UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-K

 

 

Commission File Number 1-9548

 

 

 

 

The Timberland Company

(Exact Name of Registrant as Specified in Its Charter)

 

 

Registrant’s telephone number, including area code:
(603) 772-9500

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  þ Yes     o No

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  o Yes     þ No

 

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.  þ Yes     o No

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

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

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  o Yes     þ No

 

The aggregate market value of Class A Common Stock of the Company held by non-affiliates of the Company was $2,057,934,009 on July 1, 2005, which was the last business day of the Company’s second fiscal quarter in 2005. For purposes of the foregoing sentence, the term “affiliate” includes each director and executive officer of the Company. See Item 12 of this Form 10-K. 51,927,152 shares of Class A Common Stock and 11,743,660 shares of Class B Common Stock of the Company were outstanding on February 24, 2006.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Company’s definitive Proxy Statement for the 2006 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A are incorporated by reference in Part III, Items 10, 11, 12, 13 and 14, of this Form 10-K.

 

 

PART I

 

 

Overview

 

The Timberland Company was incorporated in Delaware on December 20, 1978. We are the successor to the Abington Shoe Company, which was incorporated in Massachusetts in 1933. We refer to The Timberland Company, together with its subsidiaries, as “we”, “our”, “us”, “Timberland” or the “Company.”

 

We design, develop, engineer, market and distribute, under the Timberland^®, Timberland PRO^®, SmartWool^®, Timberland Boot Company^tm and Miōn^tm brands, premium quality footwear, apparel and accessories products for men, women and children. These products provide functional performance, classic styling and lasting protection from the elements. We believe that the combination of these features makes our products an outstanding value and distinguishes us from our competitors.

 

Our products are sold primarily through independent retailers, better-grade department stores, athletic stores and other national retailers that reinforce the high level of quality, performance and service associated with Timberland. In addition, our products are sold through Timberland^® specialty stores, Timberland^® factory outlet stores, timberland.com and franchisees in Europe, which are all dedicated exclusively to selling Timberland^® products. Our products are sold throughout the United States, Canada, Europe, Asia, Latin America and the Middle East.

 

Our principal strategic goal is to become the authentic outdoor brand of choice globally by offering an integrated product selection of footwear, apparel and accessories for men, women and children that is inspired by the outdoors. Our ongoing efforts to achieve this strategic goal include (i) enhancing our leadership position in our core footwear business globally through an increased focus on consumer segment development and technological innovation, (ii) expanding our global apparel business by leveraging the brand’s rugged heritage and consumer trust, (iii) extending enterprise reach through the development of new brand platforms such as SmartWool^®, Timberland Boot Company^tm and Miōn^tm, (iv) expanding our brands geographically, (v) driving operational and financial excellence, (vi) setting the standard for commitment to the community and (vii) striving to be a global employer of choice.

 

SmartWool Corporation

 

On December 20, 2005 we acquired SmartWool Corporation based in Steamboat Springs, Colorado. SmartWool designs, develops, markets and distributes premium performance wool-based socks, apparel and accessories for men, women and children. SmartWool^® products are available in the United States, Canada, Europe and Asia.

 

Products

 

Our products fall into two primary groups: (1) footwear and (2) apparel and accessories (including product care and licensed products). The following table presents the percentage of our total product revenue (excluding royalties from third-party distributors and licensees) derived from our sales of footwear and of apparel and accessories for the past three years:

 

 

Footwear

 

In 1973, we produced our first pair of waterproof leather boots under the Timberland^® brand. We offer a broad variety of footwear products for men, women and children, featuring premium materials, state-of-the-art functional design and components and advanced construction methods. Our key Timberland^® brand footwear categories are boots, men’s and women’s casual, kids’ and outdoor performance. The Timberland PRO^® series

for skilled tradespeople and working professionals is an additional footwear category we developed to address a consumer group’s distinct needs. Similarly, in 2005 we introduced Timberland Boot Company^tm work-wear inspired footwear that is featured in a new Timberland Boot Company^tm concept store in London and also introduced Miōn^tm outdoor performance footwear. We intend to continue our efforts to extend our brand reach through these and other initiatives. This extension of the brand’s reach through complementary sub-brands and new brands like the Timberland PRO^® series, Timberland Boot Company^tm brand, and Miōn^tm brand and our development of our core footwear business is intended to advance our goal of becoming a leading global brand. Our advanced concepts team continues to focus on developing the next innovations in footwear technologies, materials, constructions and processes including cross-category technology developments, including our new PreciseFit^tm system which will be included in certain footwear products in 2006. Technology that is or will be incorporated in most of our footwear products is discussed below in Footwear Technology.

 

Boots

 

Our key boots categories include Classic Boots, in basic, premium, chukka and oxford versions, as well as Roll-Tops and Nellies. Another important boot category is our Classic Sport Boots, built for the outdoorsman consumer. A few of the key products in this category include the Field Boot, Splitrock, Euro Hiker, Bromilly and Euro Dub Hiker, which are light and flexible, built to be rugged and durable, while still allowing for enhanced agility. Some of the principal features of these boot products include premium waterproof leather, direct-attach and seam-sealed waterproof construction, rubber lug outsoles for superior traction and abrasion resistance, shock diffusion plates, durable laces, padded collars for comfortable fit, enhanced insulation, rustproof hardware for durability and moisture-wicking components for comfort and breathability. We continue our focus on reducing the seasonality of our boots business, adding new boots that enhance breathability and comfort in warm weather months and active and casual based sandals to broaden the core product range. We are also focused on expanding our women’s boot business, supported by the introduction of women’s specific collections like the Bezel, Picudilla and Canarsie which blend functional practicality with fashion elements.

 

Men’s Casual

 

Our Timberland^® men’s casual footwear series includes Boat, Casual, Rugged Casual, Work Casual, Casual Sport, Sandals and Timberland^® LTD. Featured footwear products in these categories include boat shoes, casual bucks, loafers, sandals, oxfords, chukkas, boots and slip-ons for use in the office, home or outdoors. Our focus in the development of this line of footwear is to combine the rugged heritage of Timberland with premium leathers and functional offerings. Men’s casual footwear is rooted in craftsmanship and innovation, creating products that possess superior materials and enhanced comfort. Many of our men’s footwear products incorporate our innovative Smart Comfort^tm system, which provides superior comfort while preserving the shape and style of the footwear. Expanding Timberland’s reach of casual product, we introduced the Timberland Boot Company^tm line in the United Kingdom to provide a relevant assortment with distinctive leathers and silhouettes built upon our heritage of leather innovation.

 

Women’s Casual

 

Timberland^® women’s casual footwear line includes Casual, Natural Casual and Sport footwear with a focus on providing versatile, refined and feminine styling for the modernist consumer. To provide unparalleled comfort without sacrificing style, many of our women’s styles also incorporate our innovative Comforia^tm system. To expand Timberland’s reach with our target consumers, we plan to add dedicated design resources closer to market in Europe and expand the luxury sport footwear category for women.

 

Kids’

 

Timberland^® kids’ footwear products are take-down versions of our high-quality adult footwear products complemented by product designed and engineered for kids’ only. This line includes boots, outdoor sport, sandals and casual product categories. Featured products in the boots series include the Field Boot, 6” Premium, Euro Hiker and Euro Dub families that combine rugged durability, quality and craftsmanship. The

Casual line features product focusing on fit and functionality and includes Safari, Pawtuckaway, and Timber-Tots series providing premium leathers, linings and details. Many of our kids’ footwear products incorporate the Smart Comfort^tm system.

 

Outdoors

 

Outdoor Performance

 

Our Timberland^® outdoor performance footwear series continues to address the needs of outdoor recreationalists of all levels, offering technical, end-use driven products for outdoor adventures from summit to sea and everywhere in between. Across this series of footwear we continue to target three core categories — hiking, sport utility and water sports.

 

In 2005, we partnered with elite athletes in the design and development of two key new programs. World renowned high altitude adventurer Ed Viesturs helped to develop the new Cadion hiking program (which has won acclaim as a market-leading lightweight hiker), while the athletes of Team GoLite/Timberland collaborated in the development of Timberland’s first outdoor multi-sport shoe geared toward adventure racing. We also marked 2005 with the launch of the successful Power Lounger series — versatile after-sport shoes featuring a SmartWool^® lining, an industry first. The line continues to be built upon the Timberland^® Agile IQ platform, which addresses key areas of traction, shock absorption and fit to deliver out of the box comfort and enhance control and position sense on the trail.

 

Building on the Company’s long-term initiative to offer premium quality and performance to the entry-level consumer, we introduced the Chochorua Trail waterproof hiker in sporting goods and department stores worldwide. This value-based series, which started with the White Ledge series in 2004, will be expanded into the sport utility category in 2006.

 

Miōn^tm Footwear

 

We introduced a new performance water line in 2005 under our new Miōn^tm brand. Miōn^tm water shoes include a performance water shoe, a performance sandal, a guide slide and a pro thong for men, women and children. Miōn^tm footwear is designed for comfort and versatility in all wet conditions for the outdoor adventurer’s active lifestyle. Miōn^tm footwear features an Ergomorphic^tm footbed that permanently molds itself to each individual foot, a rib structure that wraps around the foot in critical areas to ensure the foot is held in place, a climbing-grade spiral cord that traces the rib structure to secure the foot and an outsole constructed of Gripstick^tm Wet/Dry Traction rubber, which combines multi-directional QuadCut^tm siping and proprietary compounds that improve grip in wet conditions.

