Luxottica Group, S.p.A. 20-F 2007
Documents found in this filing:
file number 1-10421
Securities registered or to be registered pursuant to Section 12(b) of the Act.
* Not for trading, but only in connection with the registration of American Depositary Shares, pursuant to the requirements of the New York Stock Exchange
Securities registered or to be registered pursuant to Section 12(g) of the Act.
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.
Indicate the number of outstanding shares of each of the issuers classes of capital or common stock as of the close of the period covered by the annual report.
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
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If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
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Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.
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If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).
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Throughout this annual report, management has made certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 which are considered prospective. These statements are made based on managements current expectations and beliefs and are identified by the use of forward-looking words and phrases such as plans, estimates, believes or belief, expects or other similar words or phrases.
Such statements involve risks, uncertainties and other factors that could cause actual results to differ materially from those which are anticipated. Such risks and uncertainties include, but are not limited to, the risk that the merger with Oakley will not be completed, the ability to successfully introduce and market new products, the ability to maintain an efficient distribution network, the ability to predict future economic conditions and changes in consumer preferences, the ability to achieve and manage growth, the ability to negotiate and maintain favorable license arrangements, the availability of correction alternatives to prescription eyeglasses, fluctuations in exchange rates, the ability to effectively integrate recently acquired businesses, as well as other political, economic and technological factors and other risks and uncertainties described in our filings with the U.S. Securities and Exchange Commission (the SEC). These forward-looking statements are made as of the date hereof, and we do not assume any obligation to update them.
Throughout this annual report, when we use the terms Luxottica, Company, we, us and our, unless otherwise indicated or the context otherwise requires, we are referring to Luxottica Group S.p.A. and its consolidated subsidiaries.
Our house brands and designer line prescription frames and sunglasses that are referred to in this annual report, and certain of our other products, are sold under names that are subject to registered trademarks held by us or, in certain instances, our licensors. These trademarks may not be used by any person without our prior written consent or the consent of our licensors, as applicable.
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
ITEM 3. KEY INFORMATION
The following tables set forth selected consolidated financial data for the periods indicated and are qualified by reference to, and should be read in conjunction with, our consolidated financial statements, the related notes thereto, and Item 5Operating and Financial Review and Prospects contained elsewhere herein. We prepare our financial statements in accordance with accounting principles generally accepted in the United States of America, or U.S. GAAP. The selected consolidated income statement data for the years ended December 31, 2004, 2005 and 2006, and the selected consolidated balance sheet data as of December 31, 2005 and 2006, are derived from the audited Consolidated Financial Statements included in Item 18. The selected consolidated income statement data for the years ended December 31, 2002 and 2003, and the selected consolidated balance sheet data as of December 31, 2002, 2003 and 2004, are derived from audited consolidated financial statements which are not included in this Form 20-F.
[TABLES APPEAR ON THE FOLLOWING PAGE]
(1) Translated for convenience at the rate of Euro 1.00 = U.S.$1.3197, based on the Noon Buying Rate of Euro to U.S. dollar on December 31, 2006. See Exchange Rate Information below for more information regarding the Noon Buying Rate.
(2) Earnings per Share for each year have been calculated based on the weighted-average number of shares outstanding during the respective years. Each American Depositary Share, or ADS, represents one ordinary share.
(3) Except per Share amounts, which are in Euro and U.S. dollars, as applicable.
(4) Cash Dividends Declared per Share are expressed in gross amounts without giving effect to applicable withholding or other deductions for taxes.
(5) Our dividend policy is based upon, among other things, our consolidated net income for each fiscal year, and dividends for a fiscal year are paid in the immediately following fiscal year. The dividends reported in the table were declared and paid in the fiscal year for which they have been reported.
(6) We acquired 82.57 percent of the outstanding shares of OPSM Group Limited (OPSM) in August 2003. As such, the results for 2003 include approximately five months of operating results of OPSM and its subsidiaries. In March 2005, we acquired the remaining 17.43 percent of the outstanding shares of OPSM and, from that date, 100 percent of the operating results of OPSM and its subsidiaries are included above.
(7) We acquired all of the outstanding shares of Cole National Corporation (Cole) in October 2004. Therefore, 2004 includes approximately three months of operating results of Cole.
(8) Certain amounts in prior years have been reclassified to conform to the 2006 presentation. The 2006 presentation includes the reclassification of the operations of the Things Remembered, Inc. (Things Remembered) specialty gift business, which was acquired as part of the Cole acquisition in 2004 and was sold to a private equity consortium in September 2006. The TR operations have been reclassified as discontinued operations for all periods presented.
(1) Translated for convenience at the rate of Euro 1.00 = U.S.$1.3197, based on the Noon Buying Rate of Euro to U.S. dollar on December 31, 2006. See Exchange Rate Information below for more information regarding the Noon Buying Rate.
(2) Working capital is total current assets minus total current liabilities. See Item 5Operating and Financial Review and ProspectsLiquidity and Capital Resources.
(3) Certain amounts in prior years have been reclassified to conform to the 2006 presentation. The 2006 presentation includes the reclassification of the operations of the Things Remembered specialty gift business which was acquired as part of the Cole acquisition in 2004 and was sold to a private equity consortium in September 2006. The Things Remembered assets and liabilities have been reclassified as assets and liabilities held for sale for all periods presented.
(4) The current portion of long-term debt was Euro 178.3 million, Euro 390.9 million, Euro 405.1 million, Euro 111.0 million and Euro 359.5 million for the years ended December 31, 2002, 2003, 2004, 2005 and 2006, respectively.
We are required to pay an annual dividend on our ordinary shares if such dividend has been approved by a majority of our shareholders at the annual ordinary meeting of shareholders. Before we may pay any dividends with respect to a fiscal year, we are required to set aside an amount equal to five percent of our statutory net income for such year in our legal reserve until the reserve, including any amounts set aside during prior years, is at least equal to one-fifth of the nominal value of our issued share capital.
At our annual ordinary meeting of shareholders held on May 15, 2007, our shareholders approved the distribution of a cash dividend in the amount of Euro 0.42 per ordinary share. Our Board of Directors proposed, and the shareholders approved, the date of May 24, 2007 as the date for the payment of such dividend to all holders of record of our ordinary shares on May 18, 2007, including Deutsche Bank Trust Company Americas, as depositary on behalf of holders of our American Depositary Shares, or ADSs. Each ADS represents the right to receive one ordinary share and is evidenced by an American Depositary Receipt, or ADR. The ADSs were traded ex-dividend on May 21, 2007, and dividends in respect of the ordinary shares represented by ADSs were paid to Deutsche Bank Trust Company Americas on May 24, 2007. Deutsche Bank Trust Company Americas converted the Euro amount of such dividend payment into U.S. dollars on May 24, 2007. The dividend amount for each ADS holder was paid commencing on June 1, 2007 to all such holders of record on May 23, 2007. Future determinations as to dividends will depend upon, among other things, our earnings, financial position and capital requirements, applicable legal restrictions and such other factors as the Board of Directors and our shareholders may determine.
The table below sets forth the cash dividends declared and paid on each ordinary share in each year indicated.
(1) Cash dividends per ordinary share are expressed in gross amounts without giving effect to applicable withholding or other deductions for taxes.
(2) Each ADS represents one ordinary share.
(3) Our dividend policy is based upon, among other things, our consolidated net income for each fiscal year, and dividends for a fiscal year are paid in the immediately following fiscal year. The dividends reported in the table were declared and paid in the fiscal year for which they have been reported.
(4) Translated at the Noon Buying Rate on the payment date to holders of ADSs. See Exchange Rate Information below for more information regarding the Noon Buying Rate. Holders of ADSs received their dividend denominated in U.S. dollars based on the conversion rate used by our paying agent, Deutsche Bank Trust Company Americas, on the ADS dividend payment date. Deutsche Bank Trust Company Americas converted the dividend in respect of the 2006 fiscal year to U.S.$0.564 per ADS on May 24, 2007.
(5) The dividend of Euro 0.42 per ordinary share was approved by our Board of Directors on March 5, 2007 and was voted upon and approved by our shareholders at the annual ordinary meeting of shareholders held on May 15, 2007.
Exchange Rate Information
The following tables set forth, for each of the periods indicated, certain information regarding the Noon Buying Rate in New York City for cable transfers in foreign currencies as certified for customs purposes by the Federal Reserve Bank of New York, which we refer to as the Noon Buying Rate, expressed in U.S.$ per Euro 1.00:
(1) The average of the Noon Buying Rates in effect on the last business day of each month during the period. When the Company consolidates its profit and loss statement, it translates U.S. dollar denominated amounts into Euro using an average U.S. dollar/Euro exchange rate of each business day during the applicable period.
On June 26, 2007, the Noon Buying Rate was U.S.$ 1.3468 per Euro 1.00.
Unless otherwise indicated, all convenience translations included in this annual report of amounts expressed in Euro into U.S. dollars for the relevant period or date have been made using the Noon Buying Rate in effect as of the end of such period or date, as appropriate.
In this annual report, unless otherwise stated or the context otherwise requires, references to $, U.S.$, dollars or U.S. dollars are to United States dollars, references to Euro and are to the Common European Currency, the Euro, references to Rs are to Indian rupees, and references to AUD or A$ are to Australian dollars.
Our future operating results and financial condition may be affected by various factors, including those set forth below.
If we are not successful in completing and integrating strategic acquisitions to expand or complement our business, our future profitability and growth will be at risk.
As part of our growth strategy, we have made, and may continue to make, strategic business acquisitions to expand or complement our business. For example, we announced on June 20, 2007 that we entered into a merger agreement for the acquisition of Oakley, Inc (Oakley). Our acquisition activities, however, can be disrupted by overtures from competitors for the targeted candidates, governmental regulation and rapid developments in our industry. We may face additional risks and uncertainties following an acquisition, including: (i) difficulty in integrating the newly-acquired business and operations in an efficient and effective manner; (ii) inability to achieve strategic objectives, cost savings and other benefits from the acquisition; (iii) the lack of success by the acquired business in its markets; (iv) the loss of key employees of the acquired business; (v) the diversion of the attention of senior management from our operations; and (vi) liabilities that were not known at the time of acquisition or the need to address tax or accounting issues. If we fail to timely recognize or address these matters or to devote adequate resources to them, we may fail to achieve our growth strategy or otherwise not realize the intended benefits of any acquisition.
If we are unable to successfully introduce new products, our future sales and operating performance will suffer.
The mid- and premium-price categories of the prescription frame and sunglasses markets in which we compete are particularly vulnerable to changes in fashion trends and consumer preferences. Our historical success is attributable, in part, to our introduction of innovative eyewear products which are perceived to represent an improvement over products otherwise available in the market. Our future success will depend on our continued ability to develop and introduce such innovative products. If we are unable to continue to do so, our future sales could decline, inventory levels could rise, leading to additional costs for storage and potential writedowns relating to the value of excess inventory, and production costs would be negatively impacted since fixed costs would represent a larger portion of total production costs due to the decline in quantities produced.
If we fail to maintain an efficient distribution network in our highly competitive markets, our business, results of operations and financial condition could suffer.
The mid- and premium-price categories of the prescription frame and sunglasses markets in which we operate are highly competitive. We believe that, in addition to successfully introducing new products, responding to changes in the market environment and maintaining superior production capabilities, our ability to remain competitive is highly dependent on our success in maintaining an efficient distribution network. If we are unable to maintain an efficient distribution network, our sales may decline due to the inability to timely deliver products to customers and our profitability may decline due to an increase in our per unit distribution costs in the affected regions, which may have an adverse impact on our business, results of operations and financial condition.
If we do not correctly predict future economic conditions and changes in consumer preferences, our sales of premium products and profitability will suffer.
The fashion eyewear industry is cyclical. Downturns in general economic conditions or uncertainties regarding future economic prospects, which affect consumer disposable income, have historically adversely affected consumer spending habits in our principal markets and thus made the growth in sales and profitability of premium-priced product categories difficult during such downturns. Therefore, future economic downturns or uncertainties could have a material adverse effect on our business, results of operations and financial condition, including sales of our designer and other premium brands.
The eyewear industry is also subject to rapidly changing consumer preferences and future sales may suffer if the fashion eyewear industry does not continue to grow or if consumer preferences shift away from our products. Changes in fashion could also affect the popularity and, therefore, the value of the fashion licenses granted to us by designers. Any event or circumstance resulting in reduced market acceptance of one or more of these designers could reduce our sales and the value of our inventory of models based on that design. Unanticipated shifts in consumer preferences may also result in excess
inventory and underutilized manufacturing capacity. In addition, our success depends, in large part, on our ability to anticipate and react to changing fashion trends in a timely manner. Any sustained failure to identify and respond to such trends would adversely affect our business, results of operations and financial condition and may result in the write down of excess inventory and idle manufacturing facilities.
If we are unable to achieve and manage growth, operating margins will be reduced as a result of decreased efficiency of distribution.
In order to achieve and manage our growth effectively, we are required to increase and streamline production and implement manufacturing efficiencies where possible, while maintaining strict quality control and the ability to deliver products to our customers in a timely and efficient manner. We must also continuously develop new product designs and features, expand our information systems and operations, and train and manage an increasing number of management level and other employees. If we are unable to manage these matters effectively, our efficient distribution process could be at risk and we could lose market share in affected regions.
If we do not continue to negotiate and maintain favorable license arrangements, our sales or cost of sales will suffer.
We have entered into license agreements that enable us to manufacture and distribute prescription frames and sunglasses under certain designer names, including Chanel, Prada, Miu Miu, Dolce & Gabbana, D&G, Versace, Versus, Bvlgari, Salvatore Ferragamo, Donna Karan, DKNY, Brooks Brothers, Anne Klein, Burberry, Polo Ralph Lauren and, most recently, Tiffany & Co. These license agreements typically have terms of between three and ten years and may contain options for renewal for additional periods and require us to make guaranteed and contingent royalty payments to the licensor. See Item 4Information on the CompanyBusiness OverviewRecent Developments regarding our new license agreement for the Tiffany & Co. name. We believe that our ability to maintain and negotiate favorable license agreements with leading designers in the fashion and luxury goods industries is essential to the branding of our products and, therefore, material to the success of our business. For the years ended December 31, 2006 and 2005, the sales realized through the Prada and Miu Miu trade names together represented approximately 5.5 percent and 4.4 percent of total sales, respectively. Accordingly, if we are unable to negotiate and maintain satisfactory license arrangements with leading designers, our growth prospects and financial results could suffer from a reduction in sales or an increase in advertising costs and royalty payments to designers.
If vision correction alternatives to prescription eyeglasses become more widely available, or consumer preferences for such alternatives increase, our business could be adversely affected.
Our business could be negatively impacted by the availability and acceptance of vision correction alternatives to prescription eyeglasses, such as contact lenses and refractive optical surgery. According to industry estimates, over 45 million people wear contact lenses in the United States, and disposable contact lenses is the fastest growing segment of the lens subsector. In addition, the use of refractive optical surgery has grown substantially since it was approved by the U.S. Food and Drug Administration in 1995.
Increased use of vision correction alternatives could result in decreased use of our prescription eyewear products, including a reduction of sales of lenses and accessories sold in our retail outlets, which would have a material adverse impact on our business, results of operations, financial condition and prospects.
If the Euro continues to strengthen relative to certain other currencies, our profitability as a consolidated group will suffer.
