14,587 which was recorded as part of “Provision for income taxes” in the Company’s Consolidated Statements of Operations. During Fiscal 2009, the Company recorded a charge of $3,423 related to the correction of an error in amounts recorded in prior periods relating to the Lejaby sale. See Note 6 of Notes to Consolidated Financial Statements. During January 2011, the Company received notification from Palmers of a French tax liability of the Company’s previously-owned Lejaby business associated with a pre-sale tax period. As a result, as part of the finalization of its financial statements for Fiscal 2010, the Company recorded a pre-tax charge of approximately $3,000 in the Loss from discontinued operations line item in its Consolidated Statement of Operations for Fiscal 2010. See also Note 19 of Notes to Consolidated Financial Statements regarding a dispute between the Company and Palmers related to the sale of the Lejaby business.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
Summarized operating results for the discontinued operations are as follows:
(a)
includes a charge of $3,423 related to the correction of an error in amounts recorded in prior periods. See Note 6 of Notes to Consolidated Financial Statements.
The assets and liabilities of the discontinued operations at January 1, 2011 and January 2, 2010 are presented in the Consolidated Balance Sheets as follows:
Note 4-Restructuring Expense and Other Exit Costs
During Fiscal 2010, the Company incurred restructuring charges and other exit costs of $9,809, primarily related to (i) costs associated with workforce reductions, including current year job eliminations and the remainder of the Company’s effort, which began in Fiscal 2008, to align its cost structure to match economic conditions ($2,279); (ii) the rationalization and consolidation of the Company’s European operations, which had begun in Fiscal 2007 ($1,757); (iii) impairment charges related to retail stores that will be closed in the fiscal year ending 2011 ($1,621) and (iv) lease contract termination costs in connection with retail store and warehouse closings ($4,120) and (v) other exit costs ($32).
During Fiscal 2009, the Company incurred restructuring charges of $12,126, primarily related to (i) the continuation of the workforce reduction, which commenced during the fourth quarter of Fiscal 2008, in order to align the Company’s cost structure to match current economic conditions ($7,110); (ii) the rationalization and consolidation of the Company’s European operations, which had begun in Fiscal 2007 ($1,230); and (iii) other exit activities, including contract termination costs, legal and other costs ($3,786).
During Fiscal 2008, the Company incurred restructuring charges of $35,260, primarily related to (i) the Collection License Company Charge ($18,535); (ii) activities associated with management’s initiatives to increase productivity and profitability in the Swimwear Group ($3,944); (iii) the rationalization and consolidation of the Company’s European operations ($1,621); (iv) a workforce reduction initiative implemented in the fourth quarter of Fiscal 2008 ($1,360) and (v) other costs, including contract termination costs, impairment of fixed assets and legal/other costs associated with various other exit activities ($9,800).
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
Each of the restructuring activities is described below:
The rationalization and consolidation of the Company’s European operations: During Fiscal 2007, the Company initiated actions to consolidate its European operations. Actions taken to date include the consolidation of warehouse and distribution facilities from several sites in Europe to a single site in the Netherlands, consolidation of certain sales functions across Europe as well as the consolidation of certain administrative and support functions across Europe into one shared service center located in the Netherlands. The charges are primarily associated with employee termination costs (related to 20 employees, 14 employees and 9 employees, in Fiscal 2010, Fiscal 2009 and Fiscal 2008, respectively) and moving, consulting and professional fees related to this initiative.
Workforce reduction: Following the economic downturn in the fourth quarter of 2008, as a result of the turmoil in world financial markets and the expected decline in the demand for the Company’s products, the Company reduced its workforce in the United States during the fourth quarter of 2008 by 44 employees at a cost of approximately $1,400 in order to align its cost structure to match current economic conditions. A further reduction in force was implemented during the Fiscal 2009 (232 employees in both the Company’s domestic and foreign operations) at a cost of approximately $7,110. During Fiscal 2010, the final charges related to this initiative were made as well as charges related to certain current year job eliminations and an initiative to consolidate certain front and back office operations in Mexico, Central and South America, at a cost of $2,279.
Charges related to store closings: During Fiscal 2010, the Company recorded non-cash impairment charges totaling $1,621 related to retail stores that will be closed in 2011 (see Note 1 of Notes to Consolidated Financial Statements - Long-lived Assets for a description of the impairment testing of retail stores).
The Collection License Company Charge: See Note 2 of Notes to Consolidated Financial Statements.
Activities associated with management’s initiatives to increase productivity and profitability in the Swimwear Group: During Fiscal 2007, the Company initiated actions to increase productivity and profitability in its Swimwear Group. Actions taken to date include the closure of the Company’s swim goggle manufacturing facility in Canada, the sale of the Company’s Mexican manufacturing facilities, the rationalization and consolidation of the Company’s warehouse and administrative facilities in California and other activities related to the exit of the designer swimwear business (excluding Calvin Klein swimwear). During Fiscal 2008, the Company recorded $3,944 related to the rationalization and consolidation of its warehouse and administrative facilities in California ($3,055) as well as facility shutdown costs ($889) associated with the Fiscal 2007 disposition of its manufacturing plants in Mexico. Costs associated with the rationalization and consolidation of its warehouse and administrative facilities in California include lease termination and related costs of $1,707, employee termination expenses of $836 (related to 14 employees) and legal and other costs of $512.
As relates to the sale of the Mexican manufacturing facilities, on October 1, 2007, the Company entered into an agreement with a local business partner (the “Local Buyer”) whereby the Company transferred the facilities to the Local Buyer. The Company also entered into a production agreement with the Local Buyer for certain stretch swimwear and other products (at market prices) through June 30, 2011. As of January 1, 2011, total commitments under the production agreement are approximately $6,000 through June 30, 2011.
Restructuring charges have been recorded in the Consolidated Statements of Operations for Fiscal 2010, Fiscal 2009 and Fiscal 2008, as follows:
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
Changes in liabilities related to restructuring are summarized below:
(a)
Includes approximately $1,216 recorded in accrued liabilities (part of current liabilities) which amounts are expected to be settled over the next 12 months and includes approximately $2,366 recorded in other long term liabilities which amounts are expected to be settled over the next three years.
Note 5-Business Segments and Geographic Information
Business Segments: The Company operates in three business segments: (i) Sportswear Group; (ii) Intimate Apparel Group; and (iii) Swimwear Group, which groupings reflect the manner in which the Company’s business is managed and the manner in which the Company’s chief operating decision maker reviews the Company’s business. The amounts of net revenues and operating income previously reported for the Sportswear Group for Fiscal 2009 and Fiscal 2008 had included certain sales of Calvin Klein products in the Intimate Apparel Group and the Swimwear Group. Such amounts have been reclassified from the Sportswear Group to the Intimate Apparel and Swimwear Groups to conform to the presentation for Fiscal 2010.
The Sportswear Group designs, sources and markets moderate to premium priced men’s and women’s sportswear under the Calvin Klein and Chaps® brands. As of January 1, 2011, the Sportswear Group operated 599 Calvin Klein retail stores worldwide (consisting of 103 full price free-standing stores, 53 outlet free-standing stores, 442 shop-in-shop/concession stores and, in the U.S., one on-line internet store). As of January 1, 2011, there were also 393 retail stores operated by third parties under retail licenses or franchise and distributor agreements.
The Intimate Apparel Group designs, sources and markets moderate to premium priced intimate apparel and other products for women and better to premium priced men’s underwear and loungewear under the Calvin Klein, Warner’s®,Olga® and Body Nancy Ganz/Bodyslimmers® brand names. As of January 1, 2011, the Intimate Apparel Group operated: (i) 760 Calvin Klein retail stores worldwide (consisting of 86 full price free-standing stores, 65 outlet free-standing stores, in the U.S., one on-line store and 608 shop-in-shop/concession stores). As of January 1, 2011, there were also 226 Calvin Klein retail stores operated by third parties under retail licenses or franchise and distributor agreements.
The Swimwear Group designs, licenses, sources, manufactures and markets mass market to premium priced swimwear, fitness apparel, swim accessories and related products under the Speedo®, Lifeguard® and Calvin Klein brand names. The Swimwear Group operates one on-line store in the U.S.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
Information by business group, excluding discontinued operations, is set forth below:
All inter-company revenues and expenses are eliminated in consolidation. Management does not include inter-company sales when evaluating segment performance. Each segment’s performance is evaluated based upon operating income after restructuring charges and shared services expenses but before unallocated corporate expenses.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
The table below summarizes corporate/other expenses for each period presented:
A reconciliation of operating income from operating groups to income from continuing operations before provision for income taxes and non-controlling interest for Fiscal 2010, Fiscal 2009 and Fiscal 2008, is as follows:
Geographic Information: Included in the consolidated financial statements are the following amounts relating to geographic locations where the Company has business operations:
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
Note 6-Income Taxes
The following presents the domestic and foreign components of income from continuing operations before provision for income taxes and non-controlling interest:
The following presents the components of the Company’s total income tax provision from continuing operations:
(a)
Includes a tax charge of approximately $2,700 associated with the correction of an error in the 2006 through 2009 income tax provisions as a consequence of the loss of a credit related to prior year tax overpayments caused by the delayed filing of tax returns in a U.S. state taxing jurisdiction.
(b)
Includes a charge of approximately $3,600 in order to correct an error in prior period income tax provisions related to the recapture of cancellation of indebtedness income, which had been deferred in connection with the Company’s bankruptcy proceedings in 2003.
(c)
Includes, among other items, approximately $14,600 related to the repatriation to the U.S. of net proceeds received in connection with the sale of the Lejaby business.