 

Timberland PRO^® Series

 

We continue to expand and broaden our offering of high performance work shoes specifically designed for working professionals who need the best in comfort, durability and protection under the Timberland PRO^® series sub-brand. In 2005, we continued to expand the TiTAN^® collection by introducing hiking silhouettes and oxford styles. All TiTAN^® styles feature the innovative TiTAN^® safety toe and our exclusive PowerFit^tm Comfort system, which provides superior fit, cushioning and shock absorption. In addition to the TiTAN^® styles, the Timberland PRO^® series offering was expanded through the introduction of new waterproof models in the industrial hiking category — a fast growing part of the work footwear market serving the younger tradesperson. We also introduced our first metatarsal protection footwear (MetGuard) which provides ultimate protection in heavy duty environments such as foundries and steel mills. All of our waterproof styles utilize seam-sealed or membrane constructions and temperature regulating foot beds, and all of our safety toe styles meet ANSI/ASTM standards. Most styles also come with slip, abrasion and oil-resistant outsoles, as well as electrical hazard protection.

Footwear Technology

 

We continue to incorporate our patent pending, technological innovation, the Smart Comfort^tm system, in many of our men’s, women’s and kids’ footwear categories. The Smart Comfort^tm system allows the footwear to expand and contract with the changing shape of the foot during the walking motion, while preserving the essential style of the footwear. Footwear incorporating the Smart Comfort^tm system provides superior comfort in a product that retains its shape. The Smart Comfort^tm system’s expandable upper allows the shoe to follow the natural movements of the foot without pinching the top of the foot. A three-zone, multi-density footbed system provides even pressure distribution under the foot. These systems work together to distribute forces and provide superior comfort everywhere the shoe touches the foot.

 

We recently announced the development of a new patent-pending Timberland^® PreciseFit^tm system which will be incorporated into select styles of men’s footwear lines in 2006. The PreciseFit^tm system will enable consumers to customize their fit through a system of forefoot inserts. Each pair of footwear will include a set of inserts of varying thicknesses that lock onto a removable footbed, creating optimal volume in each shoe and allowing for differences between the left and right foot. This tailored fit works in conjunction with the Smart Comfort^tm system to give consumers a high level of fit and comfort.

 

Many Timberland^® footwear products offer or will be designed to offer other advanced technologies developed by us that combine some or all of the following features:

 

 

Apparel and Accessories

 

Timberland^® and Timberland PRO^® Series

 

We believe that continuing to develop and expand our apparel business is important to our global brand aspirations. In 2005 we realigned our personnel, processes and products to re-establish the core positioning of the apparel offer in each geographical region to position the business for growth. With a goal to elevate the apparel offer of the brand from the grass roots up, we re-evaluated the price value equation of every existing product and redefined the materials and signature details that would tell a unique Timberland story and set criteria for future execution on all product lines. This involved a new focus on our design and manufacturing processes, resulting in a consolidation of our Essentials, or basics, program, ensuring a global consistency in our design language, and creating economies of scale, without compromising our commitment to regional

geographic differentiation. We also continued to leverage our International Design Centre (IDC) in London which enables us to get closer to the target consumer to evaluate their needs.

 

Timberland’s apparel offer for men continues to represent a rugged casual line that includes outerwear and sportswear that combine performance benefits and technical fabrics for the outdoors with versatile styling. Timberland also offers a women’s apparel line which is primarily distributed in Europe. While we also continued to offer Timberland PRO^® apparel in 2005, we will discontinue this line in the U.S. during 2006.

 

In 2005, we underpinned the men’s and women’s apparel lines with a commitment to our ‘Earthkeepers’ initiative that reflects the intersection of product design and environmental stewardship. Organic cotton, recycled yarns, and low impact materials that are biodegradable and sustainable, along with earth friendly manufacturing processes, have all been introduced into the line to ensure we create an ongoing commitment to minimize our environmental impact. We also continued our efforts to refine the Timberland^® Limited Collection, a premium offering of apparel for our international consumers. This line both compliments and elevates our overall apparel assortment.

 

SmartWool

 

Our acquisition of SmartWool Corporation at the end of 2005 is part of our ongoing efforts to extend our enterprise’s reach by offering our customers an expanded line of apparel and accessories. SmartWool is a leading provider of premium performance wool-based socks, apparel and accessories for men, women, and children. Our key SmartWool^® product categories are performance and lifestyle socks for men, women and children and 100% SmartWool^® Next-to-Skin apparel in core baselayer styles for men and women. The classic outdoor series includes the Hiking Light Crew and Hiking Medium Crew for the outdoor and snow-sport consumer. SmartWool has also expanded its apparel line through its Versawear offering of the men’s Swoop Tee and women’s Limit Top, which provide users a natural fiber alternative to synthetic materials. SmartWool^® products vaporize moisture, control temperature and odor and are guaranteed not to shrink.

 

Third-party Licensing

 

Third-party licensing enables us to expand our brand reach to appropriate and well-defined categories and to benefit from the expertise of the licensees in a manner that reduces the risks to us associated with pursuing these opportunities. We receive a royalty on sales of our licensed products. Our Timberland^® accessories products for men, women and children include all products other than footwear and apparel products. Many of these products, including packs and travel gear, watches, men’s belts, wallets, socks, gloves, sunglasses, eyewear and ophthalmic frames, and hats and caps, are designed, manufactured and distributed pursuant to licensing agreements with third parties. We also license rights to children’s apparel in the U.S., Europe and Asia. We continue to focus on improving our licensed products and distribution and to build better integration across these products to present a seamless brand worldwide. In 2005, we entered into a new license agreement for packs and travel gear. In 2004, we entered into a license agreement for the introduction of Timberland PRO^® footwear and apparel in Europe in order to leverage our licensee’s knowledge of the European safety market, as well as their existing customer relationships. Our boys’ apparel line in the U.S. was also expanded in 2004 to include an infants’ apparel line.

 

Product Sales: Business Segments and Operations by Geographic Area

 

Our products are sold in the United States and internationally primarily through independent retailers, better-grade department stores, athletic stores and other national retailers, which reinforce the high level of quality, performance and service associated with Timberland. In addition, our products are sold in Timberland^® specialty stores and Timberland^® factory outlet stores dedicated exclusively to selling Timberland^® products, as well as through franchised retail stores in Europe. We also sell our products in the U.S. online at timberland.com.

 

We operate in an industry, which includes the designing, engineering, marketing and distribution of footwear and apparel and accessories products for men, women and children. We manage our business in the

following three reportable segments, each segment sharing similar product, distribution and marketing: U.S. Wholesale, U.S. Consumer Direct and International.

 

The U.S. Wholesale segment is comprised of the sale of products to wholesale customers in the United States. The U.S. Wholesale segment also includes royalties from licensed products sold in the United States and the management costs and expenses associated with our worldwide licensing efforts. The U.S. Consumer Direct segment includes the Company-operated specialty and factory outlet stores in the United States as well as our e-commerce business. The International segment consists of the marketing, selling and distribution of footwear, apparel and accessories and licensed products outside of the United States. This includes our subsidiaries (which use wholesale and retail channels to sell footwear and apparel and accessories), independent distributors and licensees.

 

The following table presents the percentage of our total revenue generated by each of these reporting segments for the past three years:

 

 

More detailed information regarding these reportable segments, and each of the geographic areas in which we operate, is set forth in Note 15 to our consolidated financial statements, entitled “Business Segments and Geographic Information,” included in Item 8 of this Form 10-K.

 

U.S. Wholesale

 

Our wholesale customer accounts within the United States include independent retailers, better-grade department stores, outdoor specialty stores, national athletic accounts, general sporting goods retailers and other national accounts. Many of these wholesale accounts merchandise our products in selling areas dedicated exclusively to our products, or “concept shops.” These “concept shops” display the breadth of our product line and brand image to consumers, and are serviced through a combination of field and corporate-based sales teams responsible for these distribution channels. We also service our wholesale accounts through our principal showroom in New York City and regional showrooms in Dallas, Texas and Miami, Florida. We have continued our efforts to expand the brand geographically by penetrating markets in areas beyond our traditional strength in the Northeast U.S.

 

U.S. Consumer Direct

 

At December 31, 2005, we operated 21 specialty stores and 57 factory outlet stores in the United States. We also sell products through our internet store timberland.com.

 

Timberland^® Specialty Stores.  These stores carry current season, first quality merchandise and provide:

 

 

Timberland^® Factory Outlet Stores.  These stores serve as a primary channel for the sale of excess, damaged or discontinued products. We view these factory outlet stores as a way to preserve the integrity of the Timberland^® brand, while maximizing the return associated with the sale of such products.

 

Timberland.com.  Our online store allows U.S. consumers to purchase current season, first quality merchandise over the internet. This internet site also provides information about Timberland, including the

reports we file with or furnish to the Securities and Exchange Commission, investor relations, corporate governance, community involvement initiatives and employment opportunity information. Additionally, the site serves to reinforce our marketing efforts.

 

International

 

We sell our products internationally through operating divisions in the United Kingdom, Italy, France, Germany, Switzerland, Spain, Japan, Hong Kong, Singapore, Taiwan, Malaysia and Canada. Most of these operating divisions provide support for the sale of our products to wholesale customers and operate Timberland^® specialty stores and factory outlet stores in their respective countries. At December 31, 2005, we operated 117 specialty stores and shops and 28 factory outlet stores in Europe and Asia. In 2005 we also launched the Timberland^® brand in China and established a new subsidiary in Switzerland to directly offer products to customers that were formerly serviced under an agency agreement. As discussed above, we also introduced Timberland Boot Company^tm products and concept store in the United Kingdom, which features a new line of work wear-inspired boots, jeans and jackets targeting a younger consumer. We intend to continue expanding the Timberland^® brand into new markets and consumer segments to support our goal of becoming a top global brand.

