Luxottica Group, S.p.A. 20-F 2008
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission file number 1-10421
LUXOTTICA GROUP S.p.A.
(Exact name of Registrant as specified in its charter)
(Translation of Registrants name into English)
REPUBLIC OF ITALY
(Jurisdiction of incorporation or organization)
VIA C. CANTÙ 2, MILAN 20123, ITALY
(Address of principal executive offices)
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.
Yes x No o
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.
Yes o No x
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.
Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.
x Large accelerated filer o Accelerated filer o Non-accelerated filer
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
If Other has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.
Item 17 o Item 18 o
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).
Yes o No x
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 ability to successfully integrate Oakleys operations, the ability to realize expected synergies from the merger with Oakley, 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 other 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, Group, 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 for periods prior to our acquisition of Oakley, Inc. (Oakley) on November 14, 2007. References to Luxottica, Company, Group, we, us and our, for periods after such acquisition are to Luxottica Group S.p.A. and its consolidated subsidiaries, including Oakley and its subsidiaries, unless otherwise indicated or the context otherwise requires. References to Oakley for periods prior to the acquisition refer to Oakley and its consolidated subsidiaries, unless otherwise indicated or the context otherwise requires.
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.
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, 2007, 2006 and 2005, and the selected consolidated balance sheet data as of December 31, 2007 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, 2004 and 2003, and the selected consolidated balance sheet data as of December 31, 2005, 2004 and 2003, 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.$1.4603, based on the Noon Buying Rate of Euro to U.S. dollars on December 31, 2007. 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 year for which they have been shown in the table.
(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) Results of Things Remembered, our former specialty retail business, which was sold in 2006, are classified as discontinued operations and are not included in results from continuing operations.
(9) Certain amounts in prior years have been reclassified to conform to the 2007 presentation.
(10) We acquired Oakley in November 2007. Therefore, fiscal year 2007 includes operating results of Oakley for the period from and after November 14, 2007, which was the date of the closing of the Oakley acquisition.
(1) Translated for convenience at the rate of Euro 1.00 = U.S.$1.4603, based on the Noon Buying Rate of Euro to U.S. dollars on December 31, 2007. 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 2007 presentation.
(4) The current portion of long-term debt was Euro 792.6 million, Euro 359.5 million, Euro 111.0 million, Euro 405.1 million and Euro 390.9 million for the years ended December 31, 2007, 2006, 2005, 2004 and 2003, 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 ordinary meeting of shareholders. Before we may pay any dividends with respect to any fiscal year, we are required, as necessary, to set aside an amount equal to five percent of our statutory net income for such year in our legal reserve unless and until the reserve, including amounts remaining from prior years, is at least equal to one-fifth of the nominal value of our then issued share capital. Each year thereafter, such legal reserve requirement remains fulfilled so long as the reserve equals at least one-fifth of the nominal value of our issued share capital for each such year.
At our ordinary meeting of shareholders held on May 13, 2008, our shareholders approved the distribution of a cash dividend in the amount of Euro 0.49 per ordinary share. Our Board of Directors proposed, and the shareholders approved, the date of May 22, 2008 as the date for the payment of such dividend to all holders of record of our ordinary shares on May 16, 2008, 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 19, 2008, and dividends in respect of the ordinary shares represented by ADSs were paid to Deutsche Bank Trust Company Americas on May 22, 2008. Deutsche Bank Trust Company Americas converted the Euro amount of such dividend payment into U.S. dollars on May 22, 2008. The dividend amount for each ADS holder was paid commencing on May 29, 2008 to all such holders of record on May 21, 2008. 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 in the table.
(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 2007 fiscal year to U.S.$0.770 per ADS on May 22, 2008.
(5) The dividend of Euro 0.49 per ordinary share was approved by our Board of Directors on March 13, 2008 and was voted upon and approved by our shareholders at the ordinary meeting of shareholders held on May 13, 2008.
Exchange Rate Information
The following tables set forth, for each of the periods indicated, certain information regarding the Noon Buying Rate in New York City for cable transfers in foreign currencies as certified for customs purposes by the Federal Reserve Bank of New York, which we refer to as the Noon Buying Rate, expressed in U.S.$ 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 20, 2008, the Noon Buying Rate was U.S.$ 1.5626 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. 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.
Specifically, with regard to our acquisition of Oakley, we may face risks and uncertainties following such acquisition in addition to those outlined above, 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 loss of key employees of the acquired business; (iv) the diversion of the attention of senior management from our operations; (v) liabilities that were not known at the time of acquisition or the need to address tax or accounting issues; (vi) difficulty integrating Oakleys human resources systems, operating systems, inventory management systems and assortment planning systems with our systems; and (vii) the cultural differences between our organization and Oakleys organization.
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 realize the intended benefits of any acquisition. Even if we are able to integrate our business operations successfully, the integration may not result in the realization of the full benefits of synergies, cost
savings, innovation and operational efficiencies that may be possible from the integration or that the benefits will be achieved within the forecasted period of time.
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 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 and consumer products industries in which we operate are 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 industry is also subject to rapidly changing consumer preferences, and future sales may suffer if the fashion and consumer products industries do 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, Bvlgari, Tiffany &
Co., Versace, Versus, Salvatore Ferragamo, Burberry, Polo Ralph Lauren, Donna Karan, DKNY, Brooks Brothers, Anne Klein and, most recently, Stella McCartney and, through our acquisition of Oakley, Paul Smith Spectacles. 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 Stella McCartney 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, 2007 and 2006, the sales realized through the Prada and Miu Miu trade names together represented approximately 6.4 percent and 5.5 percent of total sales, respectively. For the year ended December 31, 2007, the sales realized through the Dolce & Gabbana and D&G trade names together represented approximately 5.5 percent of total sales. 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 profitability could suffer through a reduction of sales of our prescription eyewear products, including lenses and accessories.
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;
· disruptions of capital and trading markets;
· accounts receivable collection and longer payment cycles;
· potential hostilities and changes in diplomatic and trade relationships;
· changes in legal or regulatory requirements;
· 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 or patent applications may not in all instances result in the issuance of a registered trademark or patent, and trademarks or patents granted may not be effective in thwarting competition or be held valid 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.
Consistent with our strategy of vigorously defending our intellectual property rights, we devote substantial resources to the enforcement of patents issued and trademarks granted to us, to the protection of our trade secrets, trade dress or other intellectual property rights and to the determination of the scope or validity of the proprietary rights of others that might be asserted against us. 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. From time to time, third parties may assert patent, copyright, trademark or similar rights against intellectual property that is important to our business. The resolution or compromise of any litigation or other legal process to enforce such alleged third party rights, regardless of its merit or resolution, could be costly and divert the efforts and attention of our management. We may not prevail in any such litigation or other legal process or we may compromise or settle such claims because of the complex technical issues and inherent uncertainties in intellectual property disputes and the significant expense in defending such claims. 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, (iii) require us to discontinue the use of a particular patent, trademark, copyright or trade secret or (iv) 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. Additionally, as a U.S. government contractor through our Oakley and Eye Safety Systems subsidiaries, we must comply with, and are affected by, laws and regulations related to our performance of our government business. These laws and regulations, including requirements to obtain applicable governmental approval, clearances and certain export licenses, may impose additional costs and risks on our business. We may also be subject to audits, reviews and investigations of our compliance with these laws and regulations. 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 procedures designed to comply with Section 404 of the Sarbanes-Oxley Act of 2002 cause us to identify material weaknesses in our internal control over financial reporting, the trading price of our securities may be adversely impacted.
Commencing with last years annual report on Form 20-F, we 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, as amended. 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.
