Tommy’s Tales of Woe: State Probes Revealed As Pretax Income Falls

Tommy Hilfiger reported a 45.9 percent drop in 2005 net income and said it's in talks with authorities in two states to settle an income tax issue.

NEW YORK — “Tommy’s Troubles” might be a better name for his reality TV series.

As Tommy Hilfiger Corp. reported a 45.9 percent drop in its preliminary net income for fiscal 2005, it disclosed Wednesday that it is in discussions with state and local tax authorities in New York and state authorities in New Jersey to settle an income-tax issue for its subsidiary, Tommy Hilfiger Licensing Inc. THLI is a Delaware intangible holding company that collects royalties from third parties and affiliated companies that use the Hilfiger trademark.

This latest development is unrelated to the investigation by the U.S. Attorney’s Office into Hilfiger’s buying office commissions, which has resulted in 11 purported shareholder class-action lawsuits against the company as well as current and former officers and directors of the firm. Hilfiger said Wednesday it intends to “defend itself vigorously” against the shareholders’ claims, which have since been consolidated.

With respect to the U.S. Attorney’s Office investigation, the THLI matter and other tax issues, Hilfiger expects to record net provisions of $30 million to $40 million. The company said it can’t predict the ultimate impact these matters or the securities class-action lawsuit may have on its business, financial condition, results of operation, cash flow or historical financial statements. In this regard, Hilfiger hasn’t completed its required analysis as to whether any restatement or adjustments would be required under generally accepted accounting principles.

The company said it has delayed filing its fourth-quarter and full-year financial statements with the Securities and Exchange Commission due to the government’s investigation. The reports are expected to be filed on or before Aug. 10.

Hilfiger said that fiscal 2005 preliminary pretax income dropped 45.9 percent on a revenue decrease of 4.9 percent. The company revised its fiscal 2006 earnings and sales outlooks, citing in part a decline in orders from U.S. department stores.

For the 12 months ended March 31, the firm said preliminary pretax income totaled $92 million, compared with $170 million the year prior. Results in the latest year included expenses totaling $36 million related to legal fees; exiting the young men’s and H Hilfiger wholesale businesses; a restructuring of the company’s wholesale business, and the closing of the company’s Secaucus, N.J., facility.

This story first appeared in the June 16, 2005 issue of WWD.  Subscribe Today.

Income from operations fell 42.4 percent to $114 million in the year from $198 million. Revenues in the year fell to $1.8 billion from $1.9 billion a year ago.

The company disclosed that fourth-quarter net revenues were $492 million, down 3.5 percent from $510 million in the same period a year ago. Tommy Hilfiger Europe posted fourth-quarter revenue of approximately $200 million, compared with $164 million a year ago.

In fiscal 2006, Hilfiger expects net revenues to decrease in the mid-single digits, while pretax income is seen increasing by 30 to 35 percent. The anticipated decline in net revenues released Wednesday is slightly larger than the initial outlook in February due to anticipated order reductions by U.S. department stores and the recent decline in the value of the euro against the U.S. dollar, the company said in a statement. Shares of Tommy Hilfiger Corp. rose 96 cents, or 8.5 percent, to close at $12.20 on the New York Stock Exchange Wednesday.

Discussing the results during a conference call Wednesday, David F. Dyer, president and chief executive officer of Hilfiger, said: “Fiscal 2005 was a challenging year, and while our results fell short of our initial plan, we made significant strides in accomplishing many of the objectives we set out to achieve.” Among those were restructuring its U.S. wholesale business, growing its European operations and revitalizing its product assortment.

He explained the company took “an important first step in evolving into a multibrand enterprise” with the acquisition of the Karl Lagerfeld brand. Dyer said the company plans to launch a small capsule collection of Karl Lagerfeld women’s and men’s wear for spring 2006, followed by a full-fledged launch in fall 2006. The collection will target top-tier specialty and department stores.

Further, he said Hilfiger has diversified its distribution channels by launching an e-commerce platform that will begin in July. It has also repositioned its H Hilfiger better line from the wholesale channel to a retail concept and plans to open four new H Hilfiger stores by February 2006. For the first time in several years, the company has achieved positive comparable-store sales in its U.S. outlet stores, added Dyer.

Although Hilfiger reduced its selling, general and administrative expenses in the U.S. by approximately $60 million in the last 18 months, it still needs to improve profitability, said Dyer.

Turning to the women’s area, Dyer said the firm remains on target to introduce a casual career line for women for spring 2006 under the Tommy Hilfiger Crest label. He said the juniors’ business is improving, and there has been strength in denim in the misses’ division.