Our principal manufacturing facilities are located in Italy. We also maintain manufacturing facilities in China as well as sales and distribution facilities throughout the world. As a result, we are vulnerable to foreign exchange rate fluctuations in two principal areas:
we incur most of our manufacturing costs in Euro and receive a significant part of our revenues in other currencies, particularly the U.S. and Australian dollars. Therefore, a strengthening of the Euro relative to other currencies in which we receive revenues could negatively impact the demand for our products or decrease our profitability in consolidation, thus adversely affecting our business and results of operations; and
a substantial portion of our assets, liabilities, revenues and costs are denominated in various currencies other than Euro, with most of our operating expenses being denominated in U.S. dollars. As a result, our operating results, which are reported in Euro, are affected by currency exchange rate fluctuations, particularly between the U.S. dollar and the Euro.
As our international operations grow, future changes in the exchange rate of the Euro against the U.S. dollar and other currencies may negatively impact our reported results.
See Item 11Quantitative and Qualitative Disclosures about Market Risk.
If our international sales suffer due to changing local conditions, our profitability and future growth will be affected.
We currently operate worldwide and have begun to expand our operations in many countries, including certain developing countries in Asia. Therefore, we are subject to various risks inherent in conducting business internationally, including the following:
exposure to local economic and political conditions;
export and import restrictions;
currency exchange rate fluctuations and currency controls;
withholding and other taxes on remittances and other payments by subsidiaries;
investment restrictions or requirements; and
local content laws requiring that certain products contain a specified minimum percentage of domestically produced components.
The likelihood of such occurrences and their potential effect on us vary from country to country and are unpredictable, but any such occurrence may result in the loss of sales or increased costs of doing business and may have a significant effect on our business, results of operations, financial condition and prospects.
If we are unable to protect our proprietary rights, our sales might suffer, and we may incur significant costs to defend such rights.
We rely on trade secret, unfair competition, trade dress, trademark, patent and copyright laws to protect our rights to certain aspects of our products and services, including product designs, proprietary manufacturing processes and technologies, product research and concepts and recognized trademarks, all of which we believe are important to the success of our products and services and our competitive position. However, pending trademark applications may not generate registered trademarks, and any trademark registration that is granted may be ineffective in preventing competition and could be held invalid if subsequently challenged. In addition, the actions we take to protect our proprietary rights may be inadequate to prevent imitation of our products and services. Our proprietary information could become known to competitors, and we may not be able to meaningfully protect our rights to proprietary information. Furthermore, other companies may independently develop substantially equivalent or better products or services that do not infringe on our intellectual property rights or could assert rights in, and ownership of, our proprietary rights. Moreover, the laws of certain countries do not protect proprietary rights to the same extent as the laws of the United States.
We devote significant resources toward defending our proprietary rights. However, if the level of potentially infringing activities by others were to increase substantially, we might have to significantly increase the resources we devote to protecting our rights. Additionally, an adverse determination in any dispute involving our proprietary rights could, among other things, (i) require us to grant licenses to, or obtain licenses from, third parties, (ii) prevent us from manufacturing or selling our products or (iii) subject us to substantial liability. Any of these possibilities could have a material adverse effect on our business including by reducing our future sales or causing us to incur significant costs to defend our rights.
If we are unable to maintain our current operating relationship with Cole Licensed Brands host stores, we could suffer loss of sales and possible impairment of certain intangible assets.
Our sales depend in part on our relationships with the host stores that allow us to operate our Coles Licensed Brands division, including Sears. Our leases and licenses with Sears are terminable upon short notice. If our relationship with Sears were to end, we would suffer a loss of sales and the possible impairment of certain intangible assets. This could have a material adverse effect on our business, results of operations, financial condition and prospects.
If we become subject to adverse judgments or determinations in legal proceedings to which we are, or may become, a party, our future profitability could suffer through a reduction of sales or increased costs.
We are currently a party to certain legal proceedings as described in Item 8Financial InformationLegal Proceedings. In addition, in the ordinary course of our business, we become involved in various other claims, lawsuits, investigations and governmental and administrative proceedings, some of which are significant. Adverse judgments or
determinations in one or more of these proceedings could require us to change the way we do business or use substantial resources in adhering to the settlements and could have a material adverse effect on our business including, among other consequences by significantly increasing our costs to operate our business.
If we become subject to additional regulation by governmental authorities, our compliance with these regulations could have an adverse effect on our financial condition, including adversely affecting the way we manufacture or distribute our products.
Our operations are subject to regulation by governmental authorities in the United States and other jurisdictions in which we conduct business. Governmental regulations, both in the United States and other jurisdictions, have historically been subject to change. New or revised requirements imposed by governmental regulatory authorities could have an adverse effect on us, including increased costs of compliance. We may also be adversely affected by changes in the interpretation or enforcement of existing laws and regulations by governmental authorities that could affect sales or the way we currently manufacture or distribute our products. See Item 4Information on the CompanyRegulatory Matters and Item 8Financial InformationLegal Proceedings.
Adverse weather conditions could affect consumer spending which could adversely impact our future sales and financial results.
Weather conditions around the world can affect consumer spending and could have a significant impact on our sales. Our sunglass sales are particularly vulnerable to weather conditions. Unusually bad weather during the spring and summer months in one or more of our markets could adversely affect sales of our sunglasses in those markets. Additionally, severe weather such as snowstorms and hurricanes, can inhibit consumers from discretionary shopping. This could affect both our ophthalmic and sunglass sales and create excess inventory which may cause writedowns in the future.
If our implementation of procedures designed to comply with Section 404 of the Sarbanes-Oxley Act of 2002 causes us to identify material weaknesses in our internal control over financial reporting, the trading price of our securities may be adversely impacted.
Commencing with this annual report, we have included a report from our management relating to its evaluation of our internal control over financial reporting as required under Section 404 of the U.S. Sarbanes-Oxley Act of 2002. There are inherent limitations on the effectiveness of internal controls, including collusion, management override and failure of human judgment. In addition, control procedures are designed to reduce rather than eliminate business risks. As a consequence of the systems and procedures we have implemented to comply with these requirements, we may uncover circumstances that we determine, with guidance from our independent auditors, to be material weaknesses, or that otherwise result in disclosable conditions. Although we intend to take prompt measures to remediate any such identified material weaknesses in our internal control structure, measures of this kind may involve significant effort and expense, and any disclosure of such material weaknesses or other disclosable conditions may result in a negative market reaction to our securities.
ITEM 4. INFORMATION ON THE COMPANY
We are a world leader in the design, manufacture and distribution of prescription frames and sunglasses in the mid- and premium-price categories, based on sales. We operate in two industry segments: (i) manufacturing and wholesale distribution and (ii) retail distribution. See Item 18 Financial Statements for additional disclosures about our operating segments. Through our manufacturing and wholesale distribution segment, we are engaged in the design, manufacture, wholesale distribution and marketing of house and designer lines of mid- to premium-priced prescription frames and sunglasses. We operate our retail segment principally through LensCrafters, Sunglass Hut, OPSM and Cole.
Our manufacturing activities are carried out through six production facilities in Italy and two manufacturing facilities in China. In 2006, we manufactured approximately 37 million prescription frames and sunglasses.
We operate our distribution activities through an extensive worldwide wholesale and retail distribution network based primarily in North America, Australia and, with the acquisitions in 2006, in mainland China and in Hong Kong. In 2006, through our wholesale and retail networks, we distributed approximately 18.6 million prescription frames and approximately 24.8 million sunglasses in approximately 5,100 models. Our products are distributed in approximately 130 countries worldwide.
Our products are marketed under a variety of well-known brand names. Our house brands include Ray-Ban, Revo, Arnette, Killer Loop, Persol, Vogue, Luxottica and Sferoflex. Our designer lines include Prada, Chanel, Miu Miu, Dolce & Gabbana, D&G, Versace, Versus, Bvlgari, Salvatore Ferragamo, Donna Karan, DKNY, Brooks Brothers, Anne Klein, Burberry, Polo Ralph Lauren and Puma (distribution license only). In early 2008, we will launch the first collection of Tiffany & Co. eyewear. The distribution of the Tiffany collections will start with Tiffanys own stores as well as through certain of our other distribution channels in North America, Japan, Hong Kong, South Korea, key Middle East markets and Mexico and will extend over time to additional markets and through new distribution channels.
Our wholesale network is comprised of 32 wholly or majority owned subsidiaries operating in principal markets, over 1,700 sales representatives and approximately 100 independent distributors. Our primary wholesale customers include retailers of mid- and premium-priced eyewear such as independent opticians, optical and sunglass chains, optical superstores, sunglass specialty stores and duty-free shops. In certain countries, and especially in North America, wholesale customers also include optometrists and ophthalmologists, health maintenance organizations, or HMOs, and department stores.
Our retail network is mainly comprised of our subsidiaries: in North America, LensCrafters, Inc. (LensCrafters), Sunglass Hut International, Inc. and its subsidiaries (Sunglass Hut) and Cole, which operates Pearle Vision and our Licensed Brands (Sears Optical, Target Optical and BJs Optical); and in Australia, New Zealand and Asia, OPSM Group Limited (OPSM). Our North American retail business is the largest optical retail business in North America based on total sales. Our retail network in Asia expanded in 2006 with three acquisitions that included an aggregate of 274 retail locations located in Beijing, Guangdong and Shanghai, China. In 2007, we continued to strengthen our North American retail business with the acquisition of certain assets of D.O.C Optics, which operates approximately 100 stores located primarily in the midwest United States. In addition, we expanded our global retail business by acquiring two prominent specialty sun chains in South Africa with a total of approximately 65 retail locations.
See Products and Services below for a more detailed discussion of our business.
In 1961, Leonardo Del Vecchio and others established our original operations in Agordo, near Belluno, in northeastern Italy. Since that time, we have enjoyed significant growth in the scope and size of our operations. We have developed and grown in several phases, each of which is related to a specific business strategy. Throughout most of the 1960s, we manufactured molds, metal-cutting machinery, frame parts and semi-finished products for the optical market. We then progressively expanded our production capabilities to enable us to produce a finished frame product.
In 1969, we launched our first line of Luxottica brand frames and began our transformation from a third-party supplier to an independent manufacturer with a line of branded products.
In the early 1970s, we distributed our products exclusively through wholesalers. In 1974, with the acquisition of the distributor that had marketed the Luxottica product line in Italy since 1971, we took our first step towards vertical integration.
Luxottica Group S.p.A. was organized as a corporation on November 23, 1981 under the laws of the Republic of Italy. During the early 1980s, we continued to pursue vertical integration by acquiring independent optical distributors and forming wholesale subsidiaries in strategic markets. In 1981, with our acquisition of La Meccanoptica Leonardo S.p.A., the owner of the Sferoflex brand and the holder of an important patent for a flexible hinge, we increased our market share in Italy and various key European markets. During the late 1980s, we began to expand our product lines to include the design, manufacture and distribution of designer frames through license agreements with major fashion designers.
In 1990, our ADSs were listed on the New York Stock Exchange. Throughout the 1990s, we continued to expand our distribution network by forming new wholesale subsidiaries. In 1995, we became the first frame manufacturer to enter the North American retail market through the acquisition of LensCrafters. Throughout the 1990s, we also expanded into the sunglasses business through various acquisitions. In 1990, we acquired Florence Line S.p.A., the owner of the Vogue brand. In 1995, we acquired the medium- to high-end brand product line of Persol S.p.A.
In June 1999, we acquired the Global Eyewear Division of Bausch & Lomb Incorporated, which we refer to as our Ray-Ban business. The Ray-Ban acquisition significantly increased our presence in the sunglasses market, strengthened our house brand portfolio and provided us with sunglass crystal lens manufacturing technology, manufacturing facilities and equipment.
In December 2000, our ordinary shares were listed on the Mercato Telematico Azionario della Borsa Italiana S.p.A., which we refer to as the Italian Stock Exchange.
In April 2001, we continued to strengthen our sunglasses business by acquiring Sunglass Hut, a leading retailer of sunglasses worldwide based on sales. In May 2001, we acquired all of the issued and outstanding common stock of First American Health Concepts, Inc., which at that time was a leading provider of managed vision care plans in the United States based on sales. In August 2003, we acquired 82.57 percent of the outstanding shares of OPSM (we acquired the remaining 17.43 percent interest in March 2005), resulting in our leadership position in the prescription business based on sales in the Australian and New Zealand markets, while at the same time presenting us with new growth opportunities in the Asia-Pacific markets. In October 2004, we strengthened and expanded our North American retail and managed vision care business with the acquisition of Cole. In 2006, we expanded our retail presence in China by acquiring three premium retail chains, Beijing Xueliang Optical Technology Co. Ltd. Ming Long Optical, and Modern Sight Optics to become a leading operator of premium optical stores in China based on the number of stores, with a total of 274 locations in three of the top premium optical markets in mainland China, as well as Hong Kong, an important market in Asia for luxury goods.
Our capital expenditures for our continuing operations were Euro 272.2 million for the year ended December 31, 2006 and Euro 53.5 million for the three-month period ended March 31, 2007. We expect 2007 aggregate capital expenditures to be approximately Euro 300.0 million, in addition to investment for any acquisitions. We will fund these future capital expenditures with our current available borrowing capacity and available cash. For a description of capital expenditures for the previous three years, see Item 5Operating and Financial Review and ProspectsLiquidity and Financial ResourcesOur Cash FlowsInvesting Activities.
Our principal executive offices are located at Via C. Cantù 2, Milan, 20123, Italy, and our telephone number at that address is (011) 39-02-863341. Our agent for service for limited purposes in the United States is CT Corporation, 111 Eighth Avenue, New York, New York 10011, telephone number (212) 894-8940. We are domiciled in Milan, Italy.
On June 20, 2007, we announced that we entered into a definitive merger agreement with Oakley, a worldwide specialist in sport performance optics with brands including Dragon, Eye Safety Systems, Fox Racing, Mosley Tribes, Oliver Peoples and Paul Smith Spectacles, and retail chains including Bright Eyes, Oakley Stores, Sunglass Icon and The Optical Shop of Aspen. As part of the merger, we will acquire all of the outstanding shares of Oakley for a cash purchase price of U.S.$29.30 per share, together with the purchase of all outstanding options and other equity rights at the same price per share less the exercise price. The total purchase price will be approximately U.S.$2.1 billion (approximately Euro 1.6 billion). The transaction is expected to close in the second half of 2007 and is subject to certain conditions, including regulatory approvals.
In February 2007, we completed the acquisition of the retail optical business of D.O.C Optics, comprising approximately 100 stores located primarily in the midwest United States, for approximately U.S.$110 million in cash. We expect to rebrand the acquired stores as LensCrafters and Pearle Vision.
During the second quarter of 2007, we completed the acquisitions of two prominent specialty sun chains in South Africa, with a total of 65 stores, for approximately Euro 10 million. The two acquisitions represent an important step in the expansion of our sun retail presence worldwide.
Ray Ban Indian Holdings Offer
On August 29, 2003, the Securities Appellate Tribunal, or SAT, in India upheld the decision of the Securities Exchange Board of India to require our subsidiary Ray Ban Indian Holdings, Inc. to make a public offer in India to acquire up
to an additional 20 percent of the outstanding shares of RayBan Sun Optics India Ltd. (RayBan Sun Optics). The Supreme Court of India, by an order dated December 12, 2006, directed that a public offer be made within 45 days of the order, using April 28, 1999 as the reference date for calculating the offer price. The Supreme Court also directed that interest be paid at the rate of 10 percent per annum for the period between August 27, 1999 and the closing date to all persons who were shareholders of RayBan Sun Optics throughout such period. On April 25, 2007, pursuant to the December 12, 2006 Supreme Court order and in compliance with Regulation 10 and 12 of Chapter III of the SEBI Regulations 1997, we launched a public offer through our subsidiary, Ray Ban Indian Holdings, Inc., to acquire up to 4,895,900 shares, representing approximately 20 percent of the equity share capital of RayBan Sun Optics, which we subsequently increased to up to 7,545,200 shares, representing approximately 31 percent of the equity share capital of RayBan Sun Optics. 6,454,280 shares were tendered in the offer, which closed on May 14, 2007. Effective upon the entry of the share transfers in the share register on June 26, 2007, our stake in RayBan Sun Optics increased to 70.5 percent. We paid total consideration of approximately Euro 13.0 million for the tendered shares. RayBan Sun Optics is listed on the Bombay Stock Exchange. We acquired our interest in RayBan Sun Optics in connection with the purchase of the RayBan eyewear business from Bausch & Lomb in 1999.
