þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the Quarterly Period Ended July 1, 2006
or
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

Delaware		13-2622036
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
650 Madison Avenue, New York, New York		10022 (Zip Code)
(Address of principal executive offices)

Large accelerated filer þ	Accelerated filer o	Non-accelerated filer o

				Page
PART I. FINANCIAL INFORMATION (Unaudited)
Item 1.		Financial Statements:
		Consolidated Balance Sheets			3
		Consolidated Statements of Operations			4
		Consolidated Statements of Cash Flows			5
		Notes to Consolidated Financial Statements			6
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			24
Item 3.		Quantitative and Qualitative Disclosures about Market Risk			34
Item 4.		Controls and Procedures			34
PART II. OTHER INFORMATION
Item 1.		Legal Proceedings			35
Item 1A.		Risk Factors			36
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			36
Item 5.		Other Information			36
Item 6.		Exhibits			37
Signatures					38
EX-10.1: CLIFF RESTRICTED PERFORMANCE SHARE UNIT AWARD OVERVIEW
EX-10.2: STOCK OPTION AWARD OVERVIEW
EX-10.3: PRO-RATA RESTRICTED PERFORMANCE SHARE UNIT AWARD OVERVIEW
EX-10.4: AMENDMENT TO 1997 LONG-TERM STOCK INCENTIVE PLAN
EX-31.1: CERTIFICATION
EX-31.2: CERTIFICATION
EX-32.1: CERTIFICATION
EX-32.2: CERTIFICATION

2

 

CONSOLIDATED BALANCE SHEETS

		July 1,				April 1,
		2006				2006
		(millions)
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	429.2			$	285.7
Accounts receivable, net of allowances of $103.6 and $115.0 million			349.7				484.2
Inventories			525.6				485.5
Deferred tax assets			33.6				32.4
Prepaid expenses and other			102.3				90.7
Total current assets			1,440.4				1,378.5
Property and equipment, net			541.6				548.8
Deferred tax assets			9.9				—
Goodwill			705.4				699.7
Intangible assets, net			253.1				258.5
Other assets			234.2				203.2
Total assets		$	3,184.6			$	3,088.7
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	203.6			$	202.2
Income tax payable			86.0				46.6
Accrued expenses and other			308.2				314.3
Current maturities of debt			291.0				280.4
Total current liabilities			888.8				843.5
Deferred tax liabilities			20.5				20.8
Other non-current liabilities			183.5				174.8
Commitments and contingencies (Note 11)
Total liabilities			1,092.8				1,039.1
Stockholders’ equity:
Class A common stock, par value $.01 per share; 66.8 and 66.4 million shares issued; 61.3 and 62.1 million shares outstanding			0.7				0.7
Class B common stock, par value $.01 per share; 43.3 million shares issued and outstanding			0.4				0.4
Additional paid-in-capital			760.4				783.6
Retained earnings			1,454.2				1,379.2
Treasury stock, Class A, at cost (5.5 and 4.3 million shares)			(156.1	)			(87.1	)
Accumulated other comprehensive income			32.2				15.5
Unearned compensation			—				(42.7	)
Total stockholders’ equity			2,091.8				2,049.6
Total liabilities and stockholders’ equity		$	3,184.6			$	3,088.7

3

 

CONSOLIDATED STATEMENTS OF OPERATIONS

		Three Months Ended
		July 1,				July 2,
		2006				2005
		(millions, except per share data)
		(unaudited)
Net sales		$	903.3			$	694.6
Licensing revenue			50.3				57.3
Net revenues			953.6				751.9
Cost of goods sold(a)			(422.1	)			(337.5	)
Gross profit			531.5				414.4
Other costs and expenses:
Selling, general and administrative expenses(a)			(390.3	)			(333.2	)
Amortization of intangible assets			(5.6	)			(1.0	)
Restructuring charges			(2.2	)			—
Total other costs and expenses			(398.1	)			(334.2	)
Operating income			133.4				80.2
Foreign currency gains (losses)			(1.1	)			—
Interest expense			(4.4	)			(2.5	)
Interest income			3.8				2.9
Equity in income of equity-method investees			0.8				1.8
Minority interest expense			(4.0	)			(1.4	)
Income before provision for income taxes			128.5				81.0
Provision for income taxes			(48.3	)			(30.3	)
Net income		$	80.2			$	50.7
Net income per common share:
Basic		$	0.76			$	0.49
Diluted		$	0.74			$	0.48
Weighted average common shares outstanding:
Basic			105.1				103.0
Diluted			108.1				105.5
Dividends declared per share		$	0.05			$	0.05
(a) Includes total depreciation expense of:		$	(32.2	)		$	(27.7	)

4

		Three Months Ended
		July 1,				July 2,
		2006				2005
		(millions)
		(unaudited)
Cash flows from operating activities:
Net income		$	80.2			$	50.7
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization expense			37.8				28.7
Deferred income tax expense (benefit)			(2.7	)			(7.0	)
Minority interest expense			4.0				1.4
Equity in the income of equity-method investees, net of dividends received			0.3				(1.8	)
Non-cash stock compensation expense			7.5				4.9
Non-cash provision for bad debt expense			0.8				0.2
Loss on disposal of property and equipment			2.2				0.2
Non-cash foreign currency losses (gains)			(0.9	)			(1.3	)
Non-cash restructuring charges			2.1				—
Changes in operating assets and liabilities:
Accounts receivable			141.6				175.0
Inventories			(34.8	)			(47.2	)
Accounts payable and accrued liabilities			37.4				(20.5	)
Other balance sheet changes			(43.7	)			7.4
Net cash provided by operating activities			231.8				190.7
Cash flows from investing activities:
Acquisitions, net of cash acquired and purchase price settlements			2.1				—
Capital expenditures			(34.5	)			(32.6	)
Net cash used in investing activities			(32.4	)			(32.6	)
Cash flows from financing activities:
Payments of capital lease obligations			(1.2	)			(0.7	)
Payments of dividends			(5.3	)			(5.2	)
Repurchases of common stock			(67.6	)			(1.6	)
Proceeds from exercise of stock options			8.3				25.6
Excess tax benefits from stock-based compensation arrangements			3.7				—
Net cash (used in) provided by financing activities			(62.1	)			18.1
Effect of exchange rate changes on cash and cash equivalents			6.2				(4.4	)
Net increase (decrease) in cash and cash equivalents			143.5				171.8
Cash and cash equivalents at beginning of period			285.7				350.5
Cash and cash equivalents at end of period		$	429.2			$	522.3

5

POLO RALPH LAUREN CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In millions, except per share data and where otherwise indicated)

(Unaudited)

 

 

Polo Ralph Lauren Corporation (“PRLC”) is a global leader in the design, marketing and distribution of premium lifestyle products. PRLC’s long-standing reputation and distinctive image have been consistently developed across an expanding number of products, brands and international markets. PRLC’s brand names include Polo, Polo by Ralph Lauren, Ralph Lauren Purple Label, Ralph Lauren Black Label, RLX, Ralph Lauren, Blue Label, Lauren, RL, Rugby, Chaps and Club Monaco, among others. PRLC and its subsidiaries are collectively referred to herein as the “Company,” “we,” “us,” “our” and “ourselves,” unless the context indicates otherwise.