We are a world leader in the design, manufacture and distribution of prescription frames and sunglasses in the mid- and premium-price categories. 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, and with the acquisition of Oakley in November 2007, we are a designer, manufacturer and worldwide distributor of performance optics products. We operate our retail segment principally through our retail brands, which include, among others, LensCrafters, Sunglass Hut, Pearle Vision, OPSM, Laubman & Pank and our Licensed Brands (Sears Optical and Target Optical), as well as through the retail brands of our newly-acquired business, Oakley, which include, among others, Oakley Stores and Vaults, Sunglass Icon, The Optical Shop of Aspen and Bright Eyes.
Our manufacturing activities are carried out through six manufacturing facilities in Italy, two manufacturing facilities in China, one manufacturing facility in India and two manufacturing facilities in the United States obtained as part of the Oakley acquisition. In 2007, we manufactured approximately 41.8 million prescription frames and sunglasses, of which 0.8 million were attributable to the inclusion of prescription frames and sunglasses manufactured by Oakley since the acquisition date. See Item 4Information on the CompanyRecent DevelopmentsAcquisitions.
We operate our distribution activities through an extensive worldwide wholesale distribution network and a retail distribution network based primarily in North America, Europe, Australia, mainland China and Hong Kong. In 2007, through our wholesale and retail distribution networks, we distributed approximately 21.0 million prescription frames, of which approximately 0.1 million were attributable to the inclusion of prescription frames distributed by Oakley since the acquisition date, and approximately 29.0 million sunglasses, of which approximately 1.2 million were attributable to the inclusion of sunglasses distributed by Oakley since the acquisition date, in approximately 5,600 models. Our products are distributed in over 130 countries worldwide.
Our products are marketed under a variety of well-known brand names. Our house brands include Ray-Ban, Persol, Vogue, Arnette, Revo, Luxottica, Sferoflex and Killer Loop. They also include Oakley, Eye Safety Systems, Mosley Tribes and Oliver Peoples, all acquired in connection with our acquisition of Oakley. Our designer lines include Chanel, Prada, Miu Miu, Dolce & Gabbana, D&G, Bvlgari, Tiffany & Co, Versace, Versus, Salvatore Ferragamo, Burberry, Polo Ralph Lauren, Donna Karan, DKNY, Brooks Brothers, Anne Klein and Puma (distribution license only). Our designer lines also include Paul Smith Spectacles, obtained in connection with our acquisition of Oakley. Additionally, in the summer of 2009, we will launch the first collection of Stella McCartney eyewear. Stella McCartney sunglasses will be distributed through premium retail locations. After an initial launch phase during which the new collections will be distributed through Stella McCartney stores and exclusive doors in North America, Japan, Hong Kong and the Middle East, distribution will be broadened to reach all other key global eyewear markets.
Our wholesale network is comprised of 42 wholly- or majority-owned subsidiaries operating in principal markets, over 2,000 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, sporting goods and specialty sports 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. In 2007, we continued to strengthen our wholesale network with the acquisition of Oakley. See Item 4Information on the CompanyRecent DevelopmentsAcquisitions.
Our retail network is mainly comprised of the following retail brands: Sunglass Hut, which is operated globally; LensCrafters, which is operated in North America, China and Hong Kong; Pearle Vision, our Licensed Brands (Sears Optical and Target Optical), ILORI, the retail brands we acquired with Oakley (Oakley Stores and Vaults, Sunglass Icon, The Optical Shop of Aspen and Oliver Peoples) and Internet and telesales operations, which are all operated in North America; and OPSM, Laubman & Pank and Budget Eyewear, as well as the Bright Eyes stores that we acquired through the acquisition of Oakley, which are operated in Australia, New Zealand and Asia (other than China and Hong Kong). Our North American retail business is the largest optical retail business in North America based on total sales. In 2007, in addition to our acquisition of Oakley, we continued to strengthen our North American retail business with the acquisition of certain assets of D.O.C Optics, which operated approximately 100 stores located primarily in the Midwest United States. We also 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 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 became the first frame manufacturer to enter the North American retail market through the acquisition of LensCrafters. In the same year, we also acquired the medium- to high-end brand product line of Persol S.p.A.
Throughout the 1990s, we continued to expand our distribution network by forming new wholesale subsidiaries. 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 Milan Stock Exchange, or MTA.
Since 2000, we have made a number of key strategic acquisitions to strengthen our business. In April 2001, we acquired 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 leading 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, which, among other things, operates Pearle Vision and the Licensed Brands. 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. In November 2007, we acquired Oakley, a worldwide specialist in performance optics with brands including Oakley, Eye Safety Systems, Fox, Mosley Tribes, Oliver Peoples and Paul Smith Spectacles, and retail chains including Oakley Stores and Vaults, Sunglass Icon, The Optical Shop of Aspen, Oliver Peoples and Bright Eyes. See Item 4Information on the CompanyRecent DevelopmentsAcquisitions.
Our capital expenditures for our continuing operations were Euro 334.8 million for the year ended December 31, 2007 and Euro 49.7 million for the three-month period ended March 31, 2008. We expect 2008 aggregate capital expenditures to be approximately Euro 300 million, in addition to investment for any acquisitions. The most significant investments planned are for the remodeling of existing stores for our North American retail operations, at an expected cost of approximately Euro 23.7 million. 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 Capital ResourcesCash 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. We are domiciled in Milan, Italy.
On November 14, 2007, we completed the acquisition of Oakley, a worldwide leader in the design, development, manufacture, distribution and marketing of performance optics products, including market-leading premium sunglasses, prescription eyewear, goggles and electronically-enabled eyewear. As part of the merger, we acquired 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 was approximately U.S.$2.1 billion (approximately Euro 1.6 billion). In addition to Oakley-branded optics products, Oakleys eyewear portfolio also includes the Eye Safety Systems, Mosley Tribes, Oliver Peoples and Paul Smith Spectacles brands. Oakley also offers an array of Oakley-branded apparel, footwear, watches and accessories. We also acquired retail locations through Oakley, including Oakley Stores and Vaults, Sunglass Icon, The Optical Shop of Aspen, Oliver Peoples and Bright Eyes. We believe Oakleys principal strength is its ability to develop products that demonstrate superior performance and aesthetics through proprietary technology, manufacturing processes and styling.
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.
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 have since rebranded the acquired stores as either LensCrafters or Pearle Vision.
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 initial interest in RayBan Sun Optics in connection with the purchase of the RayBan eyewear business from Bausch & Lomb in 1999.
On April 17, 2008, we signed a long-term exclusive license agreement for the design, production and worldwide distribution of sunglasses under the luxury lifestyle brand Stella McCartney. The agreement, which will begin on January 1, 2009, is for an initial term of six years, automatically renewable for an additional five-year term. The first collection will be launched in the summer of 2009. Stella McCartney first introduced her eyewear line in 2003. She will continue to personally follow each step of the creative process, together with the Luxottica design and product team.
On January 30, 2008, we signed a new license agreement with Chanel. This marks the further extension of a long-term relationship between the two companies, which started in 1999 with the launch of Chanels first eyewear collections and now seeks to capture the additional growth opportunities for this exclusive and iconic luxury fashion brand.
On May 29, 2008, we entered into a Euro 250 million revolving credit facility agreement, guaranteed by our subsidiary Luxottica U.S. Holdings Corp. (U.S. Holdings) with Intesa Sanpaolo S.p.A. as agent and Intesa Sanpaolo S.p.A., Banca Popolare di Vicenza S.c.p.A. and Banca Antonveneta S.p.A. as lenders. The final maturity of the credit facility is May 29, 2013. The credit facility is a Euro 250 million revolving facility, which will require repayment of equal quarterly instalments of principal of Euro 30 million starting August 29, 2011 and a last repayment of Euro 40 million on the final maturity date. Interest accrues at Euribor (as defined in the agreement) plus a margin between 0.40 percent and 0.60 percent based on the Net Debt/EBITDA ratio, as defined in the agreement.