Sale of Things Remembered
In September 2006, we completed the sale of Things Remembered, a personalized gift retail chain based in the United States, for consideration with an approximate value of U.S.$200 million. This business, which had been acquired in October 2004 through the acquisition of Cole, was non-core for us.
In December 2006, we signed a 10-year license agreement for the design, manufacturing and worldwide distribution of ophthalmic and sun collections under the Tiffany & Co. brand. The launch of the first collection is expected in early 2008. The distribution of the Tiffany collections will start with Tiffanys own stores as well as through certain of our other distribution channels in North America, Japan, Hong Kong, South Korea, key Middle East markets and Mexico, and will extend over time to additional markets and through new distribution channels.
In February 2007, we exercised an option included in the Amended Euro 1,130 Million and U.S.$325 Million Credit Facility to extend the maturity date of Tranches B and C to March 2012. For additional information, see Note 9 to our Consolidated Financial Statements included in Item 18 of this annual report.
Products and Services
In our wholesale operations, we manufacture and sell our prescription frames and sunglasses as either house brands or designer lines. House brands consist of eyewear sold under brand names that we own. Designer lines are produced under designer names held by us under license agreements with third parties. Our products, for both house brands and designer lines, consist of a variety of different styles, from conventional to contemporary and fashion forward styling. Each brand is tailored for a specific market segment based on certain characteristics, such as the consumers age, lifestyle and fashion consciousness.
House Brands: Our house brands are sold worldwide under brand names such as Ray-Ban. We currently produce approximately 1,850 distinct styles of frames within our house brands. Each style is typically produced in three sizes and at least four colors. Actual availability of product styles, colors and sizes varies among geographic markets depending upon local demand.
The following is a summary description of each of our most significant house brands:
· Ray-Ban: Created in 1937, the Ray-Ban line is the brand leader in the eyewear market based on sales and consumer awareness, bringing together renowned sunglass lenses and a timeless style.
· Persol: Created in 1917 and acquired by Luxottica in 1995, the Persol brand is synonymous with design, elegance, tradition, and technical precision. Our Persol line, which includes a wide range of prescription frames and sunglasses, is marketed as a timeless fashion accessory due to the elegance and design of our products.
· Vogue: Acquired by us in 1990, the Vogue brand is recognized as trendy and innovative and symbolizes a young and dynamic style that stresses attention to detail and fashion.
· Arnette: Targeted to young consumers, this sports product line is characterized by a very forward-thinking design.
· Revo: A product line targeted towards sport and leisure wearers, the Revo line is known for its high quality lenses which are treated with a specialized coating process.
· Luxottica: Luxottica is our original product line, comprised of prescription frames and sunglasses. Luxottica targets a broad mix of consumers of eyewear.
· Sferoflex: This product line, which in 1981 became the first brand name acquired by Luxottica Group, the Sferoflex line is comprised of prescription frames characterized by a classic and comfortable style, with flexible hinges that allow the frame to adapt to the unique face shape of each wearer.
· Killer Loop: Created in 1989 as a sun and sports eyewear brand that combines design and quality, this brand has evolved throughout the years from exclusively sports eyewear to also include leisure eyewear.
Designer Lines: Our designer lines are produced and distributed through license agreements with major fashion houses. Currently, we sell designer lines under the names Chanel, Prada, Miu Miu, Dolce & Gabbana, D&G, Versace, Versus, Bvlgari, Salvatore Ferragamo, Donna Karan, DKNY, Brooks Brothers, Anne Klein, Burberry and Polo Ralph Lauren with its six lines (Purple Label, Polo, Ralph Lauren, Ralph, Chaps and Club Monaco). Beginning early in 2008, they will also include Tiffany & Co. The license agreements governing these designer lines are exclusive contracts and typically have terms of between three and ten years. See Trademarks, Trade Names and License AgreementsLicense Agreements. Designer collections are developed through the collaborative efforts of our in-house design staff and the brand designer. Our designer lines presently feature approximately 3,200 different styles.
The following is a summary description of our main designer lines:
· Chanel: In 1999, we became the first company licensed to produce Chanel products. The Chanel product line, targeting the high-end consumer, reflects the essential characteristics of the brand: style, elegance and class.
· Prada: The Prada license agreement was signed in 2003. The Prada collections offer a range of glasses proposed in optical frames and sunglasses collections, and also a series of models created for leisure time, identified by the unmistakable red stripe. The Prada collections have always been distinctive not only for their high quality but also for their forward-thinking approach and style, enabling the brand to anticipate and often inspire trends across all sectors. Sophisticated, elegant and refined, Prada products are identified by their strong character and unique style.
· Miu Miu: The Miu Miu license agreement was signed in 2003 and it comprises both optical frames and sunglasses. This brand addresses a clientele particularly attentive to the free and easy as well as to the sophisticated new trends. This collection expresses Miuccia Pradas vision of an alternative style, always characterized by a strong personality. The brand Miu Miu can be defined as: urban, young, sophisticated and sensual, an alternative vision, a new classic.
· Dolce & Gabbana: Our Dolce & Gabbana eyewear collection draws its inspiration from the 60s and 70s. This collection brings the periods shapes up to date and highlights its materials, characterized by precious details such as logos in Swarovski crystals or elegant metal circles.
· D&G: The D&G eyewear collection has a youthful, innovative and unconventional spirit. The D&G models are characterized by vintage forms that take their inspiration from the 70s and 80s, as well as loud and colorful sporty frames reminiscent of the racing world.
· Versace: Versace is a lifestyle brand for the modern man or woman who chooses to express his/her strength, confidence and uniqueness through a bold and distinctive personal style. Versace represents the ideal of a sophisticated, free and highly desirable lifestyle.
· Versus: While staying true to the essence of the core brand, Versus represents a younger, edgier take on those themes. Filled with spirit and energy, Versus challenges convention, always in the vanguard of modern urban style.
· Bvlgari: Bvlgari eyewear is distinguished by the high quality of its material, attention to detail and elegant design. This product line is targeted towards a clientele who seek something exclusive.
· Salvatore Ferragamo: The Salvatore Ferragamo collections include both optical frames and sunglasses; they are characterized by the greatest attention to detail as well as by an original use of materials and choice of colors. The eyewear collection is inspiredlike all the other Salvatore Ferragamo productsby the craftsmanlike tradition of this fashion house, reinterpreted according to contemporary trends.
· Donna Karan: This product line reflects the design sensibility and spirit of the Donna Karan collection, offering men and women styles that are sophisticated, using modern and lightweight materials.
· DKNY: DKNY is fast fashion with an urban mind-set, the New York City street-smart look. DKNY eyewear addresses modern, urban, fashion-conscious women and men with multifaceted lifestyles: international, eclectic, fun and real.
· Brooks Brothers: Characterized by lightweight materials and a slender line, the Brooks Brothers collections reflect the unique features of the style of this American brand. This is an affordable product line with classic style that delivers functionality, lightness and high quality.
· Anne Klein: This product line targets successful professional women who place an emphasis on quality and image.
· Burberry: A license agreement between Burberry Group Plc and Luxottica was signed in October 2005 with the first release of the Burberry eyewear collection in October 2006. This collection features the brands core values of form and function, innovation and the essence of classic style.
· Polo Ralph Lauren: Polo Ralph Lauren is comprised of six collections:
· Purple Label: A small and exclusive eyewear collection, the Purple Label combines the elegance of tradition with the requirements of the modern gentleman: high quality, precious materials, details and style.
· Ralph Lauren: The Ralph Lauren eyewear collection embraces a youthful sophisticated elegance that mixes refined luxury with cinematic glamour and an air of mystery. For the fashion-conscious woman seeking timeless styling with a modern attitude.
· Polo: The Polo collection focuses on refined designs, inspired by the heritage of Polo Ralph Lauren apparel. Emblematic models that are classic and never out of style. Polo is the ideal collection for men who appreciate quality and tradition and are seeking classic styles with a fresh design.
· Ralph: This line is an expression of the Ralph Lauren spirit at an accessible price point. It features the latest looks and trends, as well as some more classic looks. Vibrant colors for a feminine, flirty and fun look.
· Chaps: Chaps features easy, wearable designs in the classic tradition of Polo Ralph Lauren. The line offers a designer name to the young moderately priced sportswear consumer. Since its introduction, Chaps has come to represent classic design, excellent quality and value.
· Club Monaco: Club Monaco offers individuals a unique brand of quality eyewear at exceptional value and uncompromised style for an accessible luxury. The styling targets are: men and women, between 20 and 40 years old, who are urban professionals, style enthusiasts, and who appreciate sophisticated design at a mid-level price point.
· Tiffany & Co.: This world renowned jeweler operates jewelry and specialty retail stores and manufactures products through its subsidiary corporation. For 169 years, Tiffany & Co. has designed and produced standard-setting jewelry and accessories. We expect our first collection of Tiffany & Co. eyewear, which is to launch in early 2008, to remain true to the brands high standards.
The following table presents the respective percentages of our total unit (a unit represents an eyeglass frame or sunglass and excludes sales of other materials) sales that our designer and house brands comprised during the periods indicated:
Prescription Frames and Sunglasses
In 2006, our manufacturing facilities produced a combined total of approximately 37.0 million prescription frames and sunglasses. In 2005 and 2004, our manufacturing facilities produced a combined total of approximately 28.5 million and 27.8 million prescription frames and sunglasses, respectively.
Since 1990, sunglasses have become an increasingly significant product line for us as we seek to capitalize on growth opportunities in the sunglasses segment. In 1990, we acquired a distributor that supplied sunglasses under the Vogue brand name. In 1995, we expanded our activities in the sunglasses market by acquiring Persol S.p.A., an Italian producer of high-quality, fashionable sunglasses and prescription frames in the premium-priced segment of the market. In 1999, we acquired the Ray-Ban business from Bausch & Lomb Incorporated, including the Ray-Ban, Revo, Arnette and Killer Loop brand names. As a result of our acquisition of the Ray-Ban business, the percentage of our unit sales represented by sunglasses that we manufacture has grown significantly. This trend continued with the acquisition of Sunglass Hut and in
2007, with the expansion of our sunglass based retail business in South Africa. We expect it to continue to develop once the announced acquisition of Oakley has been completed.
Unit sales of sunglasses manufactured by us and third parties in 2006, as a percentage of our total aggregate unit sales, were 57.2 percent, as compared to 55.8 percent in 2005 and 57.3 percent in 2004.
The following table presents the respective percentages of our total unit sales that our prescription frames and sunglasses comprised for the periods indicated:
Our retail division is operated by our subsidiaries LensCrafters, Sunglass Hut, OPSM, several subsidiaries in Asia and, starting in 2007, in South Africa, and the Cole group of companies. LensCrafters and Sunglass Hut are strong trade names in the North American retail market place, and OPSM owns three main trade names in the Asia-Pacific market. The Cole group of companies operates Pearle Vision and our Licensed BrandsSears Optical, Target Optical and BJs Optical. In addition to ophthalmic products and sunglasses, we continue to sell watches and accessories in certain of our retail locations in North America. In September 2006, we sold Things Remembered, a personalized gift retail chain based in the United States.
LensCrafters. Through LensCrafters in North America, we operate a retail network of 902 locations which offer a wide selection of prescription frames, sunglasses, lenses and other optical products. LensCrafters is currently the largest optical retail chain in North America in terms of sales. LensCrafters stores sell not only Luxottica products, but also a wide range of lenses and optical products made by other suppliers. LensCrafters products include innovative lenses, such as FeatherWates® (lightweight, thin and impact-resistant lenses), DURALENS® (super scratch-resistant lenses), ByeLinesÔ (bifocal lenses without visible lines), Invisibles® (anti-reflective lenses) and MVP Maximum View Progressives® (multi-focal lenses without visible lines). Substantially all of our LensCrafters stores are located in high-traffic commercial malls and shopping centers, have an employed optometrist or an independent, licensed optometrist on site (thereby allowing the customer to have an eye examination on site), provide a large range of prescription eyewear choices and include a laboratory, which enables us to provide the selected frame with prescription lenses to our customers in approximately one hour.
We believe that our acquisition of LensCrafters in 1995 has allowed us to:
obtain a significant competitive advantage for market share in the North American market; and
enter a complementary segment that allows for a direct distribution to, and closer relationship with, the end customer.
When we acquired LensCrafters in 1995, LensCrafters had approximately 600 stores. Between 1995 and 1998, we opened new stores and acquired other retail chains, reaching over 850 stores in North America by 1999.
From 1999 to 2004, LensCrafters expansion focused primarily on further development of those stores opened between 1996 and 1998. We continue to evaluate potential retail expansion opportunities in North America through the opening of retail chains and stores in areas where we are not already heavily represented and in other prime locations. As of December 31, 2006, LensCrafters leased 902 retail stores in North America.
Since the LensCrafters acquisition, we have improved the efficiency of LensCrafters stores by managing the inventory from our central worldwide distribution center in Italy. This has improved inventory service and allowed for a more rapid supply of styles based on daily sales and inventory data. This has also increased the percentage of our products available in LensCrafters stores. In addition, we have focused our promotional activities on those customers looking for a better purchase experience with high-quality products, rapid and efficient customer service and innovative lens and frame technology. As a result of these initiatives, LensCrafters net sales have increased significantly since 1995.
During the last few years we have shifted LensCrafters to a more premium brand. During this time we have added additional elements such as a new store concept, associate training, advertising and marketing that together represent the premium brand and future direction of LensCrafters. With these new initiatives, we have seen the average transaction per customer grow. LensCrafters is becoming known as one of the best places to purchase fashionable, designer prescription frames and sunglasses. LensCrafters hopes to shorten the purchase cycle of typically two to three years with this new focus on prescription frames as fashion. LensCrafters is also working to increase its share of the contact lens market. This initiative focuses on selected products (mostly national brand names) and more competitive pricing. This new push for contact lenses is being supported through in-store displays, marketing and associate training.
One of the most visible changes in LensCrafters shift toward a premium and stylish eyewear shopping experience is a new design for the stores, which will be adopted in new and remodeled store locations across North America. The store design features elegant eyewear display boxes, wood flooring, fashion graphics, sleek decorative accents and artistic lighting fixtures. Every feature of the design directs the spotlight on the shopping gallery of designer eyewear collections, while the
fit and finish stations are more private and separated from the shopping and frame selection. We have begun to display the eyewear collections by designer brand to help our customers shop for the style that is right for them.
As part of the brand transformation, in North America LensCrafters has rolled out a new style-focused magazine advertising campaign to communicate the brands approach to eyewear style. The ads have appeared in more than two dozen premium fashion, lifestyle, cultural and entertainment magazines for women and men. Titled Make an Appearance, they are distinguished from other LensCrafters ads, using bold, engaging visuals to emotionally appeal to the fashion and style desires within eyeglass wearers. In 2007, the LensCrafters brand launched a new television and print campaign in North America called Open Your Eyes that positions eyewear as a prized wardrobe item, just as a favorite black dress, handbag or shoes.
In 2006, we began to expand the use of the LensCraftersname by rebranding certain retail locations that we acquired in China to LensCrafters. We expect to have rebranded 153 locations in China and Hong Kong with the LensCrafters name by the end of 2007.