 

The Company classifies its interests into three business segments: Wholesale, Retail and Licensing. Through those interests, the Company designs, licenses, contracts for the manufacture of, markets and distributes men’s, women’s and children’s apparel, accessories, fragrances and home furnishings. The Company’s wholesale sales are made principally to major department and specialty stores located throughout the United States and Europe. The Company also sells directly to consumers through full-price and factory retail stores located throughout the United States, Canada, Europe, South America and Asia, and through its jointly owned retail internet site located at www.polo.com. In addition, the Company often licenses the right to third parties to use its various trademarks in connection with the manufacture and sale of designated products, such as apparel, eyewear and fragrances, in specified geographical areas for specified periods.

 

 

Basis of Consolidation

 

The accompanying consolidated financial statements present the financial position, results of operations and cash flows of the Company and all entities in which the Company has a controlling voting interest. The consolidated financial statements also include the accounts of any variable interest entities in which the Company is considered to be the primary beneficiary and such entities are required to be consolidated in accordance with accounting principles generally accepted in the United States (“US GAAP”). In particular, pursuant to the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 46R (“FIN 46R”), the Company consolidates (a) Polo Ralph Lauren Japan Corporation (“PRL Japan”, formerly known as New Polo Japan, Inc.), a 50%-owned venture with Onward Kashiyama Co. Ltd (45%) and The Seibu Department Stores, Ltd (5%), and (b) Ralph Lauren Media, LLC (“RL Media”), a 50%-owned venture with NBC Universal, Inc. and an affiliated company (collectively, “NBC”). RL Media conducts the Company’s e-commerce initiatives through a jointly owned internet site known as Polo.com.

 

All significant intercompany balances and transactions have been eliminated in consolidation.

 

Fiscal Year

 

The Company’s fiscal year ends on the Saturday closest to March 31. As such, all references to “Fiscal 2007” represent the 52-week fiscal year ending March 31, 2007 and references to “Fiscal 2006” represent the 52-week fiscal year ending April 1, 2006.

 

The financial position and operating results of the Company’s consolidated 50% interest in PRL Japan are reported on a one-month lag. Similarly, prior to the fourth quarter of Fiscal 2006, the financial position and operating results of RL Media were reported on a three-month lag. During the fourth quarter of Fiscal 2006, RL Media changed its fiscal year, which was formerly on a calendar-year basis, to conform with the Company’s fiscal-year basis. In connection with this change, the three-month reporting lag for RL Media was eliminated. Accordingly, the Company’s operating results for the first quarter of Fiscal 2007 include the operating results of RL Media for the three-month period ended July 1, 2006, whereas the first quarter of Fiscal 2006 include the

 

POLO RALPH LAUREN CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

operating results of RL Media for the three-month period ended March 31, 2005. The net effect from this change in RL Media’s fiscal year was not material.

 

Interim Financial Statements

 

The accompanying consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). The accompanying consolidated financial statements are unaudited. But, in the opinion of management, such consolidated financial statements contain all normal and recurring adjustments necessary to present fairly the consolidated financial condition, results of operations and changes in cash flows of the Company for the interim periods presented. In addition, certain information and footnote disclosures normally included in financial statements prepared in accordance with US GAAP have been condensed or omitted from this report as is permitted by the SEC’s rules and regulations. However, the Company believes that the disclosures herein are adequate to make the information presented not misleading.

 

The consolidated balance sheet data as of April 1, 2006 is derived from the audited financial statements included in the Company’s Annual Report on Form 10-K filed with the SEC for the year ended April 1, 2006 (the “Fiscal 2006 10-K”), which should be read in conjunction with these financial statements. Reference is made to the Fiscal 2006 10-K for a complete set of financial statements.

 

Use of Estimates

 

The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and footnotes thereto. Actual results could differ materially from those estimates.

 

Significant estimates inherent in the preparation of the accompanying consolidated financial statements include reserves for customer returns, discounts, end-of-season markdown allowances and operational chargebacks; reserves for the realizability of inventory; reserves for litigation matters; impairments of long-lived tangible and intangible assets; depreciation and amortization expense; accounting for income taxes; the valuation of stock-based compensation and related forfeiture rates; and accounting for business combinations under the purchase method of accounting.

 

Seasonality of Business

 

The Company’s business is affected by seasonal trends, with higher levels of wholesale sales in its second and fourth quarters and higher retail sales in its second and third quarters. These trends result primarily from the timing of seasonal wholesale shipments and key vacation travel and holiday periods in the retail segment. Accordingly, the Company’s operating results and cash flows for the three-month period ended July 1, 2006 are not necessarily indicative of the results that may be expected for Fiscal 2007 as a whole.

 

Reclassifications

 

Certain reclassifications have been made to the prior period’s financial information in order to conform to the current period’s presentation.

 

 

Revenue Recognition

 

Revenue within the Company’s wholesale segment is recognized at the time title passes and risk of loss is transferred to customers. Wholesale revenue is recorded net of estimates of returns, discounts, end-of-season markdown allowances and operational chargebacks. Returns and allowances require pre-approval from management and discounts are based on trade terms. Estimates for end-of-season markdown allowances are based on

 

POLO RALPH LAUREN CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

historical trends, seasonal results, an evaluation of current economic and market conditions, and retailer performance. The Company reviews and refines these estimates on a quarterly basis. The Company’s historical estimates of these costs have not differed materially from actual results.

 

Retail store revenue is recognized net of estimated returns at the time of sale to consumers. E-commerce revenue from sales of products ordered through the Company’s jointly owned retail internet site known as Polo.com is recognized upon delivery and receipt of the shipment by its customers. Such revenue also is reduced by an estimate of returns.

 

Licensing revenue is initially recognized based upon the higher of (a) contractually guaranteed minimum royalty levels and (b) estimates of actual sales and royalty data received from the Company’s licensees.

 

Accounts Receivable

 

In the normal course of business, the Company extends credit to customers that satisfy defined credit criteria. Accounts receivable, net, as shown in the Company’s consolidated balance sheet, is net of certain reserves and allowances. These reserves and allowances consist of (a) reserves for returns, discounts, end-of-season markdown allowances and operational chargebacks and (b) allowances for doubtful accounts. These reserves and allowances are discussed in further detail below.

 

A reserve for trade discounts is determined based on open invoices where trade discounts have been extended to customers, and is treated as a reduction of revenue.

 

Estimated end-of-season markdown allowances are included as a reduction of revenue. These provisions are based on retail sales performance, seasonal negotiations with customers, historical deduction trends and an evaluation of current market conditions.

 

A reserve for operational chargebacks represents various deductions by customers relating to individual shipments. This reserve, net of expected recoveries, is included as a reduction of revenue. The reserve is based on chargebacks received as of the date of the financial statements and past experience. Costs associated with potential returns of products also are included as a reduction of revenues. These return reserves are based on current information regarding retail performance, historical experience and an evaluation of current market conditions. The Company’s historical estimates of these operational chargeback and return costs have not differed materially from actual results.