 

Timberland^® products are sold elsewhere in Europe, Asia, the Middle East, Africa, Central America and South America by distributors, franchisees and commissioned agents, some of which also may operate Timberland^® specialty and factory outlet stores located in their respective countries.

 

Distribution

 

We distribute our products through three Company-managed distribution facilities which are located in Danville, Kentucky; Ontario, California and Enschede, Holland and through third-party managed distribution facilities which are located in Asia.

 

Advertising and Marketing

 

Timberland’s mission is to equip people to make a difference in their world. This is reflected in the way we design, manufacture and market our products. Our marketing programs and promotions are designed to increase consumer awareness of and purchase intent for Timberland as a premium brand that equips consumers through the use of purposeful product. These programs and promotions are increasingly delivered throughout the year, rather than only during select seasons as has historically been the case.

 

In 2005, we continued to build on the consumer segmentation approach that we launched in 2004. This approach helps us identify target consumers and provides insight into the needs and purchasing behavior of each unique consumer group that we target. Our deeper understanding of consumers enables us to improve our product development and go-to-market execution and further differentiate Timberland products for consumers where they shop. We also continued to elevate our brand voice through the Make it better^tm marketing campaign. This integrated communications platform spanned print, outdoor, internet, experiential marketing and point-of-sale with an overarching goal to inspire and engage our consumers. Our print campaign focused on publications like Men’s Journal, Sports Illustrated, GQ, Outside, Rolling Stone, Backpacker and Cargo. Timberland also ran out-of-home advertising in markets such as New York, Washington DC, Chicago and Seattle. Our internet campaign utilized sites such as weather.com, cnet.com, espn.com and aol.com. Our Community Builder’s Tour, which unites local residents, community organizations and select retailers around Timberland’s ethic of service, continued in 2005, with events in Philadelphia, Baltimore and Atlanta.

 

Our marketing efforts were supported by distributor and licensee funded marketing campaigns, developed in close concert with Timberland to ensure consistent and effective brand presentation.

 

Seasonality

 

In 2005, as has been historically the case, our revenue was higher in the last two quarters of the year than in the first two quarters. Accordingly, the amount of fixed costs related to our operations represented a larger

percentage of revenue in the first two quarters of 2005 than in the last two quarters of 2005. We expect this seasonality to continue in 2006.

 

Backlog

 

At December 31, 2005, our backlog of orders from our customers was $381 million. Excluding SmartWool our backlog of orders from our customers was $369 million, compared with $386 million at December 31, 2004 and $332 million at December 31, 2003. While all orders in the backlog are subject to cancellation by customers, we expect that the majority of such orders will be filled in 2006. We believe that backlog at year-end is an imprecise indicator of total revenue that may be achieved for the full year because backlog only relates to wholesale orders for the next season, is affected by the timing of customers’ orders and product availability and excludes potential sales in our retail stores during the year.

 

Manufacturing

 

We continue to operate manufacturing facilities in the Dominican Republic. However, we closed our Puerto Rico footwear manufacturing facility at the end of 2005 due, in part, to the loss of certain tax benefits. We relocated some of the manufacturing capacity to our state-of-the-art footwear manufacturing facility in the Dominican Republic and expanded production capability in that location. We believe we benefit from our internal manufacturing capability which provides us with sourcing for fashion and core assortment, planning efficiencies and lead time reduction, refined production techniques and favorable duty rates and tax benefits. During 2005, we manufactured approximately 10% of our footwear unit volume in Puerto Rico and the Dominican Republic, compared to approximately 9% during 2004 and 10% during 2003. The remainder of our footwear products and all of our apparel and accessories products were produced by independent manufacturers and licensees in Asia, Europe, Mexico, Africa, and South and Central America. Approximately 90% of the Company’s 2005 footwear unit volume was produced in Asia by independent manufacturers in China, Vietnam and Thailand. Three of these manufacturers produced approximately 17% to 20% each of the Company’s 2005 footwear volume. The Company continually evaluates footwear production sources in other countries to maximize cost efficiencies and to keep pace with advanced production techniques.

 

We maintain a product quality management group, which develops, reviews and updates our quality and production standards. To help ensure such standards are met, the group also conducts product quality audits at our factories and distribution centers and our independent manufacturers’ factories and distribution centers. We have offices in Bangkok, Thailand; Zhu Hai, China; Hong Kong; Istanbul, Turkey and Ho Chi Minh City, Vietnam to supervise our sourcing activities conducted in the Asia-Pacific region.

 

Materials

 

In 2005, nine suppliers provided, in the aggregate, approximately 82% of our leather purchases. Two of these suppliers together provided approximately 31% of our leather purchases in 2005. We historically have not experienced significant difficulties in obtaining leather or other materials in quantities sufficient for our operations. However, our gross profit margins are adversely affected to the extent that the selling prices of our products do not increase proportionately with increases in the costs of leather and other materials. Any significant, unanticipated increase or decrease in the prices of these commodities could materially affect our results of operations. We attempt to manage this risk, as we do with all other footwear and non-footwear materials, on an ongoing basis by monitoring related market prices, working with our suppliers to achieve the maximum level of stability in their costs and related pricing, seeking alternative supply sources when necessary and passing increases in commodity costs to our customers, to the maximum extent possible, when they occur. No assurances can be given that such factors will protect us from future changes in the prices for such materials.

 

In addition, we have established a central network of suppliers through which our footwear manufacturing facilities and independent footwear manufacturers can purchase materials. We seek sources of materials local to manufacturers, in an effort to reduce lead times while maintaining our high quality standards. We believe that key strategic alliances with leading materials vendors help reduce the cost and provide greater consistency

of materials procured to produce Timberland^® products and improve compliance with our production standards. In 2005, we renewed contracts with global vendors for box toes and counters, cellulose and nonwoven insole board, Ströbel^® construction insole materials and thread, and entered into new global contracts for pvc compounds and synthetic suede lining materials. Global contracts remained in effect for packaging, laces, soling components, waterproof membrane gasket material, waterproof seam seal adhesives, topline reinforcement tape and packaging labels.

 

Trademarks and Trade Names; Patents; Research & Development

 

Our principal trade name is The Timberland Company and our principal trademarks are TIMBERLAND and the TREE DESIGN LOGO, which have been registered in the United States and many foreign countries. Some of our other trademarks or registered trademarks are: 24/7 Comfort Suspension, ArchLogic, Balm Proofer, Boot Sauce, Blackridge Mountain, B.S.F.P., Cast-Bond, Comforia, Earthkeepers, Endoskeleton, Ergomorphic, Gripstick, Independent Suspension Network, ISN, Jackson Mountain, Ladder Lock, Made To Work, Make it better, Miōn, Path of Service, PowerFit, PreciseFit, PRO 24/7, PRO 24/7 Comfort Suspension, Pull On Your Boots, Pull On Your Boots and Make a Difference, QuadCut, SafeGrip, Smart Comfort, SmartWool, Splash Blaster, TBL, Timberland Boot Company, Timberland PRO, Timber Trail, TiTAN, Trail Grip, Weathergear, Waximum and Workboots For The Professional.

 

 

We regard our trade name and trademarks as valuable assets and believe that they are important factors in marketing our products. We seek to protect and vigorously defend our trade name and trademarks against infringement under the laws of the United States and other countries. In addition, we seek to protect and vigorously defend our patents, designs, copyrights and all other proprietary rights under applicable laws.

 

We conduct research, design and development efforts for our products, including field testing of a number of our products to evaluate and improve product performance. Our Invention Factory, an advanced concepts footwear team, continued its efforts in 2005 to develop future technologies for our footwear products. We have also dedicated resources to an international design and development team based in Europe. Our expenses

relating to research, design and development have not represented a material expenditure relative to our other expenses.

 

Competition

 

Our footwear and apparel and accessories products are marketed in highly competitive environments that are subject to changes in consumer preference. Although the footwear industry is fragmented to a great degree, many of our competitors are larger and have substantially greater resources than us, including athletic shoe companies, several of which compete directly with some of our products. In addition, we face competition from retailers that have established products under private labels and from direct mail companies in the United States. The competition from some of these competitors is particularly strong where such competitor’s business is focused on one or a few product categories or geographic regions in which we also compete. However, we do not believe that any of our principal competitors offer a complete line of products that provides the same quality and performance as the complete line of Timberland^®, Timberland PRO^®, SmartWool^®, Timberland Boot Company^tm and Miōn^tm footwear and apparel and accessories products.

 

Product quality, performance, design, styling and pricing, as well as consumer awareness, are all important elements of competition in the footwear and the apparel and accessories markets served by us. Although changing fashion trends generally affect demand for particular products, we believe that, because of the functional performance, classic styling and high quality of Timberland^® footwear products, demand for most Timberland^® footwear products is less sensitive to changing trends in fashion than other products that are designed specifically to meet such trends.

 

Environmental Matters

 

Compliance with federal, state and local environmental regulations has not had, nor is it expected to have, any material effect on our capital expenditures, earnings or competitive position based on information and circumstances known to us at this time.

 

Employees

 

At December 31, 2005, we had approximately 5,300 employees worldwide. Our management considers our employee relations to be good. None of our employees is represented by a labor union, and we have never suffered a material interruption of business caused by labor disputes involving our own employees.