Mainland China and Hong Kong. In 2006, we acquired three optical retailers operating in the premium optical markets in mainland China, with a total of 274 retail locations in Asia. In addition, they will expand our presence in Hong Kong, which we believe to be one of the most important markets for luxury goods.
Hong Kong is one of the most significant Chinese luxury markets where middle class and affluent mainland Chinese visit frequently to purchase luxury goods. Launching LensCrafters as a premium brand in Hong Kong increases awareness and consumer demand for our products and services. This strategy supports our next stage of expansion into mainland China, rebranding the stores we acquired to LensCrafters and developing worldwide recognition for our premium retail brand.
In September of 2006, we launched LensCrafters in Beijing, beginning the re-branding strategy of our acquisitions.
Sunglass Hut. With the acquisition of Sunglass Hut in 2001, we became the worlds leading specialty retailer of sunglasses based on sales, and a specialty retailer of popular priced watches. Sunglass Hut has 1,818 retail locations located throughout North America, Europe and Australia. Sunglass Hut operates in-line stores and kiosks in shopping malls, as well as stores in street centers in high-traffic streets and in airports. We have increased sales of Luxottica-manufactured products at Sunglass Hut locations from approximately 14.3 percent of total Sunglass Hut net sales in April 2001 (the first month following the acquisition) to 69 percent in December 2006. In addition to sunglasses that we manufacture, Sunglass Hut continues to sell a variety of frames manufactured by third-party vendors, including Oakley, Maui Jim, Inc. and others. Oakley is our largest third-party supplier, accounting for approximately 6.8 percent, 4.9 percent and 5.7 percent of our total merchandise purchases from suppliers in 2004, 2005 and 2006, respectively. See Item 4Information on the CompanyRecent DevelopmentsAcquisitions. Although we buy products from third parties, including Oakley, we do not believe that the loss of any one supplier would have a significant impact on our future operations as we could easily replace lost supply with other sunglasses manufactured by us or other third-party vendors. After the acquisition of Sunglass Hut and Cole, we consolidated the administrative and certain other functions of these businesses with our existing business to allow significant synergies between sun and optical retail operations. Sunglass Hut outlets are located mostly in enclosed malls and airports with an average retail space of approximately 400 square feet per kiosk/store.
In the second quarter of 2007, we completed the acquisitions of two prominent specialty sun chains in South Africa, for a total of 65 stores, which will be converted into Sunglass Hut stores. Both chains have prominent locations in shopping centers in urban areas including Johannesburg and Cape Town as well as attractive airport locations.
Cole. With the acquisition of Cole in October 2004, we acquired a group of distribution outlets and a provider and administrator of managed vision care services under one group. Cole, through its wholly owned subsidiaries, operates retail vision locations under the name Pearle Vision as well as under the names Sears Optical, Target Optical and BJs Optical, which we refer to as our Licensed Brands. Managed vision care programs and benefits were previously sold through the Cole Managed Vision Division; renewals and new sales are now administered through Eyemed Vision Care. Additionally, Cole operated a chain of personalized gift stores, e-commerce and catalogs under the name Things Remembered, which was sold in September 2006.
The Licensed Brands optical retail locations are located in the host stores that bear the names of the hosts. Pearle Vision stores are mostly located in strip malls outside of the conventional malls where most LensCrafters and Sunglass Hut stores are located. In addition, we have franchised Pearle Vision locations located throughout North America. We believe that
this combination with Cole has allowed us to:
strengthen our retail operations in the United States;
strengthen our managed vision care business by increasing the number of people for whom we provide managed vision care benefits as well as by adding well established retailers to our existing family of retailers; and
increase our sales of frames manufactured by us in Cole retail stores.
We substantially completed our strategic integration plan with respect to Cole in the third quarter of 2006. As of December 31, 2006, Cole operated 1,781 owned and leased department locations and 417 franchise locations throughout North America.
Our retail network in North America has expanded in 2007 with the completion of our acquisition of D.O.C. Optics, an optical retail business with approximately 100 stores located primarily in the midwest United States. This acquisition represents another key step in our strategy to maximize growth opportunities for our optical retail brands, including LensCrafters and Pearle Vision. We will continue to look to expand our retail operations in North America through the opening of new stores or kiosks, or strategic acquisitions when we deem them to be appropriate.
OPSM. In August 2003, we completed the acquisition of 82.57 percent of OPSM, and we completed the acquisition of the minority interest in OPSM in March 2005. This acquisition has resulted in what we believe is a leadership position in the prescription business in the Australian and New Zealand markets and provided us with new growth opportunities in the Asian market. As of December 31, 2006, OPSM had 466 stores in Australia operating under three brands, OPSM, Laubman & Pank and Budget Eyewear, each of which targets a clearly defined market segment, and operates 22 franchise locations throughout Australia. OPSM is the market leader in New Zealand, based on corporate-owned store locations, with 39 stores as of December 31, 2006. OPSM sold its businesses in Singapore and Malaysia during 2005.
Our Principal Markets
The following table presents our net sales by geographic market for the periods indicated:
(1) Excludes the sales of our Things Remembered specialty retail business, which was sold in September 2006. Things Remembered sales for fiscal 2004, 2005 and 2006 were Euro 75.7 million, Euro 236.5 million and Euro 157.1 million, respectively.
(2) Adjustment/Eliminations represents the elimination of intercompany sales.
Seasonality and Effect of 53-Week Year
We have also historically experienced sales volume fluctuations by quarter due to seasonality associated with the sale of sunglasses, which represented 57.2 percent and 55.8 percent of our units sold in 2006 and 2005, respectively. As a result, our net sales are typically higher in the second quarter, which includes sales to customers and increased sales in our Sunglass Hut stores, and lower in the first quarter, as sunglass sales are lower in the cooler climates of North America, Europe and Northern Asia. These seasonal variations could affect the comparability of our results from period to period. Our retail fiscal year is either a 53-week year or a 52-week year, which also can affect the comparability of our results from period to period. When a 53-week year occurs, we generally add the extra week to the fourth quarter. A 53-week year occurs in five to six year intervals and is expected to occur again in fiscal 2008.
We produce both metal and plastic frames. In addition to our frame manufacturing capacity, since 1999 we have also produced crystal and polycarbonate sunglass lenses exclusively for our sunglasses collections. Production is principally carried out in our six Italian manufacturing facilities. In China, we produce certain products distributed mainly by our North American retail group and certain finished products for our wholesale business, mainly in our owned production facilities. Each of our facilities is tailored to a specific production technology that we believe allows us to achieve a high level of productivity.
Design and Prototype Selection
We believe that an important aspect of our success has been our emphasis on design and the continuous development of new styles. Our in-house designers work jointly with external designers to develop new models.
For our designer line products, our design team works with licensors to discuss the basic themes and fashion concepts for each product and then works closely with the licensors designers to refine such themes. In addition, our design team works directly with our marketing and sales departments, which monitor demand for our current models as well as general style trends in eyewear. The data obtained from our marketing and sales departments is then used to refine existing product designs and market positioning in order to react to changing consumer preferences.
Once the product concepts have been selected and approved, we produce prototypes that are used to evaluate the proposed design. Our prototypes are developed using computer-aided design/computer-aided manufacturing technology, known as CAD/CAM, which is fully integrated with our manufacturing processes. CAD/CAM technology allows a designer to view and modify two- and three-dimensional images of a new frame. Because this technology is fully integrated with the manufacturing processes, the conversion from prototype to production is streamlined.
All prototypes are subject to review and approval by our licensors and our designers to ensure consistency with the distinctive image of each product line. Our collections consist of both new models and the most successful existing models. Each year, we add approximately 1,800 new models to our eyewear collections. The ability to constantly renew our product base has enabled us to meet consumer demand in each market segment in which our brands are targeted. See Item 3Key InformationRisk Factors If we do not correctly predict future economic conditions and changes in consumer preferences, our sales of premium products and profitability will suffer.
The principal raw materials and parts purchased for our manufacturing process include plastic resins, metals, lenses and frame parts. We purchase a substantial majority of our raw materials in Europe and to a lesser extent in Asia and the United States. In addition, we use certain external suppliers for frames, eyeglass cases and packaging materials. The Ray-Ban acquisition provided us with know-how and sunglass crystal lens manufacturing capabilities. We believe that our ability to produce sunglass crystal lenses is strategically important given our expanded presence in the sunglasses market.
We do not depend on any single supplier for any of our principal raw materials or frames. Although we do not have formal, long-term contracts with our suppliers, we have not experienced any significant interruptions in our supplies. Historically, prices of the principal raw materials used in our manufacturing process have been stable.
We have six frame manufacturing facilities in Italy. Five facilities are located in northeastern Italy, the area in which most of the countrys optical industry is based, and the remaining facility is located near Turin. All of our facilities are highly automated, which has allowed us to maintain a high level of production without significant capital outlay. In certain of these facilities, we also produce sunglass crystal lenses and polycarbonate lenses. In 2006, we rationalized our operations in Italy by building a new, approximately 32,000 square meters manufacturing facility to produce acetate frames and sunglasses for a total investment of approximately Euro 20.0 million. We were able to re-dedicate one of our former facilities to our logistics operation for a total investment of Euro 6.2 million. From 1998 to 2001, we operated, through our 50 percent-owned joint venture (Tristar Optical Company Ltd.) with a Japanese partner, a facility in China to manufacture prescription frames. In 2001, we acquired the remaining 50 percent interest in this Chinese company so that it became one of our wholly owned subsidiaries. In 2006, we increased our manufacturing capacity in mainland China through the construction of a new, approximately 26,000 square meters manufacturing facility to produce both metal and plastic frames for a total investment of approximately Euro 20.0 million. After the construction of this new facility, our annual average daily production in mainland China increased by approximately 80 percent compared to 2005. The percentage of private label products produced at our facilities in China has been decreasing in favor of increased production of certain of our core, fashion and North American brands.
Over the past several years, we have consolidated our manufacturing processes by tailoring each of our manufacturing facilities in Italy to a specific production technology. This consolidation has allowed us to improve both the productivity and quality of our operations. We produce plastic frames in our facilities in Sedico, Pederobba and Turin, while metal frames are produced in our facilities in Agordo and Rovereto. Certain frame parts are produced in our facility in Cencenighe. In 2006, approximately 56 percent of the frames manufactured by us were metal-based, and the remainder was plastic.
The manufacturing process for both metal and plastic frames and sunglasses begins with the fabrication of precision tooling and molds based on prototypes developed by our in-house design and engineering staff. We believe that our in-house capacity to engineer and produce precision tooling and molds gives us a strong competitive advantage by enabling us to reduce the lead time for product development and thereby adapt quickly to market trends, contain production costs, and maintain smaller and more efficient production runs so that we can better respond to the varying needs of different markets.
The manufacturing process for metal frames is comprised of approximately 70 phases, beginning with the production of basic components such as rims, temples and bridges, which are produced through a molding process. These components are welded together to form frames through numerous stages of detailed assembly work. Once assembled, the metal frames are treated with various coatings to improve their resistance and finish, and then prepared for lens fitting and packaging.
We manufacture plastic frames using either a milling process or injection molding, depending upon the style and color of the frame. In the milling process, a computer-controlled machine carves frames from colored plastic sheets. This process produces rims, temples and bridges that are then assembled, finished and packaged. In the injection molding process, plastic resins are liquefied and injected in molds. The plastic parts are then assembled, coated, finished and packaged.
Our efficient distribution network allows us to track sales and inventory data on a weekly basis. As a result, we are able to:
make and revise manufacturing plans on the basis of current sales information;
reallocate inventory within our wholesale subsidiaries, thereby reducing overall inventory levels and the risk of obsolescence; and
react quickly to changing market trends by providing rapid feedback to our in-house design team.
We engage in research and development activities relating to our manufacturing processes on an on-going basis. As
a result of such activities, we have invested, and will continue to invest, in automation, thus increasing efficiency while improving quality. Much of our manufacturing process is automated, including the production of metal and plastic frame parts and the galvanization of metal frames.
Costs associated with research and development activities are expensed when incurred and are not significant.
One of our key strategic objectives is ensuring the quality of our products. In 1997, we were among the first companies in the eyewear industry to obtain ISO 9001 certifications. Subsequently, in 2003, we obtained the Vision 2000 certification, which is the third-generation industry recognition for quality production. To ensure the high quality of our products, our quality control and process control teams regularly inspect work-in-progress at various stages of the production cycle. In addition, the majority of materials that we purchase are quality tested. We also conduct inspections of, and certify compliance with, the production processes of our main suppliers. Each of our prescription frames and sunglasses undergoes several stages of quality inspection. Due to the efficiency of our quality controls, the return rate for defective merchandise manufactured by us is approximately one percent.
We distribute our products through wholesale and retail channels.
Distribution by Wholesale Division
We currently distribute our products in approximately 130 countries and operate 32 wholly or majority owned wholesale distribution subsidiaries strategically located in major markets worldwide. In markets where we do not have wholesale distribution subsidiaries, we employ approximately 100 independent distributors.
Each wholesale distribution subsidiary operates its own network of sales representatives, who are normally retained on a commission basis. Our network of wholesale distribution subsidiaries represents a key element of our business. We believe that control over an extensive distribution network provides us with a competitive advantage, because it enables us to maximize our brand image, marketing efforts and customer service activities by tailoring our operations to meet the specific needs and peculiarities of local markets.
The following table sets forth certain information regarding our wholesale distribution subsidiaries and affiliates:
(1) The shares of RayBan Sun Optics are publicly traded on the BSE Stock Exchange, Mumbai. Since we did not own a 50 percent equity interest in the entity as of December 31, 2006, we accounted for this entity under the equity method of accounting for the year ending December 31, 2006. Effective as of June 26, 2007, we acquired approximately 70.5 percent of RayBan Sun Optics through a public tender offer. See Item 4Information on the CompanyBusiness OverviewRecent DevelopmentsRay Ban Indian Holdings Offer above for more information.
We maintain close contact with our distributors in order to monitor sales and to control the quality of the points of sale that display products. We typically enter into distribution agreements with importers and distributors that establish minimum annual purchases and impose territorial limitations. In addition, to the extent permitted by law, we allow for distribution only through specifically authorized retail channels and qualified sales agents.
No single customer or group of related customers accounted for more than five percent of our consolidated net sales in any of the past three years. We do not believe that the loss of any single customer would have a material adverse effect on our financial condition or results of operations.
Our distribution system is integrated internationally. A worldwide computerized information network links the distribution and sales systems with the production facilities in Italy. This network enables us to monitor worldwide sales trends and inventory positions on a daily basis and to allocate production resources accordingly.
We believe that one of our key competitive strengths is our ability to promptly satisfy customer demand in a timely manner, both prior to and following a sale. In order to further improve our customer service capabilities, we have centralized our distribution centers in Europe (Italy) and Asia (Japan). Since the Cole acquisition, we have consolidated our distribution centers in Memphis and Atlanta, the main distribution center for our retail division, and are in the final stages of centralizing our wholesale distribution centers in North America. We believe that centralizing our distribution centers improves the efficiency of our distribution operations while reducing the related costs.
Distribution by Retail Division
Through our retail division, we believe we operate the largest group of optical superstores in both the United States and Canada based on both sales and store count. We believe we are the largest specialty retailer of sunglasses in the world based on 2006 revenues and believe we have become a leading player in the Australian prescription segment. We also sell watches and accessories in certain sunglass retail locations and, until September 2006, sold personalized gifts under the name Things Remembered.