In February 2008, we exercised an option included in the Amended Euro 1,130 Million and U.S.$325 Million Credit Facility entered into by us and our subsidiary U.S. Holdings on June 3, 2004, to extend the maturity date of Tranches B and C to March 2013.
To finance the Oakley acquisition discussed in Acquisitions above, on October 12, 2007, we and our subsidiary U.S. Holdings entered into two credit facilities with a group of banks providing for certain term loans and a short-term bridge loan for an aggregate principal amount of U.S.$2.0 billion. The term loan facility is a five-year term loan of U.S.$1.5 billion, with options to extend the maturity on two occasions for one year each time. The term loan facility is divided into two facilities, Facility D and Facility E. Facility D consists of an amortizing term loan in an aggregate amount of U.S.$1.0 billion, made available to U.S. Holdings, and Facility E consists of a bullet term loan in an aggregate amount of U.S.$500 million, made available to the Company. Each facility has a five-year term, with options to extend the maturity on two occasions for one year each time. The term loan has a spread of between 20 and 40 basis points over LIBOR, depending on the Groups ratio of net debt to EBITDA. Interest accrues on the term loan at LIBOR (as defined in the agreement) plus 0.40 percent (5.503 percent for Facility D and 5.458 percent for Facility E on December 31, 2007). The final maturity of the credit facility is October 12, 2012. This credit facility contains certain financial and operating covenants. We were in compliance with those covenants as of March 31, 2008. We had borrowed U.S.$1.5 billion under this credit facility as of December 31, 2007.
During the fourth quarter of 2007, we entered into ten interest rate swap transactions with an aggregate initial notional amount of U.S.$500 million with various banks (Tranche E Swaps). These swaps will expire on October 12, 2012. The Tranche E Swaps were entered into as a cash flow hedge on Facility E of the credit facility discussed above. The Tranche E Swaps exchange the floating rate of LIBOR for an average fixed rate of 4.26 percent per annum.
The short-term bridge loan facility is for an aggregate principal amount of U.S.$500 million. Interest accrues on the short-term bridge loan at LIBOR (as defined in the agreement) plus 0.15 percent (5.208 percent on December 31, 2007). The final maturity of the credit facility was eight months from the first utilization date. On April 29, 2008, we and our subsidiary U.S. Holdings entered into an amendment and transfer agreement to this facility. The terms of such amendment agreement among other things, reduced the total facility amount from U.S. $500 million to U.S. $150 million and provide for a final maturity date that is eighteen (18) months from the effective date of the agreement.
For additional information, see Item 5Operating and Financial Review and ProspectsLiquidity and Capital ResourcesOur Indebtedness and 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 ranging 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 and Oakley. We currently develop approximately 2,180 distinct styles of frames within our house brands, of which approximately 1,230 are optical and 950 are sun. 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 and acquired by us in 1999, 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.
· Oakley: Founded in 1975, Oakley is a market-leading, strong, iconic brand of performance optics products, including premium sunglasses, prescription eyewear, goggles and electronically-enabled eyewear, whose loyal consumers and athletes have helped create a culture and brand that are intertwined.
· Persol: Created in 1926 and acquired by us 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.
· Oliver Peoples: Founded in 1986, Oliver Peoples helped establish the luxury eyewear market. Oliver Peoples classic designs fuse old-world aesthetics with modern-day finesse and are worn by many of the worlds most recognizable celebrities.
· Vogue: Created in 1973 and 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: Created in California in 1992 and acquired by us in 1999, Arnette is targeted at young consumers. This sports product line is characterized by a very forward-thinking design and provides outstanding comfort and functionality, ideal for those who enjoy dynamic and extreme sports.
· Revo: A product line targeted towards sport and leisure wearers, the Revo line is known for its high-quality lenses that 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 eyewear consumers.
· Sferoflex: The Sferoflex product line, which in 1981 became the first brand name acquired by Luxottica Group, 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 and a more urban style.
· Mosley Tribes: The Mosley Tribes brand, launched in 2005, is a modern brand fusing fashion and urban lifestyles.
· Eye Safety Systems: ESS designs, develops and markets advanced eye protection systems for military, firefighting and law enforcement professionals and is a leading supplier of protective eyewear to the U.S. military and firefighting markets.
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, Bvlgari, Tiffany & Co., Versace, Versus, Salvatore Ferragamo, Burberry, Polo Ralph Lauren with its six lines (Purple Label, Polo, Ralph Lauren, Ralph, Chaps and Club Monaco), Donna Karan, DKNY, Brooks Brothers and Anne Klein. They also include Paul Smith Spectacles, obtained in connection with our acquisition of Oakley. Additionally, in the summer of 2009, we will launch the first collection of Stella McCartney eyewear. The license agreements governing these designer lines are exclusive contracts and typically have terms of between three and ten years. See Trademarks, Trade Names, Patents 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 3,300 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 luxury-oriented consumers, 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 presented in optical frames and sunglasses collections, as well as a series of models created for leisure time, identified by the brands 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 comprises both optical frames and sunglasses. This brand addresses a clientele particularly attentive to the free and easy, as well as 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: Under license since 2005, our Dolce & Gabbana eyewear collection is an expression of ultimate luxury. 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 eyewear collection emphasizes the spirit of the brand: innovative, provocative and cosmopolitan.
· Bvlgari: Under license since 1997, Bvlgari eyewear is distinguished by the high quality of its materials, attention to detail and elegant design. This product line is targeted towards a clientele who seek something exclusive.
· Tiffany & Co.: For 169 years, Tiffany & Co. has designed and produced standard-setting jewelry and accessories. The first collection of Tiffany & Co. eyewear, launched in early 2008, remains true to the brands high standards.
· Versace: Versace is a lifestyle brand for the modern man or woman who chooses to express 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 Versace 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.
· Paul Smith Spectacles: The Paul Smith Spectacles brand, which launched in 1994, includes prescription eyewear and sunglasses that feature the whimsical yet classic designs and attention to detail that are synonymous with one of Britains leading fashion designers.
· Salvatore Ferragamo: The Salvatore Ferragamo collections 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 inspired by the craftsmanlike tradition of this fashion house, reinterpreted according to contemporary trends.
· Burberry: The Burberry license agreement was signed in 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: An 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. This collection features 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, and 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 consumer of moderately-priced sportswear. 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 both men and women, between 20 and 40 years of age, who are urban professionals, style enthusiasts, and who appreciate sophisticated design at a mid-level price point.
· 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 mindset, the New York City street-smart look. DKNY eyewear caters to 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.
· Stella McCartney: This eyewear collection is inspired by Stella McCartneys modern sense of innovation in the creation of desirable fashion. Combining everyday functionality with a strong fashion sensibility, the eyewear collection offers contemporary femininity with a sense of modern luxury.
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 2007, our manufacturing facilities produced a combined total of approximately 41.8 million prescription frames and sunglasses, of which 0.8 million were attributable to the inclusion of prescription frames and sunglasses manufactured by Oakley since the acquisition date. In 2006 and 2005, our manufacturing facilities produced a combined total of approximately 37.0 million and 28.5 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 this growth trend in our sunglass business to continue as a result of our acquisition of Oakley. In addition to the more fashion-oriented sun and ophthalmic products for which we have earned a strong reputation, the Oakley acquisition brings to us a complementary technological expertise and know-how in high-performance optics, which includes sunglasses, prescription eyewear, goggles, shields, visors and electronically-enabled eyewear, most of which feature Oakleys High Definition Optics® (HDO®) technology.
Unit sales of sunglasses manufactured by us and third parties in 2007, as a percentage of our total aggregate unit sales, were 58.4 percent, as compared to 57.2 percent in 2006 and 55.8 percent in 2005.