 

Available Information

 

Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, exhibits and amendments to those reports that are filed with or furnished to the Securities and Exchange Commission are made available free of charge through our website www.timberland.com, as soon as reasonably practicable after we electronically file them with, or furnish them to, the Securities and Exchange Commission. The charters for the Audit, Governance and Nominating, and Management Development and Compensation committees of our Board of Directors as well as our Corporate Governance Principles and Code of Ethics are available free of charge through our website www.timberland.com. You may request a copy of any of the above documents by writing to the Secretary, The Timberland Company, 200 Domain Drive, Stratham, New Hampshire 03885.

 

We submitted to the New York Stock Exchange in 2005 the CEO certification required by Section 303A.12(a) of the New York Stock Exchange Listed Company Manual.

Executive Officers of the Registrant

 

The following table lists the names, ages and principal occupations during the past five years of our executive officers. All executive officers serve at the discretion of our Company’s Board of Directors.

 

 

ITEM 1A.  RISK FACTORS

 

CAUTIONARY STATEMENTS FOR PURPOSES
OF THE “SAFE HARBOR” PROVISIONS OF
THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

 

The Timberland Company (the “Company”) wishes to take advantage of The Private Securities Litigation Reform Act of 1995, which provides a “safe harbor” for forward-looking statements to encourage companies to provide prospective information. Prospective information is based on management’s then current expectations or forecasts. Such information is subject to the risk that such expectations or forecasts, or the assumptions used in making such expectations or forecasts, may become inaccurate. The following discussion

identifies important factors that could affect the Company’s actual results and could cause such results to differ materially from those contained in forward-looking statements made by or on behalf of the Company. The Company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

 

Risks Related to Our Business

 

We operate in a highly competitive industry.

 

We market our products in highly competitive environments. Many of our competitors are larger and have substantially greater resources for marketing, research and development and other purposes. These competitors include athletic and other footwear companies, branded apparel companies and private labels established by retailers. Furthermore, efforts by our footwear competitors to dispose of their excess inventory could put downward pressure on retail prices and could cause our wholesale customers to redirect some of their purchases away from our products.

 

Our products may not appeal to consumers.

 

As we continue to market established products and develop new products, our success depends in large part on our ability to anticipate, understand and react to changing consumer demands. Our products must appeal to a broad range of consumers whose preferences cannot be predicted with certainty and are subject to rapid change. The success of our products and marketing strategy will also depend on a favorable reception by our wholesale customers. We cannot ensure that any existing products or brands will continue to be successfully received by consumers or our wholesale customers. We cannot ensure that any new products or brands that we introduce will be successfully received by consumers or our wholesale customers. We believe that our more fashion-focused boots, men’s apparel and women’s footwear products are more susceptible to changing fashion trends and consumer preferences than our other products. Any failure on our part to anticipate, identify and respond effectively to changing consumer demands and fashion trends could adversely affect retail and consumer acceptance of our products and leave us with unsold inventory or missed opportunities. If that occurs, we may be forced to rely on markdowns or promotional sales to dispose of excess, slow-moving inventory, which may harm our business. At the same time, our focus on tight management of inventory may result, from time to time, in not having an adequate supply of products to meet consumer demand and cause us to lose sales.

 

We conduct business outside the United States which exposes us to foreign currency, import restrictions and duties and other risks.

 

We manufacture and source a majority of our products outside the United States. Our products are sold in the U.S. and internationally. Accordingly, we are subject to the risks of doing business abroad, including, among other risks, foreign currency exchange rate risks, import restrictions, anti-dumping investigations, political or labor disturbances, expropriation and acts of war. The European Union is considering imposition of anti-dumping measures, including increased import duties, with respect to leather footwear imported from China and Vietnam and safety footwear imported from China and India. The imposition of such measures could adversely impact our ability to source footwear from the affected countries in a cost effective manner because of higher costs to us and potentially our customers. Although we pay for the purchase and manufacture of our products primarily in U.S. dollars, we are routinely subject to currency rate movements on non-U.S. denominated assets, liabilities and income as we sell goods in local currencies through our foreign subsidiaries. No assurances can be given that we will be protected from future changes in foreign currency exchange rates that may impact our financial condition or performance.

 

We depend on independent manufacturers to produce the majority of our products and our business could suffer if we need to replace manufacturers or suppliers or find additional capacity.

 

During 2005, we manufactured approximately 10% of our footwear unit volume. Independent manufacturers and licensees in Asia, Europe, Mexico, Africa and South and Central America produced the remainder

of our footwear products and all of our apparel and accessories products. Independent manufacturers in China, Vietnam and Thailand produced approximately 90% of our 2005 footwear unit volume. Three of these manufacturers produced approximately 17% to 20% each of our 2005 footwear volume. If we experience a significant increase in demand or a manufacturer is unable to ship orders of our products in a timely manner or to meet our quality standards, then we could miss customer delivery date requirements for those items, which could result in cancellation of orders, refusal to accept deliveries or a reduction in purchase prices, any of which could have a material adverse effect on our financial condition and results of operations. We compete with other companies for the production capacity of our manufacturers and import quota capacity. Any long-term economic downturn could cause our suppliers to fail to make and ship orders placed by us. There is no assurance that we will be able to maintain current relationships with our current manufacturers or locate additional manufacturers that can meet our requirements or manufacture on terms that are acceptable to us.

 

The loss of one or more of our major suppliers for materials may interrupt our supplies.

 

We depend on a limited number of key sources for leather, our principal material, and other proprietary materials used in our products. In 2005, nine suppliers provided, in the aggregate, approximately 82% of our leather purchases. Two of these suppliers provided approximately 31% of our leather purchases in 2005. While historically we have not experienced significant difficulties in obtaining leather or other materials in quantities sufficient for our operations, there have been significant changes in the prices for these materials. Our gross profit margins are adversely affected to the extent that the selling prices of our products do not increase proportionately with increases in the costs of leather and other materials. Any significant unanticipated increase or decrease in the prices of these commodities could materially affect our results of operations. Increasing oil-related product costs could also adversely impact gross margins. As we discussed in our public filings with the Securities and Exchange Commission during 2001, leather hide prices increased significantly in 2001 and adversely impacted our gross margins that year. No assurances can be given that we will be protected from future changes in the prices for such materials.

 

Our business could be adversely impacted by any disruption to our supply chain.

 

Independent manufacturers manufacture a majority of our products outside of our principal sales markets, which requires us to transport our products through third parties over large geographic distances. Delays in the shipment or delivery of our products due to the availability of transportation, work stoppages or other factors could adversely impact our financial performance.

 

Our business could be adversely impacted by the financial instability of our customers.

 

We sell our products to wholesale customers and extend credit based on an evaluation of each customer’s financial condition, usually without requiring collateral. The financial difficulties of a customer could cause us to curtail doing business with that customer. Our inability to collect from our customers could have an adverse effect on our business or our financial condition.

 

We depend on sales forecasts which may not be accurate and may result in higher infrastructure and product investments.

 

We base our investments in infrastructure and product, in part, on sales forecasts. We do business in highly competitive markets, and our business is affected by a variety of factors, including brand awareness, product innovations, retail market conditions, economic and other factors, changing consumer preferences, fashion trends, seasonality and weather conditions. One of our principal challenges is to predict these factors to enable us to match the production of our products with demand. If sales forecasts are not achieved, these investments could represent a higher percentage of revenue, and we may experience higher inventory levels and associated carrying costs, all of which could adversely affect our financial performance.

Declines in revenue in our retail stores could adversely affect profitability.

 

We have made significant capital investments in opening retail stores and incur significant expenditures in operating these stores. The higher level of fixed costs related to our retail organization can adversely affect profitability, particularly in the first half of the year, as our revenue historically has been more heavily weighted to the second half of the year. Our ability to recover the investment in and expenditures of our retail organization can be adversely affected if sales at our retail stores are lower than anticipated. Our gross margin could be adversely affected if off-price sales increase as a percentage of revenue.

 

We rely on our licensing partners to help us preserve the value of our brand.

 

Since late 1994, we have entered into several licensing agreements which enable us to expand our brand to product categories and geographic territories in which we have not had an appreciable presence. The risks associated with our own products also apply to our licensed products. There are also any number of possible risks specific to a licensing partner’s business, including, for example, risks associated with a particular licensing partner’s ability to obtain capital, manage its labor relations, maintain relationships with its suppliers, manage its credit risk effectively and maintain relationships with its customers. Although our license agreements prohibit licensing partners from entering into licensing arrangements with certain of our competitors, generally our licensing partners are not precluded from offering, under other brands, the types of products covered by their license agreements with us. A substantial portion of sales of the licensed products by our domestic licensing partners are also made to our largest customers. While we have significant control over our licensing partners’ products and advertising, we rely on our licensing partners for, among other things, operational and financial control over their businesses.

 

The loss of key executives could cause our business to suffer, and control by members of the Swartz family and the anti-takeover effect of multiple classes of stock could discourage attempts to acquire us.

 

Sidney W. Swartz, our Chairman, Jeffrey B. Swartz, our President and Chief Executive Officer, and other executives have been key to the success of our business to date. The loss or retirement of these or other key executives could adversely affect us. Sidney W. Swartz and various trusts established for the benefit of his family or for charitable purposes, hold approximately 70% of the combined voting power of our capital stock in the aggregate, enabling him to control our affairs and to influence the election of the three directors entitled to be elected by the holders of Class A common stock voting separately as a class. Members of the Swartz family will, unless they sell substantially all of their Class B common stock, have the ability, by virtue of their stock ownership, to prevent or cause a change in control of the Company.

