Oakley, Inc. will file an amendment to its 2004 Annual Report, restating certain financial information for the 2000-2004 fiscal years to correct its application of certain Financial Accounting Standards, due to insufficient documentation of certain foreign currency hedging activities. Additionally, the company will amend its previously filed 2005 Quarterly Reports.
Oakley uses hedge instruments to manage foreign currency financial exposures that occur in the normal course of its business. The company does not hold or issue derivatives for trading or speculative purposes.
“This restatement is necessary because we determined we did not satisfy certain detailed documentation standards at the inception of the hedges as required for hedge accounting under FAS 133,'' said Richard Shields, chief financial officer, Oakley, Inc. “These hedges were effective from an economic perspective and they achieved our risk management objectives. While the impact of this restatement will change net income within the various periods covered — increasing in some periods and decreasing in others — the cumulative impact on net income over the life of each hedge derivative instrument is the same under both the restated and prior accounting treatments.''
“This change in the accounting classification of the foreign currency hedging activities will have no impact on the company's net sales, cash flows, cash position, debt covenant compliance or dividends,'' Shields continued. “We are currently taking steps to ensure that documentation of our future hedging activities will be in compliance with FAS 133. These future activities are expected to be accounted for as cash flow hedges consistent with our prior accounting treatment.''
The company expects to file a Form 12b-25 seeking an extension of time to file its annual report on Form 10-K for the fiscal year ended December 31, 2005 and expects to file both the 2005 Annual Report on Form 10-K and amended 2004 Annual Report on Form 10-K/A by March 31, 2006. The company also expects to file amended 2005 Quarterly Reports on Form 10-Q/A prior to filing its first quarter 2006 Form 10-Q in May 2006.
Revised Accounting Procedures
The company's management has determined that a control deficiency existed with respect to internal control over financial reporting related to the company's review of hedging activity under FAS 133. Accordingly, the company concluded that its disclosure controls and procedures were not effective and this control deficiency constituted a material weakness in its internal control over financial reporting as of December 31, 2004.
The primary effect of the restatements will be a change in the accounting classification of the company's foreign currency derivative instruments. Under the prior accounting classification, these instruments were considered cash flow hedges and therefore any increases or decreases in the fair value of these instruments were included in accumulated other comprehensive income on the company's balance sheet, and therefore had no effect on net income for the reporting period. Any realized gains or losses were recorded in cost of goods sold when the instruments matured. Under the revised accounting treatment, any increase or decrease in the fair value of these instruments is recorded in cost of goods sold each month.
The following table summarizes the estimated impact of the revisions to hedge accounting and related effective tax rate on the company's net income and earnings per share for the amended periods:
Twelve Months Ended December 31, ------------------------------------------------- 2005 2004 2003 2002 2001 ------- ------- ------- ------- ------- (dollars in thousands except for EPS) Net income, as previously reported $51,851(a) $41,550 $38,196 $40,637 $50,371 Net income, as restated 59,660 43,515 32,949 37,092 53,079 ------- ------- ------- ------- ------- Difference 7,809 1,965 (5,247) (3,545) 2,708 Earnings per diluted share, as previously reported $0.75(a) $0.60 $0.56 $0.59 $0.72 Earnings per diluted share, as restated 0.87 0.63 0.48 0.53 0.76 ---- ---- ---- ---- ---- Difference 0.12 0.03 (0.08) (0.06) 0.04 (a) preliminarily reported on February 9, 2006
Impact on Guidance
The company announced on February 9 that 2006 earnings per diluted share were expected to be approximately $0.73 — equal to the 2005 preliminary results of $0.75, less $0.02 for the implementation of expensing stock options in 2006. The company also announced, at that time, that the fair value of its hedging instruments at December 31, 2005 was a gain of $4.3 million recorded on its balance sheet in accumulated other comprehensive income. The company also indicated that if it were to change the accounting for its hedging activities, the actual gains on these instruments, which will be recorded in 2006 when they mature, would be reduced by this $4.3 million gain.
The 2006 guidance provided on February 9 assumed that all gains on hedge instruments would be taken into income upon the expiration of the underlying hedge instruments in 2006. Due to the change in accounting for hedge activities, the fair value gain of $4.3 million will now be recorded in the company's net income for 2005. The company also indicated that it now expects to have an effective tax rate of approximately 35 percent in 2006. Accordingly, the company is reducing its 2006 annual earnings per share guidance by the after-tax effect of this $4.3 million gain and higher tax rate, or $0.05 per share, resulting in $0.68 expected earnings for the year. The company reaffirmed that it expects net sales growth of at least 10 percent in 2006 and that the restatement has no effect on the company's underlying operating performance.
The company reaffirmed its previously issued 2007 earnings per diluted share guidance which reflected compound growth of at least 10 percent per year from the preliminary 2005 results reduced for stock options expensing.