 

A rollforward of the activity for the three months ended July 1, 2006 and July 2, 2005, respectively, in the Company’s reserves for returns, discounts, end-of-season markdown allowances and operational chargebacks is presented below:

 

 

An allowance for doubtful accounts is determined through analysis of periodic aging of accounts receivable, assessments of collectibility based on an evaluation of historic and anticipated trends, the financial condition of the Company’s customers, and an evaluation of the impact of economic conditions. A rollforward of the activity for the

		Three Months Ended
		July 1,				July 2,
		2006				2005
		(millions)
Beginning reserve balance		$	7.5			$	11.0
Amount charged to expense to increase reserve			0.8				0.2
Amount written off against customer accounts to decrease reserve			(0.3	)			(1.2	)
Foreign currency translation			0.3				(0.4	)
Ending reserve balance		$	8.3			$	9.6

		Three Months Ended
		July 1,				July 2,
		2006				2005
		(millions)
Basic			105.1				103.0
Dilutive effect of stock options, restricted stock and restricted stock units			3.0				2.5
Diluted shares			108.1				105.5

4.	Recently Issued Accounting Standards

9

 

POLO RALPH LAUREN CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Employees,” (“APB 25”), which permitted the use of the intrinsic-value method in accounting for stock-based compensation, and Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” as amended by Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (“FAS 123”), which allowed companies applying APB 25 to just disclose in their financial statements the pro forma effect on net income from applying the fair-value method of accounting for stock-based compensation. The Company adopted FAS 123R as of April 2, 2006 (see Note 10).

 

Other Recently Issued Accounting Standards

 

In July 2006, the FASB issued Financial Accounting Standards Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The evaluation of a tax position in accordance with FIN 48 is a two-step process. The Company first will be required to determine whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. A tax position that meets the “more-likely-than-not” recognition threshold will then be measured to determine the amount of benefit to recognize in the financial statements based upon the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company currently is evaluating the effect of FIN 48 on its financial statements.

 

In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections” (“FAS 154”). FAS 154 generally requires that accounting changes and errors be applied retrospectively. Effective April 2, 2006, the Company adopted the provisions of FAS 154. The application of FAS 154 did not have an effect on the Company’s financial statements.

 

In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151, “Inventory Costs” (“FAS 151”). FAS 151 clarifies standards for the treatment of abnormal amounts of idle facility expense, freight, handling costs and spoilage. Effective April 2, 2006, the Company adopted the provisions of FAS 151. The application of FAS 151 did not have a material effect on the Company’s financial statements.

 

 

Acquisition of Polo Jeans Business

 

On February 3, 2006, the Company acquired from Jones Apparel Group, Inc. and subsidiaries (“Jones”) all of the issued and outstanding shares of capital stock of Sun Apparel, Inc., the Company’s licensee for men’s and women’s casual apparel and sportswear in the United States and Canada (the “Polo Jeans Business”). The acquisition cost was approximately $260 million, including $5 million of transaction costs. In addition, simultaneous with the transaction, the Company settled all claims under its litigation with Jones for a cost of $100 million.

 

The results of operations for the Polo Jeans Business have been consolidated in the Company’s results of operations commencing February 4, 2006. In addition, the purchase price has been allocated on a preliminary basis as follows: inventory of $36 million; finite-lived intangible assets of $159 million (consisting of the re-acquired license of $97 million, customer relationships of $57 million and order backlog of $5 million); goodwill of $127 million; and deferred tax and other liabilities, net, of $62 million. Other than inventory, Jones retained the right to all working capital balances on the date of closing.

 

The Company is in the process of completing its assessment of the fair value of assets acquired and liabilities assumed. As a result, the purchase price allocation is subject to change. Also, the Company has entered into a transition services agreement with Jones to provide a variety of operational, financial and information systems services over a period of six to twelve months from the date of the acquisition of the Polo Jeans Business.

 

POLO RALPH LAUREN CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Acquisition of Footwear Business

 

On July 15, 2005, the Company acquired from Reebok International, Ltd. (“Reebok”) all of the issued and outstanding shares of capital stock of Ralph Lauren Footwear Co., Inc., the Company’s global licensee for men’s, women’s and children’s footwear, as well as certain foreign assets owned by affiliates of Reebok (collectively, the “Footwear Business”). The acquisition cost was approximately $112 million in cash, including $2 million of transaction costs. In addition, Reebok and certain of its affiliates entered into a transition services agreement with the Company to provide a variety of operational, financial and information systems services over a period of twelve to eighteen months from the date of the acquisition of the Footwear Business.

 

The results of operations for the Footwear Business for the period are included in the consolidated results of operations commencing July 16, 2005. In addition, the accompanying consolidated financial statements include the following allocation of the acquisition cost to the net assets acquired based on their respective fair values: trade receivables of $17 million; inventory of $26 million; finite-lived intangible assets of $62 million (consisting of the footwear license at $38 million, customer relationships at $23 million and order backlog at $1 million); goodwill of $20 million; other assets of $1 million; and liabilities of $14 million.

 

 

Inventories consist of the following:

 

 

 

The Company has recorded restructuring liabilities over the past few years relating to various cost-savings initiatives, as well as certain of its acquisitions. In accordance with US GAAP, restructuring costs incurred in connection with an acquisition are capitalized as part of the purchase accounting for the transaction. Such acquisition-related restructuring costs were not material in any period. However, all costs for non-acquisition-related restructuring initiatives are required to be expensed either in the period they were incurred or committed to, in accordance with US GAAP. A description of the nature of significant non-acquisition-related restructuring activities and related costs is presented below.

 

Fiscal 2006 Restructuring

 

During the fourth quarter of Fiscal 2006, the Company committed to a plan to restructure the Company’s Club Monaco retail business. In particular, this plan consisted of the closure of all five Club Monaco factory outlet stores and the intention to dispose of by sale or closure all eight of Club Monaco’s Caban Concept Stores (the “Caban Stores” and, collectively, the “Club Monaco Restructuring Plan”). In connection with this plan, an aggregate restructuring-related charge of $12 million was recognized in Fiscal 2006.

 

During the first quarter of Fiscal 2007, the Company ultimately decided to close all Caban Stores and recognized an additional $2.2 million of restructuring charges, primarily relating to lease termination costs. During the second quarter of Fiscal 2007, the Company expects to incur additional restructuring charges of approximately $1 million relating to additional lease termination costs for space that was still being used at the end of the first quarter of Fiscal 2007.

		Lease and
		Contract
		Termination
		Costs
		(millions)
Balance at April 1, 2006		$	1.2
Additions charged to expense			2.2
Cash payments charged against reserve			(0.8	)
Balance at July 1, 2006		$	2.6

8.	Derivative Financial Instruments

12

13

9.	Stockholders’ Equity

		Three Months Ended
		July 1,				July 2,
		2006				2005
		(millions)
Balance at beginning of period		$	2,049.6			$	1,675.7
Comprehensive income:
Net income			80.2				50.7
Foreign currency translation gains (losses)			25.3				(33.7	)
Net realized and unrealized derivative financial instrument gains (losses)			(8.6	)			23.1
Total comprehensive income			96.9				40.1
Dividends declared			(5.2	)			(5.2	)
Repurchases of common stock			(67.6	)			(1.6	)
Other, primarily shares issued and equity grants made pursuant to stock compensation plans			18.1				34.1
Balance at end of period		$	2,091.8			$	1,743.1

10.	Stock-Based Compensation

14

		Three Months Ended
		July 1,				July 2,
		2006				2005(a)
		(millions)
Compensation expense		$	(7.5	)		$	(4.9	)
Income tax benefit		$	2.9			$	1.9

		Three Months Ended
		July 1, 2006
		(millions, except
		per share data)
Income before provision for income taxes		$	(2.6	)
Income tax benefit			1.0
Net income		$	(1.6	)
Basic net income per common share		$	(0.02	)
Diluted net income per common share		$	(0.01	)
Cash flows from operating activities(b)		$	(3.7	)
Cash flows from financing activities		$	3.7
Unearned compensation(c)		$	43.0
Additional paid-in capital		$	(43.0	)

(a)		Prior to the adoption of FAS 123R and in accordance with existing accounting principles, the Company recognized stock-based compensation expense in connection with both service-based and performance-based restricted stock units, as well as for shares of restricted stock.
(b)		Prior to the adoption of FAS 123R, benefits of tax deductions in excess of recognized compensation costs were reported as operating cash flows. FAS 123R requires excess tax benefits to be reported as a financing cash inflow rather than a reduction of taxes paid.
(c)		Unearned compensation was eliminated against additional paid-in capital as part of the adoption of FAS 123R.