 

Our charter documents and Delaware law may inhibit a change of control that stockholders may consider favorable.

 

Under our Certificate of Incorporation, the Board of Directors has the ability to issue and determine the terms of preferred stock. The ability to issue preferred stock coupled with the anti-takeover provisions of Delaware law could delay or prevent a change of control or change in management that might provide stockholders with a premium to the market price of their common stock.

 

Our inability to attract and retain qualified employees could impact our business.

 

We compete for talented employees within our industry. We must maintain competitive compensation packages to recruit and retain qualified employees. Our failure to attract and retain qualified employees could adversely affect the sales, design and engineering of our products.

 

Our ability to protect our trademarks and other intellectual property rights may be limited.

 

We believe that our trademarks and other proprietary rights are important to our success and our competitive position. We devote substantial resources to the establishment and protection of our trademarks on a worldwide basis. We cannot ensure that the actions we have taken to establish and protect our trademarks and other proprietary rights will be adequate to prevent imitation of our products by others or to prevent others

from seeking to block sales of our products as a violation of the trademarks and proprietary rights of others. Also, we cannot ensure that others will not assert rights in, or ownership of, trademarks and other proprietary rights of ours or that we will be able to successfully resolve these types of conflicts to our satisfaction. We are also susceptible to injury from parallel trade and counterfeiting of our products. In addition, the laws of certain foreign countries may not protect proprietary rights to the same extent as do the laws of the United States.

 

We cannot assure the successful implementation of our strategy.

 

As part of our growth strategy, we seek to enhance the premium positioning of our brand, to extend our brands into complementary product categories and consumer groups, to expand geographically and to improve our operational performance. There can be no assurance that we will be able to successfully implement any or all of these strategies, which could lead to a decline in our results in operations, which in turn could have a negative effect on our stock.

 

The value of our brand, and our sales, could be diminished if we are associated with negative publicity.

 

While our staff and third-party compliance auditors periodically visit and monitor the operations of our vendors, independent manufacturers and licensees, we do not control these vendors or independent manufacturers or their labor practices. A violation of our vendor policies, labor laws or other laws by these vendors or independent manufacturers could interrupt or otherwise disrupt our sourcing or damage our brand image. Negative publicity, for these or other reasons, regarding our Company, brand or products, including licensed products, could adversely affect our reputation and sales.

 

Risks Related to Our Industry

 

We face intense competition in the worldwide footwear and apparel industry, which may impact our sales.

 

We face a variety of competitive challenges from other domestic and foreign footwear and apparel producers, some of which may be significantly larger and more diversified and have greater financial and marketing resources than we have. We compete with these companies primarily on the basis of anticipating and responding to changing consumer demands in a timely manner, maintaining favorable brand recognition, developing innovative, high-quality products in sizes, colors and styles that appeal to consumers, providing strong and effective marketing support, creating an acceptable value proposition for retail customers, ensuring product availability and optimizing supply chain efficiencies with manufacturers and retailers, and obtaining sufficient retail floor space and effective presentation of our products at retail. Increased competition in the worldwide footwear and apparel industries, including internet-based competitors, could reduce our sales, prices and margins and adversely affect our results of operations.

 

A downturn in the economy may affect consumer purchases of discretionary items and retail products, which could adversely affect our sales.

 

The industries in which we operate are cyclical. Many factors affect the level of consumer spending in the footwear and apparel industries, including, among others, general business conditions, interest rates, the availability of consumer credit, weather, taxation and consumer confidence in future economic conditions. Consumer purchases of discretionary items, including our products, may decline during recessionary periods and also may decline at other times when disposable income is lower. A downturn in the economies in which we, or our licensing partners, sell our products, whether in the United States or abroad, may adversely affect our sales. Our gross margin could also be adversely affected if off-price sales increase as a percentage of revenue.

 

Retail trends could result in downward pressure on our prices.

 

With the growing trend toward retail trade consolidation, we increasingly depend upon a reduced number of key retailers whose bargaining strength is growing. Changes in the policies of these retail trade customers, such as increased at-once ordering, limitations on access to shelf space and other conditions may result in

lower net sales. Further consolidations in the retail industry could result in price and other competition that could damage our business.

 

ITEM 1B.  UNRESOLVED STAFF COMMENTS

 

None.

 

 

Since April 1994, we have leased our worldwide headquarters located in Stratham, New Hampshire. Our current lease for this property expires in September 2010, with the option to extend the term for two additional five-year periods. We consider our headquarters facilities adequate and suitable for our current needs.

 

We lease our manufacturing facilities located in Santiago, Dominican Republic, under leasing arrangements, which expire on various dates through 2009. We own our distribution facility in Danville, Kentucky, and we lease our facilities in Ontario, California and Enschede, Holland. The Company and its subsidiaries lease all of their specialty and factory outlet stores. Our subsidiaries also lease office and warehouse space to meet their individual requirements.

 

 

We are involved in various litigation and legal matters that have arisen in the ordinary course of business. We believe that the ultimate resolution of any existing matter will not have a material adverse effect on our consolidated financial statements.

 

 

During the fourth quarter of the fiscal year ended December 31, 2005, no matter was submitted to a vote of security holders through the solicitation of proxies or otherwise.

 

PART II

 

 

Our Class A Common Stock is traded on the New York Stock Exchange under the symbol TBL. There is no market for shares of our Class B Common Stock; however, shares of Class B Common Stock may be converted into shares of Class A Common Stock on a one-for-one basis and will automatically be converted upon any transfer (except for estate planning transfers and transfers approved by the Board of Directors).

 

The following table presents the high and low closing sales prices of our Class A Common Stock for the past two years, as reported by the New York Stock Exchange and restated to reflect the 2-for-1 stock split in May 2005.

 

 

As of February 24, 2006, the number of record holders of our Class A Common Stock was 788 and the number of record holders of our Class B Common Stock was 6. The closing sales price of our Class A Common Stock on February 24, 2006 was $34.86 per share.

We have never declared a dividend on either the Company’s Class A or Class B Common Stock. Our ability to pay cash dividends is limited pursuant to loan agreements (see notes to the Company’s consolidated financial statements). The Company has no plans to issue a cash dividend at this time.

 

ISSUER PURCHASES OF EQUITY SECURITIES(1)

 

For the Three Fiscal Months Ended December 31, 2005

 

 

Footnote(1)

 

 

Program 1 was completed on December 1, 2005. No other existing programs expired or were terminated during the reporting period. See Note 16 to our consolidated financial statements, entitled “Stockholders’ Equity”, included in Item 8 of this Form 10-K for additional information.

 

Share and price per share information in Program 1 are adjusted to reflect the Company’s 2-for-1 stock split. The Board approved a 100% increase in shares remaining under its previously announced October 2003 repurchase program as of the April 14, 2005 record date to reflect the impact of the stock split. The increase was effective immediately after the May 2, 2005 distribution date.

 

 

 

Selected Statement of Income Data

 

 

 

 

Earnings per share have been restated to reflect the 2-for-1 stock split in May 2005.

 

Selected Consolidated Balance Sheet Data

 

 

 

The following discusses The Timberland Company’s (“we”, “our”, “us”, “Timberland” or the “Company”) results of operations and liquidity and capital resources. The discussion, including known trends and uncertainties identified by management, should be read in conjunction with the consolidated financial statements and related notes. Included herein are discussions and reconciliations of total Company and International revenue growth to constant dollar revenue growth, diluted earnings per share (“EPS”) to diluted EPS excluding restructuring and related costs and diluted EPS to diluted EPS excluding restructuring and related costs and including stock-based employee compensation costs. Constant dollar revenue growth, which excludes the impact of changes in foreign exchange rates, diluted EPS excluding restructuring and related costs and diluted EPS excluding restructuring and related costs and including stock-based employee compensation costs are not Generally Accepted Accounting Principle (”GAAP”) performance measures. We provide constant dollar revenue growth for total Company and International results because we use the measure to understand revenue growth excluding any impact from foreign exchange rate changes. Management provides diluted EPS excluding restructuring and related costs because we use the measure to understand earnings excluding these identifiable expenses. Management provides diluted EPS excluding restructuring and related costs and including stock-based employee compensation costs to provide comparability to future reported results that will include stock-based employee compensation costs as prescribed by Statement of Financial Accounting Standards (“SFAS”) 123(R), “Share Based Payment.”

Recent Developments

 

On December 20, 2005 the Company completed its acquisition of SmartWool Corporation (“SmartWool”), a company that designs, develops, markets and distributes premium performance socks, apparel and accessories for men, women and children. The purchase price was $81.3 million, net of cash acquired, and was funded through our existing cash balances. Due to the timing of the close, SmartWool had a minimal impact on 2005 earnings. We anticipate the acquisition of SmartWool will add approximately $0.03 to our diluted EPS in 2006, with benefits weighted toward the second half of the year.

 

On February 9, 2006, the Company announced that its Board of Directors authorized the repurchase of up to an additional 6,000,000 shares of our Class A Common Stock. This additional program supplements the Company’s current share authorization, of which approximately 1.5 million shares were outstanding as of December 31, 2005.

 

Overview

 

Our principal strategic goal is to become the authentic outdoor brand of choice globally. We continue to develop a diverse portfolio of footwear, apparel and accessories that reinforces the functional performance, benefits and classic styling that consumers have come to expect from our brand. We sell our products to consumers who embrace an outdoor-inspired lifestyle through high-quality distribution channels, including our own retail stores, which reinforce the premium positioning of the Timberland^® brand.