The following table presents the respective percentages of our total unit sales that our prescription frames and sunglasses comprised for the periods indicated:
We operate our retail operations through our retail brands, which include, among others, LensCrafters, Sunglass Hut, Pearle Vision, ILORI, The Optical Shop of Aspen, OPSM, Laubman & Pank, Budget Eyewear and Bright Eyes. Due to the fragmented nature of the European retail market, we do not operate optical retail stores in Europe outside of the United Kingdom. As of March 31, 2008, our retail business consisted of 5,627 corporate store locations and 580 franchised locations as follows:
LensCrafters. As of March 31, 2008, we operated a retail network of 1,110 LensCrafters locations worldwide (of which 951 locations are in North America) offering 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), Advanced View ProgressiveÔ (free-form, digitally surfaced progressive lenses), 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, in North America, include a laboratory, which enables us to provide the selected frame with prescription lenses to our customers in approximately one hour. 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 acquiring of retail chains and opening of stores in areas where we are not already heavily represented and in other prime locations. 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 volume 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 premium store concept that is being adopted as stores are remodeled across North America, associate training, advertising and marketing, which 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.
As noted above, 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 is 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.
In 2006, we began to expand the use of the LensCrafters name by rebranding certain retail locations to LensCrafters that we acquired as part of the acquisitions of three optical retailers in China, which had a combined total of 274 stores across Asia, including Hong Kong. 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 was important for increasing awareness and consumer demand for our products and services. In September 2006, we launched LensCrafters in Beijing, beginning the re-branding strategy of our acquisitions. By the end of 2007, we rebranded 165 locations in China and Hong Kong with the LensCrafters name. Based on the strategy for 2008, the remaining not yet rebranded stores will maintain the original brand name.
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 popularly priced watches. As of March 31, 2008, Sunglass Hut had 1,567 retail locations in North America, 288 in Australia, New Zealand and South Africa, and 115 in the Middle East and Europe. Sunglass Hut operates in-line stores and kiosks in shopping malls, as well as stores in street centers on 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 69.4 percent in December 2007, including Oakley products. In addition to sunglasses that we manufacture, Sunglass Hut continues to sell a variety of frames manufactured by third-party vendors, including Maui Jim, Inc. and others. Although we
buy products from third parties, 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 rebranded to Sunglass Hut stores by the end of 2008. Both chains have prominent locations in shopping centers in urban areas, including Johannesburg and Cape Town, as well as attractive airport locations.
ILORI. ILORI is our new high-end fashion sunwear retail brand with seven stores in the United States as of March 31, 2008, including flagship stores in the SoHo neighborhood of New York City and in Beverly Hills, CA. ILORI caters to a different, more exclusive clientele than Sunglass Hut or Sunglass Icon with higher-priced collections and more pampered, personalized service in luxurious surroundings.
Sunglass Icon. Our Sunglass Icon multi-branded sunglass specialty retail locations offer a full range of eyewear, including brands owned or licensed by us, as well as eyewear from other designers and brands. As of March 31, 2008, Sunglass Icon operated 143 locations throughout North America (11 of which are operated under license). The Sunglass Icon retail stores are located in premium malls throughout the United States, with a concentration primarily in the southwest United States.
Pearle Vision. With the acquisition of Cole in October 2004, we acquired Pearle Vision, the second-largest optical chain after LensCrafters in North America. Although both brands address the mid- to high-end customer bracket, their positioning is complementary. Pearle Vision focuses on the factors that made the brand a success: customers trust in the doctors experience and the quality of service they receive. Pearle Vision stores are mostly located in strip malls instead of the conventional malls where most LensCrafters and Sunglass Hut stores are located. In addition, Luxottica has franchised Pearle Vision locations located throughout North America.
Our relaunching of the Pearle Vision brand in 2004 and 2005 was centered on a return to its original values, which had made Pearle Vision the Home of Trusted Eyecare for generations of Americans.
A product mix increasingly geared to premium, high value-added products has helped restore strong customer relationships, as have efforts to portray doctors in various advertising campaigns. At the same time, a significant reduction in sales promotions helped improve the positioning of the stores and consumer perceptions, resulting in increasing profitability.
Sales of Luxottica products at Pearle Vision stores enjoyed strong growth, reaching nearly 78.7 percent of total sales in 2007. Ray-Ban, Prada, Brooks Brothers and Versace were some of the stronger-selling brands.
In order to centralize services and achieve economies of scale, most in-store labs were closed, and their work was transferred to nearby LensCrafters labs or to one of our eight large central lens finishing facilities.
Pearle Visions franchises are increasingly turning to us as their preferred supplier, not only due to the strength of our brands and the quality of our products, but also because of Luxotticas Franchise Advantage Program. This program, which is available to franchisees, features marketing solutions, preferential pricing and savings on selected categories of products, including lenses, lab services, contact lenses and accessories, all of which are provided with a high level of service and merchandising support.
We firmly believe that the Pearle Vision brand has significant growth opportunities in both the United States and Canada, where the brand was strengthened in 2006 and is now the only optical chain represented throughout Canada.
As of March 31, 2008, Pearle Vision operated 470 corporate store locations and had 405 franchise locations throughout North America.
Licensed Brands. With the acquisition of Cole, we also acquired a group of distribution outlets under the names Sears Optical and Target Optical (the BJs Optical license acquired with Cole was terminated in March 2008), which we refer to as our Licensed Brands. The Licensed Brands optical retail locations are located in the host stores that bear the names of the hosts. Both of these brands offer consumers the convenience of taking care of their optical needs where they
shop and have a precise market positioning. Sears, a department store with a vast and heterogeneous customer base, has further improved the services that were launched in 2005. In 2006, Ray-Ban was introduced in all stores. In 2007, Target Optical, which appeals to customers who enjoy fashion and novelty, reported improved performance in its 296 Target stores, which are mostly in large urban and suburban centers. Efforts were focused on improving service and consulting by the sales personnel, who adopted a new take it and try it sales method, as well as on strengthening its fashion positioning by offering brands such as Ray-Ban and Vogue.
As of March 31, 2008, we operated 881 Sears Optical and 304 Target Optical locations throughout North America.
Oakley Stores and Vaults. As of March 31, 2008, we operated 55 retail stores in North America under the Oakley Store name, which offer a full range of Oakley-branded optics products as well as Oakley apparel, footwear and accessories. These stores are designed and merchandised to immerse consumers in the Oakley brand through innovative use of product presentation, graphics, audio and visual elements. In addition to these full-price retail venues, we operated 30 Oakley Vaults, our Oakley outlet store concept, featuring discontinued and excess seasonal Oakley-branded merchandise in addition to newer products priced at full retail. Our retail stores are located in some of the nations leading shopping malls and average approximately 2,500 square feet in size. We had 6 Oakley Stores and Vaults under franchise in Mexico as of March 31, 2008. Outside of North America, as of March 31, 2008, we operated 23 corporate-owned Oakley Stores and Vaults and had eight franchise locations.
The Optical Shop of Aspen. As of March 31, 2008, we operated 20 The Optical Shop of Aspen stores throughout the United States, which are luxury optical retail stores offering fashion and luxury eyewear from a variety of designers, as well as certain Oakley-owned brands, including Oliver Peoples.
Oliver Peoples. Our Oliver Peoples subsidiary operates four luxury optical retail stores (two in Southern California and two in New York City). An additional two Oliver Peoples retail locations are operated by others under license, one in Southern California and one in Tokyo.