15

		Three Months Ended
		July 2, 2005
		(millions, except
		per share amounts)
Net income as reported		$	50.7
Add: stock-based employee compensation expense included in reported net income, net of tax			3.0
Deduct: total stock-based employee compensation expense determined under fair value based method for all awards, net of tax			(6.7	)
Pro forma net income		$	47.0
Net income per share as reported —
Basic		$	0.49
Diluted		$	0.48
Pro forma net income per share —
Basic		$	0.46
Diluted		$	0.45

16

 

POLO RALPH LAUREN CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Risk-free Interest Rate — The risk-free interest rate is determined using the implied yield for a traded zero-coupon U.S. Treasury bond with a term equal to the option’s expected term.

 

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:

 

 

A summary of the stock option activity under all plans during the three months ended July 1, 2006 is as follows:

 

 

The aggregate intrinsic value of stock options exercised during the three months ended July 1, 2006 and July 2, 2005 was $10.3 million and $6.4 million, respectively. As of July 1, 2006, there was $19.4 million of total unrecognized compensation expense related to nonvested stock options granted and the unrecognized compensation expense is expected to be recognized over a weighted-average period of 1.6 years. Cash received from the exercise of stock options during the three months ended July 1, 2006 and July 2, 2005 was $8.3 million and $25.6 million, respectively, and the related tax benefits realized were $3.7 million and $6.5 million, respectively.

 

Restricted Stock and Restricted Stock Units (“RSUs”)

 

The Company grants a combination of (a) restricted shares of Class A common stock, (b) service-based restricted stock units and (c) performance-based restricted stock units to its key executives, certain of its employees and non-employee directors.

 

Restricted shares of Class A common stock, which entitle the holder to receive a specified number of shares of Class A common stock at the end of a vesting period, are accounted for at fair value at the date of grant. Generally, restricted stock grants vest over a five-year period of time, subject to the executive’s continuing employment.

 

Restricted stock units entitle the grantee to receive shares of Class A common stock at the end of a vesting period. Service-based restricted stock units are payable in shares of Class A common stock and generally vest over a five-year period of time, subject to the executive’s continuing employment. Performance-based restricted stock units also are payable in shares of Class A common stock and may vest over (1) a three-year period of time (cliff vesting), subject to the employee’s continuing employment and the Company’s satisfaction of certain performance goals over the three-year period; or (2) ratably over a three-year period of time (graded vesting), subject to the

 

POLO RALPH LAUREN CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

employee’s continuing employment during the applicable vesting period and the achievement by the Company of separate annual performance goals. In addition, holders of certain restricted stock units are entitled to receive dividend equivalents in the form of additional restricted stock units in connection with the payment of dividends on the Company’s Class A common stock. Restricted stock units, including shares resulting from dividend equivalents paid on such units, are accounted for at fair value at the date of grant. The fair value of a restricted security is based on the fair value of unrestricted Class A common stock, as adjusted to reflect the absence of dividends for those restricted securities that are not entitled to dividend equivalents. Compensation expense for performance-based restricted stock units is recognized over the service period when attainment of the performance goals is probable.

 

A summary of the restricted stock and restricted stock unit activity during the three months ended July 1, 2006 is as follows:

 

 

 

There were no restricted stock awards granted during the three months ended July 2, 2005. No restricted stock awards vested during the three months ended July 1, 2006. The total fair value of restricted stock awards vested during the three months ended July 2, 2005 was $1.1 million. The weighted-average grant date fair value of service-based restricted stock units granted during the three months ended July 2, 2005 was $43.20. No service-based restricted stock units vested during the three months ended July 1, 2006 or July 2, 2005. The weighted-average grant date fair value of performance-based restricted stock units granted during the three months ended July 2, 2005 was $43.09. The total fair value of performance-based restricted stock units vested during the three months ended July 1, 2006 and July 2, 2005 was $3.4 million and $2.7 million, respectively.

 

 

Credit Card Matters

 

We are indirectly subject to various claims relating to allegations of a security breach in 2004 of our retail point of sale system, including fraudulent credit card charges, the cost of replacing cards and related monitoring expenses and other related claims. These claims have been made by various banks in respect of credit cards issued by them pursuant to the rules of Visa^® and MasterCard^® credit card associations. We recorded an initial charge of $6.2 million to establish a reserve for this matter in the fourth quarter of Fiscal 2005, representing management’s best estimate at the time of the probable loss incurred. In September 2005 we were notified by our agent bank that the aggregate amount of claims had increased to $12 million, with an estimated $1 million of additional claims yet to be asserted. Accordingly, we recorded an additional $6.8 million charge during the second quarter of Fiscal 2006 to increase our reserve against this revised estimate of total exposure.

 

POLO RALPH LAUREN CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The ultimate outcome of this matter could differ materially from the amounts recorded and could be material to the results of operations for any affected period. However, management does not expect that the ultimate resolution of this matter will have a material adverse effect on the Company’s liquidity or financial position.

 

Wathne Imports Litigation

 

On August 19, 2005, Wathne Imports, Ltd., our domestic licensee for luggage and handbags (“Wathne”), filed a complaint in the U.S. District Court in the Southern District of New York against us and Ralph Lauren, our Chairman and Chief Executive Officer, asserting, among other things, Federal trademark law violations, breach of contract, breach of obligations of good faith and fair dealing, fraud and negligent misrepresentation. The complaint sought, among other relief, injunctive relief, compensatory damages in excess of $250 million and punitive damages of not less than $750 million. On September 13, 2005, Wathne withdrew this complaint from the U.S. District Court and filed a complaint in the Supreme Court of the State of New York, New York County, making substantially the same allegations and claims (excluding the Federal trademark claims), and seeking similar relief. On February 1, 2006, the court granted our motion to dismiss all of the causes of action, including the cause of action against Mr. Lauren, except for the breach of contract claims, and denied Wathne’s motion for a preliminary injunction against our production and sale of men’s and women’s handbags. On May 16, 2006, a discovery schedule was established for this case running through November 2006. Depositions are expected to commence in this case in September 2006. We believe this suit to be without merit and intend to continue to contest it vigorously. Accordingly, management does not expect that the ultimate resolution of this matter will have a material adverse effect on the Company’s liquidity or financial position.