 

To deliver against our long-term goals, we are focused on driving progress on key strategic fronts. These include enhancing our leadership position in our core footwear business, capturing the opportunity that we see for outdoor-inspired apparel, extending enterprise reach through development of new brand platforms and brand building licensing arrangements, expanding geographically and driving operational and financial excellence while setting the standard for commitment to the community and striving to be a global employer of choice.

 

Highlights of our 2005 financial performance include the following:

 

 

Restructuring charges related to the consolidation of our Caribbean manufacturing facilities reduced operating profits by $4.3 million. Excluding this impact, operating profit, net income and diluted EPS increased 6.7%, 10.6% and 15.4%, respectively, in 2005. For 2006, we are targeting mid single-digit revenue growth and moderate declines in comparable EPS to 2005. For the purpose of comparison, we estimate that 2005 diluted EPS would have been approximately $2.35, after excluding restructuring costs and including costs related to stock options and our employee stock purchase plan (see Reconciliation of Diluted EPS to Diluted EPS Excluding Restructuring and Related Costs and Including Stock-Based Employee Compensation Costs below). Restructuring costs related to the Company’s Caribbean manufacturing operations were $4.3 million in 2005 and are estimated to be approximately $0.3 million in Q1 2006.

 

Our financial outlook reflects anticipated pressure on gross margins in 2006, driven by product mix changes and macro factors such as higher oil-related product costs. We are also planning for high single-digit

growth in operating expenses, driven by investments to advance Timberland’s global development and organization capability and by incremental equity-based compensation costs, reflecting new accounting requirements. Impacts from these factors are expected to be greater in the first half of 2006.

 

Critical Accounting Policies

 

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to sales returns and allowances, realization of outstanding accounts receivable, the carrying value of inventories, derivatives, other contingencies, impairment of assets, incentive compensation accruals and the provision for income taxes. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Historically, actual results have not been materially different from our estimates. Because of the uncertainty inherent in these matters, actual results could differ from the estimates used in applying our critical accounting policies. The Company is not aware of any reasonably likely events or circumstances that would result in materially different amounts being reported. Our significant accounting policies are described in Note 1 to the Company’s consolidated financial statements.

 

We have identified the following as critical accounting policies, based on the significant judgments and estimates used in determining the amounts reported in our consolidated financial statements:

 

Sales Returns and Allowances

 

Our revenue consists of sales to wholesale customers, retail store revenues, license fees and royalties. We record wholesale revenues when title passes and the risks and rewards of ownership have passed to the customer, based on the terms of sale. Title passes generally upon shipment or upon receipt by the customer depending on the country of sale and the agreement with the customer. Retail store revenues are recorded at the time of the sale. License fees and royalties are recognized as earned per the terms of our licensing and royalty agreements. We record reductions to revenue for estimated wholesale and retail customer returns and allowances. We base our estimates on historical rates of customer returns and allowances, as well as the specific identification of outstanding returns and allowances, which are known to us but which have not yet been received. Our total reserves for sales returns and allowances were $43.9 million at December 31, 2005 and $42.0 million at December 31, 2004. The actual amount of customer returns and allowances, which are inherently uncertain, may differ from our estimates. If we determine that increases or decreases to sales returns and allowances are appropriate, we record either a reduction or an increase in sales in the period in which we make such a determination.

 

Allowance for Doubtful Accounts

 

We make ongoing estimates for losses relating to our allowance for uncollectible accounts receivable resulting from the potential inability of our customers to make required payments. We estimate potential losses primarily based upon our historical rate of credit losses and our knowledge of the financial condition of our customers. Our allowances for doubtful accounts totaled $8.8 million and $8.9 million at December 31, 2005 and 2004, respectively. Historically, losses have been within our expectations. If the financial condition of our customers were to change, adjustments may be required to these estimates. Furthermore, we provide for estimated losses resulting from disputes, which arise with respect to the gross carrying value of our receivables and the amounts which customers owe to us. The settlement or resolution of these differences could result in future changes to these estimates. If we determine that increases or decreases to the allowance for doubtful accounts are appropriate, we record either an increase or decrease to selling expense in the period in which we make such a determination.

Inventory Valuation

 

We value our inventory at the lower of cost (first-in, first-out) or market value. Market value is estimated based upon assumptions made about future demand and retail market conditions. If we determine that the estimated market value of our inventory is less than the carrying value of the inventory, we provide a reserve for the difference as a charge to cost of sales. Our reserves related to inventory valuation totaled $10.8 million at December 31, 2005 and $10.0 million at December 31, 2004. If actual market conditions are more or less favorable than our estimates, adjustments to our inventory reserves may be required. The adjustments would decrease or increase our cost of sales and net income in the period in which they are recognized.

 

Derivatives

 

We are routinely subject to currency rate movements on non-U.S. dollar denominated assets, liabilities and income as we purchase and sell goods in foreign markets in their local currencies. We use derivative instruments, specifically forward contracts, to hedge a portion of our forecasted foreign currency transactions. We use our operating budget and periodic forecasts to estimate future economic exposure and to determine the appropriate levels and timing of related hedging transactions. We closely monitor our foreign currency exposure and adjust our hedge positions accordingly. Our estimates of anticipated transactions could fluctuate over time and could vary from the ultimate transactions (see Note 4 to our consolidated financial statements in Item 8 of this Form 10-K). Future operating results could be impacted by adjustments to these estimates.

 

Contingencies

 

In the ordinary course of business we are involved in legal proceedings involving contractual and employment relationships, product liabilities, trademark rights and a variety of other matters. We record contingent liabilities when it is probable that a liability has been incurred and the amount of the loss is estimable. We disclose a contingent liability when there is at least a reasonable possibility that a loss has been incurred. Estimating probable losses requires analysis and judgment about the potential actions. Therefore, actual losses in any future period are inherently uncertain. We do not believe that any pending legal proceeding or claims will have a material impact on our financial statements. However, if actual or estimated probable future losses exceed our recorded liability, we would record additional expense during the period in which the loss or change in estimate occurred.

 

Long-lived Assets

 

When events or circumstances indicate that the carrying value of a long-lived asset may be impaired, we estimate the future undiscounted cash flows to be derived from the asset to determine whether or not a potential impairment exists. If the carrying value exceeds the estimate of future undiscounted cash flows, impairment is calculated as the excess of the carrying value of the asset over the estimate of its fair market value. We estimate future undiscounted cash flows using assumptions about expected future operating performance. Those estimates of undiscounted cash flows could differ from actual cash flows due to, among other things, technological changes, economic conditions or changes to business operations. For fiscal 2005, 2004 and 2003, no significant impairment related to the carrying value of our long-lived assets has been recorded.

 

Incentive Compensation Accruals

 

We use incentive compensation plans to link compensation to the achievement of specific annual performance targets. We accrue for this liability during each year based on certain estimates and assumptions. The amount paid, based on actual performance, could differ from our accrual.

 

Income Taxes

 

We record deferred tax assets and liabilities based upon temporary book to tax differences. The carrying value of our net deferred tax assets assumes that we will be able to generate sufficient future taxable income in certain tax jurisdictions to realize the value of these assets. If we were unable to generate sufficient future

taxable income in these jurisdictions, an adjustment could be required in the net carrying value of the deferred tax assets, which would result in additional income tax expense in our consolidated statements of income. Management evaluates the realizability of the deferred tax assets and assesses the need for any valuation adjustment quarterly.

 

We estimate what the effective tax rate will be for the full fiscal year and record a quarterly income tax provision in accordance with the anticipated annual rate. As the fiscal year progresses, the estimate is refined based upon actual events and earnings by jurisdiction during the year. This continual estimation process periodically results in a change to the expected effective tax rate for the fiscal year. When this occurs, we adjust the income tax provision during the quarter in which the change in estimate occurs so that the year-to-date provision reflects the expected annual rate. In the fourth quarter of 2005, we adjusted our effective tax rate estimate to 33.9% from the previous estimate of 34.0% used for the first three quarters of 2005.

 

We have provided reserves for certain tax matters, both domestic and foreign, which we believe could result in additional tax being due. Any additional assessment or reduction of these contingent liabilities will be reflected in the Company’s effective tax rate.

 

Results of Operations

 

 

Earnings per share and weighted-average shares have been restated to reflect the 2-for-1 stock split in May 2005.

 

2005 Compared to 2004

 

Revenue

 

Consolidated revenue growth of 4.3% in 2005 reflected strong gains in our International operations, offset by a slight decline in our U.S. business. Revenue from the U.S. business totaled $872.4 million in 2005, down 0.8% from the prior year. International revenues were $693.3 million, 11.6% ahead of 2004, up 11.4% in constant dollars. For 2006, we are targeting revenue growth in the mid single-digit range leveraging continued global expansion of the Timberland^® brand and benefits from our development of new brand platforms.

 

Segments Review

 

We have three reportable business segments (see Note 15 to the consolidated financial statements in Item 8 of this Form 10-K): U.S. Wholesale, U.S. Consumer Direct and International.

double-digit gains in boots, kids’ and women’s casual products. Footwear revenue growth offset constant dollar declines in apparel and accessories revenue. In Asia, revenues grew 22.3% to $121.3 million, up 17.4% excluding foreign exchange, driven by double-digit gains in Japan, Hong Kong, Taiwan, Malaysia and our distributor business. This growth reflects continued benefits from our successful efforts to upgrade Timberland’s retail and wholesale distribution throughout the region. Our footwear business in Asia expanded significantly reflecting strong growth in men’s casual, boots, women’s casual and kids’ footwear, offsetting declines in our outdoor performance business. Our apparel and accessories business also posted strong gains.