In our optical retail stores, customers can choose from a large selection of frames and lenses offering a high level of comfort and fit. LensCrafters customers can obtain a completed pair of prescription glasses in approximately one hour because of on-site lens grinding laboratories. In our Sunglass Hut locations, customers can choose from a large selection of Luxottica and third-party vendor manufactured sunglasses. In addition, Sunglass Hut locations can assist customers in purchasing other accessories to complement their sunglasses. As of December 31, 2006, our retail division consisted of 5,280 owned or leased department retail locations and 454 franchised locations as follows:
In 2006, units manufactured with our own brand names or our licensed brands, represented approximately 72.4 percent, 42.1 percent, 42.1 percent and 66.6 percent of the total sales of frames based on units sold by LensCrafters, Cole, OPSM and Sunglass Hut, respectively. OPSM was acquired in August 2003 and at such time 3.5 percent of the total sales of frames sold were supplied by us. Cole was acquired in October 2004, and at such time less than one percent of the total sales of frames sold were supplied by us. The retail divisions outlets sell not only frames that we manufacture but also a wide range of frames, lenses and other ophthalmic products manufactured by other companies.
Substantially all LensCrafters (excluding the LensCrafters rebranded stores in China), Cole and OPSM stores have an employed or independent optometrist on site, allowing the customer to have an eye examination, select from a large range of prescription eyewear, and receive the selected frame with prescription lenses from one location. In addition, substantially all of our LensCrafters stores (excluding the LensCrafters rebranded stores in China), have a lens grinding laboratory on site, which allows our customers to receive a complete set of prescription frames or sunglasses in approximately one hour.
The prescription frame and sunglasses industry is highly competitive and fragmented. As we market our products throughout the world, we compete with many prescription frame and sunglasses companies in various local markets. We believe that our principal competitor in the design, manufacture and distribution of eyewear within the prescription frames market is Safilo Group S.p.A., or Safilo. We believe that our principal competitors in the sunglasses market include Safilo, De Rigo S.A. and Oakley. See Business OverviewRecent DevelopmentsAcquisitions for more information regarding the Oakley acquisition. Several of our most significant competitors in the manufacture and distribution of eyewear are significant vendors to our retail division. Our success in these markets will depend on, among other things, our ability to manage an efficient distribution network and to market our products effectively as well as on the popularity and market acceptance of our brands. See Item 3Key InformationRisk FactorsIf we are unable to successfully introduce new products, our future sales and operating performance will suffer and If we fail to maintain an efficient distribution network in our highly competitive markets, our business, results of operations and financial condition could suffer.
The highly competitive optical retail market in North America includes a large number of small independent competitors and several national and regional chains of optical superstores. In recent years, a number of factors, including consolidation among retail chains and the emergence of optical departments in discount retailers, have resulted in significant competition within the optical retailing industry. We compete against several large optical retail chains in North America, including Wal-Mart and Eye Care Centers of America, and, in the sunglasses area, numerous sunglass outlet centers. Our optical retail operations emphasize product quality, selection, customer service and convenience. We do not compete primarily on the basis of price.
Our marketing and advertising activities are designed primarily to enhance the image of Luxottica and our brand portfolio and to drive traffic into our retail locations. Advertising expenses amounted to approximately six percent of our net sales in each of 2004, 2005 and 2006.
Marketing Strategy for Our Wholesale Distribution Business
Our marketing strategy in the wholesale distribution business is focused on promoting our extensive brand portfolio, our corporate image and the value of our products. Advertising is extremely important in supporting our marketing strategy, and we therefore engage in extensive advertising activities, both at the point-of-sale and through various media directed at the end consumer of our products.
In our media advertising, we utilize direct media, such as print, radio and television, as well as billboard advertising. The extent of our advertising activities and the selection of different media depend upon the competitive conditions in each particular market. In addition, we advertise in publications targeted to independent practitioners and other market-specific magazines.
Our point-of-sale marketing materials consist of displays, counter cards, catalogs, posters and product literature. Many of these materials are linked to our consumer advertising campaigns. Because the point-of-sale has become increasingly important both as a communication medium and in terms of the consumer brand experience. In 2007, we have
developed a new approach for our Ray-Ban brand with a shop-in-shop modular concept. This concept can be adapted to the stores we identify as the most suitable, permitting the best delivery of Ray-Bans clear and unique brand signature.
We also benefit from brand-name advertising carried out by licensors of our designer lines intended to promote the image of the designer line. Our advertising and promotional efforts in respect of our licensed brands are developed in coordination with our licensors. We contribute to the designer a specified percentage of our sales of the designer line to be devoted to advertising and promotion.
Finally, we participate in major industry trade fairs (including the MIDO fair in Milan, Vision Expo in the United States and the SILMO in Paris), where our new collections are displayed and promoted to the market.
Marketing Strategy for Our Retail Business
In addition to the marketing activities described above, we engage in promotional and advertising activities through our retail business with both short- and long-term objectives. Our short-term objectives are to attract customers to our stores and promote sales. Our long-term objective is to build the image and visibility of our retail brands throughout the world, such as the LensCrafters and Pearle Vision brands in North America, the Sunglass Hut brand worldwide, the OPSM, Laubman & Pank and Budget Eyewear brands in Australia and New Zealand, thereby encouraging customer loyalty and return purchases. We believe that the product quality and service provided by our retail business contribute to our short- and long-term marketing objectives.
A considerable amount of our retail businesss marketing budget is dedicated to direct marketing activities, such as communications with customers (e.g., mailings and catalogues). Our direct marketing activities benefit from our large database of customer information in the United States and in Australia. Another significant portion of the marketing budget is allocated to broadcast and print media (e.g., television, radio and magazines) designed to reach the broad markets in which we operate with image-building messages about our retail business.
Trademarks, Trade Names and License Agreements
Trademarks and Trade Names
As of December 31, 2006, our principal trademarks or trade names included Luxottica, Ray-Ban, Persol, Vogue, LensCrafters, Sunglass Hut, Pearle Vision, OPSM, Laubman & Pank and Budget Eyewear. Our principal trademarks are registered world-wide. Other than Luxottica, Ray-Ban, LensCrafters, Sunglass Hut, Pearle Vision, OPSM, Laubman & Pank and Budget Eyewear, we do not believe that any single trademark or trade name is material to our business or results of operations. Ray-Ban products accounted for approximately 13.5 percent of our net sales in 2006. Management believes that our trademarks have significant value in marketing our products.
LensCrafters has introduced several trademarked lenses in recent years that contain innovative technology, such as FeatherWatesÒ) (lightweight, thin and impact resistant lenses), DURALENSÒ (super scratch-resistant lenses), InvisiblesÒ (anti-reflective lenses) and MVP Maximum View ProgressivesÒ (multi-focal lenses without visible lines). LensCrafters purchases these lenses under non-exclusive arrangements with third parties. The names of the lenses used by LensCrafters are typically trademarked, and the trademarks are typically owned by us. OPSM has trademarked several lenses in recent years that it uses in its advertising. They include ActiviseÔ for contact lenses, ActiveÔ for polycarbonate eyeglass lenses and InvisiblesÔ for multi-coated eyeglass lenses.
We do not have any patents that we believe are, individually or in the aggregate, material to our results of operations or financial condition.
See Item 3 Key InformationRisk FactorsIf we are unable to protect our proprietary rights, our sales might suffer and we may incur significant costs to defend such rights.
We have entered into certain license agreements to manufacture and distribute prescription frames and sunglasses with numerous designers. These license agreements have terms expiring through 2022. The table below summarizes the principal terms of our most significant license agreements.
* Retail Brand Alliance, Inc. is indirectly owned and controlled by one of our directors.
** Adrienne Vittadini LLC was indirectly owned and controlled by one of our directors until November 2006, at which time it was transferred to a third party.
*** U.S., Canada, Mexico and Japan only.
Under these license agreements, we are required to pay a royalty which generally ranges from five percent to twelve percent of net sales of the relevant collection, which may be offset by any guaranteed minimum royalty payments. The license agreements also provide for a mandatory marketing contribution that generally amounts between five percent and ten percent of net sales. The particular licensor is responsible for the manner and form of advertising for its collection. These license agreements typically have terms ranging from three to ten years, but may be terminated early by either party for a variety of reasons, including non-payment of royalties, failure to meet minimum sales thresholds, product alteration and, under certain agreements, any change in the ownership of the ordinary shares resulting in a change in control of Luxottica Group S.p.A.
Other than Prada and Miu Miu (which in aggregate account for 5.5 percent of net sales), no single designer line accounted for more than five percent of net sales for the year ended December 31, 2006. Management believes that, while the early termination of one or a small number of the current license agreements may have an adverse effect on our results of operations in the short term, any such termination would not have a material adverse effect on our long-term results of operations or financial condition. Upon any early termination of an existing license agreement, we expect that we would seek to enter into alternative arrangements with other designers to reduce any negative impact of such a termination.
Our products are subject to governmental health and safety regulations in most of the countries where they are sold, including the United States. We regularly inspect our production techniques and standards to ensure compliance with applicable requirements. Historically, compliance with such requirements has not had a material effect on our operations.
In addition, governments throughout the world impose import duties and tariffs on products being imported into their countries. Although in the past we have not experienced situations in which the duties or tariffs imposed materially impacted our operations, we can provide no assurances that this will be true in the future.
Our past and present operations, including owned and leased real property, are subject to extensive and changing environmental laws and regulations pertaining to the discharge of materials into the environment, the handling and disposition of waste or otherwise relating to the protection of the environment. We believe that we are in substantial compliance with the applicable environmental laws and regulations. However, we cannot predict with any certainty that we will not in the future incur liability under environmental statutes and regulations with respect to contamination of sites formerly or currently owned or operated by us (including contamination caused by prior owners and operators of such sites) and the off-site disposal of hazardous substances.
Our retail operations are also subject to various legal requirements in the United States, Australia, Canada, New Zealand, Hong Kong, Singapore and Malaysia that regulate the permitted relationships between licensed optometrists or ophthalmologists, who primarily perform eye examinations and prescribe corrective lenses, and opticians, who fill such prescriptions and sell eyeglass frames.
We are a holding company, and virtually all of our operations are conducted through our wholly owned subsidiaries. We operate in two industry segments: (i) manufacturing and wholesale distribution, and (ii) retail distribution. In the retail segment, we primarily conduct our operations through LensCrafters, Sunglass Hut, Pearle Vision, Cole Licensed Brands and OPSM. In the manufacturing and wholesale distribution segment, we operate through approximately eight manufacturing plants and 32 geographically oriented wholesale distribution subsidiaries. See Distribution for a breakdown of the geographic areas.
The significant subsidiaries controlled by Luxottica Group S.p.A., including holding companies, are:
Property, Plants and Equipment
Our corporate headquarters is located at Via C. Cantù 2, Milan, Italy. Information regarding the location, use and approximate size of our principal offices and facilities as of December 31, 2006 is set forth below:
As of December 31, 2006, LensCrafters leased 977 retail stores in North America and China (including Hong Kong), and Sunglass Hut leased 1,818 retail locations throughout North America, Europe and Australia.
As of December 31, 2006, Cole leased 1,781 optical retail locations including 1,358 stores in licensed departments in host stores. OPSM leased 505 retail stores in Australia and New Zealand and 199 retail stores in mainland China and Hong Kong. All of our leases expire between 2007 and 2025 and have terms that we believe are generally reasonable and reflective of market conditions.
We believe that our current facilities (including our manufacturing capacity) are adequate to meet our present and reasonably foreseeable needs. Other than the capital lease for our offices in Valbonne (France), there are no encumbrances on any of our principal owned properties.
ITEM 4A. UNRESOLVED STAFF COMMENTS
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
We operate in two industry segments: (i) manufacturing and wholesale distribution and (ii) retail distribution. Through our manufacturing and wholesale distribution segment, we are engaged in the design, manufacture, wholesale distribution and marketing of house brand and designer lines of mid- to premium-priced prescription frames and sunglasses. We operate in our retail segment principally through LensCrafters, Sunglass Hut, OPSM, and since October 2004, Cole. As of December 31, 2006, the retail segment consisted of 5,280 owned or leased corporate-owned retail locations and 454 franchised locations as follows:
LensCrafters and Cole have retail distribution operations located throughout the United States, Canada and Puerto Rico, while OPSM operates retail outlets located in Australia, New Zealand, and Hong Kong. Sunglass Hut is a leading retailer of sunglasses worldwide based on sales. In 2006, we began operating retail locations in mainland China and currently we are in the process of rebranding many of the locations to our premium LensCrafters brand. We expect to rebrand approximately 153 a stores in China to LensCrafters by the end of 2007.
Our net sales consist of direct sales of finished products manufactured with our own brand names or our licensed brands to opticians and other independent retailers through our wholesale distribution channel and sales directly to consumers through our retail division retail channel. Our average retail unit selling price is significantly higher than our average wholesale unit selling price, as our retail sales typically include lenses as well as frames.
Demand for our products, particularly our higher-end designer lines, is largely dependent on the discretionary spending power of the consumers in the markets in which we operate. See Item 3Key InformationRisk FactorsIf we do not correctly predict future economic conditions and changes in consumer preferences, our sales of premium products and profitability will suffer. We have also historically experienced sales volume fluctuations by quarter due to seasonality associated with the sale of sunglasses. As a result, our net sales are typically higher in the second quarter and lower in the first quarter.
As a result of our acquisition of LensCrafters in May 1995 and the subsequent expansion of our business activities in the United States through the acquisition of the Ray-Ban business, Sunglass Hut and Cole, our results of operations, which are reported in Euro, have been rendered more susceptible to currency rate fluctuations between the Euro and the U.S. dollar. The U.S. dollar/Euro exchange rate has fluctuated from an average exchange rate of Euro 1.00 = U.S.$1.2435 in 2004 to Euro 1.00 = U.S.$1.2444 in 2005 to Euro 1.00 = U.S.$1.2553 in 2006. Additionally, with the acquisition of OPSM, our results of operations have been rendered susceptible to currency fluctuations between the Euro and the Australian dollar. Although we engage in certain foreign currency hedging activities to mitigate the impact of these fluctuations, they have impacted our reported revenues and expenses during the periods discussed herein. See Item 11Quantitative and Qualitative Disclosures About Market RiskForeign Exchange Sensitivity and Item 3Key InformationRisk FactorsIf the Euro continues to strengthen relative to certain other currencies, our profitability as a consolidated group will suffer.
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our estimates are based on historical experience and currently available information. Our significant accounting policies are discussed in Note 1 to our Consolidated Financial Statements included in Item 18 of this annual report. The following is a discussion of what management believes are our most critical accounting policies:
Revenues include sales of merchandise (both wholesale and retail), insurance and administrative fees associated with the Companys managed vision care business, eye exams and related professional services and sales of merchandise to franchisees, along with other revenues from franchisees such as royalties based on sales and initial franchise fee revenues.
In some countries, the wholesale and retail divisions offer the customer the right to return products for a limited period of time after the sale. However, such right of return does not impact the timing of revenue recognition as all conditions of SFAS No. 48, Revenue Recognition When Right of Return Exists, are satisfied at the date of sale. We have estimated and accrued for the amounts to be returned in the subsequent period. This estimate is based on our right of return policies and practices along with historical data, sales trends and the timing of returns from the original transaction date when applicable. Changes to these policies and practices or a change in the trend of returns could lead to actual returns being different from the amounts estimated and accrued.
Also included in retail division revenues are managed vision care revenues consisting of (i) insurance revenues which are recognized when earned over the terms of the respective contractual relationships and (ii) administrative services revenues which are recognized when services are provided during the contract period. Accruals are established for amounts due under these relationships determined to be uncollectible. Our insurance contracts require us to estimate the potential costs and exposures over the life of the agreement such that the amount charged to the customers will cover these costs. To mitigate the exposure risk, these contracts are usually short-term in nature. However, if we do not accurately estimate the future exposure and risks associated with these contracts, we may suffer losses as we would not be able to cover our costs incurred with revenues from the customer.