 

Polo Trademark Litigation

 

On October 1, 1999, we filed a lawsuit against the United States Polo Association Inc. (“USPA”), Jordache, Ltd. and certain other entities affiliated with them, alleging that the defendants were infringing on our trademarks. In connection with this lawsuit, on July 19, 2001, the USPA and Jordache filed a lawsuit against us in the United States District Court for the Southern District of New York. This suit, which was effectively a counterclaim by them in connection with the original trademark action, asserted claims related to our actions in connection with our pursuit of claims against the USPA and Jordache for trademark infringement and other unlawful conduct. Their claims stemmed from our contacts with the United States Polo Association’s and Jordache’s retailers in which we informed these retailers of our position in the original trademark action. All claims and counterclaims, except for our claims that the defendants violated the Company’s trademark rights, were settled in September 2003. We did not pay any damages in this settlement. On July 30, 2004, the Court denied all motions for summary judgement, and trial began on October 3, 2005 with respect to the four “double horseman” symbols that the defendants sought to use. On October 20, 2005, the jury rendered a verdict, finding that one of the defendant’s marks violated our world famous Polo Player Symbol trademark and enjoining its further use, but allowing the defendants to use the remaining three marks. On November 16, 2005, we filed a motion before the trial court to overturn the jury’s decision and hold a new trial with respect to the three marks that the jury found not to be infringing. The USPA and Jordache opposed our motion, but did not move to overturn the jury’s decision that the fourth double horseman logo did infringe on our trademarks. On July 7, 2006, the judge denied our motion to overturn the jury’s decision. We have filed a Notice of Appeal with the court to preserve our option to appeal this decision to the United States Court of Appeals for the Second Circuit and are considering our future course of action at this time.

 

California Labor Law Litigation

 

On September 18, 2002, an employee at one of our stores filed a lawsuit against the Company and our Polo Retail, LLC subsidiary in the United States District Court for the District of Northern California alleging violations of California antitrust and labor laws. The plaintiff purported to represent a class of employees who had allegedly been injured by a requirement that certain retail employees purchase and wear Company apparel as a condition of their employment. The complaint, as amended, sought an unspecified amount of actual and punitive damages,

 

POLO RALPH LAUREN CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

disgorgement of profits and injunctive and declaratory relief. The Company answered the amended complaint on November 4, 2002. A hearing on cross motions for summary judgment on the issue of whether the Company’s policies violated California law took place on August 14, 2003. The Court granted partial summary judgment with respect to certain of the plaintiff’s claims, but concluded that more discovery was necessary before it could decide the key issue as to whether the Company had maintained for a period of time a dress code policy that violated California law. On January 12, 2006, a proposed settlement of the purported class action was submitted to the court for approval. A hearing on the settlement was held before the Court on June 29, 2006, and the Court is currently reviewing the terms of the settlement. The proposed settlement cost of $1.5 million does not exceed the reserve for this matter that we established in Fiscal 2005. The proposed settlement would also result in the dismissal of the similar purported class action filed in San Francisco Superior Court as described below.

 

On April 14, 2003, a second putative class action was filed in the San Francisco Superior Court. This suit, brought by the same attorneys, alleges near identical claims to these in the Federal class action. The class representatives consist of former employees and the plaintiff in the federal court action. Defendants in this class action include us and our Polo Retail, LLC, Fashions Outlet of America, Inc., Polo Retail, Inc. and San Francisco Polo, Ltd. subsidiaries as well as a non-affiliated corporate defendant and two current managers. As in the federal action, the complaint seeks an unspecified amount of actual and punitive restitution of monies spent, and declaratory relief. If the judge in the federal class action accepts the proposed $1.5 million settlement, the state court class action would subsequently be dismissed.

 

On March 2, 2006, a former employee at our Club Monaco store in Los Angeles, California filed a lawsuit against us in the San Francisco Superior Court alleging violations of California wage and hour laws. The plaintiff purports to represent a class of Club Monaco store employees who allegedly have been injured by being improperly classified as exempt employees and thereby not receiving compensation for overtime and not receiving meal and rest breaks. The complaint seeks an unspecified amount of compensatory damages, disgorgement of profits, attorneys’ fees and injunctive relief. We believe this suit is without merit and intend to contest it vigorously. Accordingly, management does not expect that the ultimate resolution of this matter will have a material adverse effect on the Company’s liquidity or financial position.

 

On June 2, 2006, a second putative class action was filed by different attorneys by a former employee of our Club Monaco store in Cabazon, California against us in the Los Angeles Superior Court alleging virtually identical claims as the San Francisco action and consisting of the same class members. As in the San Francisco action, the complaint seeks an unspecified amount of compensatory damages, disgorgement of profits, attorneys’ fees and injunctive relief. We believe this suit is without merit and intend to contest it vigorously. Accordingly, management does not expect that the ultimate resolution of this matter will have a material adverse effect on the Company’s liquidity or financial position.

 

On May 30, 2006, four former employees of our Ralph Lauren stores in Palo Alto and San Francisco, California filed a lawsuit in San Francisco Superior Court alleging violations of California wage and hour laws. The plaintiffs purport to represent a class of employees who allegedly have been injured by not properly being paid commission earnings, not being paid overtime, not receiving rest breaks, being forced to work off of the clock while waiting to enter or leave the store and being falsely imprisoned while waiting to leave the store. The complaint seeks an unspecified amount of compensatory damages, damages for emotional distress, disgorgement of profits, punitive damages, attorneys’ fees and injunctive and declaratory relief. We believe this suit is without merit and intend to contest it vigorously. Accordingly, management does not expect that the ultimate resolution of this matter will have a material adverse effect on the Company’s liquidity or financial position.

 

Other Matters

 

We are otherwise involved from time to time in legal claims involving trademark and intellectual property, licensing, employee relations and other matters incidental to our business. We believe that the resolution of these

 

POLO RALPH LAUREN CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

other matters currently pending will not individually or in the aggregate have a material adverse effect on our financial condition or results of operations.

 

 

The Company has three reportable segments: Wholesale, Retail and Licensing. Such segments offer a variety of products through different channels of distribution. Our Wholesale segment consists of women’s, men’s and children’s apparel, accessories and related products which are sold to major department stores, specialty stores and our owned and licensed retail stores in the United States and overseas. Our Retail segment consists of the Company’s worldwide retail operations, which sell our products through our full price and factory outlet stores, as well as Polo.com, our 50%-owned e-commerce website. The stores and the website sell products purchased from our licensees, our suppliers and our Wholesale segment. Our Licensing segment generates revenues from royalties earned on the sale of our apparel, home and other products internationally and domestically through our licensing alliances. The licensing agreements grant the licensees rights to use our various trademarks in connection with the manufacture and sale of designated products in specified geographical areas for specified periods.

 

The accounting policies of our segments are consistent with those described in Notes 2 and 3 to the Company’s consolidated financial statements included in the Fiscal 2006 10-K. Sales and transfers between segments are recorded at cost and treated as transfers of inventory. All intercompany revenues are eliminated in consolidation and are not reviewed when evaluating segment performance. Each segment’s performance is evaluated based upon operating income before restructuring charges and one-time items, such as legal charges. Corporate overhead expenses (exclusive of expenses for senior management, overall branding-related expenses and certain other corporate-related expenses) are allocated to the segments based upon specific usage or other allocation methods.