 

Products

 

Worldwide footwear revenue was $1,153.2 million in 2004, up $134.9 million or 13.2% from 2003, or 9.9% excluding the benefit of foreign exchange rate changes. Growth was driven by strong global gains in boots, kids’, and men’s and women’s casual footwear. Worldwide footwear unit sales were up 16.1% while the average price decreased by 2.5%, reflecting business mix impacts and higher markdowns offset by favorable foreign exchange rates.

 

Worldwide apparel and accessories revenue increased by 7.6% to $333.3 million. Excluding impacts from foreign exchange rate changes, the growth was 2.3%, reflecting 2.5% growth from apparel and a slight increase in our accessories business. Apparel and accessories unit sales increased by 3.0%, with average selling prices up 4.5%, due to favorable foreign exchange and product mix changes.

 

Channels

 

Revenue growth reflected global gains across both our wholesale and consumer direct channels. Globally, our wholesale business recorded $1,125.6 million of revenue in 2004, a 12.4% increase. Consumer direct revenues were up 10.2% to $375.0 million. In 2004, we opened 20 stores, shops and outlets globally, closed 17 and transferred seven South Korean shops to our new distributor for that country, Kolon Fashion and Culture.

 

Gross Profit

 

Our gross profit as a percentage of sales, or gross margin, for 2004 was 49.3% as compared to 46.5% for 2003, an improvement of 280 basis points. Foreign exchange rate changes contributed 170 of the 280 basis point improvement. Additionally, we experienced benefits from lower product related costs of approximately 120 basis points, driven primarily by efficiencies in our supply chain operations. These improvements were partially offset by negative impacts from higher levels of markdowns and sales allowances, primarily in the U.S.

 

We include the costs of procuring inventory (inbound freight and duty, overhead and other similar costs) in cost of goods sold. These costs amounted to $97.3 million and $95.7 million for 2004 and 2003, respectively.

 

Operating Expense

 

Operating expense was $505.2 million in 2004, or 33.7% of revenues, as compared to $440.2 million, or 32.8% of revenues in 2003, an increase of $65.0 million. The operating expense increase was driven by a $48.9 million increase in selling expenses and a $16.1 million increase in general and administrative expenses. Foreign exchange rate changes contributed $16.7 million, or 3.8% to total operating expense growth.

 

Selling expense was $405.4 million, an increase of $48.9 million, or 13.7% compared with the prior year. Within this category of expense, approximately $17.4 million of the increase related to incremental sales and marketing expenditures, $6.2 million to International retail expansion, $5.1 million to higher distribution costs, primarily freight on increased year-over-year shipments, $2.4 million to increased incentive compensation costs and $1.0 million to investments in enhanced product development capability. Foreign exchange rate changes added $14.5 million, or 4.1% to overall selling expense growth.

We include the costs of physically managing inventory (warehousing and handling costs) in selling expense. These costs totaled $33.9 million and $31.2 million in 2004 and 2003, respectively.

 

Advertising expense, which is also included in selling expense, was $42.4 million and $33.9 million in 2004 and 2003, respectively. Advertising costs are expensed at the time the advertising is used, predominantly in the season that the advertising costs are incurred. As of December 31, 2004 and December 31, 2003, we had $0.7 million and $1.1 million of prepaid advertising recorded on our consolidated balance sheets, respectively.

 

General and administrative expense was $99.8 million, an increase of $16.1 million, or 19.2% compared with last year. As a percentage of revenue, general and administrative expense increased 40 basis points over 2003. The increase was driven by approximately $6.1 million in corporate support principally for strategic initiatives and Sarbanes-Oxley compliance efforts and $2.6 million in costs associated with the Company’s incentive compensation programs. Foreign exchange rate changes also added $2.2 million, or 2.6% to overall general and administrative expense growth.

 

Operating Income

 

Operating income was $233.9 million in 2004 and $184.3 million in 2003. As a percentage of revenue, operating income was 15.6% in 2004 and 13.7% in 2003.

 

Operating income for our U.S. Wholesale segment was $222.3 million, $13.1 million or 6.2% higher than prior year. Revenue growth of 6.3% was complemented by a 40 basis point increase in gross margin, offset by a 40 basis point increase in operating expense as a percentage of sales reflecting increased support behind brand building efforts. The margin improvement was driven by lower product costs offset by higher levels of markdown and sales allowances, reflecting soft market conditions during the winter holiday season.

 

Our U.S. Consumer Direct segment’s operating income increased by 17.8% to $35.3 million, driven by 7.1% revenue growth, a 110 basis point improvement in gross margin and cost efficiencies that resulted in a 40 basis point decrease in U.S. Consumer Direct operating expense rate.

 

Operating income for our International segment grew by 62.6% to $130.9 million. Revenue growth of 20.3% and gross margin improvement of 520 basis points drove much of the increase. Both benefited from favorable foreign exchange rate changes. Lower product related costs and more favorable product mix also supported the margin improvement. Operating expense rates for our International segment decreased by 30 basis points reflecting strong revenue growth that enabled operating expense leverage despite increased investment in retail, International product development capability and marketing.

 

Our Unallocated Corporate expenses, which include central support and administrative costs not allocated to our business segments, increased to $154.7 million or 10.3% of total revenue, a 20 basis point increase over prior year. Increased incentive compensation accruals, increased support of key brand building initiatives, including the launch of our Make it better^tm marketing campaign, and investments in enhanced product development capacity were partially offset by efficient execution of our supply chain operations, which produced favorable variances against our standard costs.

 

Other Income and Taxes

 

Interest income/(expense), net, which is comprised of interest income offset by fees related to the establishment and maintenance of our revolving credit facility and interest paid on short-term borrowings, was $1.1 million and $(0.1) million in 2004 and 2003, respectively. Higher interest rates and increased cash balances supported the increase in net interest income.

 

Other, net included $1.0 million of foreign exchange gains resulting from the timing of settlement of local currency denominated assets and liabilities in 2004. In 2003, this amount was immaterial. These results were driven by the volatility of exchange rates during the respective reporting periods, and should not be considered indicative of expected future results.

The effective income tax rate was 35.5% in 2004 and 2003 (see Note 12 to the consolidated financial statements included in Item 8 of this Form 10-K).

 

In the fourth quarter of 2004, we established a Hong Kong procurement company and an international treasury center in Switzerland to better align our organizational structure with our expanding global presence.

 

Reconciliation of Total Company and International Revenue Increases to Constant Dollar Revenue Increases

 

Total Company Revenue Reconciliation:

 

 

International Revenue Reconciliation:

 

 

Management provides constant dollar revenue growth for total Company and International results because we use the measure to understand revenue growth excluding any impact from foreign exchange rate changes.

 

Reconciliation of Diluted EPS to Diluted EPS Excluding Restructuring and Related Costs and Including Stock-Based Employee Compensation Costs

 

 

Management provides diluted EPS excluding restructuring and related costs because we use the measure to understand earnings excluding these identifiable expenses. Management provides diluted EPS excluding restructuring and related costs and including stock-based employee compensation costs to provide comparability to future reported results that will include stock-based employee compensation costs as prescribed by SFAS 123(R), “Share Based Payment.”

 

Accounts Receivable and Inventory

 

Accounts receivable was $168.8 million as of December 31, 2005. Excluding SmartWool’s $12.8 million, accounts receivable increased 0.6% to $156.0 million as of December 31, 2005, compared with $155.0 million as of December 31, 2004 and $125.1 million as of December 31, 2003. The relatively flat accounts receivable

in 2005 reflected solid collection efforts and improved timing of shipments in the fourth quarter. The increase in 2004 compared to 2003 was due to later timing of shipments in the fourth quarter, in part due to congestion in U.S. west coast ports. Days sales outstanding were 33 days (30 days excluding SmartWool) as of December 31, 2005, compared with 31 days as of December 31, 2004 and 27 days as of December 31, 2003. Wholesale days sales outstanding were 39 days (36 days excluding SmartWool), 38 days and 34 days at the end of 2005, 2004 and 2003, respectively.

 

Inventory increased 30.3% to $167.1 million as of December 31, 2005 from $128.3 million as of December 31, 2004 and $119.6 million as of December 31, 2003. In the fourth quarter of 2004, we established a Hong Kong procurement company and an international treasury center in Switzerland to better align our organizational structure with our expanding global presence and provide enhanced support to our global sourcing operations and International business. Related to the implementation of the new organizational structure, we modified certain sourcing arrangements, which resulted in earlier transfer of title for a portion of the Company’s third party sourced product in 2005. Earlier transfer of title resulted in offsetting higher quarter end inventory and accounts payable balances, as we recognized an inventory asset and related payable roughly two weeks earlier than in the prior year period. Had similar sourcing arrangements been in effect for 2004, we estimate that inventory and accounts payable balances would have increased by approximately $35.2 million. Inventory on hand as of December 31, 2005 also included $9.5 million of inventory related to SmartWool. Inventory, adjusted for these two factors, decreased 3.6% compared to the prior year level. We estimate our annual inventory turns, excluding SmartWool and assuming the new sourcing arrangements had been in place in the past, would have been 4.2 times in both 2005 and 2004.