The following presents the reconciliation of the provision for income taxes to United States federal income taxes computed at the statutory rate:
(a)
Includes a tax charge of approximately $2,700 associated with the correction of an error in the 2006 through 2009 income tax provisions as a consequence of the loss of a credit related to prior year tax overpayments caused by the delayed filing of tax returns in a U.S. state taxing jurisdiction.
(b)
Includes, among other items, approximately $14,600 related to the repatriation to the U.S. of net proceeds received in connection with the sale of the Lejaby business.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
The components of deferred tax assets and liabilities as of January 1, 2011 and January 2, 2010 were as follows:
Realization of Deferred Tax Assets
Realization of the Company’s deferred tax assets is dependent upon future earnings in specific tax jurisdictions, the timing and amount of which are uncertain. Accordingly, the Company evaluates all available positive and negative evidence and records a valuation allowance for those deferred tax assets for which management does not anticipate future realization. The Company considers income earned and losses incurred in each jurisdiction for the three most recent fiscal years and also considers its forecast of future taxable income in assessing the need for a valuation allowance. The underlying assumptions used in forecasting future taxable income requires significant judgment and take into account the Company’s recent performance. A valuation allowance is established to reduce the deferred tax assets to the amount that is more likely than not to be realized. As of January 1, 2011, the Company determined that it is more likely than not that it will realize a benefit from its domestic, federal and certain state deferred tax assets based on the criteria described above.
Domestically, the valuation allowance was approximately $6,700 and $8,200 as of January 1, 2011 and January 2, 2010, respectively, relating to certain of the Company’s state tax loss carryforwards, state tax credits, and deductible temporary differences. The decrease in the valuation allowance relates primarily to the utilization of tax loss carryforwards during Fiscal 2010 and deductible temporary differences, as well as the expiration of certain U.S. federal foreign tax credit carryforwards. Internationally, the valuation allowance was approximately $11,800 and $9,300 as of January 1, 2011 and January 2, 2010, respectively. The increase in the valuation allowance relates primarily to additional tax loss carryforwards generated during Fiscal 2010 and deductible temporary differences.
Attribute Reduction and Limitations
In connection with the Company’s emergence from bankruptcy on the Effective Date, certain of its domestic subsidiaries realized cancellation of debt (“COD”) income during the period from January 5, 2003 to February 4, 2003. Under U.S. tax law, a company that realized COD income while in bankruptcy is entitled to exclude such income from its U.S. Federal taxable income. A company that excludes COD income is then required to reduce certain tax attributes in an amount equal to the excluded COD income. The tax attributes impacted by these rules included net operating loss carry-forwards, tax credit carry-forwards and tax bases in certain assets.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
There are two alternative interpretations on how the attribute reduction rule should be applied to reduce tax attributes of a U.S. affiliated group of companies. Under one approach, the attribute reduction would be applied on a consolidated return basis and eliminate all of the Company’s U.S. consolidated net operating loss (“NOL”) carryovers generated prior to the fiscal year ended 2004 and reduce certain of its other U.S. tax attributes. Alternatively, the attribute reduction would be applied on a separate company basis and reduce the attributes of each respective entity based on the COD income excluded in that entity. The Company has applied the attribute reduction rules on a separate company basis which resulted in the retention of U.S. net operating loss carryforwards of approximately $231,000 upon the Company’s emergence from bankruptcy on the Effective Date. There can be no assurance that the Company’s position with respect to the separate company attribute reduction approach discussed above will be sustained upon audit by the Internal Revenue Service.
During Fiscal 2009, in addition to the tax charge of approximately $3,600 discussed above, the Company also corrected certain of its assets recorded upon its emergence from bankruptcy on February 4, 2003 in accordance with fresh start accounting which resulted in the following adjustments to the Company’s Consolidated Balance Sheet as of January 2, 2010 and Consolidated Statement of Operations for Fiscal 2009:
An increase in Total assets of $17,033, comprised of the following:
An increase in total liabilities of $25,980, comprised of the following:
A reduction in Retained earnings of $1,200 related to the correction of the adjustment to initially adopt FASB ASC 740-10
(Uncertainty in Income Taxes)
A reduction in Net income of $4,147, comprised of:
The Company determined that the errors were not material to any previously issued financial statements.
The use of the NOL carryforwards is also subject to an annual limitation under Section 382 of the Internal Revenue Code. Under this provision the Company can use its NOL carryforwards to reduce U.S. taxable income, if any, by approximately $23,400 per year. Any portion of the annual limitation not utilized in any given year may be carried forward and increase the annual limitation in the subsequent year. Additionally, certain losses and expenses generated during the five-year period after the Effective Date may be subject to the Section 382 limitation.
At January 1, 2011, the Company had U.S. NOL carryforwards of approximately $121,000 (including approximately $85,000 that is subject to Section 382, as described above) expiring in periods beginning in 2021 through 2027. Included in the $121,000 above, is approximately $77,000 of NOL carryforwards related to stock-based compensation in excess of that recognized for financial reporting purposes, the tax benefit of which will be recorded as a direct addition to paid-in-capital when the utilization results in a reduction of current taxes payable. NOL carryforwards are also subject to the Section 382 limitation in many state jurisdictions. The Company had state and local NOL carryforwards of approximately $168,000 expiring in periods beginning in 2011 through 2030. The Company had foreign NOL carryforwards of approximately $41,000 of which $5,000 expire between the years 2011 and 2020 and $36,000 have an indefinite life.
At January 1, 2011, the Company had alternative minimum tax credit carryforwards of $2,300 which have an indefinite carryforward period. The Company has foreign tax credit carryforwards of $216 which have an indefinite carryforward period. The Company also had state tax credit carryforwards of $2,500 of which $600 expire beginning in 2010 through 2013, $1,600 expires beginning in 2011 through 2027, and $300 have an indefinite life.
Permanent Reinvestment of Foreign Earnings
As of January 1, 2011, the total amount of undistributed earnings of foreign subsidiaries was approximately $406,000. The Company’s intention is to permanently reinvest these earnings and thereby indefinitely postpone their remittance. Accordingly, no domestic deferred income tax provision has been made for foreign withholding taxes or U.S. income taxes which may become payable if undistributed earnings were paid as dividends to the Company. Determination of the amount of unrecognized U.S. income tax liability with respect to such earnings is not practical.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
Accounting for Uncertainty in Income Taxes
At January 1, 2011 the Company had gross tax-effected unrecognized tax benefits of $86,556, all of which if recognized, would impact the effective tax rate.
Tax Years Subject to Examination - The Company and its subsidiaries conduct business globally, and as a result file income tax returns in the United States, including various U.S. state and local jurisdictions, as well as in foreign jurisdictions. The Company’s income tax returns are routinely examined by the U.S. and international tax authorities including key jurisdictions such as Canada, the People’s Republic of China, the Netherlands, Italy, Hong Kong, Korea, Mexico and Brazil. In the U.S. we are no longer subject to U.S. Federal income tax examinations by tax authorities for years before 2000. With respect to our major foreign jurisdictions, we are no longer subject to tax examinations by tax authorities for years before 1999. The Company regularly assesses the potential outcomes of both ongoing and future examinations for the current or prior years to ensure the Company’s provision for income taxes is sufficient. The Company recognizes liabilities based on estimates of whether additional taxes will be due and believes its reserves are adequate in relation to the potential assessments.
Classification of Interest and Penalties - The Company recognizes penalties and interest accrued on uncertain tax positions in income tax expense. As of January 1, 2011 and January 2, 2010, total accrued interest and penalties were approximately $11,400 and $7,000 respectively and were recorded in both the current and non-current taxes payable. During Fiscal 2010, Fiscal 2009 and Fiscal 2008, the Company recognized interest and penalties for uncertain tax positions of approximately $4,400, $2,500 and $3,000, respectively.
Tabular Reconciliation of Unrecognized Tax Benefit - The following is a tabular reconciliation of the total amount of unrecognized tax benefits at the beginning and end of Fiscal 2010, Fiscal 2009 and Fiscal 2008:
(a)
Included in Fiscal 2010 is an adjustment of approximately $3,500 related to uncertain tax positions which were excluded from the tabular rollforward presentation for uncertain tax positions in prior periods. The amounts were appropriately included in the “Other long-term liabilities” line item in the Company’s Consolidated Balance Sheet for all periods presented.
(b)
Included in Fiscal 2010 is an adjustment of approximately $7,000 related to cumulative accrued interest and penalties which were historically included in the tabular rollforward for uncertain tax positions. The amounts were appropriately included the Company’s Consolidated Balance Sheets for all periods presented.
These items described above effect the tabular presentation for uncertain tax position disclosure only. The Company has determined that they are not material to any previously issued financial statements.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
Anticipated Changes within Twelve Months - It is difficult to predict the final timing and resolution of any particular uncertain tax position. Based upon the Company’s assessment of many factors, including past experience and complex judgments about future events, it is reasonably possible that within the next twelve months the reserve for uncertain tax positions may change within a range of a $4,300 increase to a net decrease of $900. The reasons for such change includes but is not limited to tax positions expected to be taken during fiscal year 2011, the reevaluation of current uncertain tax positions arising from developments, and finalization of tax examinations, or from the closure of statutes.