Income taxes are recorded in accordance with SFAS No. 109, Accounting for Income Taxes, which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in our consolidated financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the consolidated financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. A valuation allowance is recorded for deferred tax assets if it is determined that it is more likely than not that the asset will not be realized. These estimated tax rates and the deferred tax assets, including valuation allowances placed upon those deferred tax assets, and liabilities recorded are based on information available at the time of calculation. This information is subject to change due to subsequent tax audits performed by different taxing jurisdictions and changes in corporate structure not contemplated at the time of calculation, as well as various other factors.
We have completed our evaluation of the impact of adopting Financial Accounting Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109, which we have adopted beginning on January 1, 2007. FIN 48 requires, among other things, a dual-step approach (Recognition and Measurement) in recognizing uncertain tax positions taken or expected to be taken on tax returns. The recognition test requires that the tax position meet a threshold of more-likely-than-not, based solely on its technical merits, that it will be sustained upon examination by the taxing authority. After this test is met, FIN 48 permits us to recognize a tax benefit equal to the largest amount of benefit that is more than 50 percent likely to be realized upon final settlement with the taxing authority. FIN 48 must be applied to all existing tax positions for all open tax periods as of the date of adoption. The cumulative effect of adoption will be an adjustment to our January 1, 2007 retained earnings of Euro 8.2 million.
Our manufactured inventories were approximately 75.4 percent and 66.7 percent of total frame inventory for 2005 and 2006, respectively. All inventories at December 31, 2006 were valued using the lower of cost (as determined under a
weighted-average method which approximates the first in, first out method) or market. Inventories are recorded net of allowances for possible losses among other reserves. These reserves are calculated using various factors including quantity on hand, sales volume, historical shrink results, changes in market conditions and current trends. In addition, production schedules are made on similar factors which, if not estimated correctly, could lead to the production of potentially obsolete inventory. As such, actual results could differ significantly from the estimated amounts.
Goodwill and Other Intangible Assets and Impairment of Long-Lived Assets
In connection with various acquisitions, we have recorded as intangible assets certain goodwill, trade names and certain other identifiable intangibles. At December 31, 2006, the aggregate carrying value of intangibles, including goodwill, was approximately Euro 2.5 billion or approximately 51.4 percent of total assets.
As acquisitions are an important element of our growth strategy, valuations of the assets acquired and liabilities assumed on the acquisition dates could have a significant impact on our future results of operations. Fair values of those assets and liabilities on the date of the acquisition could be based on estimates of future cash flows, and operating conditions for which the actual results may vary significantly. This may lead to, among other items, impairment charges, and payment of liabilities different than amounts originally recorded which could have a material impact on future operations.
SFAS No. 142, Goodwill and Other Intangible Assets (SFAS No. 142), sets forth requirements relating to accounting for ongoing intangibles. Under SFAS No. 142, goodwill and intangible assets deemed to have an indefinite life are no longer amortized in the same manner as under the previous standards, but rather are tested for impairment annually and, under certain circumstances, between annual periods. An impairment charge will be recorded if the fair value of goodwill and other intangible assets is less than the carrying value. The calculation of fair value may be based on, among other items, estimated future cash flows if quoted market prices in active markets are not available. We test our goodwill for impairment annually as of December 31 of each year and any other time a condition arises that may cause us to believe that an impairment has occurred. Since impairment tests use estimates of the impact of future events, actual results may differ and we may be required to record an impairment in future years.
Intangibles subject to amortization based on a finite useful life continue to be amortized on a straight-line basis over their useful lives. Our long-lived assets, other than goodwill, are tested for impairment whenever events or changes in circumstances indicate that the net carrying amount may not be recoverable. When such events occur, we measure impairment by comparing the carrying value of the long-lived asset to the estimated undiscounted future cash flows expected to result from the use of the assets and their eventual disposition. If the sum of the expected undiscounted future cash flows were less than the carrying amount of the assets, we would recognize an impairment loss, if determined to be necessary. Actual results may differ from our current estimates.
Recent Accounting Pronouncements
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assetsan amendment of FASB Statement No. 140, with respect to accounting for separately recognized servicing assets and servicing liabilities. The statement requires, among other things, that an entity use fair value to initially measure these assets and liabilities, if practicable. The adoption of such standard is for fiscal years beginning after September 15, 2006 and is not expected to have a material effect on our consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which establishes a definition of fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 does not require new fair value measurements but clarifies the definition, method and disclosure requirements of previously issued standards that address fair value measurements. The adoption of such standard is for fiscal years beginning after November 15, 2007. We are currently evaluating the disclosure requirements and their effect on our consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plansan amendment of FASB Statements No. 87, 88, 106 and 132(R), which requires us to recognize an asset or liability for the funded status (the difference between the fair value of plan assets and benefit obligation, which for defined benefit pension plans is deemed to be the projected benefit obligation) of its retirement plans and recognize changes in the funded status annually through other comprehensive income (loss). The statement also changes the date in which the funded status can be measured (eliminating the 90-day window) with limited exceptions. The effective date of the recognition of the funded status is for years ending after December 15, 2006. See Note 10 to our Consolidated Financial Statements included in Item 18 of this annual report for the effect of adoption. The effective date for the change in acceptable measurement date is for fiscal years ending after December 15, 2008. We are currently evaluating the impact of changing the
measurement date on our consolidated financial statements.
In February 2007, the Financial Accounting Standards Board (FASB) issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial LiabilitiesIncluding an amendment of FASB Statement No. 115, which allows us to record at fair value financial assets and liabilities, with any changes being recorded in earnings. This can be done on an instrument-by-instrument basis in most circumstances, is irrevocable after election for that instrument and must be applied to the entire instrument. The adoption of such standard is effective for fiscal years beginning after November 15, 2007 and is not expected to have a material effect on our consolidated financial statements.
Results of Operations
The following table sets forth, for the periods indicated, the percentage of net sales represented by certain items included in our statements of consolidated income:
(1) Results of Things Remembered, a former specialty gift business that was sold in September 2006, are reclassified as discontinued operations and are not included in results from continuing operations for 2004, 2005 and 2006.
For additional financial information by operating segment and geographic region, see Note 13 to our Consolidated Financial Statements included in Item 18 of this annual report.
Comparison of the year ended December 31, 2006 to the year ended December 31, 2005
Net Sales. Net sales increased 13.1 percent to Euro 4,676.2 million during 2006 as compared to Euro 4,134.3 million in 2005. The increases in our net sales primarily resulted from the strong performance in both the retail and the manufacturing and wholesale segments, which was partially offset by approximately Euro 34.9 million (equivalent to 0.9 percent) in negative currency fluctuations between the Euro, which is our reporting currency, and other currencies in which we conduct our business, including the U.S. dollar and the Australian dollar. After the effect of currency fluctuations, the manufacturing and wholesale segment had an increase in net sales to third parties of approximately Euro 307.0 and the retail segment had an increase in net sales to third parties of approximately Euro 234.9 million. Currency fluctuations offset the net sales for the manufacturing and wholesale segment by approximately Euro 1.9 million and by approximately Euro 33.0 million for the retail segment.
Net sales in the retail segment increased by 7.6 percent to Euro 3,294.2 million for 2006 from Euro 3,061.7 million in 2005. Euro 208.1 million of this increase was attributable to the positive performance of the North American retail operations primarily due to: (i) a 7.1 percent increase in same-store sales; and (ii) the addition of U.S.$ 26.7 million in sales from the approximately 70 new Canadian retail outlets which were acquired in June 2006, which was partially offset by a negative exchange rate effect of Euro 25.0 million. An additional Euro 20.2 million of the increase was attributable to an increase in net sales in the Asia-Pacific retail business, primarily due to Euro 11.3 million in additional net sales contributed by the newly acquired stores in China.
Net sales to third parties in the manufacturing and wholesale segment increased by 28.6 percent to Euro 1,382.0 million for 2006 as compared to Euro 1,075.0 million in 2005. This increase was mainly attributable to increased sales of our Ray-Ban brand as well as the continued success of sales of branded products of our designer lines, such as Prada and Bvlgari, and the continued development of new branded products such as Dolce & Gabbana (which we began distributing in October 2005). These increases occurred primarily in the European and North American markets, which account for approximately 78.5 percent of our net sales to third parties in our manufacturing and wholesale segment.
On a geographic basis, combined retail and manufacturing and wholesale operations in the United States and Canada resulted in net sales of Euro 3,076.4 million in 2006, comprising 65.8 percent of total net sales and an increase of Euro 264.5 million or 9.4 percent as compared to 2005. Net sales for operations in Asia-Pacific were Euro 498.4 million during 2006 as compared to Euro 461.2 million in 2005, which represented an 8.1 percent increase in net sales. Net sales for the rest of the world accounted for the remaining Euro 1,101.4 million of net sales during 2006, which represented a 27.9 percent increase in net sales as compared to 2005. The increase in the rest of the world was primarily attributable to strong performance in almost all major European markets that led to an increase in sales of Euro 190.4 million in 2006 as compared to 2005.
During 2006, net sales in the retail segment accounted for approximately 70.4 percent of total net sales, as compared to approximately 74.0 percent of net sales in 2005. This decrease in retail net sales as a percentage of total net sales is attributable to a significant increase in net sales to third parties in our manufacturing and wholesale segment, which grew by 28.6 percent in 2006.
Cost of Sales. Cost of sales increased by 8.3 percent to Euro 1,426.0 million in 2006, from Euro 1,316.7 million in 2005, primarily attributable to our overall sales growth. As a percentage of net sales, cost of sales decreased to 30.5 percent from 31.8 percent. This decrease as a percentage of net sales was primarily attributable to the change in sales mix resulting from increased sales of our Ray-Ban brand and sales of branded products of our designer lines, Prada, Bvlgari and Dolce & Gabbana, which carry a higher gross margin than other lines, increased efficiency in our manufacturing facilities leveraging the fixed cost structure to produce more frames, and increased production to cover the additional demand for our products. In 2006, the average number of frames produced daily in Luxotticas facilities was approximately 153,000 as compared to 115,000 for the same period of 2005, attributable to increased production in the Tristar facility, as well as improved productivity in our Italian factories.
Gross Profit. For the reasons described above, gross profit increased by 15.4 percent to Euro 3,250.2 million in 2006 from Euro 2,817.6 million in 2005. As a percentage of net sales, gross profit increased to 69.5 percent in 2006 from 68.2 percent in 2005, primarily due to the increase in gross profit of the manufacturing and wholesale segment.
Operating Expenses. Total operating expenses increased by 11.5 percent to Euro 2,494.2 million in 2006 from Euro 2,236.2 million in 2005. As a percentage of net sales, operating expenses decreased to 53.3 percent in 2006 from 54.1 percent in 2005 primarily attributable to the increase in net sales while maintaining strong cost controls in both our manufacturing and wholesale and our retail segments.
Selling and advertising expenses (including royalty expenses) increased by 10.9 percent to Euro 1,967.0 million in 2006, from Euro 1,774.2 million in 2005, primarily due to increased net sales. As a percentage of net sales, selling and advertising expenses decreased to 42.1 percent in 2006 from 42.9 percent in 2005, primarily attributable to a reduced commissions percentage relative to sales earned by the wholesale sales force and to lower store costs in the North American retail business leveraging the fixed cost store structure by an increase in same store sales. As we integrate the newly acquired stores in both Canada and China, we expect to further realize a reduction in selling expenses as a percentage of sales.
General and administrative expenses, including intangible asset amortization, increased by 14.1 percent to Euro 527.1 million in 2006 from Euro 462.0 million in 2005. This includes approximately Euro 48.0 million of expense relating to stock options expensed in accordance with SFAS No. 123(R), which we adopted on January 1, 2006, as compared to Euro 22.7 million in 2005 (calculated according to APB 25). As a percentage of net sales, general and administrative expenses increased to 11.3 percent in 2006 from 11.2 percent in 2005.
Income from Operations. For the reasons described above, income from operations for 2006 increased by 30.0 percent to Euro 756.0 million from Euro 581.4 million in 2005. As a percentage of net sales, income from operations increased to 16.2 percent in 2006 from 14.1 percent in 2005.
Operating margin, which is income from operations divided by net sales, in the manufacturing and wholesale segment increased to 26.0 percent in 2006 from 23.2 percent in 2005. This increase in operating margin is attributable to lower sales commissions as a percentage of sales and higher gross profit due to a more favorable brand mix, partially offset by higher advertising expenses (including royalty expenses).
Operating margin in the retail segment increased to 13.1 percent in 2006 from 11.6 percent in 2005. This increase in operating margin is attributable to lower store costs in the North American retail business, as well as increased net sales in the North American retail business due to the fixed cost store structure.
Other Income (Expense)-Net. Other income (expense)-net was Euro (77.8) million in 2006 as compared to Euro (42.1) million in 2005. This increase in other income (expense)-net is mainly attributable to net realized and unrealized foreign exchange transaction and remeasurement losses in 2006 as compared to gains on similar items in 2005. Net interest expense was Euro 60.8 million in 2006 as compared to Euro 60.5 million in 2005 attributable to an increase in interest rates which offset a decrease in outstanding indebtedness.
Net Income from Continuing Operations. Income before taxes increased by 25.7 percent to Euro 678.2 million in 2006 from Euro 539.3 million in 2005. As a percentage of net sales, income before taxes increased to 14.5 percent in 2006 from 13.0 percent in 2005. Minority interest decreased to Euro 8.7 million in 2006 from Euro 9.3 million in 2005. The Companys effective tax rate was 35.2 percent in 2006, as compared to 37.0 percent in 2005 due to a reduction in taxes in foreign jurisdictions. The most significant portion of the benefit is due to the adoption in Australia of a consolidated tax regime, which resulted in an increase in the tax basis of certain assets. We have completed our evaluation of the impact of adoption of FIN 48, Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109. See Income Taxes above for a more detailed discussion.
Net income from continuing operations increased by 30.2 percent to Euro 430.7 million in 2006 from Euro 330.8 million in 2005. Net income from continuing operations as a percentage of net sales increased to 9.2 percent in 2006 from 8.0 percent in 2005.
Basic earnings per share from continuing operations for 2006 were Euro 0.95 as compared to Euro 0.73 in 2005. Diluted earnings per share from continuing operations for 2006 were Euro 0.94 as compared to Euro 0.73 in 2005.
Discontinued Operations. Discontinued operations resulted in income in 2005 and a loss in 2006 mainly attributable to the seasonal nature of the operations of the Things Remembered discontinued business, which results in substantially all operational profits being realized during the fourth quarter. The operations were sold before the fourth quarter of 2006. In addition, the sale resulted in an accrual recorded by the Company for a potential tax liability.
Net Income. Net income increased by 24.0 percent to Euro 424.3 million in 2006 from Euro 342.3 million in 2005. Net income as a percentage of net sales increased to 9.1 percent in 2006 from 8.3 percent in 2005.
Basic earnings per share for 2006 were Euro 0.94 as compared to Euro 0.76 in 2005. Diluted earnings per share for 2006 were Euro 0.93 as compared to Euro 0.76 in 2005.
Net Sales. Net sales increased 30.0 percent to Euro 4,134.3 million during 2005 as compared to Euro 3,179.6 million for 2004. Net sales in the retail segment, through LensCrafters, Sunglass Hut, OPSM and Cole, increased by 34.8 percent to Euro 3,061.7 million for 2005 from Euro 2,271.0 million for 2004. This increase was primarily due to the inclusion of Cole sales from the date of acquisition on October 4, 2004, which amounted to Euro 761.5 million for the full fiscal year 2005 compared to Euro 164.8 million for the three-month period following the acquisition in 2004.