OPSM, Laubman & Pank and Budget Eyewear. In Australia and New Zealand, we operate three brands, which are specialists in the prescription segment: OPSM, Australias top eyewear brand for luxury and fashion-minded customers; Laubman & Pank, provider of high-quality eyecare and services; and Budget Eyewear, focused on price-conscious consumers. The three brands operate in all of Australias states, primarily in larger cities. OPSM is our only brand in New Zealand and operates in the main urban areas. All brands have continued to extend further into the fashion segment through innovative store format, personnel training and product assortment programs that are tailored to their respective segments and leverage off of our portfolio of products. In the prescription segment, the three brands have a different positioning which allows us to cover complementary segments with product offerings catering to the needs of different consumer categories. Improved understanding of customers and initiatives have helped OPSM achieve a significant increase in sales and have solidified its position as the best-known brand on the market. Laubman & Panks recognition as an optical fashion brand has continued to increase as promotional programs clearly position the brand as a national chain. The brand is perceived to have a special focus on eye health, resulting from a series of initiatives that include TV campaigns and national screening programs. Budget Eyewear has successfully extended its product offerings while remaining the preferred destination for those wanting good eyewear at lower prices. As of March 31, 2008, a total of 507 stores throughout Australia were operated under the three brands - OPSM (280 stores), Laubman & Pank (134 stores) and Budget Eyewear (73 stores)- including Budget Eyewears 20 franchise locations. OPSM is the market leader in New Zealand, based on corporate-owned store locations, with 39 stores, as of March 31, 2008, operated by the OPSM brand.
Bright Eyes. Bright Eyes, first established in 1985, is one of Australias largest and fastest growing sunglass chains, with over 140 sunglass stores across Australia operating under the Bright Eyes and Sunglass Worx names. As of March 31, 2008, Bright Eyes operated 39 corporate store locations and 102 franchise locations. The stores are located in highly desirable real estate locations and sell brands such as Oakley, Ray-Ban, Prada, Versace, Maui Jim and Arnette.
We continue to explore opportunities to expand our retail operations worldwide through the opening of new stores or kiosks, or strategic acquisitions, when appropriate.
Oakley Internet and Telesales Operations. We use our Oakley website (www.oakley.com) as a complementary sales channel to our Oakley retail operations and international distribution, allowing consumers to purchase Oakley products as efficiently as possible. The Oakley website is fully e-commerce capable, allowing consumers to purchase our Oakley products for delivery in the United States, Canada and Australia. In addition, the Oakley website includes information about our Oakley products and innovations, such as HDO® (High Definition Optics®), and news about the athletes and others who endorse Oakley products. We believe the Oakley website serves to increase consumer awareness of the Oakley brand,
improve customer service and increase sales through Oakleys retail and e-commerce channels. We also maintain a customer service team to respond to telephone inquiries and make sales directly to consumers.
EyeMed. With the acquisition of Cole, we also acquired a provider and administrator of managed vision care services. Managed vision care programs and benefits were previously sold through the Cole Managed Vision division; renewals and new sales are now serviced through EyeMed Vision Care. EyeMed Vision Care is one of the largest vision benefits organizations in the United States, serving 3,400 corporations, government entities and insurance companies through a network of optometrists, ophthalmologists, opticians and Luxottica retail stores.
In 2007, EyeMed gained 400 new clients with more than 7 million new members joining the nearly 140 million people already served by EyeMed through funded and discounted benefit plans. The primary contributors to EyeMeds growth are the increasing awareness of the importance of vision care and the expansion of existing relationships with health and ancillary benefit organizations. EyeMed also focused on targeting the smaller employer segment. EyeMed will continue to diversify its product offerings and provider networks to address the needs of its business-to-business customers, while continuing to identify and build demand in new market segments.
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 2006 (through its date of sale on September 29, 2006) and 2005 were Euro 157.1 million and Euro 236.5 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 58.4 percent and 57.2 percent of our units sold in 2007 and 2006, 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. We believe that this seasonality effect, especially in the wholesale segment, will be offset by our acquisition of Oakley, which is primarily a wholesale business, because the wholesale seasonal peaks generally precede the retail seasonal peaks by a few months. These seasonal variations could affect the comparability of our results from period to period. Our North American 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 will occur again in fiscal 2008.
We manufacture 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 manufacture 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. With the acquisition of Oakley, we have added manufacturing facilities in the United States where we manufacture or assemble most of our Oakley eyewear products.
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 together 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 each 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.
Oakley develops and employs innovative technologies, materials and processes in the design, development and manufacture of its products. To date, Oakley has designed its products using primarily in-house staff in order to speed the concept-to-market timeline and preserve brand image and authenticity.
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 sunglass market.
Oakley has built strong relationships with its major suppliers. With most suppliers, Oakley maintains agreements that prohibit disclosure of its proprietary information or technology to third parties. Although Oakley relies on outside suppliers for most of the specific molded components of its glasses, goggles, watches and footwear, it generally retains ownership of the molds used in the production of the components. We believe that most of the components that Oakley uses can be obtained from one or more alternative sources within a relatively short period of time, if necessary or desired. In addition, to further mitigate risk, Oakley has developed an in-house injection molding capability for sunglass frames.
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. For additional information, see Note 14 to our Consolidated Financial Statements included in Item 18 of this annual report. 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 modernized our operations in Italy by building a new approximately 32,000-square-meter manufacturing facility to produce acetate frames and sunglasses for a total investment of approximately Euro 20.0 million. In 2007, we further expanded our manufacturing facilities in Italy by approximately 28,000 square meters in order to rationalize the product production flow, for a total investment of approximately Euro 23.4 million. We were able to rededicate 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 from our Japanese partner the remaining 50 percent interest in this Chinese manufacturer so that it became one of our wholly-owned subsidiaries. In 2006, we increased our manufacturing capacity in China through the construction of a new approximately 26,000-square-meter 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 China increased by approximately 80 percent compared to 2005. In 2007, we further expanded our manufacturing capacity in China by approximately 74,000 square meters, for a total investment of approximately Euro 7.2 million. 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 Lauriano, while metal frames are produced in our facilities in Agordo and Rovereto. Certain frame parts are produced in our facility in Cencenighe. Our manufacturing facility in China produces both metal and plastic frames. In 2007, approximately 59 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 daily 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.
The principal manufacturing facility for our newly acquired Oakley business is located in Foothill Ranch, California, where it manufactures or assembles most of Oakleys eyewear products. Oakley has a second manufacturing facility located in Dayton, Nevada, where it produces the frames used in its X Metal® (a proprietary alloy) eyewear products.
At Oakleys manufacturing facilities, we own, operate and maintain most of the equipment used in the manufacture of Oakleys eyewear products. Much of the equipment used has been specially designed and adapted for Oakleys manufacturing processes. Manufacturing processes that Oakley believes are unlikely to add significant value are currently contracted to outside vendors. State-of-the-art manufacturing practices allow Oakley to respond quickly to customer demand, offer protection against piracy and enable it to adhere to strict quality-control standards. Oakley has the unique ability to build customized eyewear products to meet individual consumer demand for unique combinations of frame, lens and lens coating and to ship those products in less than 48 hours.
Oakley utilizes third-party manufacturers to produce its apparel, footwear, watches, electronically-enabled eyewear and certain of its goggles. Costs associated with research and development activities are expensed when incurred and are not significant.
Lens Finishing Labs
In North America, we have eight central lens finishing labs that are of strategic importance to our North American retail business. Combining our broad presence in the market with additional capacity for handling lens finishing work, we anticipate increasing availability of our higher-margin lens treatments to consumers at our stores. Lens finishing labs are also expected to contribute to a reduction of the time and cost of finishing work provided by third parties.
Oakley operates optical lens laboratories in the United States, Ireland and Japan where it surfaces prescription lenses. These labs provide prescription lenses to the North and South American, European and Asian markets, respectively, enabling it to achieve expeditious delivery, better quality control and higher optical standards.
One of our key strategic objectives is ensuring the quality of our products, which has led to the integration of every phase of production. Quality is the critical factor in the premium and luxury segments for both wholesale customers and retail consumers. 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.