 

Liquidity and Capital Resources

 

Net cash provided by operations for 2005 was $182.3 million, compared with $184.7 million in 2004. Timberland’s primary source of operating cash flow was net income of $164.6 million. A net decrease in operating working capital provided $7.7 million in cash flow primarily due to controlled growth of receivables and disciplined inventory management and the timing of vendor payments. Additional cash was provided from the timing of tax payments. Our cash provided by operations was negatively impacted by reduced accruals associated with foreign currency contracts, executive compensation and transportation costs, compared to 2004.

 

Net cash used for investing activities amounted to $107.7 million in 2005, compared with $25.8 million in 2004. The increase was primarily attributable to the use of $81.3 million, net of cash acquired, for the acquisition of SmartWool on December 20, 2005. Capital expenditures in 2005 were $26.2 million, compared to $24.1 million in 2004.

 

Net cash used for financing activities was $160.6 million in 2005, compared with $98.5 million in 2004. Cash flows from financing activities reflected increased share repurchases of $181.5 million in 2005, compared with $131.7 million in 2004. We received cash inflows of $20.8 million in 2005 from issuance of common stock primarily related to the exercise of employee stock options, compared with $33.1 million in 2004.

 

Net cash provided by operations for 2004 was $184.7 million, compared with $199.0 million in 2003. The decrease in cash generated in 2004, compared with 2003, was primarily due to increases in accounts receivable and inventory, offset by higher earnings, tax benefits from equity compensation and increases in accounts payable reflecting later timing of inventory receipts compared with 2003. Net income was $152.7 million in 2004, compared with $117.9 million in 2003. Accounts receivable increased at the end of 2004, compared with 2003. The increase in 2004 compared to 2003 was due to later timing of shipments in the fourth quarter, in part due to congestion in U.S. west coast ports. Despite these timing impacts, receivable collections remained strong, reflected in a reduction in overdue receivables as a percentage of total, compared to 2003.

 

Net cash used for investing activities amounted to $25.8 million in 2004, compared with $20.5 million in 2003. Increases were related to higher net investments in our international business and in information systems. Capital expenditures in 2004 were $24.1 million versus $24.9 million in 2003.

Net cash used for financing activities was $98.5 million in 2004, compared with $84.8 million in 2003. Cash flows from financing activities reflected share repurchases of $131.7 million in 2004, compared with $103.8 million in 2003. The Company received cash inflows of $33.0 million in 2004 from the issuance of common stock primarily related to the exercise of employee stock options, compared with $19.0 million in 2003.

 

On April 30, 2004, we entered into an amended and restated unsecured committed revolving credit agreement with a group of banks, which matures on April 30, 2007 (“Agreement”), unless prior to April 30, 2006, we elect to extend the final maturity date to April 30, 2008. The Agreement provides for $200 million of committed borrowings, of which up to $125 million may be used for letters of credit. Under certain circumstances, we may increase the committed borrowing limit by $50 million for a total commitment of $250 million. Under the terms of the Agreement, we may borrow at interest rates based on eurodollar rates (approximately 4.3% at December 31, 2005), plus an applicable margin based on a fixed-charge coverage grid of between 50 and 100 basis points that is adjusted quarterly. At December 31, 2005, the applicable margin under the facility was 60 basis points. We will pay a commitment fee of 12.5 to 25 basis points per annum on the total commitment, based on a fixed-charge coverage grid that is adjusted quarterly. At December 31, 2005, the commitment fee was 15 basis points. The Agreement places certain limitations on additional debt, stock repurchases, acquisitions, amount of dividends we may pay, and certain other financial and non-financial covenants. The primary financial covenants relate to maintaining a minimum fixed charge coverage of 3:1, a leverage ratio of 1.5:1 and under certain conditions, a minimum level of earnings before income tax, depreciation and amortization. We measure compliance with the financial and non-financial covenants and ratios as required by the terms of the Agreement on a fiscal quarter basis.

 

On December 20, 2005, we entered into a $4.5 million committed revolving credit agreement that matures on December 19, 2006 to provide for SmartWool’s working capital requirements. Up to $3 million of the facility may be used for letters of credit.

 

We had uncommitted lines of credit available from certain banks totaling $50 million at December 31, 2005. Borrowings under these lines were at prevailing money market rates (approximately 4.8% at December 31, 2005). Further, we had an uncommitted letter of credit facility of $80 million to support inventory purchases. These arrangements may be terminated at any time at the option of the banks or the Company.

 

As of December 31, 2005 and 2004, we had no borrowings outstanding, under any of our credit facilities.

 

Management believes that our capital needs and our share repurchase program for 2006 will be funded through our current cash balances, our existing credit facilities and cash from operations, without the need for additional permanent financing. However, as discussed in Item 1A, Risk Factors, several risks and uncertainties could cause the Company to need to raise additional capital through equity and/or debt financing. From time to time the Company considers acquisition opportunities which, if pursued, could also result in the need for additional financing. The availability and terms of any such financing would be subject to prevailing market conditions and other factors at that time.

 

Aggregate Contractual Obligations

 

At December 31, 2005, we have the following contractual obligations due by period:

 

 

 

Off Balance Sheet Arrangements

 

As of December 31, 2005, 2004 and 2003, we had letters of credit outstanding of $24.6 million, $35.1 million and $27.0 million, respectively. These letters of credit were issued predominantly for the purchase of inventory. The reduction in letters of credit outstanding in 2005 is attributable to more vendors transitioning to open account payment arrangements. As of December 31, 2005, the Company had $157.4 million in foreign currency contracts outstanding, all of which are due to settle within the next 13 months (see Note 8 to the consolidated financial statements included in Item 8 to this Form 10-K).

 

We have the following off-balance sheet arrangements:

 

 

We use funds from operations and unsecured committed and uncommitted lines of credit as the primary sources of financing for our seasonal and other working capital requirements. Our principal risks to these sources of financing are the impact on our financial condition from economic downturns, a decrease in the demand for our products, increases in the prices of materials and a variety of other factors. We anticipate that capital requirements for 2006 will be met through the use of our current cash balances, through our existing credit facilities (which places certain limitations on additional debt, stock repurchases, acquisitions and on the amount of dividends we may pay, and also contains certain other financial and operating covenants) and through cash flow from operations, without the need for additional permanent financing. However, if the need arises, our ability to obtain any additional credit facilities will depend upon prevailing market conditions, our financial condition and the terms and conditions of such additional facilities.

 

New Accounting Pronouncements

 

A discussion of new accounting pronouncements is included in the “Summary of Significant Accounting Policies” note (see Note 1 to the consolidated financial statements included in Item 8 to this Form 10-K).

 

Forward-looking Information

 

As discussed in Item 1A, Risk Factors, investors should be aware of certain risks, uncertainties and assumptions that could affect our actual results and could cause such results to differ materially from those contained in forward-looking statements made by or on behalf of us. Such statements are based on current expectations only and actual future results may differ materially from those expressed or implied by such

forward-looking statements due to certain risks, uncertainties and assumptions. These risks, uncertainties and assumptions include, but are not limited to:

 

 

We undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

 

 

In the normal course of business, our financial position and results of operations are routinely subject to a variety of risks, including market risk associated with interest rate movements on borrowings and investments and currency rate movements on non-U.S. dollar denominated assets, liabilities and income. We regularly assess these risks and have established policies and business practices that should result in an appropriate level of protection against the adverse effect of these and other potential exposures.

 

We utilize cash from operations and U.S. dollar denominated borrowings to fund our working capital and investment needs. Short-term debt, if required, is used to meet working capital requirements and long-term debt, if required, is generally used to finance long-term investments. In addition, we use derivative instruments in our hedging of foreign currency transactions. These debt instruments and derivative instruments are viewed as risk management tools and are not used for trading or speculative purposes. Cash balances are invested in high-grade securities with terms less than three months.

 

We have available unsecured committed and uncommitted lines of credit as sources of financing for our working capital requirements. Borrowings under these credit agreements bear interest at variable rates based on either lenders’ cost of funds, plus an applicable spread, or prevailing money market rates. At December 31, 2005, December 31, 2004 and December 31, 2003, we had no short-term or long-term debt outstanding.

 

Our foreign currency exposure is generated primarily from our European operating subsidiaries and, to a lesser degree, our Asian and Canadian operating subsidiaries. We seek to minimize the impact of these foreign currency fluctuations by hedging the related transactions with foreign currency forward contracts. These foreign currency forward contracts will expire in 13 months or less. Based upon sensitivity analysis as of December 31, 2005, a 10% change in foreign exchange rates would cause the fair value of our financial instruments to increase/decrease by approximately $14.9 million, compared with $24.4 million at December 31, 2004. The decrease at December 31, 2005, compared with December 31, 2004, is related to our choice to hedge a lesser portion of our 2006 exposure at December 31, 2005 than the portion of our 2005 exposure that was hedged at December 31, 2004, as determined in accordance with our hedging policy, as well as a reduction of our foreign currency denominated net assets at December 31, 2005 compared with December 31, 2004.

 

 

CONSOLIDATED BALANCE SHEETS
As of December 31, 2005 and 2004

 

 

Shares have been restated to reflect the 2-for-1 stock split in May 2005.

The accompanying notes are an integral part of these consolidated financial statements.

CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31, 2005, 2004 and 2003

 

 

Earnings per share and weighted-average shares have been restated to reflect the 2-for-1 stock split in May 2005.

The accompanying notes are an integral part of these consolidated financial statements.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
For the Years Ended December 31, 2005, 2004 and 2003

 

 

The accompanying notes are an integral part of these consolidated financial statements.

CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2005, 2004 and 2003