Note 7-Employee Benefit and Retirement Plans
The Company has a defined benefit pension plan covering certain full-time non-union domestic employees and certain domestic employees covered by a collective bargaining agreement who had completed service prior to January 1, 2003 (the “Pension Plan”). The Company also sponsors defined benefit plans for certain of its United Kingdom and other European employees (the “Foreign Plans”). The Foreign Plans were not considered to be material for any period presented. These pension plans are noncontributory and benefits are based upon years of service. The Company also has health care and life insurance plans that provide post-retirement benefits to retired domestic employees (the “Postretirement Plans”). The Postretirement Plans are, in most cases, contributory with retiree contributions adjusted annually.
The Company is required to recognize the funded status of a benefit plan in its Consolidated Balance Sheets. For each of the pension plans, this is measured as the difference between plan assets at fair value and the projected benefit obligation. For the Postretirement Plans (primarily retiree health care plans), this is equal to the accumulated benefit obligation since these plans are unfunded.
Effective January 1, 2003, the Pension Plan was amended such that participants in the Pension Plan will not earn any additional pension benefits after December 31, 2002. The accumulated benefit obligation for the Pension Plan was equal to the projected benefit obligation at December 31, 2002 due to the curtailment of plan benefits at that date.
The Company recognizes as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost. The Company uses a method of accounting for its defined benefit plans that accelerates the recognition of gains or losses. Gains or losses represent changes in the amount of either the projected benefit obligations or plan assets resulting from changes in assumptions, actuarial gains/losses and actual investment returns.
The following tables include the Pension Plan for Fiscal 2010 and Fiscal 2009. The Foreign Plans were not considered to be material for any period presented.
A reconciliation of the balance of Pension Plan benefit obligations follows:
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
A reconciliation of the change in the fair value of Pension Plan assets is as follows:
(a)
The net amount recognized for the Pension Plan as of January 1, 2011 is included in the Company’s Consolidated Balance Sheets in accrued pension obligations, within Accrued liabilities and Other long-term liabilities.
The components of net periodic cost are as follows:
The following table summarizes the amounts recorded in accumulated other comprehensive income that are expected to be recognized as a component of net benefit (income) cost in the fiscal year ending 2011:
The Company’s investment strategy for the Pension Plan’s assets is to invest in a diversified portfolio of assets managed by various fund and money managers. No individual manager accounts for more than 16% of overall Pension Plan assets at January 1, 2011. The target allocations for Pension Plan assets are 43% equity securities, 35% fixed income securities and 22% to all other types of investments. Equity securities primarily include investments in large-cap and mid-cap companies primarily located in the United States. Fixed income securities include corporate bonds of companies from diversified industries, mortgage backed securities, U.S. government bonds and U.S. Treasuries. Other types of investments include investments in limited partnerships that follow several different strategies. Individual fund managers are evaluated against a relevant market index and against other managers with similar investment goals. Underperforming investments are reallocated to other investments and fund managers. The portfolio is balanced annually to maintain the Company’s targeted allocation percentages by type of investment. The targeted allocation percentages are guidelines; actual investments may differ from the targeted allocations.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
Investments in equity and fixed income securities are stated at fair value based upon quoted market prices, if available (see Valuation Techniques, below). The Pension Plan also invests in limited partnerships, the amounts for which have no quoted market price and represent estimated fair value. The Pension Plan’s investments in limited partnerships (approximately $9,631 at January 1, 2011 and $12,925 at January 2, 2010) are valued based on estimated fair value by the management of the limited partnerships as reported to the Trustee in the absence of readily ascertainable market values. These estimated fair values are based upon the underlying investments of the limited partnerships. Because of the inherent uncertainty of valuation, those estimated values may differ significantly from the values that would have been used had a ready market for the securities existed, and the differences could be material. The limited partnerships utilize a “fund of funds” approach resulting in diversified multi-strategy, multi-manager investments. The limited partnerships invest capital in a diversified group of investment entities, generally hedge funds, private investment companies, portfolio funds and pooled investment vehicles which engage in a variety of investment strategies, managed by investment managers. Fair value is determined by the administrators of each underlying investment, in consultation with the investment managers. The Pension Plan records its proportionate share of the partnerships’ fair value as recorded in the partnerships’ financial statements. The limited partnerships allocate gains, losses and expenses to the partners based on the ownership percentage as described in the partnership agreements. Certain limited partnerships place limitation on withdrawals, for example by allowing only semi-annual redemptions, as described in the partnership agreements.
The Pension Plan classifies its investments in a fair value hierarchy that is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy consists of the following three levels:
Level 1, which refers to securities valued using quoted prices from active markets for identical assets;
Level 2, which refers to securities valued using quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable and market-corroborated inputs which are derived principally from or corroborated by observable market data; and
Level 3, which refers to securities valued based on significant unobservable inputs.
Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
Valuation Techniques
Corporate stocks and mutual funds: Securities traded on a national securities exchange (or reported on the NASDAQ national market) are stated at the last reported sales price on the day of valuation. To the extent these securities are actively traded and valuation adjustments are not applied, they are categorized in Level 1 of the fair value hierarchy. If they are traded on the over-the-counter market, their fair value is determined by adjusting observable prices by using models, and the fair value meets the definition of Level 2 in the fair value hierarchy;
Corporate bonds and municipal bonds: The fair value of corporate and municipal bonds is estimated using various techniques, which may consider recently executed transactions in securities of the issuer or comparable issuers, market price quotations (where observable), bond spreads and fundamental data relating to the issuer. Corporate and municipal bonds are categorized in Level 1 or Level 2 of the fair value hierarchy depending on the inputs and market activity levels for specific securities;
U.S. government securities: U.S. government securities are normally valued using a model that incorporates market observable data such as reported sales of similar securities, broker quotes, yields, bids, offers, and reference data. Certain securities are valued principally using dealer quotations. U.S. government securities are categorized in Level 1 or Level 2 of the fair value hierarchy depending on the inputs and market activity levels for specific securities;
U.S. government agencies: U.S. government agency securities are comprised of two main categories consisting of agency issued debt and mortgage pass-throughs. Agency issued debt securities are generally valued in a manner similar to U.S. government securities. Mortgage pass-throughs include mortgage passthrough certificates, which are generally valued using dealer quotations. Depending on market activity levels and whether quotations or other data are used, these securities are typically categorized in Level 1 or Level 2 of the fair value hierarchy;
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
Mortgage-backed securities: The fair value of mortgage-backed securities is estimated based on models that consider the estimated cash flows of each tranche of the entity, establishes a benchmark yield, and develops an estimated tranche specific spread to the benchmark yield based on the unique attributes of the tranche. To the extent the inputs are observable and timely, the values would be categorized in Level 2 of the fair value hierarchy; otherwise they would be categorized as level 3;
Cash equivalents: Cash equivalents are money market funds, which are categorized as Level 1, if the fair value is based on quoted market prices in an active market; and
Limited partnerships: see above.
The fair values of the Company’s Pension Plan assets at January 1, 2011, by asset category, are as follows (see above for a description of the various levels):
(a)
this category represents investment grade bonds of U.S. issuers from diverse industries.
(b)
this category represents limited partnerships that invest capital in a diversified group of investment entities, generally hedge funds, private investment companies, portfolio funds and pooled investment vehicles which engage in a variety of investment strategies, managed by investment managers.
The difference between the fair values of Pension Plan assets of $131,218 and Plan net assets of $127,694 is due to receivables and payables within the Pension Plan’s investment funds.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
The fair values of the Company’s Pension Plan assets at January 2, 2010, by asset category, are as follows:
(a)
this category represents investment grade bonds of U.S. issuers from diverse industries.
(b)
this category represents limited partnerships that invest capital in a diversified group of investment entities, generally hedge funds, private investment companies, portfolio funds and pooled investment vehicles which engage in a variety of investment strategies, managed by investment managers.
The difference between the fair values of Pension Plan assets of $121,061 and Plan net assets of $118,334 is due to receivables and payables within the Pension Plan’s investment funds.
A reconciliation of the balance of fair value measurements for Pension Plan assets using significant unobservable inputs (Level 3) from January 3, 2009 to January 1, 2011, is as follows:
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
The Company made contributions totaling $5,682 during Fiscal 2010, $10,526, during Fiscal 2009 and $8,133 during Fiscal 2008. The Company expects to contribute approximately $12,600 to the Pension Plan in the fiscal year ending 2011. The amount of cash contributions the Company is required to make to the Pension Plan could increase or decrease depending on the performance of the Pension Plan’s assets and other factors which are not in the control of the Company. The Company’s expected cash contributions to the Postretirement Plans are equal to the expected benefit payments as shown in the table below due to the nature of the Postretirement Plans.
Future benefit payments are expected to be:
The weighted-average assumptions used in the actuarial calculations for the Pension Plans and Postretirement Plans were as follows:
The Company’s discount rate used for determining projected benefit obligation for both the Pension Plan and Postretirement Plans was 5.80% for Fiscal 2010, 6.10% for Fiscal 2009, 8.0% for Fiscal 2008. The Company evaluates the discount rate each year at the valuation date and adjusts the discount rate as necessary. The discount rate is selected by matching projected benefit payments to a synthetic portfolio of high quality (rated “Aa” or higher by Moody’s Investor Services or Standard & Poors) corporate bond yields and the duration of obligations for participants in the Pension Plan. The projected benefit payments are matched to spot interest rates over the expected payment period and a single discount rate is developed. The Company believes that a 2010 discount rate of 5.80% for the Pension Plan properly reflects the characteristics of the Company’s plan, the long-term nature of its pension benefit obligations and current market conditions. Other companies’ pension plans may have different characteristics than the Company’s plans and as a result, their discount rates may be higher or lower than the rate used by the Company. Changes in the discount rate used to determine pension benefit obligations are reflected in pension expense in the fourth quarter of the Company’s fiscal year in accordance with the Company’s use of the Accelerated Method of recognizing actuarial gains and losses. The use of the Accelerated Method results in increased volatility in the Company’s reported pension expense compared to other companies. The Company’s expected rate of return on plan assets in the table above only applies to Pension Plan assets and reflects the Company’s expectation of the long-term rate of return on the Pension Plan’s assets. The Company evaluates its discount rate and long-term rate of return assumptions annually.