Oakley designs all of its products with the goal of meeting or exceeding their respective industry standards for safety, performance and durability. Throughout the development process, Oakley optics products undergo extensive testing against standards established specifically for eyewear by ANSI and ASTM. These standards relate to product safety and performance and provide quantitative measures of optical quality, UV protection, light transmission and impact resistance. In addition, Oakley performs a broad range of durability and mechanical integrity tests on its lens coatings that include extremes of exposure to UV light, heat, condensation and humidity. Oakley tests its apparel, footwear and accessories against strict guidelines established by ASTM and other industry authorities to ensure quality, performance and durability.
We distribute our products through both wholesale and retail channels.
Distribution by Wholesale Division
We currently distribute our products in over 130 countries and operate 42 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 130 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, our stake in Ray-Ban Sun Optics increased from 44.2 percent to 70.5 percent through the acquisition of additional shares in 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 control the quality of the points of sale that display our 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 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 and China. 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) and have begun a process to centralize our wholesale and retail distribution centers in North America over time. We believe that centralizing our distribution centers improves the efficiency of our distribution operations while reducing related costs.
Currently, Oakley distributes its products in the United States through a base of approximately 11,000 retail accounts. Retail accounts are comprised of optical stores, sunglass retailers, department stores, sporting goods stores and specialty sports stores, including bike, surf, snow, skate, golf and motor sports stores.
Oakleys sales organization is comprised of a combination of employees and independent sales representatives. Relationships with Oakleys large international, national and regional accounts are managed and serviced by Oakley employees. Independent sales representatives service the remaining base of retailers that carry Oakleys various product categories.
Distribution by Retail Division
Through our retail division, we believe we operate the largest group of optical superstores in 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 2007 revenues and believe we have become a leading player in the Australian prescription segment.
In our optical retail stores, customers can choose from a large selection of frames and lenses offering a high level of comfort and fit. In North America, 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, ILORI, Sunglass Icon and Bright Eyes locations, customers can choose from a large selection of Luxottica- and third-party-vendor-manufactured sunglasses. In addition, most locations can assist customers in purchasing other accessories to complement their eyewear purchases. As of March 31, 2008, our retail business consisted of 5,627 corporate store locations and 580 franchised locations. See Products and ServicesRetail Operations above for more information about our retail locations and a breakdown of the geographic regions.
In 2007, units manufactured with our own brand names or our licensed brands, represented approximately 68.4 percent of the total sales of frames based on units sold by the retail division. In contrast, when OPSM was acquired in August 2003, only 3.5 percent of the total sales of frames sold were supplied by us and, when Cole was acquired in October 2004, less than one percent of the total sales of frames sold were supplied by us. The retail divisions stores 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), Pearle Vision and Licensed Brands 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 sunglass companies in various local markets. The major competitive factors include fashion trends, brand recognition, marketing strategies, distribution channels and the number and range of products offered. 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 and De Rigo S.A.
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 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 retailers 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.
Similarly, the consumer product markets in which Oakley operates are also highly competitive in the United States and abroad. We believe that Oakleys innovative technology and design, integrated sunglass manufacturing capabilities, effective brand and product marketing efforts and vigorous protection of its intellectual property rights are important aspects of competition and are among Oakleys primary competitive advantages.
In the non-prescription sports eyewear market, Oakley competes with mostly smaller sunglass and goggle companies in various niches of the sports market and a limited number of larger competitors. We believe Oakley is a leader in this segment of the market, although various companies, including Marchon Eyewear, Inc. and Safilo Group S.p.A., and numerous smaller brands actively compete with Oakley.
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 seven percent of our net sales in each of 2007 and 2006 and approximately six percent of our net sales in 2005.
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 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 its advertising and promotion.
Oakley uses less-conventional marketing methods in addition to those mentioned above, including sports marketing, grass-roots sporting events and targeted product allocations. We believe the exposure generated by athletes wearing Oakley products during competition and in other media appearances serves as a more powerful endorsement of product performance and style than traditional commercial endorsements. Consequently, Oakley will continue to use sports marketing and
endorsement arrangements extensively to achieve exposure that results in strong brand recognition and authenticity on a global level.
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 and the OPSM, Laubman & Pank and Budget Eyewear brands in Australia and New Zealand, thereby encouraging customer loyalty and repeat purchases. Oakleys Stores and Vaults rely on similar short-term objectives. Oakleys long-term objectives are to utilize high profile retail locations to drive brand equity and create awareness for eyewear, apparel, footwear and accessories marketed under the Oakley brand.
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 and investment in customer relationships marketing technologies and skills 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, Patents and License Agreements
Trademarks, Trade Names and Patents
Our principal trademarks or trade names include Luxottica, Ray-Ban, Oakley, Persol, Vogue, Arnette, Revo, LensCrafters, Sunglass Hut, ILORI, Pearle Vision, OPSM, Laubman & Pank, Budget Eyewear and the Oakley ellipsoid O and square O logos. Our principal trademarks are registered worldwide. Other than Luxottica, Ray-Ban, Oakley, LensCrafters, Sunglass Hut, Pearle Vision, OPSM and the Oakley ellipsoid O and square O logos, 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 14.8 percent of our net sales in 2007. We believe that our trademarks have significant value for the marketing of our products and that having distinctive marks that are readily identifiable is important for creating and maintaining a market for our products; identifying our brands and distinguishing our products from those of our competitors. Therefore, we utilize a combination of trademarked logos, names and other attributes on nearly all of 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 ActiviseÒ for contact lenses, ActiveÒ for polycarbonate eyeglass lenses and InvisiblesÒ for multi-coated eyeglass lenses.
We utilize patented and proprietary technologies and precision manufacturing processes in the production of our products. As of June 20, 2008, Oakley held a portfolio of over 600 patents worldwide that protect its designs and innovations. Some of the most important of these patents relate to the following categories: innovations in dual-spherical lens technology and the associated optical advances; electronically enabled eyewear; innovations in frame design and functionality; biased, articulating and dimensionally stable eyewear; and interchangeable lenses.
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 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.
** Japan only.
*** 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 14 percent of the 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 to between five and ten percent of net sales. Each 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, a change in control of Luxottica Group S.p.A.
Other than Dolce & Gabbana and D&G and Prada and Miu Miu (which accounted for 5.5 percent and 6.4 percent of our 2007 net sales, respectively), no single designer line accounted for more than five percent of net sales for the year ended December 31, 2007. We believe that early termination of one or a small number of the current license agreements would not have a material adverse effect on our 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.
Through our acquisition of Oakley, we produce and sell to the U.S. government, including the U.S. military, and to international governments, certain Oakley and Eye Safety Systems protective eyewear products. As a result, our operations are subject to various regulatory requirements, including the necessity of obtaining government approvals for both new and continuing operations, U.S.-imposed embargoes of sales to specific countries, foreign import controls, expropriation of assets and various decrees, laws, taxes, regulations, interpretations and court decisions that are not always fully developed and that may be retroactively or arbitrarily applied. Additionally, we could be subject to periodic audits by U.S. government personnel for contract and other regulatory compliance.
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 11 manufacturing plants and 42 geographically-oriented wholesale distribution subsidiaries. See Distribution for a breakdown of the geographic regions.
The significant subsidiaries controlled by Luxottica Group S.p.A., including holding companies, are:
(1) In addition to being a holding company, Oakley, Inc. is also a manufacturer and a distributor.
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 April 30, 2008 is set forth below:
(1) Such facility is comprised of several different premises located within the same municipality.
(2) Such facility was expanded during 2007.
(3) In May 2007, we began expanding and improving this facility, and we are adding a total of 528,376 square feet. The estimated expenditure for such expansion and improvement is approximately Euro 5.0 million, of which Euro 4.2 million has already been paid. Following the finalization of the expansion, scheduled for July 2008, we anticipate that production capacity at the facility will increase by 20%.
(4) 25,963 square feet of this facility are leased.