		Three Months Ended
		July 1,				July 2,
		2006				2005
		(millions)
Net revenues:
Wholesale		$	491.2			$	337.2
Retail			412.1				357.4
Licensing			50.3				57.3
		$	953.6			$	751.9
Operating income:
Wholesale		$	90.3			$	46.3
Retail			64.6				35.6
Licensing			26.4				35.2
			181.3				117.1
Less:
Unallocated corporate expenses			(45.7	)			(36.9	)
Unallocated restructuring charges(a)			(2.2	)			—
		$	133.4			$	80.2

(a)		Consists of restructuring charges relating entirely to the Retail segment.

		Three Months Ended
		July 1,				July 2,
		2006				2005
		(millions)
Depreciation and amortization:
Wholesale		$	13.2			$	8.2
Retail			15.4				12.4
Licensing			1.2				1.4
Unallocated corporate expenses			8.0				6.7
		$	37.8			$	28.7

22

13.	Additional Financial Information

		Three Months Ended
		July 1,				July 2,
		2006				2005
		(millions)
Cash paid for interest		$	0.8			$	4.1
Cash paid for income taxes		$	6.5			$	41.7

23

 

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.

	•	our anticipated growth strategies;
	•	our plans to expand internationally;
	•	our plans to open new retail stores;
	•	our ability to make strategic acquisitions of certain selected licensees;
	•	our intention to introduce new products or enter into new licensing alliances;
	•	anticipated effective tax rates in future years;
	•	future expenditures for capital projects;
	•	our ability to continue to maintain our brand image and reputation;
	•	our ability to continue to initiate cost cutting efforts and improve profitability;
	•	our efforts to improve the efficiency of our distribution system; and
	•	our ability to refinance our Euro debt on favorable terms by November 2006.

24

provide an understanding of our financial condition, changes in financial condition and results of our operations. MD&A is organized as follows:

 

 

OVERVIEW

 

Our Company is a global leader in the design, marketing and distribution of premium lifestyle products. Our long-standing reputation and distinctive image have been consistently developed across an expanding number of products, brands and international markets. Our brand names include Polo, Polo by Ralph Lauren, Ralph Lauren Purple Label, Ralph Lauren Black Label, RLX, Ralph Lauren, Blue Label, Lauren, RL, Rugby, Chaps, and Club Monaco, among others.

 

We classify our interests into three business segments: Wholesale, Retail and Licensing. Through those interests, we design, license, contract for the manufacture of, market and distribute men’s, women’s and children’s apparel, accessories, fragrances and home furnishings. Our wholesale business consists of wholesale-channel sales made principally to major department and specialty stores located throughout the United States and Europe. Our retail business consists of retail-channel sales directly to consumers through full-price and factory retail stores located throughout the United States, Canada, Europe, South America and Asia, and through our jointly owned retail internet site located at www.polo.com. In addition, our licensing business consists of royalty-based arrangements under which we license the right to third parties to use our various trademarks in connection with the manufacture and sale of designated products, such as apparel, eyewear and fragrances, in specified geographical areas for specified periods.

 

Our business is affected by seasonal trends, with higher levels of wholesale sales in our second and fourth quarters and higher retail sales in our second and third quarters. These trends result primarily from the timing of seasonal wholesale shipments and key vacation travel and holiday periods in the retail segment. Accordingly, our operating results and cash flows for the three-month period ended July 1, 2006 are not necessarily indicative of the results and cash flows that may be expected for Fiscal 2007 as a whole.

 

During the three-month period ended July 1, 2006, we reported revenues of $953.6 million, net income of $80.2 million and net income per diluted share of $0.74. This compares to revenues of $751.9 million, net income of $50.7 million and net income per diluted share of $0.48 during the three-month period ended July 2, 2005. Operating results for the first quarter of Fiscal 2007 reflect a change in accounting for stock-based compensation relating to the Company’s adoption of Statement of Financial Accounting Standards No. 123R, “Share-Based Payments,” (“FAS 123R”). Total stock-based compensation costs were $7.5 million on a pre-tax basis ($4.6 million

		Three Months								Three Months
		Ended								Ended
		July 1,				July 2,				July 1,				July 2,
		2006				2005				2006				2005
		(millions)
Net revenues		$	953.6			$	751.9				100.0	%			100.0	%
Cost of goods sold(a)			(422.1	)			(337.5	)			(44.3	)			(44.9	)
Gross profit			531.5				414.4				55.7				55.1
Selling, general and administrative expenses(a)			(390.3	)			(333.2	)			(40.9	)			(44.3	)
Amortization of intangible assets			(5.6	)			(1.0	)			(0.6	)			(0.1	)
Restructuring charges			(2.2	)			—				(0.2	)			—
Operating income			133.4				80.2				14.0				10.7
Foreign currency gains (losses)			(1.1	)			—				(0.1	)			—
Interest expense			(4.4	)			(2.5	)			(0.5	)			(0.3	)
Interest income			3.8				2.9				0.4				0.4
Equity in income of equity-method investees			0.8				1.8				0.1				0.2
Minority interest expense			(4.0	)			(1.4	)			(0.4	)			(0.2	)
Income before provision for income taxes			128.5				81.0				13.5				10.8
Provision for income taxes			(48.3	)			(30.3	)			(5.1	)			(4.1	)
Net income		$	80.2			$	50.7				8.4	%			6.7	%
Net income per share — Basic		$	0.76			$	0.49
Net income per share — Diluted		$	0.74			$	0.48

(a)		Includes depreciation expense of $32.2 million and $27.7 million for the three-month periods ended July 1, 2006 and July 2, 2005, respectively.

26

		Three Months Ended
		July 1,				July 2,				Increase/
		2006				2005				(Decrease)				% Change
						(millions)
Net revenues:
Wholesale		$	491.2			$	337.2			$	154.0				45.7	%
Retail			412.1				357.4				54.7				15.3
Licensing			50.3				57.3				(7.0	)			(12.2	)
		$	953.6			$	751.9			$	201.7				26.8	%

	•	the inclusion of $67 million of revenue from the newly acquired Polo Jeans and Footwear Businesses;
	•	an $87 million aggregate increase in our global menswear, womenswear and domestic childrenswear businesses, primarily driven by strong growth in our Lauren product line, and the effects from the successful domestic launch of our Chaps for women and boys product lines; and
	•	a $1 million decrease in revenues due to an unfavorable foreign currency effect, primarily relating to the strengthening of the U.S. dollar in comparison to the Euro in Fiscal 2007.

	•	an aggregate $23 million increase in comparable full-price and outlet store sales. This increase was driven by a 5.0% increase in comparable full-price store sales and an 8.4% increase in comparable outlet store sales, partially relating to higher seasonal sales associated with the Easter holiday that fell in the first quarter of Fiscal 2007. Excluding an unfavorable $2 million effect on revenues from foreign currency exchange rates, comparable full-price store sales increased 5.9% and comparable outlet store sales increased 9.0%.
	•	a net increase in store count of 13 stores compared to the prior period, to a total of 295 stores, as several new openings were offset by the closure of certain Club Monaco stores in the fourth quarter of Fiscal 2006; and
	•	an $11 million increase in sales at Polo.com.

	•	the loss of licensing revenues from our Polo Jeans Business and Footwear Business now included as part of the Wholesale segment; and
	•	a decline in Home licensing royalties as a result of lower sales and minimum royalty payments from licensees.