The Company’s estimated long-term rate of return on Pension Plan assets (used to determine estimated pension expense for interim periods) is based upon the actual net returns realized by the Pension Plan’s assets for the last three years (approximately 8.0% net of Pension Plan expenses) and the return expected to be earned in the future based upon the historical rates of return earned by the S&P 500 Index (65%) and the Barclays Capital Aggregate Medium Duration Corporate Bond Index (35%), weighted to reflect the targeted mix of Pension Plan assets. The rate of compensation increase is not applicable for the Pension Plan because Pension Plan participants’ benefits have been frozen. The Company’s defined benefit plans measurement date is its fiscal year-end.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
The fair value of the Pension Plan’s assets, as noted above, was approximately $127,694 at January 1, 2011, compared to approximately $118,334 at January 2, 2010. The fair value of the Pension Plan’s assets reflects an $11,441 increase from their assumed value of approximately $116,253, net of benefits paid of $11,548, at January 1, 2011, based on an assumed rate of return of 8% per annum. In addition, the Company decreased the discount rate used to determine the benefit obligation from 6.10% in Fiscal 2009 to 5.80% in Fiscal 2010, which increased the benefit obligation. The Company recorded pension expense the fourth quarter of Fiscal 2010 of approximately $3,100 based upon the increase in the benefit obligation, which more than offset the increase in the fair value of the Pension Plan assets. The Company’s pension income/expense is also affected by Pension Plan amendments, Pension Plan benefit experience compared to assumed experience and other factors.
For measurement purposes, the weighted average annual assumed rate of increase in the per capita cost of covered benefits (health care trend rate) related to Postretirement Plans is as follows:
A one-percentage point change in assumed health care cost trend rates would have the following effects:
The Company also sponsors a defined contribution plan for substantially all of its domestic employees. Employees can contribute to the plan, on a pre-tax basis, a percentage of their qualifying compensation up to the legal limits allowed. The Company makes matching contributions to the defined contribution plan. The maximum Company contribution on behalf of any individual employee was $12.25 (including $4.90 of maximum profit sharing contribution), $12.25 (including $4.90 of maximum profit sharing contribution) and $11.50 (including $4.60 of maximum profit sharing contribution) Fiscal 2010, Fiscal 2009 and Fiscal 2008, respectively. Employees fully vest in the Company contribution once they have attained four years of service. Company contributions to the defined contribution plan, in the aggregate, were $3,869 (including $1,768 of profit sharing contribution for Fiscal 2009 made in Fiscal 2010, $4,121 (including $1,875 of profit sharing contribution for Fiscal 2008 made in Fiscal 2009) and $4,106 (including $1,822 of profit sharing contribution for Fiscal 2007 made in Fiscal 2008), respectively.
On April 25, 2005, the Company adopted a deferred compensation plan (the “Deferred Compensation Plan”) for the benefit of certain employees. The Deferred Compensation Plan allows participating employees to make pre-tax deferrals of up to 50% of their annual base salary and up to 100% of their incentive pay. A bookkeeping account is established for each participant, and each account is increased or decreased by the deemed positive or negative return based on hypothetical investment alternatives approved by the Company and selected by the participating employee. In the case of a change of control, the Company expects to establish a “rabbi” trust in connection with the Deferred Compensation Plan and will make contributions to the rabbi trust equal to the Deferred Compensation Plan’s aggregate benefit obligations. As of January 1, 2011 and January 2, 2010, the Company had a liability with respect to the Deferred Compensation Plan of $4,220 and $2,838, respectively, for employee contributions and investment activity to date, which is recorded in other long-term liabilities.
On January 31, 2007, the Company adopted a non-employee director’s deferred compensation plan (the “Directors Deferred Compensation Plan”) for the benefit of non-employee directors. The Directors Deferred Compensation Plan allows participating directors to make pre-tax deferrals of their annual retainer and committee meeting fees, whether payable in the form of cash or unrestricted shares of the Company’s common stock. A bookkeeping account is established for each participant and each account is increased or decreased by the deemed positive or negative return based on hypothetical investment alternatives approved by the Company and selected by the participating non-employee director. As of January 1, 2011 and January 2, 2010, the Company had a liability with respect to the Directors Deferred Compensation Plan of $1,015 and $703, respectively, for director contributions and investment activity to date, which is recorded in other long-term liabilities.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
Note 8-Inventories
See Note 17 of Notes to Consolidated Financial Statements for information related to derivative financial instruments used by the Company to mitigate foreign currency risk related to purchases of inventory.
Note 9-Property, Plant and Equipment
Depreciation and amortization expense related to property, plant and equipment was $43,816, $35,811 and $36,708 for Fiscal 2010, Fiscal 2009 and Fiscal 2008, respectively.
During Fiscal 2010, the Company recorded an impairment charge of $1,933 related to certain of its retail stores (see Note 1 of Notes to Consolidated Financial Statements - Long-lived Assets), which amount is included in the depreciation expense for Fiscal 2010 above.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
Note 10-Intangible Assets and Goodwill
The following tables set forth intangible assets at January 1, 2011 and January 2, 2010 and the activity in the intangible asset accounts during Fiscal 2010 and Fiscal 2009:
(a)
Relates to the correction of errors in prior period deferred tax balances associated with the recapture of cancellation of indebtedness income which had been deferred in connection with the Company’s bankruptcy proceedings in 2003. See Note 6 to Notes to Consolidated Financial Statements.
(b)
Represents amount reclassified to assets of discontinued operations and subsequently written off to Income (loss) from discontinued operations, net of taxes. See Note 3 to Notes to Consolidated Financial Statements.
(c)
Relates to the acquisition of eight retail stores in Brazil during the fourth quarter of Fiscal 2009, including an indefinite lived intangible asset of $3,592 and an intangible asset arising from favorability of acquired leases of $846, with a weighted average amortization period of 2.8 years. See Note 2 to Notes to Consolidated Financial Statements.
(d)
Relates to the correction of errors in prior period deferred tax balances associated with the recapture of cancellation of indebtedness income which had been deferred in connection with the Company’s bankruptcy proceedings in 2003.
(e)
During Fiscal 2010, the Company completed the accounting for the acquisition of certain store assets in Brazil (see Note 2 of Notes to Consolidated Financial Statements), which had been recorded as intangible assets of $3,592 on the date of acquisition during the fourth quarter of Fiscal 2009. During Fiscal 2010, the Company reclassified those assets as prepaid rent (included in Other assets on the Company’s Consolidated Balance Sheet). In addition, during Fiscal 2010, the Company recorded reacquired rights of $360 related to its acquisition of businesses in the People’s Republic of China and amortized that intangible asset to selling, general and administrative expense during Fiscal 2010. The Company also recorded reacquired rights of $18,328, which is being amortized over an eight year period, in connection with the acquisition of its Italian distributor in Fiscal 2010 (see Note 2 of Notes to Consolidated Financial Statements).
The following table summarizes the Company’s estimated amortization expense for intangible assets for the next five years:
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
The following table summarizes the changes in the carrying amount of goodwill for Fiscal 2010 and Fiscal 2009:
(a)
Relates to (i) the acquisition of businesses in Chile, and Peru ($698 in Intimate Apparel) and Brazil ($1,083 in Sportswear and $306 in Intimate Apparel), allocated based upon the relative operating income generated from sales of Calvin Klein Jeans and Calvin Klein Underwear by the eight acquired retail stores during the fourth quarter of Fiscal 2009 and (ii) an adjustment of $3,543 related to the recapture of certain reserves in the Company’s CKJEA businesses that were in existence on the date of acquisition of the CKJEA business. None of the goodwill is deductible for income tax purposes. (see Notes 2 and 6 of Notes to Consolidated Financial Statements).
(b)
Relates to the acquisition of businesses in the People’s Republic of China during Fiscal 2010 ($683 in Sportswear Group and $117 in Intimate Apparel Group) and in Italy ($6,882 in the Sportswear Group) (see Note 2 of Notes to Consolidated Financial Statements).
During the fourth quarter of Fiscal 2010, the Company conducted its annual test to determine if the carrying value of its goodwill or intangible assets, consisting primarily of licenses and trademarks for its Calvin Klein products, was impaired. See Note 1 of Notes to Consolidated Financial Statements - Significant Accounting Policies- Long-lived Assets and Goodwill and Other Intangible Assets. The Company did not identify any reporting units that failed or are at risk of failing the first step of the goodwill impairment test (comparing fair value to carrying amount) for any period presented. For Fiscal 2010, Fiscal 2009 and Fiscal 2008, no impairment charges were recorded related to the Company’s goodwill or intangible assets.
Note 11-Accumulated Other Comprehensive Income
The components of accumulated other comprehensive income as of January 1, 2011 and January 2, 2010 are summarized below:
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
Note 12-Debt
Debt was as follows:
(a)
reflects the portion of the Senior Notes (defined below) that was redeemed from bondholders on January 5, 2010 (see below).
Financing Agreements
Senior Notes
On January 5, 2010, the Company redeemed from bondholders $50,000 aggregate principal amount of its outstanding Senior Notes for a total consideration of $51,479 and on June 15, 2010, the Company redeemed from bondholders the remaining $110,890 aggregate principal amount of its outstanding Senior Notes for a total consideration of $112,530. In connection with the redemptions, the Company recognized a loss, in the Other loss (income) line item in the Company’s Consolidated Statement of Operations, of approximately $3,747 for Fiscal 2010, which included $3,119 of premium expense, the write-off of approximately $2,411 of deferred financing costs, partially offset by $1,783 of unamortized gain from the previously terminated 2003 Swap Agreement and 2004 Swap Agreement (both defined below). The Company funded the redemption of the Senior Notes on January 5, 2010 and June 15, 2010 with available cash on hand in the U.S and borrowings under its 2008 Credit Agreement (defined below).
On June 12, 2003, Warnaco completed the sale of $210,000 aggregate principal amount at par value of Senior Notes, which notes were set to mature on June 15, 2013 and which bore interest at 87/8% per annum payable semi-annually on December 15 and June 15 of each year (the “Senior Notes”). No principal payments prior to the maturity date were required. On June 2, 2006, the Company purchased $5,000 aggregate principal amount of the outstanding $210,000 Senior Notes for total consideration of $5,200 in the open market. During March 2008, the Company purchased $44,110 aggregate principal amount of the outstanding Senior Notes for a total consideration of $46,185 in the open market. In connection with the purchase, the Company recognized a loss of approximately $3,160, which included the write-off of approximately $1,085 of deferred financing costs. The loss on the repurchase was included in the other loss (income) line item in the Company’s Consolidated Statement of Operations for Fiscal 2008.
The Senior Notes were unconditionally guaranteed, jointly and severally, by Warnaco Group and substantially all of Warnaco’s domestic subsidiaries (all of which are 100% owned, either directly or indirectly, by Warnaco). The Senior Notes were effectively subordinate in right of payment to existing and future secured debt (including the 2008 Credit Agreements) and to the obligations (including trade accounts payable) of the subsidiaries that were not guarantors of the Senior Notes. The guarantees of each guarantor were effectively subordinate to that guarantor’s existing and future secured debt (including guarantees of the 2008 Credit Agreements) to the extent of the value of the assets securing that debt.
Interest Rate Swap Agreements
The Company entered into interest rate swap agreements on September 18, 2003 (the “2003 Swap Agreement”) and November 5, 2004 (the “2004 Swap Agreement”) with respect to the Senior Notes for a total notional amount of $75 million. In June 2009, the 2004 Swap Agreement was called by the issuer and the Company received a debt premium of $740. On July 15, 2009, the 2003 Swap Agreement was called by the issuer and the Company received a debt premium of $1,479. Both debt premiums were amortized as reductions to interest expense through June 15, 2013 (the date on which the Senior Notes mature), subject to acceleration for redemption of the Senior Notes. During Fiscal 2009, $273 of the debt premium was amortized. The 2003 Swap Agreement and the 2004 Swap Agreement provided that the Company would receive interest at 87/8% and pay variable rates of interest based upon six month LIBOR plus 4.11% and 4.34%, respectively. As a result of the amortization of the debt premiums, the weighted average effective interest rate of the Senior Notes was 8.53% as of January 2, 2010. As of January 1, 2011 and January 2, 2010, the Company had no outstanding interest rate swap agreements.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
2008 Credit Agreements (previously referred to as New Credit Agreements)
On August 26, 2008, Warnaco, as borrower, and Warnaco Group, as guarantor, entered into a revolving credit agreement (the “2008 Credit Agreement”) and Warnaco of Canada Company (“Warnaco Canada”), an indirect wholly-owned subsidiary of Warnaco Group, as borrower, and Warnaco Group, as guarantor, entered into a second revolving credit agreement (the “2008 Canadian Credit Agreement” and, together with the 2008 Credit Agreement, the “2008 Credit Agreements”), in each case with the financial institutions which, from time to time, will act as lenders and issuers of letters of credit (the “Lenders and Issuers”).
The 2008 Credit Agreements replaced the Company’s Amended and Restated Credit Agreement (see below), including the Term B Note. Borrowings under the 2008 Credit Agreements were used to repay the outstanding balance under the Term B Note. In addition, the 2008 Credit Agreements are used to issue standby and commercial letters of credit, to finance ongoing working capital and capital expenditure needs and for other general corporate purposes.
The 2008 Credit Agreement provides for a five-year asset-based revolving credit facility under which up to $270,000 initially will be available. In addition, during the term of the 2008 Credit Agreement, Warnaco may make up to three requests for additional credit commitments in an aggregate amount not to exceed $200,000. The 2008 Canadian Credit Agreement provides for a five-year asset-based revolving credit facility in an aggregate amount up to U.S. $30,000. The 2008 Credit Agreements mature on August 26, 2013.
At January 1, 2011, the 2008 Credit Agreement has interest rate options (dependent on the amount borrowed and the repayment period) of (i) 3.75%, based on a Base Rate plus 0.50%, or (ii) 1.80%, based on LIBOR plus 1.50%, in each case, on a per annum basis. The interest rate payable on outstanding borrowings is subject to adjustments based on changes in the Company’s financial leverage ratio. The 2008 Canadian Credit Agreement had interest rate options of (i) 3.50%, based on the prime rate announced by Bank of America (acting through its Canada branch) plus 0.50%, or (ii) 2.71%, based on the BA Rate (defined below) plus 1.50%, in each case, on a per annum basis and subject to adjustments based on changes in the Company’s financial leverage ratio. The BA Rate is defined as the annual rate of interest quoted by Bank of America (acting through its Canada branch) as its rate of interest rate for bankers’ acceptances in Canadian dollars for a face amount similar to the amount of the loan and for a term similar to the applicable interest period.
The 2008 Credit Agreements contain covenants limiting the Company’s ability to (i) incur additional indebtedness and liens, (ii) make significant corporate changes including mergers and acquisitions with third parties, (iii) make investments, (iv) make loans, advances and guarantees to or for the benefit of third parties, (v) enter into hedge agreements, (vi) make restricted payments (including dividends and stock repurchases), and (vii) enter into transactions with affiliates. The 2008 Credit Agreements also include certain other restrictive covenants. In addition, if Available Credit (as defined in the 2008 Credit Agreements) is less than a threshold amount (as specified in the 2008 Credit Agreements) the Company’s Fixed Charge Coverage ratio (as defined in the 2008 Credit Agreements) must be at least 1.1 to 1.0.
The covenants under the 2008 Credit Agreements contain negotiated exceptions and carve-outs, including the ability to repay indebtedness, make restricted payments and make investments so long as after giving pro forma effect to such actions the Company has a minimum level of Available Credit (as defined in the 2008 Credit Agreements), the Company’s Fixed Charge Coverage Ratio (as defined in the 2008 Credit Agreements) for the last four quarters was at least 1.1 to 1.0 and certain other requirements are met.
The 2008 Credit Agreements contain events of default, such as payment defaults, cross-defaults to other material indebtedness, bankruptcy and insolvency, the occurrence of a defined change of control, or the failure to observe the negative covenants and other covenants related to the operation and conduct of the Company’s business. Upon an event of default, the Lenders and Issuers will not be obligated to make loans or other extensions of credit and may, among other things, terminate their commitments and declare any then outstanding loans due and payable immediately.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
The obligations of Warnaco under the 2008 Credit Agreement are guaranteed by Warnaco Group and its indirect domestic subsidiaries (other than Warnaco) (collectively, the “U.S. Guarantors”). The obligations of Warnaco Canada under the 2008 Canadian Credit Agreement are guaranteed by the Warnaco Group, Warnaco and the U.S. Guarantors, as well as by a Canadian subsidiary of Warnaco Canada. As security for the obligations under the 2008 Credit Agreements and the guarantees thereof, the Warnaco Group, Warnaco and each of the U.S. Guarantors has granted pursuant to a Pledge and Security Agreement to the collateral agent, for the benefit of the lenders and issuing banks, a first priority lien on substantially all of their tangible and intangible assets, including, without limitation, pledges of their equity ownership in domestic subsidiaries and up to 66% of their equity ownership in first-tier foreign subsidiaries, as well as liens on intellectual property rights. As security for the obligations under the 2008 Canadian Credit Agreement and the guarantee thereof by a Warnaco Canadian subsidiary, Warnaco Canada and its subsidiary have each granted pursuant to General Security Agreements, a Securities Pledge Agreement and Deeds of Hypothec to the collateral agent, for the benefit of the lenders and issuing banks under the 2008 Canadian Credit Agreement, a first priority lien on substantially all of their tangible and intangible assets, including, without limitation, pledges of their equity ownership in subsidiaries, as well as liens on intellectual property rights.
On August 26, 2008, the Company used $90,000 of the proceeds from the 2008 Credit Agreements and $16,000 of its existing cash and cash equivalents to repay $106,000 in loans outstanding under the Term B Note of the Amended and Restated Credit Agreement in full (see below). The Amended and Restated Credit Agreement was terminated along with all related guarantees, mortgages, liens and security interests. As of January 1, 2011, the Company had no loans and approximately $72,779 in letters of credit outstanding under the 2008 Credit Agreement, leaving approximately $131,134 of availability under the 2008 Credit Agreement. As of January 1, 2011, there were no loans and no letters of credit outstanding under the 2008 Canadian Credit Agreement and available credit was approximately $22,015.
In connection with the termination of the Amended and Restated Credit Agreement during Fiscal 2008, the Company wrote-off approximately $2,100 of deferred financing costs, which had been recorded as Other Assets on the Consolidated Balance Sheet. The write-off of deferred financing costs is included in interest expense in the Consolidated Statement of Operations. In addition, approximately $200 of deferred financing costs related to the Amended and Restated Credit Agreement was not written-off and will be amortized over the term of the 2008 Credit Agreements. The Company recorded approximately $4,200 of deferred financing costs in connection with the 2008 Credit Agreements, which will be amortized using the straight-line method through August 26, 2013.
Revolving Credit Facility; Amended and Restated Credit Agreement and Foreign Revolving Credit Facility
On August 26, 2008, the Company terminated the Amended and Restated Credit Agreement, including the Term B Note, which had been entered into in January 2006, in connection with the closing of the 2008 Credit Agreements (see above). In addition, during the third quarter of Fiscal 2008, the Company terminated the Foreign Revolving Credit Facility under which no amounts were outstanding. All guarantees, mortgages, liens and security interests related to both of those agreements were terminated at that time.
Euro-Denominated CKJEA Notes Payable and Other
In connection with the CKJEA Acquisition, the Company assumed certain short-term notes payable (the “CKJEA Notes”) with a number of banks at various interest rates (primarily Euro LIBOR plus 1.0%). The total CKJEA Notes payable was $18,445 at January 1, 2011 and $47,684 at January 2, 2010. The weighted average effective interest rate for the outstanding CKJEA Notes payable was 4.29% as of January 1, 2011 and 2.18% as of January 2, 2010. All of the CKJEA Notes payable are short-term and were renewed during Fiscal 2009 for additional terms of no more than 12 months. At January 1, 2011, the Company’s Brazilian subsidiary, WBR, had lines of credit with several banks, with a total outstanding balance of $357, recorded in Short-term debt in the Company’s Consolidated Balance Sheet, which were secured by an equal amount of WBR’s trade accounts receivable.
On September 30, 2010, one of the Company’s Italian subsidiaries entered into a Euro 10.0 million loan (the “Italian Note”). The Italian Note has a term of 18 months, through March 12, 2012, and bears interest of Euro LIBOR plus 2.75%. Repayments are due monthly beginning in January 2011. At January 1, 2011, the principal balance of the Italian Note was Euro 10.0 million ($13,370), with an annual interest rate of 3.64%. The Company has the intent and ability to repay the Italian Note within one year and, accordingly, has classified the Italian Note as short-term debt.
Debt Covenants
The Company was in compliance with the covenants of its 2008 Credit Agreements as of January 1, 2011 and January 2, 2010, and of its Senior Notes as of January 2, 2010.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
Note 13-Stockholders’ Equity
Preferred Stock
The Company has authorized an aggregate of 20,000,000 shares of preferred stock, par value $0.01 per share, of which 112,500 shares are designated as Series A preferred stock, par value $0.01 per share. There were no shares of preferred stock issued and outstanding at January 1, 2011 or January 2, 2010.
Share Repurchase Program
On May 12, 2010, the Company’s Board of Directors authorized a share repurchase program (the “2010 Share Repurchase Program”) for the repurchase of up to 5,000,000 shares of the Company’s common stock. During Fiscal 2010, the Company repurchased 939,158 shares in the open market for a total cost of $47,382 (based on an average of $50.45 per share) under the 2010 Share Repurchase Program, leaving a balance of 4,060,842 shares to be repurchased. During January 2011, after the close of Fiscal 2010, the Company repurchased 560,842 shares of its common stock under the 2010 Share Repurchase Program for $29,133 (based on an average of $51.94 per share). All repurchases of shares under the new program will be made consistent with the terms of the Company’s applicable debt instruments. The share repurchase program may be modified or terminated by the Company’s Board of Directors at any time.
In May 2007, the Company’s Board of Directors authorized a share repurchase program (the “2007 Share Repurchase Program”) for the repurchase of up to 3,000,000 shares of the Company’s common stock. The share repurchase program may be modified or terminated by the Company’s Board of Directors at any time. During Fiscal 2010, the Company repurchased the remaining 1,490,131 shares of its common stock allowed to be repurchased under the 2007 Share Repurchase Program in the open market at a total cost of approximately $69,004 (an average cost of $46.31 per share). At January 1, 2011, the Company had cumulatively purchased 3,000,000 shares of common stock in the open market at a total cost of approximately $106,916 (an average cost of $35.64 per share) under the 2007 Share Repurchase Program. During Fiscal 2009, the Company did not purchase any shares. During Fiscal 2008, the Company purchased 943,000 shares of common stock in the open market at a total cost of approximately $15,865 (an average cost of $16.82 per share). During Fiscal 2007, the Company purchased 566,869 shares of common stock in the open market at a total cost of approximately $22,047 (an average cost of $38.89 per share).
Repurchased shares are held in treasury pending use for general corporate purposes.
2005 Stock Incentive Plan
The Warnaco Group, Inc. 2005 Stock Incentive Plan (the “2005 Stock Incentive Plan”), as amended, permits the granting of incentive stock options, non-qualified stock options, restricted stock, stock awards and other stock-based awards (including but not limited to restricted stock units), some of which may require the satisfaction of performance-based criteria in order to become vested or payable to participants. During Fiscal 2009, the 2005 Stock Incentive Plan was amended to increase the aggregate number of shares that may be issued to 7,150,000 shares of common stock; provided, however, that the aggregate number of shares that may be subject to restricted stock awards shall not exceed 2,725,000. Those numbers of shares are subject to adjustment for dividends, distributions, recapitalizations, stock splits, reverse stock splits, reorganizations, mergers, consolidations, split-ups, spin-offs, combinations, repurchases or exchanges of shares or other securities of the Company, issuances of warrants or other rights to purchase shares of common stock or other securities of the Company and other similar events. The Compensation Committee of the Company’s Board of Directors is responsible for administering the 2005 Stock Incentive Plan. The Company has reserved 7,150,000 shares of its common stock for stock based compensation awards granted pursuant to the 2005 Stock Incentive Plan. Substantially all awards granted under the 2005 Stock Incentive Plan have a contractual life of 10 years. Stock options, that are granted beginning in 2005, vest annually with respect to 1/3 of the award on each anniversary of the grant date provided that the grantee is employed by the Company on such date. Restricted stock awards, that were granted between 2005 and 2008, vest annually with respect to 1/3 of the award on each anniversary of the grant date, and restricted stock awards, that are granted from 2009, vest on the third anniversary of the grant date, provided that the grantee is employed by the Company on such date (see below regarding vesting of equity awards under the Retirement Eligibility feature instituted beginning in Fiscal 2010). At January 1, 2011, under the 2005 Stock Incentive Plan, there were 2,329,854 shares available for future grants, of which 1,115,645 shares were available for future grants of restricted stock awards.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
2003 Stock Incentive Plan
The Compensation Committee of the Company’s Board of Directors is responsible for administration of The Warnaco Group, Inc. 2003 Stock Incentive Plan (the “2003 Stock Incentive Plan”) and determines, subject to its provisions, the number of shares to be issued, the terms of awards, the sale or exercise price, the number of shares awarded and the rate at which awards vest or become exercisable. The Company has reserved 5,000,000 shares of common stock for stock-based compensation awards granted pursuant to the 2003 Stock Incentive Plan. Substantially all stock-based compensation awards granted after January 3, 2004 have a contractual life of 10 years and vest annually with respect to 1/3 of the award on each anniversary of the grant date beginning in 2005 provided that the grantee is employed by the Company on such date. Substantially all stock-based compensation awards granted prior to January 3, 2004 have a contractual life of 10 years and vest, with respect to 1/4 of the award, six months after the grant date and, with respect to an additional 1/4 of such award, each anniversary after the first vesting date for a period of three years provided that the grantee is employed by the Company on such date. At January 1, 2011, under the 2003 Stock Incentive Plan, there were 80,496 shares available for future grants of either stock options or restricted stock awards.
The fair values of stock options granted in Fiscal 2010, Fiscal 2009 and Fiscal 2008 were estimated at the date of grant using a Black-Scholes-Merton option pricing model with the following assumptions:
(a)
Based on the quoted yield for U.S. five-year treasury bonds as of the date of grant.
A summary of stock-based compensation expense is as follows:
(a)
The primary reason for the increase in stock-based compensation expense for Fiscal 2010, compared to Fiscal 2009, related to the incorporation of a “Retirement Eligibility” feature that was applied to all the equity awards issued in March 2010. For employee stock-based compensation awards issued in March 2010 (and for similar types of future awards), the Company’s Compensation Committee approved the incorporation of a Retirement Eligibility feature such that an employee who has attained the age of 60 years with at least five years of continuous employment with the Company will be deemed to be “Retirement Eligible”. Awards granted to Retirement Eligible employees will continue to vest even if the employee’s employment with the Company is terminated prior to the award’s vesting date (other than for cause, and provided the employee does not engage in a competitive activity). As in previous years, awards granted to all other employees (i.e. those who are not Retirement Eligible) will cease vesting if the employee’s employment with the Company is terminated prior to the award’s vesting date. Stock-based compensation expense is recognized over the requisite service period associated with the related equity award. For Retirement Eligible employees, the requisite service period is either the grant date or the period from the grant date to the Retirement Eligibility date (in the case where the Retirement Eligibility date precedes the vesting date). For all other employees (i.e. those who are not Retirement Eligible), as in previous years, the requisite service period is the period from the grant date to the vesting date. The Retirement Eligibility feature was not applied to awards issued prior to March 2010.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
As of January 1, 2011, there was $24,190 of total unrecognized compensation cost related to unvested stock-based compensation awards granted under the Company’s stock incentive plans. That cost is expected to be recognized over a weighted average period of approximately 23 months. The tax benefit realized from exercise of stock options was not material for any period presented. Shares issued under stock based compensation plans are issued from previously unissued but authorized Common Stock.
A summary of stock option award activity under the Company’s stock incentive plans as of January 1, 2011 and changes during Fiscal 2010 is presented below:
A summary of the activity for unvested restricted share/unit awards as of January 1, 2011 and changes during Fiscal 2010 is presented below:
(a)
does not include an additional 36,750 restricted units with a grant date fair value of $43.28, granted to Retirement Eligible employees, for which the requisite service period has been completed on the grant date but the restrictions will not lapse until the end of the three-year vesting period.
In March 2010, share-based compensation awards granted to certain of the Company’s executive officers under the 2005 Stock Incentive Plan included 75,750 performance-based restricted stock/restricted unit awards (“Performance Awards”) in addition to the service-based stock options and restricted stock awards, included in the preceding tables, of the types that had been granted in previous periods. The Performance Awards cliff-vest three years after the grant date and are subject to the same vesting provisions as awards of the Company’s regular service-based restricted stock/restricted unit awards granted in March 2010. The final number of Performance Awards that will be earned, if any, at the end of the three-year vesting period will be the greatest number of shares based on the Company’s achievement of certain goals relating to cumulative earnings per share growth (a performance condition) or the Company’s relative total shareholder return (“TSR”) (change in closing price of the Company’s common stock on the New York Stock Exchange compared to that of a peer group of companies (“Peer Companies”)) (a market condition) measured from the beginning of Fiscal 2010 to the end of Fiscal 2012 (the “Measurement Period”). The total number of Performance Awards earned could equal up to 150% of the number of Performance Awards originally granted, depending on the level of achievement of those goals during the Measurement Period.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
The Company records stock-based compensation expense related to the Performance Awards ratably over the requisite service period based on the greater of the estimated expense calculated under the performance condition or the grant date fair value calculated under the market condition. Stock-based compensation expense related to an award with a market condition is recognized over the requisite service period regardless of whether the market condition is satisfied, provided that the requisite service period has been completed. Under the performance condition, the estimated expense is based on the grant date fair value (the closing price of the Company’s common stock on the date of grant) and the Company’s current expectations of the probable number of Performance Awards that will ultimately be earned. The fair value of the Performance Awards under the market condition ($2,432) is based upon a Monte Carlo simulation model, which encompasses TSR’s during the Measurement Period, including both the period from the beginning of Fiscal 2010 to March 3, 2010 (the grant date), for which actual TSR’s are calculated, and for the period from the grant date to the end of Fiscal 2012, a total of 2.83 years (the “Remaining Measurement Period”), for which simulated TSR’s are calculated.
In calculating the fair value of the award under the market condition, the Monte Carlo simulation model utilizes multiple input variables over the Measurement Period in order to determine the probability of satisfying the market condition stipulated in the award. The Monte Carlo simulation model computed simulated TSR’s for the Company and Peer Companies during the Remaining Measurement Period with the following inputs: (i) stock price on the grant date (ii) expected volatility; (iii) risk-free interest rate; (iv) dividend yield and (v) correlations of historical common stock returns between the Company and the Peer Companies and among the Peer Companies. Expected volatilities utilized in the Monte Carlo model are based on historical volatility of the Company’s and the Peer Companies’ stock prices over a period equal in length to that of the Remaining Measurement Period. The risk-free interest rate is derived from the U.S. Treasury yield curve in effect at the time of grant with a term equal to the Measurement Period assumption at the time of grant.
The calculation of simulated TSR’s under the Monte Carlo model for the Remaining Measurement Period included the following assumptions:
(a)
Company expected volatility is based on a remaining measurement period of 2.83 years.
The Company recorded compensation expense for the Performance Awards during Fiscal 2010 based on the performance condition.
Performance share activity for Fiscal 2010 was as follows:
(a)
does not include 34,300 Performance Awards granted to Retirement Eligible employees, for which the requisite service period has been completed on the grant date; the restrictions on such awards will not lapse until the end of the three-year vesting period.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
The weighted average grant date fair value of options granted and the intrinsic value of options exercised and restricted shares/units vested during Fiscal 2010, Fiscal 2009 and Fiscal 2008 are as follows:
The following represents the reconciliation of the number of shares of common stock and treasury stock issued and outstanding as of January 1, 2011 and January 2, 2010:
For additional disclosures related to stock-based compensation, see Note 1 of the Notes to Consolidated Financial Statements - Stock-Based Compensation.
Note 14-Income per Common Share
The following table presents the calculation of both basic and diluted income per common share attributable to Warnaco Group, Inc. common shareholders, giving effect to participating securities. The Company has determined that based on a review of its share-based awards, only its restricted stock awards are deemed participating securities, which participate equally with common shareholders. The weighted average restricted stock outstanding was 598,047 shares, 567,917 shares and 592,559 shares for Fiscal 2010, Fiscal 2009 and Fiscal 2008, respectively. Undistributed income allocated to participating securities is based on the proportion of restricted stock outstanding to the sum of weighted average number of common shares outstanding attributable to Warnaco Group, Inc. common shareholders and restricted stock outstanding for each period presented.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
(a)
Options to purchase shares of common stock at an exercise price greater than the average market price for each period presented are anti-dilutive and, therefore not included in the computation of diluted income per common share from continuing operations.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
Note 15-Lease and Other Commitments
The Company is a party to various lease agreements for equipment, real estate, furniture, fixtures and other assets, which expire on various dates through 2028. Under these agreements, the Company is required to pay various amounts including property taxes, insurance, maintenance fees, and other costs. See Note 1 of Notes to Consolidated Financial Statements - Leases for more information on the Company’s operating leases. The following is a schedule of future minimum rental payments required under non-cancelable operating leases with terms in excess of one year, as of January 1, 2011:
Rent expense included in the Consolidated Statements of Operations for Fiscal 2010, Fiscal 2009 and Fiscal 2008 was $89,026, $73,173 and $61,314, respectively.
Contractual obligations for operating leases as of January 1, 2011 include approximately $31,400 related to a 15 year lease contract for a new distribution center in the Netherlands (the “DC”) that was entered into by one of the Company’s Netherlands subsidiaries in Fiscal 2010. In the event of default by the Netherlands subsidiary in making rental payments under the lease, the Warnaco Group has issued a guarantee to the lessor for those payments. The Warnaco Group has also issued guarantees of the indebtedness of other of its subsidiaries from time to time in the ordinary course of business.
Although the specific terms of each of the Company’s license agreements vary, generally such agreements provide for minimum royalty payments and/or royalty payments based upon a percentage of net sales. Such license agreements also generally grant the licensor the right to approve any designs marketed by the licensee. The Company has license agreements with the following minimum guaranteed royalty payments as of January 1, 2011:
(a)
Includes all minimum royalty obligations. Some of the Company’s license agreements have no expiration date or extend to 2044 or 2046. License agreements with no expiration date are assumed to end in 2044 for purposes of this table. Variable based minimum royalty obligations are based upon payments for the most recent fiscal year. Certain of the Company’s license agreements also require the Company to pay a specified percentage of net revenue (ranging from 1-6%) to the licensor for advertising and promotion of the licensed products (which amount is not included in minimum royalty obligations for purposes of this item).
The Company has entered into employment agreements with certain members of management. Minimum obligations pursuant to such agreements total $5,602, $192, $352, $201, $205, and $24 in the fiscal years ending 2011, 2012, 2013, 2014, 2015 and thereafter, respectively. These minimum obligations include deferred compensation and supplemental compensation under these agreements. See Note 4 of Notes to Consolidated Financial Statements.
As of January 1, 2011, the Company had purchase obligations of $11,983, $1,553, $698, $600 and $151 for the fiscal years ending 2011, 2012, 2013, 2014 and 2015, respectively. Amounts due include, among other items, purchase obligations of approximately $6,000 in the fiscal year ending 2011 pursuant to a production agreement with the buyer of the Company’s manufacturing facilities in Mexico. See Note 4 of Notes to Consolidated Financial Statements. In addition, amounts relate to payments for software maintenance fees, software licensing fees and advertising.
At January 1, 2011, in the ordinary course of business, the Company had open purchase orders with suppliers of approximately $371,204, all of which is payable in 2011.
As of January 1, 2011, the Company has entered into foreign currency exchange forward contracts to mitigate its foreign exchange risk. See Notes 1 and 17 of Notes to Consolidated Financial Statements for further information on these contracts.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
Note 16-Fair Value Measurement
The Company utilizes the market approach to measure fair value for financial assets and liabilities, which primarily relate to derivative contracts. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The Company classifies its financial instruments in a fair value hierarchy that is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy consists of the following three levels:
Level 1 -
Inputs are quoted prices in active markets for identical assets or liabilities.
Level 2 -
Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable and market-corroborated inputs which are derived principally from or corroborated by observable market data.
Level 3 -
Inputs are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable.
Valuation Techniques
The fair value of foreign currency exchange contracts was determined as the net unrealized gains or losses on those contracts, which is the net difference between (i) the U.S. dollars to be received or paid at the contracts’ settlement date and (ii) the U.S. dollar value of the foreign currency to be sold or purchased at the current forward exchange rate. The fair value of these foreign exchange contracts is based on quoted prices that include the effects of U.S. and foreign interest rate yield curves and, therefore, meets the definition of level 2 fair value, as defined above.
The fair value of goodwill and intangible assets was determined based on the Company’s best estimates of future cash flows (see Note 1 to Consolidated Financial Statements - Long-lived Assets and Goodwill and Other Intangible Assets).
The following table represents the Company’s assets and liabilities measured at fair value on a recurring basis as of January 1, 2011 and January 2, 2010:
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
The following table represents the Company’s assets and liabilities measured at fair value on a non-recurring basis as of January 1, 2011 and January 2, 2010 (see Note 1 of Notes to Consolidated Financial Statements - Long-lived Assets for a description of the testing of retail store assets for impairment):
Note 17-Financial Instruments
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments.
Accounts Receivable: The carrying amount of the Company’s accounts receivable approximates fair value.
Accounts Payable: The carrying amount of the Company’s accounts payable is approximately equal to their fair value because accounts payable are short-term in nature and the carrying value is equal to the settlement value.
Short-term Debt: The carrying amount of the 2008 Credit Agreements, CKJEA Notes and other short term debt is approximately equal to their fair value because of their short-term nature and because amounts outstanding bear interest at variable rates which fluctuate with market rates.
Senior Notes: The Senior Notes (as defined above) were scheduled to mature on June 15, 2013 and bore interest at 87/8% payable semi-annually beginning December 15, 2003. However, at January 1, 2011, all of the Senior Notes had been redeemed from bondholders. At January 2, 2010, the fair value of the total amount of the Senior Notes was based on the redemption price of the portion of the Senior Notes that was redeemed on January 5, 2010, including the related debt premium on the Swap Agreements (see Note 12 of Notes to Consolidated Financial Statements).
Foreign Currency Exchange Forward Contracts: The fair value of the outstanding foreign currency exchange forward contracts is based upon the cost to terminate the contracts.
The carrying amounts and fair value of the Company’s financial instruments are as follows:
Derivative Financial Instruments
The Company is exposed to foreign exchange risk related to U.S. dollar-denominated purchases of inventory, payment of minimum royalty and advertising costs and intercompany loans and payables by subsidiaries whose functional currencies are the Euro, Canadian Dollar, Korean Won, Mexican Peso or British Pound. The Company or its foreign subsidiaries enter into foreign exchange forward contracts, including zero-cost collar option contracts, to offset certain of its foreign exchange risk. The Company does not use derivative financial instruments for speculative or trading purposes.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
A number of international financial institutions are counterparties to the Company’s outstanding foreign exchange forward contracts. The Company monitors its positions with, and the credit quality of, these counterparty financial institutions and does not anticipate nonperformance by these counterparties. Management believes that the Company would not suffer a material loss in the event of nonperformance by these counterparties.
During Fiscal 2010, the Company’s Mexican subsidiary entered into foreign exchange forward contracts which were designed to satisfy receipt of the first 50% of U.S. dollar denominated inventory over an 18-month period. In addition, during Fiscal 2010 and Fiscal 2009, the Company’s Korean, European and Canadian subsidiaries continued their hedging programs, which included foreign exchange forward contracts which were designed to satisfy the first 50% of U.S. dollar denominated purchases of inventory over an 18-month period or payment of 100% of the minimum royalty and advertising expenses. All of the foregoing forward contracts were designated as cash flow hedges, with gains and losses accumulated on the Balance Sheet in Other Comprehensive Income and recognized in Cost of Goods Sold in the Statement of Operations during the periods in which the underlying transactions occur.
During Fiscal 2010 and Fiscal, 2009, the Company also continued hedging programs, which were accounted for as economic hedges, with gains and losses recorded directly in Other loss (income) or SG&A expense in the Statements of Operations in the period in which they are incurred. Those hedging programs included foreign currency exchange contracts, including, zero-cost collars, that were designed to fix the number of Euros, Korean won, Canadian dollars or Mexican pesos required to satisfy either (i) the first 50% of U.S. dollar denominated purchases of inventory over an 18-month period; (ii) 50% of intercompany purchases by a British subsidiary or (iii) U.S. dollar denominated intercompany loans and payables.
The following table summarizes the Company’s derivative instruments as of January 1, 2011 and January 2, 2010:
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
The following table summarizes the effect of the Company’s derivative instruments on the Statement of Operations for Fiscal 2010, Fiscal 2009 and Fiscal 2008:
(d)
Forward contracts used to offset 50% of U.S. dollar-denominated purchases of inventory by the Company’s foreign subsidiaries whose functional currencies were the Canadian dollar and Mexican peso, entered into by Warnaco Inc. on behalf of foreign subsidiaries.
(e)
Forward contracts used to offset 50% of Euro-denominated intercompany purchases by a subsidiary whose functional currency is the British pound.
(f)
Forward contracts used to offset payment of minimum royalty and advertising costs related to sales of inventory by the Company’s foreign subsidiary whose functional currency was the Euro, entered into by Warnaco Inc. on behalf of a foreign subsidiary.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
A reconciliation of the balance of Accumulated Other Comprehensive Income during Fiscal 2010, Fiscal 2009 and Fiscal 2008 related to cash flow hedges of foreign exchange forward contracts is as follows:
During the twelve months following January 1, 2011, the net amount of losses that were reported in Other Comprehensive Income at that date that are estimated to be amortized into earnings is $2,260. During Fiscal 2010, the Company expected that all originally forecasted purchases of inventory or payment of minimum royalties, which were covered by cash flow hedges, would occur by the end of the respective originally specified time periods. Therefore, no amount of gains or losses was reclassified into earnings during Fiscal 2010 as a result of the discontinuance of those cash flow hedges.
Note 18-Cash Flow Information
The following table sets forth supplemental cash flow information for Fiscal 2010, Fiscal 2009, and Fiscal 2008:
Note 19-Legal Matters
SEC Inquiry: As disclosed in its Annual Report on Form 10-K for Fiscal 2009, the SEC issued a formal order of investigation in September 2007 in connection with the matters associated with the Company’s restatement of its previously reported financial statements for the fourth quarter of 2005, fiscal 2005 and the first quarter of 2006. On September 20, 2010, the Company received notice that the SEC had completed its investigation and did not intend to recommend any enforcement action against the Company.
OP Litigation: On August 19, 2004, the Company acquired 100% of the outstanding common stock of Ocean Pacific Apparel Corp. (“OP”) from Doyle & Bossiere Fund I, LLC (“Doyle”) and certain minority shareholders of OP. The terms of the acquisition agreement required the Company to make certain contingent payments to the sellers of OP under certain circumstances. On November 6, 2006, the Company sold the OP business to a third party. On May 23, 2007, Doyle filed a demand against the Company for arbitration before Judicial Arbitration and Mediation Services (“JAMS”) in Orange County, California, alleging that certain contingent purchase price payments are due to them as a result of the Company’s sale of the OP business in November 2006. On February 7, 2011, the Company and Doyle entered into a settlement agreement and mutual release to the entire action described above. As a result, the entire action was dismissed by JAMS, with prejudice.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
Lejaby Claims: As of January 1, 2011, the Company had receivables (comprised of a loan receivable and a receivable for working capital, recorded in Other Assets on the Company’s Consolidated Balance Sheets) totaling $16,863 from Palmers Textil AG (“Palmers”) related to the Company’s sale of its Lejaby business to Palmers on March 10, 2008. On August 18, 2009, Palmers filed an action against the Company in Le Tribunal de Commerce de Paris (The Paris Commercial Court), alleging that the Company made certain misrepresentations in the sale agreement, and seeking to declare the sale null and void, monetary damages in an unspecified amount and other relief (the “Palmers Suit”). In addition, the Company and Palmers have been unable to agree on certain post-closing adjustments to the purchase price, including adjustments for working capital. The dispute regarding the amount of post-closing adjustments is not a subject of the Palmers Suit. The Company believes that its receivables from Palmers are valid and collectible and that the Palmers’ lawsuit is without merit. The Company is defending itself vigorously in this matter.
Other: In addition, from time to time, the Company is involved in arbitrations or legal proceedings that arise in the ordinary course of its business. The Company cannot predict the timing or outcome of these claims and proceedings. Currently, the Company is not involved in any such arbitration and/or legal proceeding that it expects to have a material effect on its financial condition, results of operations or business.
Note 20 - Quarterly Results of Operations (Unaudited)
The following tables contain selected financial data for each quarter of Fiscal 2010 and Fiscal 2009. Certain amounts have been adjusted from those originally reported in Form 10Q for the respective periods in Fiscal 2009 to give effect to the Company’s discontinued operations. The Company believes that the following information reflects all normal recurring adjustments necessary for a fair presentation of the information for each quarter of Fiscal 2010 and Fiscal 2009. The operating results for any period are not necessarily indicative of results for any future periods.
THE WARNACO GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Currencies in thousands, excluding share and per share amounts)
SCHEDULE II
VALUATION & QUALIFYING ACCOUNTS & RESERVES
THE WARNACO GROUP, INC.
VALUATION & QUALIFYING ACCOUNTS & RESERVES
(Dollars in thousands)
(1)
With respect to receivable allowances, includes bad debts, cash discounts, customer allowances and sales returns.
(2)
Credits issued and amounts written-off, net of recoveries.
(3)
Relates primarily to adjustments to the Company’s valuation allowance resulting from changes in its deferred taxes due to:
(a) basis differences resulting from the filing of the Company’s U.S. corporate income tax return, (b) finalized assessments of the Company’s foreign tax returns by local taxing authorities, (c) the realization of certain deferred tax assets that existed as of the date of the Company’s emergence from bankruptcy and (d) currency translation adjustments.
(4)
Amounts include reserve balances for discontinued operations.
A-1