In 2007, our manufacturing facilities produced a combined total of approximately 41.8 million prescription frames and sunglasses, of which 0.8 million were attributable to the inclusion of prescription frames and sunglasses manufactured by Oakley since the acquisition date. In 2006 and 2005, our manufacturing facilities produced a combined total of approximately 37.0 million and 28.5 million prescription frames and sunglasses, respectively.
Substantially all of our retail stores are leased. See Products and ServicesRetail Operations above for more information about our retail locations and a breakdown of the geographic regions.
All of our leases expire between 2008 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. There are no encumbrances on any of our principal owned properties.
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 the key brands LensCrafters, Sunglass Hut, Pearle Vision and OPSM and our Licensed Brands (Sears Optical and Target Optical) and, since November 14, 2007, through Oakleys retail brands. As of December 31, 2007, the retail segment consisted of 5,885 corporate store retail locations and 522 franchised locations as follows:
(1) Includes Sunglass Icon locations.
(2) Licensed brands include Sears Optical, Target Optical and BJs Optical (BJs Optical license terminated in March 2008).
(3) Includes Oakley Stores, Oakley Vaults, The Optical Shop of Aspen and Oliver Peoples.
(4) Includes OPSM, Laubman & Pank and Budget Eyewear.
(5) Includes Bright Eyes.
(6) Includes Pearle Vision, Sunglass Icon and Bright Eyes franchised and licensed locations.
(7) Includes Oakley stores in Japan and South America.
LensCrafters, ILORI, Pearle Vision, our Licensed Brands (Sears Optical and Target Optical), as well as the retail brands we acquired with Oakley (Oakley Stores and Vaults, Sunglass Icon, The Optical Shop of Aspen and Oliver Peoples), have retail distribution operations located throughout the United States, Canada and Puerto Rico, while OPSM, Laubman & Pank, Budget Eyewear and Bright Eyes operate retail outlets located in Australia and New Zealand. 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 have rebranded 165 locations to our premium LensCrafters brand in mainland China and Hong Kong. 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 acquisitions of the Ray-Ban business, Sunglass Hut, Pearle Vision and the Licensed Brands business and Oakley, 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 Euro/U.S. dollar exchange rate has fluctuated from an average exchange rate of Euro 1.00 = U.S.$1.2444 in 2005 to Euro 1.00 = U.S.$1.2553 in 2006 to Euro 1.00 = U.S.$1.3705 in 2007. Additionally, with the acquisition of OPSM and Bright Eyes (acquired through Oakley), 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 Oakley Merger
On November 14, 2007, we completed the merger with Oakley, for a total purchase price of approximately U.S.$2.1 billion. In accordance with the terms of the merger agreement, Oakleys outstanding shares of common stock were converted into the right to receive U.S.$29.30 per share in cash and Oakley became an indirect wholly-owned subsidiary of Luxottica. The merger was accounted for as a business combination for accounting purposes. For additional information, see Note 5 to our Consolidated Financial Statements included in Item 18 of this annual report.
We believe that our combination with Oakley will:
In connection with the acquisition, we increased our outstanding debt by approximately U.S. $2.2 billion.
Since the consummation of the acquisition, we have begun to implement our strategic integration plan with respect to Oakley. We immediately launched a full portfolio of project tasks, with specific objectives, dedicated joint teams and designated accountabilities to address key integration and synergy areas, with direct significant involvement of our top management.
We expect that our integration with Oakley will result in synergies in the following areas:
· international wholesale development;
· developments related to specific brands (especially Revo and Arnette);
· sourcing retail operations synergies in the key markets of North America and Asia-Pacific; and
· general and administrative expenses.
Currently, all integration project activities are proceeding substantially according to the plan. In particular, specific integration tasks have been completed, including the integration of the retail operations in North America, the integration of the Oakley dedicated sales force and marketing within the Luxottica commercial infrastructure in selected European countries and joint sourcing initiatives, while others are in the implementation or detailed planning phase and are expected to be executed within the planned timeframe.
We expect that the transaction will result in approximately Euro 100 million per year in operating synergies within three years of the completion of the merger, driven by revenue growth and efficiencies. We expect to realize approximately Euro 20 million, Euro 60 million and Euro 100 million of operating synergies in 2008, 2009 and 2010, respectively. We are currently on schedule to realize the initial estimate of such operating synergies. In addition, we anticipate incurring approximately Euro 30 million in one-time charges related to the acquisition and integration, spread out over a two-year period, beginning in 2008.
The primary factors that may influence our ability to execute our integration plans and realize the anticipated cost savings include:
· difficulty in integrating the newly-acquired business and operations in an efficient and effective manner;
· inability to achieve strategic objectives, cost savings and other benefits from the acquisition;
· the loss of key employees of the acquired business;
· the diversion of the attention of senior management from our operations;
· liabilities that were not known at the time of acquisition or the need to address tax or accounting issues;
· difficulty integrating Oakleys human resources systems, operating systems, inventory management systems, and assortment planning systems with our systems; and
· the cultural differences between our organization and Oakleys organization.
Critical Accounting Policies
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.
Revenue is recognized when it is realized or realizable and earned. Revenue is considered to be realized or realizable and earned when there is persuasive evidence of an arrangement, delivery has occurred, the sales price is fixed or determinable and collectability is reasonably assured.
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.
As of January 1, 2007, we adopted Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes an interpretation of FASB Statement No. 109 (FIN 48). FIN 48 provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. In addition, it provides additional requirements regarding measurement, de-recognition, disclosure, interest and penalties and classification. FIN 48 must be applied to all existing tax positions for all open tax periods as of the date of adoption (see Note 8 to our Consolidated Financial Statements included in Item 18 of this annual report for a tabular reconciliation of uncertain tax positions). The cumulative effect of adoption of FIN 48 of Euro 8.1 million was recorded as a reduction to retained earnings on the date of adoption. This information is subject to change due to subsequent tax audits, lapse of open tax periods as well as various other factors.
Our manufactured inventories were approximately 66.2 percent and 66.7 percent of total frame inventory for 2007 and 2006, respectively. All inventories at December 31, 2007 were valued using the lower of cost, as determined under a weighted-average method, or market. Inventories are recorded net of allowances for possible losses. These reserves are calculated using various factors including 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, 2007, the aggregate carrying value of intangibles, including goodwill, was approximately Euro 3.9 billion or approximately 54.6 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 2008, the Financial Accounting Standards Board (FASB) issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activitiesan amendment of FASB Statement No. 133 (SFAS 161). SFAS 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations and (c) how derivative instruments and related hedged items affect an entitys financial position, financial performance and cash flows. The guidance in SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. This Statement encourages, but does not require, comparative disclosures for earlier periods at initial adoption. We are currently assessing the impact of SFAS 161.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements an amendment to ARB No. 51, establishing new accounting and reporting standards for noncontrolling interests (formally known as minority interests) in a subsidiary and, when applicable, how to account for the deconsolidation of such subsidiary. Among its key changes, SFAS 160 provides that noncontrolling interests will be recorded as a component of equity, that the consolidated income statements and statements of comprehensive income will be adjusted to include the noncontrolling interest and that certain disclosures are to be updated. The statement is effective for the fiscal years and interim periods within those years beginning on or after December 15, 2008. Earlier adoption is prohibited. We have minority interests in certain subsidiaries and as such are currently evaluating the effect of adoption.
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations-Revised (SFAS 141(R)), which revises SFAS 141. The significant changes include a change from the cost allocation process to determine the value of assets and liabilities to a full fair value measurement approach. In addition, acquisition-related expenses will be expensed as incurred and not included in the purchase price allocation, and contingent liabilities will be separated into two categories - contractual and non-contractual and accounted for based on the category into which the contingency falls. This statement applies prospectively and is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning after December 15, 2008. Since it will be applied prospectively, it will not have an effect on the current financial statements; however, since we participate in numerous business combinations annually, we believe this statement after the adoption date will have a significant effect on future operations.
In February 2007, the 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.
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. Additionally, in February 2008, the FASB issued FASB Staff Position (FSP) No. 157-2 (FSP 157-2), which delays the effective date of SFAS No. 157 to fiscal years beginning after November 15, 2008 and interim periods with those fiscal years for all nonfinancial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually) until January 1, 2009 for calendar year-end entities. We will adopt this Statement except as it applies to nonfinancial assets and liabilities as noted in FSP 157-2 beginning in fiscal year 2008. We are currently evaluating the effect that the adoption of SFAS No. 157, as it relates to nonfinancial assets and liabilities, will have on our results of operations, financial position or cash flows.
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.
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, our former specialty gift business, which was sold in September 2006, are reclassified as discontinued operations and are not included in results from continuing operations for 2006 and 2005.
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 fiscal year ended December 31, 2007 to the fiscal year ended December 31, 2006
Net Sales. Net sales increased by Euro 289.9 million, or 6.2 percent, to Euro 4,966.1 million during 2007 from Euro 4,676.2 million in 2006. Of such increase, Euro 87.0 million is attributable to the inclusion of net sales of Oakley for the period from November 14, 2007, which was the date of the closing of the Oakley acquisition (acquisition date), until the end of the year. The remaining increase in net sales primarily resulted from the strong performance of the manufacturing and wholesale segment, which was partially offset by Euro 36.7 million in negative currency fluctuations between the Euro, which is our reporting currency, and other currencies in which we conduct our business, particularly the U.S. dollar.
Net sales in the retail segment decreased by Euro 31.9 million, or 1.0 percent, to Euro 3,262.3 million in 2007 from Euro 3,294.2 million in 2006. The decrease in net sales for the period is primarily attributable to the strengthening of the Euro, mainly versus the U.S. dollar, which decreased net sales for the period by Euro 250.1 million. The net decrease in sales created by the foreign currency fluctuations offset the growth in net sales in 2007 mainly due to the following: (i) a Euro 28.5 million increase attributable to the inclusion of Oakleys net sales related to its retail operations for the period from the acquisition date; (ii) a 0.2 percent increase in same-store sales; (iii) the addition of Euro 15.4 million in sales from the approximately 70 new Canadian retail stores which were acquired in June 2006, and therefore owned for only a portion of 2006; (iv) the addition of Euro 44.5 million in sales from approximately 90 new U.S. retail stores which were acquired in February 2007; and (v) a Euro 62.9 million increase in net sales from the Asia-Pacific retail business, of which Euro 15.8 million in net sales was due to the newly acquired stores in China and the remaining amount was mainly attributable to sales growth in Asia-Pacific.
Net sales to third parties in the manufacturing and wholesale segment increased by Euro 321.8 million, or 23.3 percent, to Euro 1,703.8 million in 2007 from Euro 1,382.0 million in 2006. Of such increase, Euro 58.5 million is attributable to the inclusion of Oakley net sales for the period from the acquisition date, and the remaining 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, Dolce & Gabbana, Versace and Bvlgari, and the launch of new products from our license agreements with Burberry and Ralph Lauren. These increases occurred primarily in the European and North American markets, which, together, accounted for approximately 78.1 percent and 78.5 percent of our net sales to third parties in our manufacturing and wholesale segment in 2007 and 2006, respectively. This increase was partially offset by the strengthening of the Euro, mainly versus the U.S. dollar, which decreased net sales by Euro 46.5 million.
During 2007, net sales in the retail segment accounted for approximately 65.7 percent of total net sales, as compared to approximately 70.4 percent of net sales in 2006. This decrease in retail net sales as a percentage of total net sales is primarily
attributable to a significant increase in net sales to third parties in our manufacturing and wholesale segment, which grew by 23.3 percent in 2007, and to negative currency effects, which primarily affected net sales in the retail segment, which are primarily concentrated in North America, Australia and China, where the Euro is not the functional currency.
On a geographic basis, which includes Oakley from the date of acquisition, combined retail and manufacturing and wholesale operations in the United States and Canada comprised 61.5 percent, or Euro 3,053.6 million, of total net sales in 2007, which decreased as compared to net sales in the United States and Canada of Euro 3,076.4 million in 2006, mainly due to the negative impact of the strengthening of the Euro compared to the U.S. dollar. Net sales for operations in Asia-Pacific comprised 11.8 percent of total net sales and totaled Euro 584.2 million in net sales during 2007, as compared to Euro 498.4 million in 2006, which represented a 17.2 percent increase in net sales, mainly due to the newly acquired stores in China. Net sales for the rest of the world comprised 26.7 percent of total net sales and accounted for Euro 1,328.3 million of net sales during 2007, which represented an increase in net sales of Euro 226.9 million or 20.6 percent as compared to 2006. The increase in net sales for the rest of the world was primarily attributable to strong performance in almost all major European markets.
During 2007, net sales to third parties in our manufacturing and wholesale segment in Europe comprised 59.9 percent of our total net sales in this segment and experienced an increase of 20.2 percent from Euro 849.8 million in 2006 to Euro 1,021.1 million in 2007. Net sales to third parties in our manufacturing and wholesale segment in the United States and Canada comprised 18.1 percent of our total net sales in this segment in 2007 and experienced an increase in its local currency of 44.6 percent from U.S.$295.5 million in 2006 to U.S.$427.2 million in 2007. In Euro, net sales in the United States and Canada increased by 31.3 percent because the local currency increase was offset by the strengthening of the Euro compared to the U.S. dollar. Net sales to third parties in our manufacturing and wholesale segment in the rest of the world comprised 21.9 percent of our total net sales in this segment and experienced an increase of 25.9 percent from Euro 296.8 million in 2006 to Euro 373.5 million in 2007.
During 2007, net sales in the retail segment in the United States and Canada comprised 84.1 percent of our total net sales in this segment. In Euro, net sales in the United States and Canada decreased by 3.4 percent because the local currency increase was offset by the strengthening of the Euro compared to the U.S. dollar. In U.S. dollars, retail net sales in the United States and Canada experienced an increase of 5.5 percent from U.S.$3,566.4 million in 2006 to U.S.$3,763.7 million in 2007. Net sales in the retail segment in the rest of the world comprised 15.9 percent of our total net sales in this segment and experienced an increase of 14.3 percent from Euro 453.2 million in 2006 to Euro 517.9 million in 2007.
Cost of Sales. Cost of sales increased by Euro 87.9 million, or 5.9 percent, to Euro 1,575.6 million in 2007, from Euro 1,487.7 million in 2006, primarily attributable to our overall sales growth and the inclusion of Oakleys cost of sales for the period from the acquisition date of Euro 37.6 million. As a percentage of net sales, cost of sales decreased to 31.7 percent in 2007, as compared to 31.8 percent in 2006. In 2007, excluding the frames manufactured at our acquired Oakley facilities, the average number of frames produced daily in our facilities increased to approximately 175,800, as compared to 154,900 in 2006, which was attributable to increased production in both the Italian and Chinese manufacturing facilities.
Gross Profit. Our gross profit increased by Euro 202.0 million, or 6.3 percent, to Euro 3,390.4 million in 2007 from Euro 3,188.5 million in 2006, of which Euro 49.3 million is attributable to the inclusion of Oakleys gross profit for the period from the acquisition date. As a percentage of net sales, gross profit increased to 68.3 percent in 2007 from 68.2 percent in 2006.
Operating Expenses. Total operating expenses increased by Euro 124.7 million, or 5.1 percent, to Euro 2,557.1 million in 2007 from Euro 2,432.5 million in 2006, of which Euro 45.6 million is attributable to the inclusion of Oakleys operating expenses for the period from the acquisition date. As a percentage of net sales, operating expenses decreased to 51.5 percent in 2007 from 52.0 percent in 2006 primarily due to th