27

	•	higher payroll-related expenses (excluding stock-based compensation) of approximately $24 million principally relating to increased selling costs associated with higher retail sales and our worldwide retail store expansion, and higher investment in infrastructure to support the ongoing growth of our businesses;
	•	the inclusion of SG&A costs for our newly acquired Footwear and Polo Jeans Businesses;
	•	higher brand-related marketing and facilities costs to support the ongoing growth of our businesses;
	•	higher depreciation costs of approximately $5 million in connection with our capital expenditures and global expansion; and
	•	incremental stock-based compensation expense of approximately $3 million as a result of the adoption of FAS 123R as of April 2, 2006 (refer to Note 10 to the unaudited consolidated financial statements contained elsewhere herein).

28

		Three Months Ended
		July 1,				July 2,				Increase/
		2006				2005				(Decrease)				% Change
						(millions)
Operating income:
Wholesale		$	90.3			$	46.3			$	44.0				95.0	%
Retail			64.6				35.6				29.0				81.5
Licensing			26.4				35.2				(8.8	)			(25.0	)
			181.3				117.1				64.2				54.8
Less:
Unallocated corporate expenses			(45.7	)			(36.9	)			(8.8	)			(23.8	)
Unallocated restructuring charges			(2.2	)			—				(2.2	)			NM
		$	133.4			$	80.2			$	53.2				66.3	%

29

30

pursuant to the Company’s common stock repurchase program at a cost of $67.6 million. The receipt of $8.3 million from the exercise of stock options, as compared to $25.6 million for the three months ended July 2, 2005 also contributed to the decrease. The change in the reporting of excess tax benefits from stock-based compensation arrangements discussed above partially offset the decrease by approximately $4 million.

 

Liquidity

 

The Company’s primary sources of liquidity are the cash flow generated from its operations, which includes the approximate $200 million to be received in January 2007 under a new eyewear licensing agreement with Luxottica Group, S.p.A. and affiliates, $450 million of availability under its credit facility, available cash and equivalents and other potential sources of financial capacity relating to its under-leveraged capital structure. These sources of liquidity are needed to fund the Company’s ongoing cash requirements, including working capital requirements, retail store expansion, construction and renovation of shop-within-shops, investment in technological infrastructure, acquisitions, dividends, debt repayment, stock repurchases and other corporate activities. Management believes that the Company’s existing resources of cash will be sufficient to support its operating and capital requirements for the foreseeable future.

 

As discussed below under the section entitled “Debt and Covenant Compliance,” the Company had no borrowings under its credit facility as of July 1, 2006. However, in the event of a material acquisition, settlement of a material contingency or a material adverse business development, the Company may need to draw on its credit facility or other potential sources of financing. Also, as discussed below, the Company currently intends to seek to refinance its Euro debt obligations that mature in November 2006 during Fiscal 2007, subject to prevailing market conditions and its ability to refinance such debt obligations on acceptable terms.

 

Common Stock Repurchase Program

 

The Company currently has a common stock repurchase program that allows it to repurchase, from time to time, an aggregate of up to $100 million of Class A common stock. Share repurchases are subject to overall business and market conditions. During the fiscal quarter ended July 1, 2006, approximately 1.2 million shares of Class A common stock were repurchased at a cost of $67.6 million, As of July 1, 2006, the remaining availability under the program was $32.4 million.

 

Dividends

 

The Company intends to continue to pay regular quarterly dividends on its outstanding common stock. However, any decision to declare and pay dividends in the future will be made at the discretion of the Company’s Board of Directors and will depend on, among other things, the Company’s results of operations, cash requirements, financial condition and other factors that the Board of Directors may deem relevant.

 

We declared a quarterly dividend of $0.05 per outstanding share in the first quarter of both Fiscal 2007 and Fiscal 2006. The aggregate amount of dividend payments was $5.3 million in the three-month period ended July 1, 2006, compared to $5.2 million in the three-month period ended July 2, 2005.

 

Debt and Covenant Compliance

 

Euro Debt

 

The Company has outstanding approximately €227 million principal amount of 6.125% notes that are due in November 2006 (the “Euro Debt”). The carrying value of the Euro Debt changes as a result of changes in Euro exchange rates and changes in its fair value associated with an interest-rate swap agreement that had been used until its termination in March 2006 as an effective hedge against changes in the fair value of the Euro Debt.

 

As of July 1, 2006, the carrying value of the Euro Debt was $291.0 million, compared to $280.4 million at April 1, 2006. The Company has the option to redeem the Euro Debt at any time prior to its scheduled maturity. The Company currently intends to seek to refinance the Euro Debt during Fiscal 2007, subject to prevailing market conditions and its ability to refinance such debt obligations on acceptable terms. In June 2006, the Company entered

into two forward-starting interest rate swap contracts aggregating €175 million notional amount of indebtedness in anticipation of the Company’s proposed refinancing. See “Market Risk Management.”

 

Revolving Credit Facility

 

The Company has a credit facility (the “Credit Facility”) that currently provides for a $450 million revolving line of credit, which can be increased to up to $525 million if one or more new or existing lenders under the facility agree to increase their commitments. The credit facility also is used to support the issuance of letters of credit. As of July 1, 2006, there were no borrowings outstanding under the Credit Facility, but the Company was contingently liable for $66.5 million of outstanding letters of credit (primarily relating to inventory purchase commitments). Subsequent to the end of the first quarter of Fiscal 2007, Standard & Poor’s raised its credit rating on the Company and its unsecured borrowings from BBB to BBB+ (the “S&P credit rating adjustment”). This had the effect of lowering certain fees and borrowing costs described below.

 

The Credit Facility expires on October 6, 2009. There are no mandatory reductions in borrowing availability throughout its term.

 

Borrowings under the Credit Facility bear interest, at the Company’s option, either (a) a base rate determined by reference to the higher of (i) the prime commercial lending rate of JPMorgan Chase Bank in effect from time to time and (ii) the weighted-average overnight Federal funds rate (as published by the Federal Reserve Bank of New York) plus 50 basis points or (b) a LIBOR rate in effect from time to time, as adjusted for the Federal Reserve Board’s Euro currency liabilities maximum reserve percentage plus a margin defined in the Credit Facility (“the applicable margin”). The applicable margin was 62.5 basis points as of July 1, 2006 and is subject to adjustment based on the Company’s credit ratings at the time of any borrowings. The applicable margin was reduced to 50 basis points as a result of the S&P credit rating adjustment.

 

In addition to paying interest on any outstanding borrowings under the Credit Facility, the Company is required to pay a commitment fee to the lenders under the Credit Facility in respect of the unutilized commitments. The commitment fee rate was 15 basis points as of July 1, 2006, and is subject to adjustment based on the Company’s credit ratings. The commitment fee rate was reduced to 10 basis points as a result of the S&P credit rating adjustment.

 

The Credit Facility contains a number of covenants that, among other things, restrict the Company’s ability, subject to specified exemptions, to incur additional debt; incur liens and contingent liabilities; sell or dispose of assets, including equity interests; merge with or acquire other companies; liquidate or dissolve itself; engage in businesses that are not in a related line of business; make loans, advances or guarantees; engage in transactions with affiliates; and make investments. In addition, the Credit Facility requires the Company to maintain certain financial covenants, consisting of (i) a minimum ratio of Earnings Before Interest, Taxes, Depreciation, Amortization, Rent and certain non-recurring non-cash expenses (such as impairment of assets) (“EBITDAR”) to the sum of Consolidated Interest Expense and Consolidated Lease Expense and (ii) a maximum ratio of Adjusted Debt to EBITDAR, as such terms are defined in the Credit Facility. As of July 1, 2006, the Company was in compliance with all covenants under the Credit Facility.