Net sales to third parties in the manufacturing and wholesale segment increased by 18.3 percent to Euro 1,075.0 million for 2005 as compared to Euro 908.6 million in 2004. This increase was mainly attributable to increased sales of our Ray-Ban brand, as well as Prada, Versace, Bulgari and Dolce & Gabbana (which we began distributing in October 2005). Wholesale sales were strong in all geographic areas.
On a geographic basis net of intercompany transactions, operations in North America resulted in net sales of Euro 2,811.9 million during 2005, comprising 68.0 percent of total net sales, an increase of Euro 804.1 million from 2004. This increase was primarily due to the inclusion of Cole sales from the date of acquisition on October 4, 2004, which amounted to Euro 761.5 million for the full fiscal year 2005 compared to Euro 164.8 million for the three-month period following the acquisition in 2004. This sales increase was mostly driven by our focus on selling premium frames and products at both our Sunglass Hut and LensCrafters North American retail outlets. This focus included the remodeling, opening or relocation of over 250 Sunglass Hut outlets. Net sales for operations in Asia-Pacific, which consists of Australia, New Zealand, Singapore, Malaysia, Hong Kong, Thailand, China, Japan and Taiwan, were Euro 461.2 million during 2005, comprising 11.2 percent of total net sales, an increase of Euro 26.2 million as compared to 2004. Net sales for the rest of the world accounted for the remaining Euro 861.2 million of net sales during 2005, which represented a 16.9 percent increase as compared to 2004.
During 2005, net sales in the retail segment accounted for approximately 74.0 percent of total net sales, as compared to approximately 71.4 percent of total net sales in 2004 due to the retail acquisition described above.
Cost of Sales. Cost of sales increased by 29.3 percent to Euro 1,316.7 million in 2005 from Euro 1,018.6 million in 2004. Cost of sales in the retail segment increased by Euro 273.5 million, which increase is primarily attributable to the inclusion of Cole in our results of operations for three months in 2004 compared to a full 12 months in 2005. Cost of sales in the manufacturing and wholesale segment increased by Euro 68.6 million due to the increase in net sales. As a percentage of net sales, cost of sales decreased to 31.8 percent from 32.0 percent. This was mostly attributable to the placement of more Luxottica manufactured products in our newly acquired Cole retail locations. Manufacturing labor costs increased by 17.3 percent to Euro 301.3 million in 2005 from Euro 256.9 million in 2004. This increase is attributable to the increase in net sales. As a percentage of net sales, cost of labor decreased to 7.3 percent in 2005 from 8.1 percent in 2004, due to higher productivity in the wholesale division, as well as due to the inclusion of Cole results, since Coles cost of labor as a percentage of sales is lower than that of the rest of the Group. For 2005, the average number of frames produced daily in our facilities (including Tristar, our Chinese factory) was approximately 125,000, which was in line with 2004 production.
Gross Profit. For the reasons outlined above, gross profit increased by 30.4 percent to Euro 2,817.6 million in 2005, from Euro 2,161.0 million in 2004. As a percentage of net sales, gross profit increased to 68.2 percent in 2005 from 68.0 percent in 2004.
Operating Expenses. Total operating expenses increased by 33.0 percent to Euro 2,236.2 million in 2005 from Euro 1,681.5 million in 2004. As a percentage of net sales, operating expenses increased to 54.1 percent in 2005 from 52.9 percent in 2004.
Selling and advertising expenses, including royalty expenses, increased by 32.1 percent to Euro 1,774.2 million during 2005 from Euro 1,343.0 million in 2004. Euro 297.4 million of this increase is attributable to the inclusion of Cole in our results of operations for the full fiscal year in 2005 compared to only the fourth quarter of 2004 (from the date of acquisition). As a percentage of net sales, selling and advertising expenses increased to 42.9 percent in 2005 from 42.2 percent in 2004. This increase as a percentage of sales is primarily attributable to the consolidation of Coles results in our results of operations.
General and administrative expenses, including intangible asset amortization, increased by 36.5 percent to Euro 462.0 million in 2005 from Euro 338.5 million in 2004. Euro 81.0 million of this increase is attributable to the inclusion of Cole in our results of operations for the full fiscal year in 2005 compared to only the fourth quarter of 2004 (from the date of acquisition). As a percentage of net sales, general and administrative expenses increased to 11.2 percent in 2005 from 10.6 percent in 2004. This increase was primarily due to the consolidation of Cole results in our results of operations. As we continue the integration of Cole, we expect its operating expenses as a percentage of sales to decrease due to the expected higher efficiency in the fixed cost structure.
Income from Operations. For the reasons outlined above, income from operations for 2005 increased by 21.3 percent to Euro 581.4 million from Euro 479.5 million in 2004. As a percentage of net sales, income from operations decreased to 14.1 percent in 2005 compared to 15.1 percent for 2004.
Operating margin, calculated as income from operations divided by net sales, in the manufacturing and wholesale distribution segment increased to 23.2 percent in 2005 from 21.3 percent in 2004. This increase in operating margin is attributable to higher efficiency in our fixed cost structure driven by increases in net sales and lower sales commissions, partially offset by higher advertising expenses.
Operating margin in the retail segment decreased to 11.6 percent in 2005 from 13.1 percent in 2004, due to the inclusion of the results for Cole, whose operating margin is lower than that of our other retail chains. However, we believe that when the final restructuring of the North American Retail Division is completed by the end of 2006, we will return to our historical operating margins.
Other Income (Expense)-Net. Other income (expense)-net was a net expense of Euro 42.1 million in 2005 as compared to a net expense of Euro 34.9 million in 2004. This increase in other income (expense)-net is mainly attributable to an increase in interest expense of Euro 11.2 million due to the debt incurred for the acquisition of Cole, as well as rising interest rates. We expect an increase in interest expense for 2006 due to the rising interest rate environment.
Net Income from Continuing Operations. Income before taxes increased by 21.3 percent to Euro 539.3 million in 2005 from Euro 444.6 million in 2004. As a percentage of net sales, income before taxes decreased to 13.0 percent in 2005 from 14.0 percent in 2004, mainly due to the integration of the Cole operations. Minority interest increased to Euro (9.3) million in 2005 from Euro (8.6) million in 2004. Our effective tax rate was 37.0 percent in 2005, while it was 35.4 percent in 2004. Net income increased by 18.5 percent to Euro 330.8 million in 2005 from Euro 279.1 million in 2004. Net income from continuing operations as a percentage of net sales decreased to 8.0 percent in 2005 from 8.8 percent in 2004.
Basic earnings per share from continuing operations for 2005 were Euro 0.73, increasing from Euro 0.62 for 2004. Diluted earnings per share from continuing operations for 2005 were Euro 0.73 increasing from Euro 0.62 for 2004.
Discontinued Operations. Discontinued operations resulted in income of Euro 11.5 million in 2005, as compared to Euro 7.8 million in 2004. The increase was due to the consolidation of the Things Remembered operations only for three months in 2004 because the acquisition date occurred on October 4, 2004.
Net Income. Net income increased by 19.3 percent to Euro 342.3 million in 2005 from Euro 286.9 million in 2004. Net income as a percentage of net sales decreased to 8.3 percent in 2005 from 9.0 percent in 2004.
Basic earning per share for 2005 were Euro 0.76, increasing from Euro 0.64 for 2004. Diluted earnings per share for 2005 were Euro 0.76, increasing from Euro 0.64 for 2004.
Our effective tax rates for the years ended December 31, 2004, 2005 and 2006 were approximately 35.4 percent, 37.0 percent and 35.2 percent, respectively. The 2004 effective tax rate was less than the statutory tax rate due to permanent differences between our income for financial reporting and tax purposes which reflect the net loss carry-forward caused by the prior funding of subsidiary losses through capital contributions that are deductible for income tax purposes under Italian law, and the reduction in certain investments in subsidiaries. Such subsidiary losses were primarily attributable to the amortization of certain intangible assets associated with our acquisitions. This remaining net loss carry-forward was completely utilized in 2004. For fiscal 2005 we received a net permanent benefit caused by the Company complying with an Italian law that allows for the step up in tax basis of certain intangible assets for which this benefit offset the aggregate effect of different rates in foreign jurisdictions. For fiscal 2006 the tax rate includes the results from the adoption of a change in the tax law in Australia, which introduced a tax consolidation regime for wholly owned group entities. The tax consolidation rules effectively pushed down the cost of acquiring an entity (or group of entities) to the assets that the entity (or group) owns. This results in the resetting of the cost basis of the assets for tax purposes and, for OPSM, in the related increases in fixed assets and intangibles as of the date of tax consolidation in December 2006, when OPSM filed its consolidated 2005 tax return, providing a one time permanent benefit to the tax provision.
Operating Activities. The Companys cash provided by operating activities was Euro 603.3 million, Euro 605.7 million and Euro 508.3 million for 2006, 2005 and 2004, respectively. The Euro 2.4 million decrease in 2006 as compared to 2005 was primarily attributable to increased net income, partially offset by advance payments made by the Company to certain designers for future contracted minimum royalties, increases in accounts receivable and inventory and tax payments to comply with an Italian tax law allowing for the step-up in tax basis of certain intangible assets. The Euro 97.5 million increase in 2005 as compared to 2004 was primarily attributable to increased net income and additional depreciation and amortization resulting from the Cole acquisition, including Euro 17.3 million relating to the amortization of its intangible assets.
Depreciation and amortization were Euro 220.8 million in 2006 as compared to Euro 184.6 million in 2005. This increase was primarily attributable to increased fixed assets. Deferred taxes were Euro 72.5 million in 2006 as compared to Euro 91.3 million in 2005. This decrease was primarily attributable to the fact that deferred taxes in 2006 included a benefit due to the revaluation of certain tangible and intangible assets in the retail division in Australia, while in 2005 it included the effect of the adoption of an Italian tax law allowing for the step-up in tax basis of certain intangible assets. Non-cash stock-based compensation expenses were Euro 47.9 million in 2006 as compared to Euro 22.7 million in 2005. This increase was primarily attributable to the adoption of SFAS 123(R) for stock compensation expense on two new Company stock option performance plans implemented in July 2006. The use of cash associated with accounts receivable was Euro 83.1 million in 2006 as compared to Euro 33.6 million in 2005. The increase in accounts receivable balances, thus a use of cash, was primarily attributable to the increase in sales of our manufacturing and wholesale segment. Prepaid expenses and other was a source of cash of Euro 8.6 million in 2006, as compared to a use of cash of Euro 56.7 million in 2005, primarily attributable to advance payments of Euro 30.0 million made in 2005 by us to certain of our licensors and the timing of certain tax payments by foreign subsidiaries in 2005. Inventories were a use of cash in 2006 of Euro 27.7 million in 2006 compared to a source of cash of Euro 66.5 million in 2005, primarily attributable to growing inventory level to support the business. Cash provided by operating activities for accounts payable increased by Euro 26.4 million in 2006 as compared to the same period of 2005. The increase was primarily attributable to improved timing of payments. Cash provided by operating activities for accrued expenses decreased by Euro 6.7 million in 2006 as compared to the same period of 2005. The decrease was primarily attributable to a termination of sales of the retail divisions priced extended warranty contracts with terms of coverage of 12 months to 24 months in 2005. Income tax payable was a source of cash in 2006 of Euro 5.9 million as compared Euro 126.7 million for 2005. This decrease was primarily attributable to timing of tax payments, and to increased accruals for income taxes in 2005 due to the adoption of an Italian tax law to be paid in cash during fiscal 2006.
Investing Activities. The Companys cash used in investing activities was Euro 263.7 million, Euro 166.4 million and Euro 479.7 million in 2006, 2005 and 2004, respectively. The Euro 97.3 million increase in 2006 as compared to 2005 was primarily attributable to acquisitions of businesses and capital expenditures. In 2006, the Companys acquisitions of businesses were Euro 134.1 million, net of cash acquired, and included Shoppers Optical, a Canadian-based optical chain, for approximately Euro 48.7 million, Beijing Xueliang Optical Technology Co. Ltd. for approximately Euro 17.0 million, the remaining 49 percent stake of the Turkish-based distributor Luxottica Gozluk Ticaret A.S. for approximately Euro 11.7 million, Ming Long Optical for approximately Euro 29.0 million, and Modern Sight Optics for approximately Euro 14.0 million. Such increase was partially offset by the sale of Things Remembered, a specialty gifts retail business previously included in the North American retail division, with net proceeds of Euro 128.0 million. In 2005, the Company acquired the remaining minority stake of OPSM for Euro 61.9 million and also completed two asset acquisitions by the North American retail division for an aggregate amount of Euro 11.1 million and the acquisition of 27 stores in Canada for approximately Euro 13.8 million. These uses of cash from investing activities were partially offset by the sale of Pearle Europe, with net proceeds of Euro 144 million. The Euro 313.3 million decrease in 2005 as compared to 2004 was primarily attributable to the Cole acquisition in 2004, for an aggregate amount of Euro 363.0 million, net of cash acquired and including direct acquisition-related expenses.
Our capital expenditures were Euro 272.2 million in 2006 as compared to Euro 220.0 million in 2005. This increase was primarily attributable to the investment in manufacturing facilities for the wholesale division and the opening, remodeling and relocation of stores in the retail division, in addition to the costs associated with the expansion of the North American retail divisions home office. Capital expenditures were Euro 53.5 million in the three-month period ended March 31, 2007. It is our expectation that 2007 annual capital expenditures will be approximately Euro 300.0 million, in addition to
investments for any acquisitions. We will pay for these future capital expenditures with our currently available borrowing capacity and available cash.
Cash received from disposals of property, plant and equipment was Euro 21.6 million in 2006 as compared to Euro 1.0 million in 2005. This increase in cash provided by the disposal of fixed assets is primarily attributable to the sale of an obsolete aircraft in October 2006 for a net price of Euro 15.6 million, the sale of unused manufacturing facilities in the wholesale division in Italy and a building in the United Kingdom. Acquisitions of intangible assets resulted in a use of cash of Euro 1.1 million in 2006 compared to Euro 4.5 million in 2005.
Financing Activities. The Companys cash used in financing activities was Euro 349.9 million, Euro 350.0 million and Euro 67.5 million in 2006, 2005 and 2004, respectively. Cash used in financing activities in 2006 consisted primarily of the proceeds of Euro 84.1 million from long-term debt which were used to partially repay Euro 215.3 million of long-term debt. Cash used in financing activities for 2005 consisted primarily of net long term repayments on maturing debt of approximately Euro 254.4 million. Dividends paid to the Companys shareholders in 2006 and 2005 were Euro 131.4 million and Euro 103.5 million, respectively. In 2004, our cash used in financing activities consisted primarily of: (i) the net proceeds of Euro 88.6 million from all the credit facilities and (ii) Euro 446.9 million of proceeds of Tranche B and Tranche C of the credit facility, which we used in connection with the acquisition of Cole, including the repayment of Coles existing notes. We borrowed Euro 405.0 million in June 2004 (consisting of the proceeds of Tranche A of the credit facility) to repay Euro 400.0 million of long-term debt. Additionally, we used cash provided by financing activities to reduce bank overdrafts and to pay Euro 94.1 million of dividends to our shareholders.
Our debt agreements contain certain covenants, including covenants that restrict our ability to incur additional indebtedness. We do not currently expect to require any additional financing that would require us to obtain consents or waivers of any existing restrictions on additional indebtedness set forth in our debt agreements.