According to Dyer, the company’s top initiatives for fiscal 2006 are:

  • Allocate resources to sustain the positive momentum in Europe.
  • Position the U.S. wholesale business for growth.
  • Expand the U.S. outlet store base.
  • Develop viable U.S. retail concepts.
  • Expand the e-commerce platform.
  • Continue to rationalize U.S. infrastructure.

Dyer said retail, e-commerce and the Karl Lagerfeld business are expected to be “major contributors to our profits and growth in the future.”

“Finding a valid retail concept is very important to our future,” added Dyer. In fact, he pointed out that the firm’s Canadian and European businesses have a “more balanced” portfolio of retail and wholesale operations. In addition, Dyer said it was imperative “not to put all our eggs in one basket,” and having a diverse business will result in future success.

“Europe,” he said, will continue to grow “by double-digit increases for the next several years.” Dyer said the company hasn’t tapped Eastern Europe and Scandinavia yet, which represent “tremendous opportunity,” and Hilfiger has taken back its Italian distributorship. “Europe is a well-oiled machine, and we’re doing many things right. There are other opportunities to grow, too, and to have more impact on our P&Ls as we look at more European areas,” said Dyer.

Dyer added that the firm continues to seek acquisitions to improve both its top and bottom lines, but hasn’t seen anything that fits the bill in the marketplace.

Elaborating on its disappointing U.S. wholesale performance in fiscal 2005, Dyer said the business was negatively impacted by door reductions and decreased orders on comparable doors from the company’s major customers. U.S. wholesale revenue for fiscal 2005 declined to approximately $684 million from $958 million in the prior year. Major department stores reduced their orders for the company’s women’s wear, men’s wear and children’s wear. The decline, however, was partially offset by higher average unit prices, especially in women’s wear and children’s wear.

On the other hand, international wholesale revenue for fiscal 2005 rose to approximately $526 million from $430 million, driven by both increased volume and higher foreign currency exchange rates in Europe and Canada.

Retail revenue for fiscal 2005 increased to about $501 million from $426 million in the prior year. Licensing revenue rose to approximately $74 million for fiscal 2005 from $63 million for the prior year, due to the company’s international licensees, the translation of the strong euro and Japanese yen and the strength in the fragrance and home businesses.

For fiscal 2006, the company expects U.S. wholesale revenue to decline approximately 30 percent from $684 million in fiscal 2005, partly due to the closing of its young men’s jeans and wholesale H Hilfiger businesses. The company expects an overall decrease in its continuing U.S. women’s, men’s and children’s businesses in the mid-20 percent range due to changes in the buying patterns of U.S. departments stores.

Dyer added, “I’m more interested in running a small, very profitable business than a large business that is marginally profitable.”

On an upbeat note, Dyer believes that “The Cut,” Hilfiger’s new reality series on CBS, will have a positive impact on the firm’s business. He said the debut episode was the second most-watched program on CBS last Thursday night, following “CSI,” and “even beat the NBA playoffs.”

“To have that brand exposure on a national basis for the next 12 weeks is pretty good for the brand,” he said. He also anticipates that the new fragrance launch, True Star Men, featuring spokesman Enrique Iglesias, will have a positive impact on the brand. “There are a lot of great things going on that will help drive sales for the fall period,” said Dyer.

As for the U.S. Attorney’s investigation, Dyer said reports were presented to the board in March and then to the U.S. Attorney’s Office in April. The special committee of independent directors has found that the company had a “good faith basis for adopting the buying office commission rate” paid by the company’s subsidiaries to Tommy Hilfiger Eastern Hemispheres Ltd.

“After the special committee made its report in May 2005, the company initiated discussion with the U.S. Attorney’s Office about the possible resolution of the investigation on a civil basis,” said Dyer. He said it also initiated discussions with the Inland Revenue Department in Hong Kong to resolve any issues concerning whether Tommy Hilfiger Eastern Hemisphere is subject to profits tax in Hong Kong.

Dyer said the court has consolidated the shareholders’ class-action lawsuits and named a lead counsel and lead plaintiffs. He said the lead plaintiff filed an amended complaint on May 13 and under the court’s scheduling orders, Hilfiger has until July 15 to answer or move to dismiss the complaint.

In another tax development, Hilfiger has filed for a refund for related tax payments it has made to New Jersey. During fiscal 2003, the state of New Jersey instituted an Alternative Minimum Assessment. Hilfiger included the AMA in its provisions for income taxes and began to make related tax payments to the state. Prior to filing its fiscal 2004 New Jersey state income tax return in December 2004, Hilfiger determined that the AMA wasn’t properly applied and that the company’s obligations for AMA were less than previously estimated. After discussions with the state of New Jersey, the company has filed for a refund.