 

Upon the occurrence of an event of default under the Credit Facility, the lenders may cease making loans, terminate the Credit Facility, and declare all amounts outstanding to be immediately due and payable. The Credit Facility specifies a number of events of default (many of which are subject to applicable grace periods), including, among others, the failure to make timely principal and interest payments or to satisfy the covenants, including the financial covenants described above. Additionally, the Credit Facility provides that an event of default will occur if Mr. Ralph Lauren, the Company’s Chairman and Chief Executive Officer, and related entities fail to maintain a specified minimum percentage of the voting power of the Company’s common stock.

 

MARKET RISK MANAGEMENT

 

As discussed in Note 14 to our audited consolidated financial statements included in our Annual Report on Form 10-K for Fiscal 2006 and Note 8 to the accompanying unaudited consolidated financial statements contained elsewhere herein, we are exposed to market risk arising from changes in market rates and prices, particularly

movements in foreign currency exchange rates and interest rates. We manage these exposures through operating and financing activities and, when appropriate, through the use of derivative financial instruments, consisting of interest rate swap agreements and foreign exchange forward contracts.

 

In June 2006, the Company entered into two forward-starting interest rate swap contracts aggregating €175 million notional amount of indebtedness in anticipation of the Company’s planned refinancing of its Euro Debt. The Company designated these agreements as a cash flow hedge of a forecasted transaction to issue new debt in connection with the planned refinancing of its Euro Debt. The interest rate swaps hedged a total of €175.0 million, a portion of the underlying interest rate exposure on the anticipated refinancing. Under the terms of the two interest swap contracts, the Company pays a weighted-average fixed rate of interest of 4.1% and receives the variable interest based upon six-month EURIBOR. The interest rate swaps mature in November 2013; however, the Company intends to terminate the swaps upon the completion of its anticipated Euro Debt refinancing.

 

The €175.0 million interest rate swaps are reflected at a fair value of $1.9 million in the consolidated balance sheet as an asset at July 1, 2006. As a cash flow hedge, the related gains or losses from the swaps are deferred as a component of comprehensive income within stockholders’ equity. The deferred gain on the €175.0 million of interest rate swaps as of July 1, 2006 is expected to be recognized in income as an adjustment to interest expense over the life of the debt to be issued in connection with the planned refinancing. There was no assumed hedge ineffectiveness as the interest rate swap terms matched the terms of the hedged anticipated debt to be issued.

 

As of July 1, 2006, other than the aforementioned forward-starting interest rate swap contracts, there have been no other significant changes in our interest rate and foreign currency exposures, changes in the types of derivative instruments used to hedge those exposures, or significant changes in underlying market conditions since the end of Fiscal 2006.

 

CRITICAL ACCOUNTING POLICIES

 

Our significant accounting policies are described in Notes 3 and 4 to our audited consolidated financial statements included in our Annual Report on Form 10-K for Fiscal 2006. The SEC’s Financial Reporting Release No. 60, “Cautionary Advice Regarding Disclosure About Critical Accounting Policies” (“FRR 60”), suggests companies provide additional disclosure and commentary on those accounting policies considered most critical. FRR 60 considers an accounting policy to be critical if it is important to the Company’s financial condition and results and requires significant judgment and estimates on the part of management in its application. For a complete discussion of the Company’s critical accounting policies, see page 43 in the Company’s Annual Report on Form 10-K for Fiscal 2006. The following discussion only is intended to update the Company’s critical accounting policies for any changes in policy implemented during Fiscal 2007.

 

Effective April 2, 2006, the Company adopted Statement of Financial Accounting Standards No. FAS 123R, “Share-Based Payments,” (“FAS 123R”), using the modified prospective application transition method. Under this transition method, the compensation expense recognized in the consolidated statement of operations beginning April 2, 2006 includes compensation expense for (a) all stock-based payments granted prior to, but not yet vested as of April 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” as amended by Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (“FAS 123”), and (b) all stock-based payments granted subsequent to April 1, 2006 based on the grant-date fair value estimated in accordance with the provisions of FAS 123R.

 

Prior to April 2, 2006, the Company accounted for stock-based compensation plans under the intrinsic value method in accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB 25”), and adopted the disclosure-only provisions of FAS 123. Under this standard, the Company did not recognize compensation expense for the issuance of stock options with an exercise price equal to or greater than the market price at the date of grant. However, as required, the Company disclosed, in the notes to the consolidated financial statements, the pro forma expense impact of the stock option grants as if the fair-value-based recognition provisions of FAS 123 were applied. Compensation expense was previously recognized for restricted stock and restricted stock units. The effect of forfeitures on restricted stock and restricted stock units was recognized when such forfeitures occurred.

 

Item 3.	Quantitative and Qualitative Disclosures About Market Risk.

 

Item 4.	Controls and Procedures.

34

 

PART II. OTHER INFORMATION

 

Item 1.	Legal Proceedings.

35

 

Item 1A.	Risk Factors.

 

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.

										Total Number of				Maximum Number
										Shares Purchased				(or Approximate Dollar Value)
										as Part of Publicly				of Shares That May Yet be
		Total Number of				Average Price				Announced Plans				Purchased Under the Plans
		Shares Purchased(1)				Paid per Share				or Programs				or Programs (in millions)
April 2, 2006 to April 29, 2006			71,300			$	59.05				71,300			$	95.8
April 30, 2006 to May 27, 2006			228,700				58.46				228,700				82.4
May 28, 2006 to July 1, 2006			910,595	(2)			56.43				884,800				32.4
			1,210,595								1,184,800

(1)		Except as noted below, these purchases were made on the open market under the Company’s current Class A Common Stock repurchase program, which was first publicly announced on February 2, 2005. This program provides for the repurchase, from time to time, of up to an aggregate of $100 million of Class A Common Stock, and does not have a fixed termination date
(2)		Includes 25,795 shares surrendered to, or withheld by, the Company in satisfaction of withholding taxes in connection with the vesting of an award under the Company’s 1997 Long-Term Stock Incentive Plan.

 

Item 5.	Other Information.

36

 

Item 6.	Exhibits.

10.1		Cliff Restricted Performance Share Unit Award Overview containing the standard terms of restricted performance share awards under the Stock Incentive Plan.
10.2		Stock Option Award Overview — U.S. containing the standard terms of stock option awards under the Stock Incentive Plan.
10.3		Pro-Rata Restricted Performance Share Unit Award Overview containing the standard terms of restricted performance share awards under the Stock Incentive Plan.
10.4		Amendment as of June 30, 2006, to the Company’s 1997 Long-Term Stock Incentive Plan, as Amended and Restated as of August 12, 2006.
31.1		Certification of Ralph Lauren, Chairman and Chief Executive Officer, pursuant to 17 CFR 240.13a-14(a).
31.2		Certification of Tracey T. Travis, Senior Vice President and Chief Financial Officer, pursuant to 17 CFR 24013a-14(a).
32.1		Certification of Ralph Lauren, Chairman and Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification of Tracey T. Travis, Senior Vice President and Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

	By:	/s/  TRACEY T. TRAVIS

38

 

1

2

3

		1 If at least a Threshold level of performance is achieved.

4