Our credit facilities contain certain financial covenants including ratios of Net Financial Position (NFP) (as defined in the agreements) to shareholders equity, NFP to EBITDA (earnings before interest, taxes and depreciation as defined in the agreements), and EBITDA to net financial charges (as defined in the agreements). As of March 31, 2007, we were in compliance with these financial covenants and we expect to continue to be in compliance in the foreseeable future periods. We believe that after giving effect to any additional financing that we may incur in connection with the announced acquisition of Oakley as discussed in Item 4 Information on the CompanyBusiness OverviewRecent DevelopmentsAcquisitions, such restrictions would not materially affect our compliance with these covenants, our ability to incur the additional debt or our future business operations.
The Company has relied primarily upon internally generated funds, trade credit and bank borrowings to finance its operations and expansion.
Bank overdrafts represent negative cash balances held in banks and amounts borrowed under various unsecured short-term lines of credit obtained by the Company and certain of its subsidiaries through local financial institutions. These facilities are usually short-term in nature or contain evergreen clauses with a cancellation notice period. Certain of these subsidiaries agreements require a guaranty from Luxottica Group S.p.A. Interest rates on these lines vary based on the country of borrowing, among other factors. The Company uses these short-term lines of credit to satisfy its short-term cash needs.
Group total indebtedness was Euro 1,487.6 million as of December 31, 2006. Available additional borrowings under credit facilities as of such date were Euro 1,137.1 million.
The U.S.$350 Million Credit Facility with UniCredito Italiano and the Convertible Swap Step-Up
To refinance previously issued Eurobonds, in June 2002, U.S. Holdings, a U.S. subsidiary, entered into a U.S.$350 million credit facility with a group of four Italian banks led by UniCredito Italiano S.p.A. The term loan portion of the credit facility provided U.S.$200 million of borrowing and required equal quarterly principal installments beginning in March 2003. The revolving loan portion of the credit facility allowed for maximum borrowings of U.S.$150 million. Interest accrued under the credit facility at LIBOR (as defined in the agreement) plus 0.5 percent and the credit facility allowed U.S.
Holdings to select interest periods of one, two or three months. The credit facility contained certain financial and operating covenants. The credit facility was guaranteed by Luxottica Group S.p.A. and matured in June 2005, and at such time we repaid in full all of the outstanding amounts under this credit facility.
In July 2002, U.S. Holdings entered into a Convertible Swap Step-Up (2002 Swap). The beginning and maximum notional amount of 2002 Swap was U.S.$275 million, which decreased by U.S.$20 million quarterly, beginning with the quarter commencing on March 17, 2003. The 2002 Swap was entered into to convert the floating rate credit agreement referred to in the preceding paragraph to a mixed position rate agreement by allowing U.S. Holdings to pay a fixed rate of interest if LIBOR remains under certain defined thresholds and for U.S. Holdings to receive an interest payment at the three-month LIBOR rate as defined in the agreement. These amounts were settled net every three months until the final expiration of the 2002 Swap which occurred on June 17, 2005. The 2002 Swap did not qualify for hedge accounting under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended, and, as such, was marked to market with the gains or losses from the change in value reflected in current operations. Marked to market gains of Euro 1.491 million are included in current operations in 2004, while in 2005 we recognized a loss of Euro 0.163 million in current operations.
The Euro 650 Million Credit Facility with Banca Intesa and the Intesa Swaps
In December 2002, we entered into an unsecured credit facility with Banca Intesa S.p.A. The unsecured credit facility provided borrowing availability of up to Euro 650 million. The facility included a Euro 500 million term loan, which required a balloon payment of Euro 200 million in June 2004 and repayment of equal quarterly installments of principal of Euro 50 million subsequent to that date. The revolving portion provided borrowing availability of up to Euro 150 million which could be borrowed and repaid until final maturity. Interest accrued on the both the term and revolving loan at Euribor as defined in the agreement plus 0.45 percent. The final maturity of all outstanding principal amounts and interest was December 27, 2005 and at such time we repaid in full all of the outstanding amounts under this credit facility.
In December 2002, we entered into two interest rate swap transactions (the Intesa Swaps) beginning with an aggregate maximum notional amount of Euro 250 million, which decreased by Euro 100 million on June 27, 2004 and by Euro 25 million during each subsequent three-month period. These Intesa Swaps expired on December 27, 2005. The Intesa Swaps were entered into as a cash flow hedge of a portion of the Banca Intesa Euro 650 million unsecured credit facility discussed above. The Intesa Swaps exchanged the floating rate based on Euribor to a fixed rate of 2.985 percent.
The U.S.$300 Million Senior Unsecured Guaranteed Notes and the DB Swaps
On September 3, 2003, Luxottica U.S. Holdings Corp. (U.S. Holdings) closed a private placement of U.S.$300 million of senior unsecured guaranteed notes (the Notes), issued in three series (Series A, Series B and Series C). Interest on the Series A Notes accrues at 3.94 percent per annum and interest on each of the Series B and Series C Notes accrues at 4.45 percent per annum. The Series A and Series B Notes mature on September 3, 2008 and the Series C Notes mature on September 3, 2010. The Series A and Series C Notes require annual prepayments beginning on September 3, 2006 through the applicable dates of maturity. The Notes are guaranteed on a senior unsecured basis by the Company and Luxottica S.r.l., the Companys wholly owned subsidiary. The Notes can be prepaid at U.S. Holdings option under certain circumstances. The proceeds from the Notes were used for the repayment of outstanding debt and for other working capital needs. The Notes contain certain financial and operating covenants. As of December 31, 2006, the Company was in compliance with all of its applicable covenants, including calculations of financial covenants when applicable.
In connection with the issuance of the Notes, U.S. Holdings entered into three interest rate swap agreements with Deutsche Bank AG (collectively, the DB Swap). The three separate agreements notional amounts and interest payment dates coincide with those of the Notes. The DB Swap exchanged the fixed rate of the Notes for a floating rate of the six-month LIBOR rate plus 0.66 percent for the Series A Notes and the six-month LIBOR rate plus 0.73 percent for the Series B and Series C Notes. U.S. Holdings terminated all three agreements comprising the DB Swap in December 2005.
The OPSM Acquisition and the Euro 200 Million Credit Facility with Banca Intesa and Related Interest Rate Swaps
In September 2003, the Company entered into a new credit facility with Banca Intesa S.p.A. of Euro 200 million. The credit facility includes a Euro 150 million term loan, which will require repayment of equal semi-annual installments of principal of Euro 30 million starting September 30, 2006 until the final maturity date. Interest accrues on the term loan at Euribor (as defined in the agreement) plus 0.55 percent (4.27 percent on December 31, 2006). The revolving loan provides borrowing availability of up to Euro 50 million; amounts borrowed under the revolving portion can be borrowed and repaid until final maturity. As of December 31, 2006, Euro 25 million had been drawn from the revolving portion. Interest accrues on
the revolving loan at Euribor (as defined in the agreement) plus 0.55 percent (4.10 percent on December 31, 2006). The final maturity of the credit facility is September 30, 2008. The Company can select interest periods of one, two or three months. The credit facility contains certain financial and operating covenants. As of December 31, 2006, the Company was in compliance with all of its applicable covenants, including calculations of financial covenants when applicable. Under this credit facility, Euro 145 million was outstanding as of December 31, 2006.
In June 2005, the Company entered into four interest rate swap transactions with various banks with an aggregate initial notional amount of Euro 120 million, which will decrease by Euro 30 million every six months starting on March 30, 2007 (Intesa OPSM Swaps). These swaps expire on September 30, 2008. The Intesa OPSM Swaps were entered into as a cash flow hedge on a portion of the Banca Intesa Euro 200 million unsecured credit facility discussed above. The Intesa OPSM Swaps exchange the floating rate of Euribor for an average fixed rate of 2.38 percent per annum.
Amended and Restated Euro 1,130 Million and U.S.$325 Million Credit Facility and Related Interest Rate Swaps
On June 3, 2004, the Company and U.S. Holdings entered into a new credit facility with a group of banks providing for loans in the aggregate principal amount of Euro 740 million and U.S.$325 million. The facility consists of three tranches (Tranche A, Tranche B and Tranche C). On March 10, 2006, this agreement was amended to increase the available Tranche C borrowings to Euro 725 million, decrease the interest margin and define a new maturity date of five years from the date of the amendment for Tranche B and Tranche C. Tranche A is a Euro 405 million amortizing term loan requiring repayment of nine equal quarterly installments of principal of Euro 45 million beginning in June 2007, which is to be used for general corporate purposes, including the refinancing of existing Luxottica Group S.p.A. debt as it matures. Tranche B is a term loan of U.S.$325 million which was drawn upon on October 1, 2004 by U.S. Holdings to finance the purchase price for the acquisition of Cole National. Amounts borrowed under Tranche B will mature in March 2011. Tranche C is a revolving credit facility of Euro 725 million-equivalent multi-currency (Euro/U.S. dollar). Amounts borrowed under Tranche C may be repaid and reborrowed with all outstanding balances maturing in March 2011. On December 31, 2006, U.S.$190 million (Euro 144.0 million) had been drawn from Tranche C by U.S. Holdings and Euro 100 million by Luxottica Group S.p.A. The Company can select interest periods of one, two, three or six months with interest accruing on Euro-denominated loans based on the corresponding Euribor rate and U.S. dollar denominated loans based on the corresponding LIBOR rate, both plus a margin between 0.20 percent and 0.40 percent based on the Net Debt/EBITDA ratio, as defined in the agreement. The interest rate on December 31, 2006 was 3.97 percent for Tranche A, 5.62 percent for Tranche B, 5.60 percent on Tranche C amounts borrowed in U.S. dollars and 3.96 percent on Tranche C amounts borrowed in Euro. This credit facility contains certain financial and operating covenants. The Company was in compliance with those covenants as of December 31, 2006. Under this credit facility, Euro 895.2 million was outstanding as of December 31, 2006. In February 2007, we exercised an option included in the amendment to extend the maturity date of Tranches B and C to March 2012. For additional information, see Note 9 to our Consolidated Financial Statements included in Item 18 of this annual report.
In June 2005, the Company entered into nine interest rate swap transactions with an aggregate initial notional amount of Euro 405 million with various banks which will decrease by Euro 45 million every three months starting on June 3, 2007 (Club Deal Swaps). These swaps expire on June 3, 2009. The Club Deal Swaps were entered into as a cash flow hedge on Tranche A of the credit facility discussed above. The Club Deal Swaps exchange the floating rate of Euribor for an average fixed rate of 2.40 percent per annum.
Australian Dollar 30 Million Credit Facility
In August 2004, OPSM re-negotiated its multicurrency (AUD/HKD) loan facility with Westpac Banking Corporation. The credit facility had a maximum available line of AUD 100 million, which was reduced to AUD 50 million in September 2005. This facility expired on August 31, 2006. After negotiations, the credit facility was renewed for AUD 30 million and expires on August 31, 2007. The interest rate margin has been reduced to 0.275 percent. For borrowings denominated in Australian dollars, the interest accrues on the basis of BBR (Bank Bill Rate), and for borrowings denominated in Hong Kong dollars the rate is based on HIBOR (HK Interbank Offered Rate) plus an overall 0.275 percent margin. At December 31, 2006, the interest rate was 4.39 percent on the borrowings denominated in Hong Kong dollars and is payable monthly in arrears. The facility was utilized for an amount of HKD 125.0 million (AUD 20.2 million) and there was no drawdown in Australian dollars. The credit facility contains certain financial and operating covenants. As of December 31, 2006, the Company was in compliance with all of its applicable covenants, including calculations of financial covenants when applicable.
In December 2005, the Company entered into an unsecured credit facility with Banca Popolare di Verona e Novara Soc. Coop. a R.L. The 18-month credit facility consists of a revolving loan that provides borrowing availability of up to Euro 100 million. Amounts borrowed under the revolving portion can be borrowed and repaid until final maturity. As of March 31, 2007, Euro 60 million had been drawn and was outstanding from the revolving loan. Interest accrues on the revolving loan at
Euribor (as defined in the agreement) plus 0.25 percent (4.11 percent on March 31, 2007). The Company can select interest periods of one, three or six months. The final maturity of the credit facility was June 1, 2007. In June 2007, the Company renewed the credit facility with Banca Popolare di Verona e Novara Soc. Coop. a R.L. to replace the December 2005 credit facility that expired on June 1, 2007. The 18-month credit facility consists of a revolving loan that provides borrowing availability of up to Euro 100 million. Amounts borrowed under the revolving portion can be borrowed and repaid until final maturity. The Company can select interest periods of one, three or six months.
Our Working Capital
Set forth below is certain information regarding our Working Capital (total current assets minus total current liabilities):
The increase in working capital in 2005 reflects the repayment of maturing debt and the refinancing of current debt maturities with long-term debt. In 2006, working capital decreased due to an increase in the current portion of long-term debt scheduled to mature in 2007.
We believe that the financial resources available to us will be sufficient to meet our currently anticipated working capital and capital expenditure requirements for the next 12 months.
We do not believe that the relatively moderate rates of inflation which have been experienced in the geographic markets where we compete have had a significant effect on our net sales or profitability. In the past, we have been able to offset cost increases by increasing prices, although we can give no assurance that we will be able to do so in the future.
Off-Balance Sheet Arrangements
We have no material off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources.
We use, from time to time, derivative financial instruments, principally interest rate and currency swap agreements, as part of our risk management policy to reduce our exposure to market risks from changes in foreign exchange rates. Although we have not done so in the past, we may enter into other derivative financial instruments when we assess that the risk can be hedged effectively.
Contractual Obligations and Commercial Commitments
We are party to numerous contractual arrangements consisting of, among other things, royalty agreements with designers, leases for retail store, plant, warehouse and office facilities, as well as certain data processing and automotive equipment, and outstanding borrowings under credit agreements and facilities with financial institutions to finance our operations. These contractual arrangements may contain minimum annual commitments. A more complete discussion of the obligations and commitments is included in Notes 9 and 15 to our Consolidated Financial Statements included in Item 18 of this annual report.
The following table summarizes the scheduled maturities of our long-term debt, minimum lease commitments under noncancelable operating leases and minimum payments under noncancelable royalty arrangements as of December 31, 2006. The table does not include pension liabilities. Our pension plans are discussed in Note 10 to our Consolidated Financial Statements included in Item 18 of this annual report.
(1) As described previously, our long-term debt has certain financial and operating covenants that may cause the acceleration of future maturities if we do not comply with them. We were in compliance with these covenants as of December 31, 2006. In addition, the above table does not take into account the February 2007 extension of our Amended Euro 1,130 Million and U.S.$325 Million Credit Facility as described above.
(2) These amounts do not include interest payments due under our various revolving credit facilities as the amounts to be borrowed in future years are uncertain at this time. In addition, interest rates used to calculate the future interest due on our variable interest rate term loans were calculated based on the interest rate as of December 31, 2006 and assume that we make all scheduled principal payments as they mature.
At December 31, 2006, we had available funds of approximately Euro 581.1 million under our unused short-term lines of credit. Substantially all of these lines are for less than one year but they have been renewed annually in prior years. In addition, certain U.S. subsidiaries obtained various letters of credit from banks outstanding of Euro 36.1 million as of December 31, 2006. Most of these letters of credit are used as security in risk management contracts or store leases. Most contain annual evergreen clauses under which they are automatically renewed unless the bank is notified of non-renewal. As of December 31, 2006, substantially all of our outstanding letters of credit mature within one year.
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
Directors and Senior Management
The Board of Directors of Luxottica Group S.p.A. currently consists of 14 members.
The current term of the Board of Directors expires at the time of the approval of the statutory financial statements as of and for the year ended December 31, 2008.
Set forth below is certain information regarding the directors and senior management of Luxottica Group S.p.A. as of December 31, 2006, except as otherwise specified: