UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 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 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.  o

 

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

 

 

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

 

The aggregate market value of Class A Common Stock of the Company held by non-affiliates of the Company was $1,220,010,695 on June 29, 2007, which was the last business day of the Company’s second fiscal quarter in 2007. For purposes of the foregoing sentence, the term “affiliate” includes each director and executive officer of the Company. See Item 12 of this Annual Report on Form 10-K.

 

On February 22, 2008, 48,371,257 shares of the Company’s Class A Common Stock and 11,743,660 shares of Class B Common Stock were outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Company’s definitive Proxy Statement for the 2008 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 Annual Report on 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, Miōn^®, GoLite^®, Howies^® and IPATH^® 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 in Timberland^® specialty stores and Timberland^® factory outlet stores dedicated exclusively to selling Timberland^® and Timberland^® sub-branded products, as well as through franchised retail stores in Europe. We also sell our products in the United States online at timberland.com and smartwool.com, and in the United Kingdom online at timberlandonline.co.uk. Our products are sold throughout the United States, Canada, Europe, Asia, Latin America, South Africa 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 Timberland^® 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 through establishment of licensing arrangements with globally trusted partners, such as Phillips-Van Heusen, (iii) expanding our brands geographically, (iv) driving operational and financial excellence, (v) setting the standard for commitment to the community and (vi) striving to be a global employer of choice.

 

Products

 

Our products fall into three primary groups: (1) footwear, (2) apparel and accessories (including product care and licensed products) and (3) royalties from third-party licensees and distributors. The following summarizes our revenue by product 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. In 2007, we continued our focus on developing products to meet the needs of distinct consumer groups. One example of this was our acquisition of the assets of IPATH, LLC. IPATH designs, develops and markets skateboarding inspired casual footwear, apparel and accessories. In 2006 we developed a new line of advanced footwear for trail running enthusiasts under the GoLite^® brand. This

footwear line is designed to meet the needs of high-altitude runners by being ultra-light and adaptable to the uneven, rugged terrain found in the mountains. In 2005 we introduced Timberland Boot Company^tm work-wear inspired footwear that is featured in our Timberland Boot Company^tm concept store in the United Kingdom and we also introduced Miōn^® outdoor performance footwear designed to meet the needs of water adventurers. We intend to continue our efforts to selectively extend our brand reach through these and other initiatives but our primary focus in 2008 will be on reinvigorating our core Timberland^® brand footwear business. Our refocus on developing our core footwear business is intended to return our business to healthy financial performance and to advance our goal of becoming a leading global brand. Our advanced concepts footwear team, which we call the Invention Factory, continues to focus on developing the next innovations in footwear products and technologies, materials, constructions and processes. 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 Chelseas. Another important boot category is our Classic Sport Boots. A few of the key products in this category include the Field Boot, Euro Hiker, 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 continued our focus on reducing the seasonality of our boots business by again marketing the Summer Mesh series with Timberland^® Vent Tech material, which features lightweight breathable mesh construction. We added the Timberland^® Vent Tech material into additional boot styles throughout 2007. In late 2007 we reintroduced key boot styles from past seasons in their exact form, detail for detail, under our Timberland Authentics line. We also made efforts to improve the quality of materials in color extensions of classic boots and eliminated underperforming themes that were inconsistent with brand platform. Lifestyle footwear, as well as active and casual based sandals, broadens the core product range. Regional programs such as Rugged Street and Cruise Master serve to drive consumer interest in new markets. We are also focused on expanding our women’s boot business, supported by the introduction of women’s specific collections like the Chronicle and Crepe, 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. In 2007 we incorporated sustainable and recycled materials into a casual offering and successfully launched our Earthkeepers^tm collection. 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^® system, which provides superior comfort while preserving the shape and style of the footwear. Expanding the reach of our casual product, in 2007 we introduced the Timberland Boot Company^tm line in the United States to provide a relevant assortment with distinctive leathers and silhouettes built upon our heritage of leather innovation. This line was originally offered for the first time in 2005 in the United Kingdom.

 

Women’s Casual

 

Timberland^® women’s footwear line builds on the Rugged Casual and Sport Casual footwear offering with the introduction of the Timberland^® City product collection. This collection provides product for a more refined wearing occasion for our Engager consumer, a woman who is confident, active, cares about the environment and looks for ways to get involved in the world around her. Timberland^® City product

encompasses higher heel heights, sleeker last shapes and a more refined styling overall. We have followed a good/better/best strategy in the construction of the line with Essentials, Key items and Premium product offerings: Essentials are seasonal and seasonless basics with replenishment capabilities; Key items are seasonal items with fresh style and color injections; and Premium items provide seasonal positioning styles that clearly articulate the seasonal creative story with elevated design details.

 

Our focus in the development of this line of footwear was to combine the rugged heritage of Timberland with premium leathers, craftsmanship and relevant functionality with feminine styling for the target consumer. To provide unparalleled comfort without sacrificing style, most of our women’s product also incorporates our innovative Smart Comfort^® system.

 

Kid’s Casual

 

Timberland^® kids’ footwear products are designed and engineered specifically for kids with the same high-quality standards and materials as our adult footwear products. This line includes Rugged Casual, Outdoor Performance/Adventure, Sport Casual and toddlers and infants product categories. Featured products focus on fit and functionality and include programs like Kerplunc, Rock Skipper sandals, Power Lounger, Hikers with Gore-Tex^® material and Snow Stomper winter boots. The toddlers and infants category provides premium leathers, linings and details designed and engineered specifically for the needs of this consumer. Many of our kids’ footwear products incorporate the Smart Comfort^® 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 tech casual.

 

In 2007, we added more technology and more innovation to our versatile collection of performance footwear. We partnered with world-renowned high altitude adventurer Ed Viesturs in 2006 to help us develop the Cadion hiking program, which has since won acclaim as a market-leading lightweight hiker. We also marked 2007 with the launch of B Life, a millennial consumer focused initiative featuring a SmartWool^® lining and performance features for a younger outdoor athlete. The Outdoor Performance 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 performance and value to the entry-level outdoor recreationalist consumer, we offered lines like the Ossipee and the Resolve, which help make the outdoors more accessible to a variety of consumers.

 

Miōn^® Footwear

 

Our performance water line was first introduced in 2005 under the Miōn^® brand name. Miōn^® water shoes include a performance water shoe, a performance sandal, a guide slide and a pro thong for men, women and children. Miōn^® footwear is designed for comfort and versatility in all wet conditions for the outdoor adventurer’s active lifestyle. Miōn^® footwear features an Ergomorphic^tm footbed that 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.

 

GoLite^® Footwear

 

Our Invention Factory developed a new line of advanced footwear in 2006 for trail running enthusiasts under the GoLite^® brand. This footwear line is inspired by the extreme challenges of sky runners, or high-

altitude runners, and their need for ultra-light, technically advanced footwear. The advanced technology includes an independent spring suspension system that adapts to uneven, rugged terrain and improves the runner’s stability. This new line appeared in the market in March 2007. The initial distribution included highly regarded retail trendsetters in the outdoor and running specialty channels. Timberland acquired certain assets of GoLite LLC, including trademarks, in 2006. GoLite LLC continues to market apparel, equipment and accessories as an independent company not affiliated with us.

 

IPATH^® Footwear

 

In 2007 we purchased substantially all of the assets of IPATH, LLC. IPATH designs, develops and markets skateboarding-inspired casual footwear, apparel and accessories. The IPATH^® brand mantra is “Follow Your Path” and represents a confluence of youth lifestyles, drawing strong influence from music, art and culture.

 

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 2007, we continued to expand our selection in the occupational category by adding a slip resistance series named “Black” targeting the hospitality industry, and a line of lightweight performance boots named “Valor” aimed at first responders and public safety professionals. The Black series is a line of slip resistant dress shoes designed for professionals who work in a variety of work environments such as restaurants, hotels, leisure facilities, and other service environments. The shoes feature premium leathers and fabrics, slip resistant outsoles, include third party technology such as Scotchgard^tm protector and offer a 30-day comfort guarantee. The Black series also features Timberland PreciseFit^tm technology, which provides end-users better fit and improves retailer inventory turns due to carrying fewer sizes. The Valor series is a selection of footgear designed for first responders such as medical personnel, law enforcement officials, security officers, and other public safety professionals. This product was designed for rugged and challenging working conditions, incorporates premium leathers and fabrics, and offers premium positioning in the category via third party technology such as GoreTex^® membrane and Thinsulate^tm insulation. The Valor series also offers a 30 day comfort guarantee, and also includes Timberland PreciseFit^tm technology. We continued to expand the best selling TiTAN^® collection, targeted at those who prefer lightweight comfort, with various silhouettes and 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, and offers the 30 day comfort guarantee. In addition to the TiTAN^® styles, we continued to expand the selection of PowerWelt series featuring Ever-Guard^tm genuine leather. This abrasion resistant leather provides the ultimate in protection in challenging work environments, and increases consumer wear time with abrasion resistant Ever-Guard^tm genuine leather. Also, in 2007, Timberland PRO introduced an innovative insulated and waterproof work boot called Thermal Force. Aimed at those who work in cold temperatures, Thermal Force utilizes an insulated toe cap and nanotechnology in the lining to keep feet warm and regulate temperatures. The Thermal Force comes with Timberland PRO^® Rubber Ice-Trax outsole for better grip on icy conditions. 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/AS^tm standards. Most styles also come with slip, abrasion and oil-resistant outsoles, as well as electrical hazard protection. In 2007, Timberland PRO won Tractor Supply Company’s Total Company Large Vendor of the Year Award for Timberland PRO’s efforts in building Tractor Supply Company’s leather footwear business under the C. E. Schmidt private label program.

 

Footwear Technology

 

We continue to incorporate our patent pending, technological innovation, the Smart Comfort^® system, in many of our men’s, women’s and kids’ footwear categories. The Smart Comfort^® 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^® system provides superior comfort in a product that retains its shape. The Smart Comfort^® 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.

 

Our patent-pending Timberland^® PreciseFit^tm system has been incorporated into select styles of men’s footwear lines since 2006. The PreciseFit^tm system enables consumers to customize their fit through a system of forefoot inserts. Each pair of footwear includes 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^® 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

 

Timberland’s apparel offer for men and kids 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 that is primarily distributed in Europe. We believe that continuing to develop and expand our apparel business is important to our global brand aspirations. To help maximize our brand potential, on February 7, 2007, we announced that beginning in Fall 2008 our Timberland^® brand apparel line will be offered in North America pursuant to a licensing arrangement with Phillips-Van Heusen. We believe that working with a powerful partner like Phillips-Van Heusen will maximize our brand potential because of their apparel expertise and strong distribution network. We will continue to design, source and market Timberland^® apparel for our European and Asian operations through our London based International Design Center, which enables us to remain close to the target consumers we

will continue to serve directly. We will also continue to design, source and market worldwide Timberland^® Outdoor Performance apparel. We reintroduced Timberland PRO^® apparel in the United States and Canada in 2007 pursuant to a licensing arrangement and will continue to offer it in Europe pursuant to a licensing arrangement that has been in effect since 2004.

 

During 2007, we continued to underpin 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 extended our enterprise’s reach by offering our customers an expanded line of apparel and accessories. SmartWool is a leading provider of premium performance merino 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 base layer styles for men and women. Our classic outdoor socks include the Hiking Light Crew and Hiking Medium Crew for the outdoor and snow-sport consumer. SmartWool continues to innovate with the introduction of their new PhD^tm line of outdoor and on-snow performance socks with WOWTECH^tm knitting technique.

 

SmartWool has also expanded its apparel line through its Sport NTS, a form-fitting performance base layer for the mountain athlete. SmartWool also offers a complete line of performance and lifestyle sweaters that reflects our mountain town heritage. SmartWool^® accessories include hats, gloves and infant wear. SmartWool^® products vaporize moisture, control temperature and odor and are guaranteed not to shrink. SmartWool^® products are sold through independent retailers, better-grade department stores, athletic stores and smartwool.com.

 

Howies Limited

 

On December 1, 2006, we acquired Howies Limited, an active sports apparel brand founded on the idea of designing and manufacturing clothing for the inspired action sports and outdoor consumer. Howies is located in Cardigan Bay, Wales, U.K.

 

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. 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. Our licensed Timberland^® products for men, women and children include all products other than footwear. The accessories products include packs and travel gear, watches, belts, wallets, socks, gloves, sunglasses, eyewear and ophthalmic frames, and hats and caps, and are designed, manufactured and distributed pursuant to licensing agreements with third parties. We also license rights to children’s apparel in the United States, Europe and Asia. On February 7, 2007, we announced that beginning in Fall 2008 our Timberland^® brand apparel line will be offered in North America pursuant to a licensing arrangement with Phillips-Van Heusen Corporation. In addition, we reintroduced Timberland PRO^® apparel in the United States and Canada to complement our successful Timberland PRO^® footwear business pursuant to a licensing arrangement. We continue to offer Timberland PRO^® footwear and apparel in Europe under a license agreement.

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, Timberland^® factory outlet stores and Timberland^® footwear plus stores dedicated exclusively to selling Timberland^® products and Timberland^® sub-branded products, as well as through franchised retail stores in Europe. We also sell our products in the United States online at timberland.com and smartwool.com, and in the United Kingdom online at timberlandonline.co.uk.

 

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 worldwide, the management costs and expenses associated with our worldwide licensing efforts and certain marketing expenses and value added services. The U.S. Consumer Direct segment includes the Company-operated specialty, factory outlet and footwear plus stores in the United States as well as our U.S. 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. Products are sold outside of the United States through our subsidiaries (which use wholesale and retail channels, including e-commerce in the United Kingdom, 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 16 to our consolidated financial statements, entitled “Business Segments and Geographic Information,” included in Item 8 of this Annual Report on 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 Atlanta, Georgia, 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

 

On September 26, 2007 we announced our plan to close approximately 40, principally larger, specialty stores in the United States, Europe and Asia. This step is consistent with the Company’s strategy to open smaller, footwear-focused stores in the United States. Most of the store closures will occur in the United States and are expected to be completed in the first half of 2008. The Company had closed 6 specialty stores under this program in the United States by the end of 2007. The Company also plans to close several underperforming U.S. outlet stores.

At December 31, 2007, we operated 13 specialty stores, 63 factory outlet stores and 3 footwear plus stores in the United States, but following store closures in the first half of 2008 we expect that there will be 1 specialty store, 56 factory outlet stores and 4 to 8 footwear plus stores in the United States. We also sell products through our internet stores timberland.com and smartwool.com.

 

Timberland^® Specialty Stores.  Most of these stores will be closed as part of our store closure plan as we transition to smaller, footwear focused stores, or footwear plus stores. These larger specialty stores carried current season, first quality merchandise, including footwear, apparel and accessories.

 

Timberland^® Factory Outlet Stores.  These stores serve as a primary channel for the sale of excess, damaged or discontinued products from our specialty stores. Our factory outlet stores also sell products specifically made for them. 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^® Footwear Plus Stores.  This new store concept began to be tested in the U.S. in 2007. These are smaller, 1,200 to 1,500 square feet stores that primarily sell our most popular footwear products along with a smaller assortment of our apparel 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. Certain of these stores will be closed in connection with our global retail store review announced in 2007. At December 31, 2007, we operated 132 company-owned specialty stores and shops and 33 factory outlet stores in Europe and Asia but following store closures in the first half of 2008 we expect that there will be 108 company-owned specialty stores and shops and 33 factory outlet stores in Europe and Asia. One of our specialty stores in the United Kingdom focuses solely on the marketing and sale of Timberland Boot Company^tm products, which feature our line of work wear-inspired boots, jeans and jackets targeting a younger consumer. In 2007, we opened our first international online store in the United Kingdom, www.timberlandonline.co.uk. 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. We continued our expansion of the Timberland^® brand in China during 2007 through distributors and also began selling in Russia during 2007 through distributors.

 

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 will be increasingly delivered throughout the year, rather than only during select seasons as has historically been the case.

 

In 2007, we continued to elevate our brand voice through the Make it better^tm marketing campaign. This integrated communications platform spanned print, outdoor, internet, and point-of-sale with an overarching goal to inspire and engage our consumers through brand, values and product communication. Under this brand umbrella, we ran targeted advertising campaigns to our key consumer segments.

 

 

In the spirit of our Make it better^tm campaign, we demonstrated our commitment to reducing our environmental footprint through several consumer-facing initiatives:

 

 

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 2007, 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 2007 than in the last two quarters of 2007. We expect this seasonality to continue in 2008.

 

Backlog

 

At December 31, 2007, our backlog of orders from our customers was $305 million compared to $372 million at December 31, 2006 and $381 million at December 31, 2005. While all orders in the backlog are subject to cancellation by customers, we expect that the majority of such orders will be filled in 2008. 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. The decline in backlog is primarily due to decreased demand for boots and kids footwear, and a soft response to apparel and accessories in an overall weak retail environment, as we transition our apparel business to licensing arrangements.

Manufacturing

 

We operate a manufacturing facility in the Dominican Republic. We manufacture four different construction footwear types for both Timberland^® boots and shoes as well as our Timberland PRO^® series work shoes. 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 2007 and 2006, we manufactured approximately 11% and 9%, respectively, of our footwear unit volume in the Dominican Republic. We manufactured approximately 10% of our footwear unit volume during 2005 in Puerto Rico and the Dominican Republic. 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 89% of the Company’s 2007 footwear unit volume was produced in Asia by independent manufacturers in China, Vietnam, Thailand, India and Indonesia. Two of these manufacturers together produced approximately 55% of the Company’s 2007 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; Ho Chi Minh City, Vietnam; and Chennai, India to supervise our sourcing activities conducted in the Asia-Pacific region.

 

Materials

 

In 2007, eleven suppliers provided, in the aggregate, approximately 82% of our leather purchases. Two of these suppliers together provided approximately 29% of our leather purchases in 2007. 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. We continue to work to offset cost increases with cost savings by utilizing new lower cost suppliers and consolidating existing suppliers. However, during 2007 our cost savings efforts were unable to offset increases in our raw materials costs which increased due to rising oil prices. In 2007, we maintained contracts with global vendors for hand-sewn thread, leather laces, waterproof membrane gasket material, waterproof seam-seal adhesives, topline reinforcement tape, packaging, laces, box toes and counters, cellulose and nonwoven insole board, Ströbel^® construction insole materials and thread, synthetic suede lining materials, soling components and compounds, 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. Other trademarks or registered trademarks of The Timberland Company, or its affiliated companies, are: 24/7 Comfort Suspension, Air Raider, Amorphic Suspension, Balm Proofer, Boot Sauce, B.S.F.P., Cast-Bond, ClimatePath, Coconut Honeycomb Tech, Comforia, Earthkeepers, EasyDry, Endoskeleton, Ergomorphic, Ever-Guard, Follow Your Path, Free to GoLite, GoLite, Green Index, Gripstick, GSR, Howies, Independent Suspension Network, IntraMet, IPATH, ISN, Isomorphic Suspension, Jackson Mountain, Ladder Lock, Made To Work, Make it better, Measure Up, Miōn, NEOform, Path of Service, PowerFit, PreciseFit, PRO 24/7, PRO 24/7 Comfort Suspension, QuadCut, Renewbuck, SafeGrip, Smart Comfort, SmartPrint, Leave my SmartPrint, Smart Basket, SmartWool, Start Small, Think Big, Splash Blaster, TBL, Timberland Boot Company, Timberland PRO, TiTAN, Trail Grip, Weathergear, Waximum, and Whole Body Stability.

 

 

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 2007 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. 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 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 offers 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, Miōn^®, GoLite^®, Howies^®, and IPATH^® footwear and apparel and accessories products.

 

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

 

We had approximately 6,300 full and part-time employees worldwide at December 31, 2007 and 2006. Reductions in headcount associated with our Retail and Global Organization restructurings in 2007 were offset by increases in our Dominican Republic manufacturing facilities associated with a shift in production to those facilities in 2007. Our management considers our employee relations to be good. None of our employees are 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, Management Development and Compensation, and Corporate Social Responsibility committees of our Board of Directors as well as our Corporate Governance Principles and Code of Ethics and other corporate information 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 2007 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.

 

 

 

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. 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. Consumer demand for our boot products has declined during the last three years as fashion trends have favored lower profile, casual footwear. Revenue declines associated with lower boot sales have adversely impacted our financial results and no assurances can be made that sales of our boot products will increase in the short-term or that we will be able to develop or market alternative products to mitigate the loss of such sales. 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. 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.

 

Our inability to execute key strategic initiatives, including the closure of targeted stores.

 

Over the last few months we have undertaken initiatives to restructure our business operations to maximize operating effectiveness and efficiency and to reduce costs. Achievement of the targeted benefits depends in part on our ability to appropriately identify, develop and effectively execute strategies and

initiatives. We cannot be assured that we will achieve the targeted benefits under these programs within a targeted timeframe or within targeted costs or that the benefits, even if achieved, will be adequate.

 

We conduct business outside the United States which exposes us to foreign currency, import restrictions, taxes, 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. Additionally, as a global company, our effective tax rate is highly dependent upon the geographic composition of worldwide earnings and tax regulations governing each region.

 

On March 22, 2006, the European Commission imposed provisional duties on leather upper footwear originating from China and Vietnam and imported into European Member States. These provisional duties, which began on April 7, 2006, were effective for a six month period and were phased in over a period of five months, beginning at a rate of about 4% and ending at a 19.4% rate for China sourced footwear and at a 16.8% rate for Vietnam sourced footwear. These duties became definitive on October 7, 2006, for a period of two years, with a final 16.5% rate for China sourced footwear and a 10% rate for Vietnam sourced footwear. Pursuant to European Union regulations, only provisional duties which do not exceed the definitive duty rates will be collected. Children’s footwear with leather uppers was excluded from the provisional duties, but is subject to definitive duties.

 

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 2007, we manufactured approximately 11% 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, Thailand, India and Indonesia produced approximately 89% of our 2007 footwear unit volume. Two of these manufacturers together produced approximately 55% of our 2007 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 2007, eleven suppliers provided, in the aggregate, approximately 82% of our leather purchases. Two of these suppliers provided approximately 29% of our leather purchases in 2007. 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.

 

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. Due to poor financial performance at some of our retail stores, primarily in the U.S., in late 2007 we announced the closure of approximately 50 stores globally. As discussed above, there can be no assurance that we will be able to effectively implement this program or that anticipated benefits will be achieved.

 

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. As previously announced, we have licensed our North American Timberland^® apparel product line to Phillips-Van Heusen Corporation as we believe they have the capabilities to help us maximize our brand potential through an improved apparel offering and strengthened distribution. 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, Jeffrey B. Swartz and various trusts established for the benefit of their families or for charitable purposes, hold approximately 72% of the combined voting power of our capital stock in the aggregate, enabling them 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 shares of Class B common stock that would reduce the Class B common stock outstanding to 12.5% or less of total Class A and Class B shares outstanding, 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.

 

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.

 

 

None.

 

 

We lease our worldwide headquarters located in Stratham, New Hampshire. The 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.

 

Our headquarters, manufacturing facilities and U.S. distribution facilities are included in Unallocated Corporate for purposes of segment reporting. Our distribution facility in Enschede is included in our International segment. Specialty and factory outlet stores are included in both the U.S. Consumer Direct and International segments, and office and warehouse space is included in each of our segments.

 

 

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, 2007, 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.

 

 

As of February 22, 2008, the number of record holders of our Class A Common Stock was 812 and the number of record holders of our Class B Common Stock was 7. The closing sales price of our Class A Common Stock on February 22, 2008 was $14.68 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 Note 11 to the Company’s consolidated financial statements included in Item 8 of this Annual Report on Form 10-K). The Company has no plans to issue a cash dividend at this time.

Performance Graph

 

The following graph shows the five year cumulative total return of Class A Common Stock as compared with the Standard & Poor’s (S&P) 500 Stock Index and the weighted average of the S&P 500 Footwear Index and the S&P 500 Apparel, Accessories and Luxury Goods Index. The total return for the Footwear and Apparel, Accessories and Luxury Goods indices is weighted in proportion to the percent of the Company’s revenue derived from sales of footwear and from apparel and accessories (excluding royalties on products sold by licensees), respectively, for each year.

 

 

 

 

(1) Indexed to December 31, 2002

ISSUER PURCHASES OF EQUITY SECURITIES(1)

 

For the Three Fiscal Months Ended December 31, 2007

 

 

Footnote(1)

 

 

 

 

The following selected financial data should be read in conjunction with our consolidated financial statements and related notes, included in Item 8 of this Annual Report on Form 10-K.

 

Selected Statement of Income Data

 

 

 

 

Selected Consolidated Balance Sheet Data

 

 

 

The following discusses The Timberland Company’s (“we”, “our”, “us”, “its”, “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 with respect to 2007 versus 2006 comparisons are discussions and reconciliations of (i) total Company, total International, Europe and Asia revenue changes to constant dollar revenue changes; and (ii) operating expense, operating income, net income and diluted earnings per share (“EPS”) to operating expense, operating income, net income and diluted EPS, respectively, excluding restructuring and related costs. With respect to 2006 versus 2005 comparisons, we include discussions and reconciliations of (i) total Company, total International, Europe and Asia revenue changes to constant dollar revenue changes; and (ii) operating expense, operating income, net income and diluted EPS to operating expense, operating income, net income and diluted EPS, respectively, excluding restructuring and related costs and including share-based employee compensation costs related to stock option and employee stock purchase plans as prescribed by Statement of Financial Accounting Standards (“SFAS”) 123(R), Share-Based Payment.

 

Constant dollar revenue changes, which exclude the impact of changes in foreign exchange rates; operating expense, operating income, net income and diluted EPS excluding restructuring and related costs; and operating expense, operating income, net income and diluted EPS excluding restructuring and related costs and including share-based employee compensation costs related to stock option and employee stock purchase plans are not Generally Accepted Accounting Principle (“GAAP”) performance measures. The difference between changes in reported revenue (the most comparable GAAP measure) and constant dollar revenue changes is the impact of foreign currency. We provide constant dollar revenue changes for total Company, total International, Europe and Asia results because we use the measure to understand the underlying growth rate of revenue excluding the impact of items that are not under management’s direct control, such as changes in foreign exchange rates. The limitation of this measure is that it excludes items that have an impact on the Company’s revenue. This limitation is best addressed by using constant dollar revenue changes in combination with the GAAP numbers. We provide operating expense, operating income, net income and diluted EPS excluding restructuring and related costs because we use these measures to analyze the earnings of the Company. Management believes these measures are a reasonable reflection of the underlying earnings levels and trends from core business activities, as well as more indicative of future results. The difference between operating expense, operating income, net income and diluted EPS excluding restructuring and related costs and their most comparable GAAP measures (operating expense, operating income, net income and diluted EPS) is the impact of restructuring and related charges that may mask our underlying operating results and/or business trends. The limitation of these measures is that they exclude items that would otherwise increase the Company’s operating expenses and decrease the Company’s operating profit, net income and diluted EPS. These limitations are best addressed by using them in combination with the most comparable GAAP measures in order to better understand the amounts, character and any impact of any increase or decrease on reported results. We provide operating expense, operating income, net income and diluted EPS excluding restructuring and related costs and including share-based employee compensation costs related to stock option and employee stock purchase plans because we use these measures to analyze the earnings of the Company. Management believes these measures are a reasonable reflection of the underlying earnings levels and trends from core business activities, are more indicative of future results, and provide comparability to reported results that include share-based employee compensation costs as prescribed by SFAS 123(R).

 

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.

 

A summary of our 2007 financial performance, compared to 2006, follows:

 

 

During 2007 we continued our focus on leadership, innovation and community and were recognized for these efforts by vendors, as Timberland PRO^® received the Total Company Large Vendor of the Year Award from Tractor Supply Co.; by industry associations, as we were recognized by the Outdoor Industry Association for our efforts in creating the Green Index^TM rating system, and received the Visual Merchandising and Retail Design Award in recognition of eco-friendly store design; and by publications such as BusinessWeek, who named us winners of 2 International Design Excellence Awards (IDEA) for GoLite^® footwear and the Greenscapes Mountain Sneaker. We were also named one of CRO Magazine’s “100 Best Corporate Citizen’s”; one of Working Mother Magazine’s Top 100 companies in the U.S. for working mothers; and ranked #3 among the Top 100 Best Adoption-Friendly Workplaces.

 

Restructuring Programs

 

The Company incurred net restructuring and related charges of $24.7 million in the year ended 2007. The components of these charges are discussed below. See Note 18 to the Company’s consolidated financial statements in Item 8 of this Annual Report on Form 10-K for additional information with respect to these charges.

Global Efficiency Review

 

As part of an ongoing initiative to rationalize our operating expense structure, in the fourth quarter we undertook a review of each function in our entire global organization and announced plans to transition to a reorganized, more efficient organization. This included changes to the U.S. sales team, a streamlined global product development organization, and reorganized support organizations around the globe. We incurred a net restructuring charge of approximately $6.8 million in the fourth quarter of 2007, primarily related to severance, of which $3.1 million, $2.6 million and $1.1 million were reported in the Unallocated Corporate, International, and U.S. Wholesale segments, respectively.

 

Global Retail Portfolio Review

 

During the third quarter of 2007, we announced our decision to close approximately 40, principally larger, specialty retail stores in the U.S., Europe and Asia. This action is consistent with the Company’s plan to continue to develop smaller, footwear-focused stores in the U.S. and certain international markets. The Company also plans to close several underperforming U.S. outlet stores. For the year ended December 31, 2007 the U.S. Consumer Direct segment incurred $7.5 million in restructuring and related costs, which included impairment charges related to property and equipment of $3.9 million, $2.1 million for lease termination costs, and severance and related costs for field employees of $1.5 million. For the year ended December 31, 2007 the International segment incurred charges of $2.9 million, of which $1.9 million was an impairment charge related to property and equipment and $1.0 million was for severance and related costs for field employees. We expect to incur additional charges of $5.5 million, of which $2.1 million relate to our U.S. Consumer Direct segment and $3.4 million relate to our International segment, in the first half of 2008. These expected costs primarily relate to lease termination costs.

 

North American Apparel Licensing

 

During the first quarter of 2007, we entered into a five year licensing agreement with Phillips-Van Heusen for the design, sourcing and marketing of apparel in North America under the Timberland^® brand, beginning with the Fall 2008 line. We incurred a restructuring charge of $3.1 million in our U.S. Wholesale segment in the year ended December 31, 2007 to reflect employee severance, outplacement services and asset disposal costs associated with the implementation of this strategy.

 

Executive Departure

 

During the first quarter of 2007, we also announced that Kenneth P. Pucker, Executive Vice President and Chief Operating Officer would be leaving the Company effective March 31, 2007. Mr. Pucker entered into a separation agreement with the Company, which provided for a cash payment and, pursuant to a prior award agreement, the vesting of certain shares previously awarded under the Company’s incentive compensation plans. In connection with our Global Reorganization discussed below, the Company recorded a restructuring charge of approximately $3.6 million in the first quarter of 2007 to record these costs. Additionally, a credit of approximately $0.8 million was recorded to restructuring associated with the forfeiture of other shares awarded to Mr. Pucker but not vested upon termination. See Note 14 to the Company’s consolidated financial statements in Item 8 of this Annual Report on Form 10-K for details of the impact of share-based awards included in this restructuring charge. Of the total charge, $3.0 million was a cash item that was paid in the second quarter of 2007. The remaining $0.6 million charge and the $(0.8) million credit were recorded as a net reduction to equity. The total net charge of $2.8 million is reflected in our Unallocated Corporate component for segment reporting.

 

Global Reorganization

 

During the fourth quarter of 2006, the Company announced a global reorganization to better align our organizational structure with our key consumer categories. During the year ended December 31, 2007 we incurred charges of $1.6 million for severance and employment related items, of which $1.4 million related to our International segment and $0.2 million is in Unallocated Corporate.

Outlook

 

In February 2008 we announced we had taken several actions to streamline our global operations which are expected to result in incremental operating expense savings of $30 million. These actions, when combined with our previously announced decisions to license our U.S. apparel business, close underperforming retail stores and reorganize our U.S. sales and global product organizations, are expected to result in $65 million of annual operating expense savings. The Company plans to invest incrementally in consumer-facing marketing spend, international expansion and other growth initiatives resulting in a recalibrated operating expense base for 2008 in the range of $550 million.

 

For 2008, we are targeting low-single digit revenue declines, operating expenses in the range of $550 million and flat to modest operating margin improvement excluding restructuring costs, compared with 2007 comparable results. As defined, 2007 comparable results exclude $24.7 million in restructuring and related costs, and approximately $30 million in revenues associated with stores targeted for closure that generated an operating loss of approximately $2 million. The Company believes that actions taken to rationalize its operating expense structure should offset continued soft market trends. We anticipate our full year 2008 tax rate to be in the range of 40%.

 

The Company continues to target mid-single digit revenue declines and improved operating contribution excluding restructuring costs for the first half of 2008, compared with 2007 first half comparable results. As defined, 2007 first half comparable results exclude $7.5 million in restructuring and related costs, and approximately $8 million in revenues associated with stores targeted for closure that generated an operating loss of approximately $2 million. We also anticipate an additional $6 million in restructuring costs to be incurred in the first half of 2008 for charges associated with our retail closure plan and now believe total plan costs will be in the range of $16 million, slightly below our initial estimate.

 

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 of America. 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, shared-based compensation 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. Our significant accounting policies are described in Note 1 to the Company’s consolidated financial statements in Item 8 of this Annual Report on Form 10-K.

 

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 (including distributors, franchisees and commissioned agents), retail and e-commerce store revenues, license fees and royalties. We record wholesale and e-commerce store revenues when title passes and the risks and rewards of ownership have passed to our customer, based on the terms of sale. Title passes generally upon shipment to or upon receipt by our customer, depending on the country of sale and the agreement with our 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 in the same period the related sales are recorded. 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 $30.0 million and $35.9 million at December 31, 2007 and 2006, respectively. The actual amount of customer returns and allowances 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 $14.8 million and $12.5 million at December 31, 2007 and 2006, 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. 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 $8.1 million and $9.9 million at December 31, 2007 and 2006, respectively. 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 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 cash flows as we purchase and sell goods in foreign markets in their local currencies. We use derivative instruments, specifically forward contracts, to manage the impact of foreign currency fluctuations on a portion of our forecasted foreign currency exposures. These derivatives are carried at fair value on our consolidated balance sheet. Changes in fair value of derivatives not designated as hedge instruments are recorded in other income/(expense), net in our consolidated statements of income (see Notes 1 and 3 to our consolidated financial statements in Item 8 of this Annual Report on Form 10-K). For our derivative contracts that have been designated as hedge instruments, the effective portion of gains and losses resulting from changes in the fair value of the instruments are deferred in accumulated other comprehensive income and reclassified to earnings in the period that the transaction that is subject to the related hedge contract is recognized in earnings. The ineffective portion of the hedge is reported in other income/(expense), net in our consolidated statements of income. We use our operating budget and forecasts to estimate future economic exposure and to determine the levels and timing of derivative transactions intended to mitigate such exposures in accordance with our risk management policies. We closely monitor our foreign currency exposure and adjust our derivative positions accordingly. Our estimates of anticipated transactions could fluctuate over time and could vary from the ultimate transactions. Future operating results could be impacted by adjustments to these estimates and changes in foreign currency forward rates.

 

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 consolidated 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 2007, we recorded impairment charges of $5.8 million associated with the closure of certain of our retail stores. See Note 18 to the Company’s consolidated financial statements in Item 8 of this Annual Report on Form 10-K for additional information regarding the Company’s Global Retail Portfolio Review. In 2006, no significant impairment related to the carrying value of our long-lived assets was 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.

 

Share-based Compensation

 

The Company estimates the fair value of its stock option awards and employee stock purchase plan (the “ESP Plan”) rights on the date of grant using the Black-Scholes option valuation model. The Black-Scholes model includes various assumptions, including the expected volatility for stock options and ESP Plan rights and the expected term of stock options. These assumptions reflect the Company’s best estimates, but they involve inherent uncertainties based on market conditions generally outside of the Company’s control. As a result, if other assumptions had been used, share-based compensation expense, as calculated and recorded under SFAS 123(R) could have been materially impacted. Furthermore, if the Company uses different assumptions in future periods, share-based compensation expense could be materially impacted in future periods. See Note 14 to the Company’s consolidated financial statements in Item 8 of this Annual Report on Form 10-K for additional information regarding the Company’s share-based compensation.

 

Income Taxes

 

We record deferred tax assets and liabilities based upon temporary book to tax differences and to recognize tax attributes, such as tax loss carryforwards and credits. 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 allowance quarterly.

 

We estimate the effective tax rate 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.

 

Effective January 1, 2007 we adopted FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109. Under FIN 48 we recognize the impact of a tax position in our financial statements if that position is more likely than not to be sustained upon examination by the appropriate taxing authority, based on its technical merits. As a result of the adoption of FIN 48, we recognized a $3.3 million increase in our liability for unrecognized tax benefits, which was recorded as a reduction to the January 1, 2007 retained earnings balance. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. Our accounting for income taxes in connection with the adoption of FIN 48 is discussed in Notes 1 and 12 to the Company’s consolidated financial statements included in Item 8 of this Annual Report on Form 10-K.

 

The Company exercises its judgment in determining whether a position meets the more likely than not threshold for recognition, based on the individual facts and circumstances of that position in light of all available evidence. In measuring the FIN 48 liability, we consider amounts and probabilities of outcomes that could be realized upon settlement with taxing authorities using the facts, circumstances and information available at the balance sheet date. These reflect the Company’s best estimates, but they involve inherent uncertainties. As a result, if new information becomes available, the Company’s judgments and estimates may change. A change in judgment relating to a tax position taken in a prior annual period will be recognized as a discrete item in the period in which the change occurs. A change in judgment relating to a tax position taken in a prior interim period within the same fiscal year will be reflected through our effective tax rate.

 

Results of Operations

 

 

2007 Compared to 2006

 

Revenue

 

Consolidated revenue for 2007 was $1,436.5 million, a decrease of $131.2 million, or 8.4%, compared to 2006. On a constant dollar basis, consolidated revenues were down 11.0%. Anticipated declines in boots and kids’ footwear and decreases in Timberland^® apparel offset strong gains in SmartWool^® products and Timberland PRO^® series footwear. U.S. revenue was $701.2 million, a 17.1% decline from 2006. International revenue was $735.3 million, an increase of 1.8% over 2006. On a constant dollar basis, International revenue decreased 3.9%, with solid growth in Asia offset by a decline in Europe.

Segments Review

 

We have three reportable business segments (see Note 16 to the consolidated financial statements in Item 8 of this Annual Report on Form 10-K): U.S. Wholesale, U.S. Consumer Direct and International.

 

U.S. Wholesale revenues were $509.8 million in 2007, down 21.3% compared to 2006. The decrease was driven primarily by anticipated declines in boots and kids’ footwear, and decreases in Timberland^® apparel as we experienced soft retail demand for our apparel as we transitioned our North American apparel business to a licensing arrangement. This decrease was partially offset by strong growth in SmartWool^® products and Timberland PRO^® series footwear, as well as the acquisition of IPATH.

 

U.S. Consumer Direct revenues decreased 3.2% to $191.4 million from $197.7 million reported in 2006. Lower retail sales of Timberland^® apparel, due to soft retail demand as we transitioned our North American apparel business to a licensing arrangement, as well as declines in boots and outdoor performance footwear offset increases in casual footwear, kids’ footwear and SmartWool’s e-commerce business. Comparable store sales declined 5.5% in a soft retail environment. We had 13 specialty, 3 footwear plus, and 63 outlet stores at December 31, 2007 compared to 20 specialty and 61 outlets stores at December 31, 2006. On September 26, 2007 we announced our plan to close approximately 40, principally larger, specialty stores in the United States, Europe and Asia. This step is consistent with the Company’s strategy to open smaller, footwear-focused stores in the United States. The Company also plans to close several underperforming U.S. outlet stores. The Company had closed 6 specialty stores under this program by the end of 2007. We expect the remaining closures to be completed in the first half of 2008, and following the store closures we expect that there will be 1 specialty store, 56 factory outlet stores and 4 to 8 footwear plus stores in the United States.

 

International revenues grew 1.8% to $735.3 million in 2007, and accounted for 51.2% of consolidated revenues, but declined 3.9% in constant dollars, where growth in Asia and Canada was offset by a decline in Europe. Europe’s revenue was $539.2 million, flat with 2006, but a decline of 7.2% in constant dollars. Growth in our European distributor business, and gains in Scandinavia were offset by weak sales results across Europe. Further revenue gains from the acquisitions of Howies and IPATH, along with growth in casual and outdoor performance footwear, were offset by an anticipated decline in boots and kids’ footwear.

 

Asia recorded revenues of $155.5 million in 2007, up 7.4%, or 6.5% in constant dollars, over 2006. Revenue increases are attributed primarily to strong gains in our Asian distributor business, reflecting our continued expansion in China. Additional growth in Malaysia, Japan and Singapore was partially offset by declines in Taiwan. Asia’s growth is supported by sales gains in all product categories.

 

Canada grew 9.4% to $27.0 million. Gains in Timberland PRO^®, SmartWool^® apparel and accessories, and the benefit of foreign exchange rate changes offset declines primarily in boots and kids’ footwear.

 

Products

 

Worldwide footwear revenue was $1,004.8 million in 2007, a decline of 10.8% as compared to 2006. Anticipated sales declines in boots and kids’ along with lower sales of outdoor performance footwear were partially offset by higher sales of the Timberland PRO^® series and revenue associated with the acquisition of IPATH. Unit sales were 10.9% lower than 2006, reflecting lower sales of boots and kids’ footwear, while average selling prices remained flat.

 

Worldwide apparel and accessories revenue was $411.6 million in 2007, a decrease of 2.6% compared to 2006. This decrease reflects a decline in Timberland^® brand apparel sales worldwide, partially as a result of the transition of our North American apparel business to a licensing arrangement. This decrease was offset in part by double-digit growth in SmartWool^® socks and apparel and the revenue associated with the acquisition of Howies. Unit sales of apparel and accessories increased 2.8%, while the average selling price decreased 5.2%.

 

Royalty and other revenue, which consists primarily of royalties from third-party licensees and distributors, increased 9.7% to $20.0 million, reflecting increased sales of licensed Timberland PRO apparel, licensed kids’ apparel and growth in our international distributor business.

Channels

 

Growth in our global consumer direct business was offset by continued softness in worldwide wholesale revenue. Consumer direct revenues grew 4.6% to $393.2 million, primarily due to growth in Europe and Asia from door expansion. Globally, comparable store sales were down 4.8% from 2006 to 2007. We had 243 Company owned stores, shops and outlets worldwide at the end of 2007 compared to 246 at December 31, 2006. During 2007 we evaluated the performance of our worldwide retail stores and announced we would close approximately 40, principally larger, specialty retail stores in the United States, Europe and Asia. The Company had closed 6 specialty stores in the United States included in this plan by the end of 2007. This action is consistent with the Company’s strategy to transition to smaller, footwear-focused stores in the U.S. and in certain international markets. We also plan to close several underperforming U.S. outlet stores. The majority of the store closures are expected to occur in the first half of 2008, and the reduction in door count is anticipated to increase annual operating profits by approximately $2 million, while lowering annual revenues by approximately $30 million. We believe that retail is an important component of our multi-channel distribution strategy and will continue to operate approximately 200 retail doors globally following these select closures. These company managed stores, when combined with over 600 stores and shops operated by franchise partners and distributors, will leave the Company with more than 800 Timberland^® retail locations worldwide following the closures.

 

Wholesale revenue was $1,043.2 million, a 12.5% decrease compared to 2006. Wholesale revenue declines in the U.S. and Europe were largely driven by sales declines in boots and kids’, declines in Timberland^® apparel and, to a lesser extent, decreases in casual and outdoor performance footwear. These declines offset growth in Asia primarily in boots and casual footwear, as well as strong growth from SmartWool, Timberland PRO^®, and revenue associated with the IPATH acquisition in the U.S.

 

Gross Profit

 

Gross profit as a percentage of sales, or gross margin, was 46.3% compared to 47.5% in 2006. This decrease reflects impacts from higher levels of off-price and close out activity; higher comparable product costs, including effects from anti-dumping duties on certain footwear imported into the EU; and mix impacts, including lower sales of boots and kids’ footwear. These impacts were partially offset by favorable foreign exchange impacts.

 

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 $91.0 million and $97.7 million in 2007 and 2006, respectively.

 

Operating Expense

 

Total operating expense was $605.5 million in 2007, $24.0 million, or 4.1% higher than in 2006. As a percentage of revenue, operating expense was 42.2%, up 510 basis points from the 37.1% reported in 2006. Operating expenses included $24.7 million in restructuring and related charges in 2007 and $3.9 million in 2006. An increase of $12.4 million in selling expense was partially offset by a decrease of $9.2 million in general and administrative costs. Excluding restructuring and related costs in both 2007 and 2006, base operating expense increased $3.2 million, or 0.6%.

 

Selling expense for 2007 was $464.7 million, an increase of $12.4 million or 2.8% compared to the prior year. The increase was driven primarily by costs associated with International retail expansion totaling $9.9 million and new businesses and specialty category development of $9.2 million, offset by decreases of $9.9 million in global marketing costs primarily related to non-consumer facing activities and share-based and incentive compensation costs of $9.3 million. The impact of changes in foreign exchange rates added approximately $13.3 million to selling expense.

 

We include the costs of physically managing inventory (warehousing and handling costs) in selling expense. These costs totaled $43.0 million and $38.2 million in 2007 and 2006, respectively.

Advertising expense, which is included in selling expense, was $30.0 million and $28.1 million in 2007 and 2006, respectively. Decreases in co-op advertising were offset by increased media spending primarily related to our “Rain” TV commercials and Earthkeepers product launch in the fourth quarter of 2007. Advertising costs are expensed at the time the advertising is run, predominantly in the season that the advertising costs are incurred. As of December 31, 2007 and December 31, 2006, we had $0.1 million and $0.7 million of prepaid advertising costs recorded on our consolidated balance sheets, respectively.

 

General and administrative expense was $116.2 million, a decrease of $9.2 million or 7.4% compared to 2006. The decrease was driven primarily by a $9.4 million reduction in share-based and incentive compensation costs and a $7.8 million decrease in corporate administrative and support costs, partially offset by $4.1 million associated with International expansion and $3.3 million related to new business initiatives. Foreign exchange rate changes added approximately $2.1 million to overall general and administrative expenses.

 

Restructuring and related costs totaled $24.7 million in 2007 compared to $3.9 million in 2006. New restructuring initiatives in 2007 included $10.4 million associated with a global retail portfolio review, $6.8 million associated with a global efficiency review, $3.1 million associated with our decision to license our North American apparel business, and $4.4 million related to the global reorganization begun in 2006. Restructuring charges in 2006 were comprised of $3.0 million associated with the global reorganization, $0.7 million to establish a European shared service center and $0.2 million associated with the closure of our Puerto Rico manufacturing facility at the end of 2005.

 

Operating Income

 

Operating income was $59.2 million in 2007 compared to $162.6 million in 2006. Operating income as a percentage of revenue fell from 10.4% in 2006 to 4.1% in 2007, reflecting an 8.4% decrease in revenues, pressure on gross margins due to increased off-price and close out activity, higher operating expenses over a lower revenue base, and increased restructuring and related charges.

 

Our U.S. Wholesale segment’s operating income decreased 38.3% to $111.3 million in 2007, driven by declines in both revenue and gross margin partially offset by a decrease in operating expense. Revenue was down 21.3%, driven by decreases in boots and kids’ footwear, as well as Timberland^® apparel. Gross margin fell 295 basis points, pressured primarily by increased off-price sales of both footwear and apparel. Operating expense decreased 5.4%, as lower non-consumer facing marketing expenses, compensation costs, and a reduction in bad debt expense as a result of a customer’s bankruptcy which resulted in a non-recurring charge in 2006, were partially offset by costs associated with new business initiatives and restructuring charges of $3.1 million associated with our decision to license our North American apparel business and $1.1 million associated with the global efficiency review we undertook in the fourth quarter of 2007.

 

Operating income for our U.S. Consumer Direct segment was $9.5 million for 2007 compared to $16.6 million in 2006. Revenue decreased 3.2%, reflecting a 5.5% decline in comparable store sales, while gross margin improved slightly, by 65 basis points. Operating expense increased 8.3%, driven by $7.5 million of restructuring and related costs associated with our Global Retail Portfolio Review.

 

International operating income was down 36.7% to $92.5 million in 2007, driven by a 20.0% increase in operating expense reflecting costs associated with International retail expansion, an increase in our allowance for doubtful accounts primarily associated with certain franchisees, new business initiatives and the impact of foreign exchange rate changes. Additionally, the International segment recorded restructuring and related charges in 2007 associated with our Global Retail Portfolio Review of $2.9 million, our global efficiency review of $2.6 million and the global reorganization we undertook beginning in 2006 of $1.4 million. Additionally, gross margin was down 140 basis points, pressured by higher comparable product costs, primarily the effects of EU anti-dumping duties, and increased levels of close out activity and markdowns and allowances, partially offset by favorable foreign exchange rate impacts.

 

Our Unallocated Corporate operating loss decreased $26.3 million, or 14.6%, to $154.1 million in 2007. Unallocated Corporate operating loss as a percentage of total revenue decreased 80 basis points to 10.7% of

total revenue. The primary drivers of this decrease in operating loss were reduced costs associated with incentive and share-based compensation, reductions in corporate and administrative spending, and lower marketing support costs, partially offset by an incremental $3.0 million in restructuring charges in 2007, primarily related to an executive departure.

 

Other Income and Taxes

 

Interest income, 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 $0.8 million and $1.0 million in 2007 and 2006, respectively. The decrease is primarily due to reduced cash balances.

 

Other, net, included $0.5 million and $(8.4) million of foreign exchange gains/(losses) for 2007 and 2006, respectively, resulting from changes in the fair value of financial derivatives not designated as hedges, specifically forward contracts, and the timing of settlement of local currency denominated assets and liabilities. 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 33.0% in 2007, compared to 35.8% in 2006. This decrease reflects the release of a specific tax reserve due to the closure of certain audits in the fourth quarter of 2007 and the geographic mix of our profits. We expect our full year effective tax rate in 2008 to be in the range of 40%. (See Note 12 to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K).

 

Reconciliation of Total Company, Total International, Europe and Asia Revenue Changes to Constant Dollar Revenue Changes

 

 

The difference between changes in reported revenue (the most comparable GAAP measure) and constant dollar revenue changes is the impact of foreign currency. We provide constant dollar revenue changes for total

Company, total International, Europe and Asia results because we use the measure to understand the underlying growth rate of revenue excluding the impact of items that are not under management’s direct control, such as changes in foreign exchange rates.

 

Reconciliation of Operating Expense to Operating Expense Excluding Restructuring and Related Costs

 

 

Management provides operating expense excluding restructuring and related costs because it is used to analyze the operating expenses of the Company. Management believes this measure is a reasonable reflection of the underlying expense levels and trends from core business activities.

 

Reconciliation of Operating Income to Operating Income Excluding Restructuring and Related Costs

 

 

Management provides operating income excluding restructuring and related costs because it is used to analyze the operating income of the Company. Management believes this measure is a reasonable reflection of the underlying income levels and trends from core business activities.

 

Reconciliation of Net Income to Net Income Excluding Restructuring and Related Costs

 

 

Management provides net income excluding restructuring and related costs because it is used to analyze net income of the Company. Management believes this measure is a reasonable reflection of the underlying net income levels and trends from core business activities.

 

Reconciliation of Diluted EPS to Diluted EPS Excluding Restructuring and Related Costs

 

Management provides diluted EPS excluding restructuring and related costs because it is used to analyze the earnings of the Company. Management believes this measure is a reasonable reflection of the underlying earnings levels and trends from core business activities.

 

2006 Compared to 2005

 

Revenue

 

Consolidated revenue of $1,567.6 million in 2006 was flat when compared to 2005. Benefits from the addition of SmartWool, which contributed an incremental $51.2 million to revenue growth, solid growth in international markets and gains in Timberland PRO^® footwear and Timberland^® brand apparel offset sales declines in boots and kids’ footwear, primarily in the U.S.

 

Segments Review

 

U.S. Wholesale revenues were $647.9 million in 2006, down 2.9% compared to 2005. The decrease was driven primarily by declines in boots and kids’ footwear. This decrease was partially offset by a full year of sales from SmartWool, which added $42.8 million in incremental revenue, and strong growth in Timberland PRO^® footwear and Timberland^® brand apparel sales.

 

U.S. Consumer Direct revenues declined 7.0% to $197.7 million in 2006. Comparable store sales declined 9.6%, reflecting both unseasonably warm weather trends which pressured sales and our decision to remove classic boot product from outlet stores in the second half of the year as part of our strategy to strengthen overall pricing for these products in the U.S. market. Strong growth in our e-commerce business, due primarily to incremental SmartWool sales, partially offset the decrease in comparable store sales.

 

International revenues grew 5.2% to $722.1 million in 2006, reflecting growth across Europe, Asia and Canada. Overall, International revenues grew to 46.1% of consolidated revenues. Europe’s revenue increased 2.5%, or 1.7% in constant dollars, to $539.8 million. Growth in our European distributor business, expansion in the key southern European markets of Italy and Spain and gains in Scandinavia offset softer sales results in France, Benelux and the U.K. Double digit growth in men’s and women’s casual footwear and solid gains in apparel and accessories were partially offset by declines in boots and outdoor performance and kids’ footwear.

 

Asia posted revenues of $144.8 million, up 9.0%, or 11.0% in constant dollars, over 2005. Revenue increases were attributed to strong gains in Japan; our Asian distributor business, reflecting our continued expansion in China; and Taiwan. Asia’s growth was supported by sales gains in all product categories. We continued to expand our retail presence in Asia, with a net addition of 14 stores and shops in 2006.

 

Canada expanded significantly over the prior year, growing 42.4% to $24.6 million. Sales results reflect benefits from the 2006 reacquisition of distribution rights for apparel in Canada and gains in accessories and Timberland PRO^® and women’s casual footwear.

 

Products

 

Worldwide footwear revenue was $1,126.9 million, down 6.1% from 2005. Footwear results were driven by a decline in boots and kids’ footwear sales, partially offset by higher sales of Timberland PRO^® and men’s and women’s casual footwear. Unit sales were 9.2% lower than 2005, reflecting lower sales of boots and kids’ footwear. The average selling price increased 3.5% as a result of business mix impacts reflecting growth in international markets.

 

Worldwide apparel and accessories revenue was $422.4 million in 2006, an increase of 21.1% compared to 2005. This increase reflects a full year of SmartWool sales, which contributed an incremental $51.2 million in revenue, as well as solid growth in Timberland^® brand apparel sales worldwide. Unit sales of apparel and accessories increased 48.8%, while the average selling price decreased 18.6%, reflecting impacts from the addition of SmartWool’s products, which have lower average selling prices.

Royalty and other revenue, which consists primarily of royalties from third-party licensees and distributors, increased 9.2% to $18.3 million, reflecting increased sales of licensed kids’ apparel in the U.S. and growth in our international distributor business.

 

Channels

 

Worldwide wholesale revenue growth offset the decline in our global consumer direct business. Worldwide wholesale revenue was $1,191.6 million, a 1.2% increase over 2005. Sales gains in apparel and accessories, Timberland PRO^® footwear and men’s and women’s casual footwear offset lower sales of boots and kids’ footwear. Global consumer direct revenues were $376.0 million, 3.0% lower than 2005. Worldwide comparable store sales declined 8.7%, reflecting unseasonably warm weather trends that pressured retail sales in the U.S. and Europe. This decrease more than offset benefits from global door expansion and strong performance from our e-commerce business. During 2006, we opened 35 stores, shops and outlets and closed 12 worldwide.

 

Gross Profit

 

Gross profit as a percentage of sales, or gross margin, was 47.5% in 2006, compared to 49.5% in 2005. This decrease reflects impacts from product mix impacts, including lower sales of boots and kids’ footwear; higher levels of off-price and discounted sales; and higher comparable product costs, including effects from anti-dumping duties on EU footwear, which added $5.5 million to product costs in 2006.

 

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 $97.7 million and $101.4 million in 2006 and 2005, respectively.

 

Operating Expense

 

Total operating expense was $581.5 million in 2006, $47.1 million, or 8.8% higher than in 2005. As a percentage of revenue, operating expense was 37.1%, up 300 basis points from the 34.1% reported in 2005. Excluding restructuring and related costs in both 2006 and 2005, and including share-based compensation costs in 2005, base operating expense increased $35.0 million, or 6.5%, driven by $26.4 million of incremental costs associated with new businesses and category development, including the addition of SmartWool, $18.2 million of cost growth related to International expansion and $7.4 million of incremental costs associated with share-based compensation, as a result of new accounting requirements, offset by a $10.4 million reduction in marketing expenses and a $9.3 million decline in worldwide incentive compensation costs.

 

Selling expense for 2006 was $452.2 million, an increase of $32.9 million or 7.8% compared to 2005. The increase was driven by $21.5 million in costs related to new businesses and category development, $18.2 million in International business expansion and $5.1 million in share-based employee compensation costs. These increases were partially offset by decreases of $10.4 million in marketing costs and $5.3 million in worldwide incentive compensation costs. Foreign exchange rate changes had minimal impact on selling expense growth.

 

We include the costs of physically managing inventory (warehousing and handling costs) in selling expense. These costs totaled $38.2 million and $37.8 million in 2006 and 2005, respectively.

 

Advertising expense, which is included in selling expense, was $28.1 million and $36.6 million in 2006 and 2005, respectively. The decrease reflects shifts in spending towards other brand building activities such as investments in our international business and retail expansion. 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, 2006 and December 31, 2005, we had $0.7 million and $1.2 million of prepaid advertising costs recorded on our consolidated balance sheets, respectively.

 

General and administrative expense was $125.4 million, an increase of $14.6 million or 13.2% over 2005. The increase was driven by $4.9 million related to new business initiatives, $2.3 million of share-based employee compensation costs, $2.9 million in costs associated with operating the new European finance shared

service center, $2.4 million in legal and compliance costs and $0.5 million in certain insurance costs. These increases were offset by a $4.0 million decline in worldwide incentive compensation costs. Foreign exchange rate changes added $2.2 million or 2.0% to overall general and administrative expenses growth.

 

Operating Income

 

Operating income was $162.6 million in 2006 compared to $240.1 million in 2005. Operating income as a percentage of revenue fell from 15.3% in 2005 to 10.4% in 2006, reflecting pressure on gross margins as well as higher operating expenses over a flat revenue base.

 

Our U.S. Wholesale segment’s operating income decreased 16.2% to $180.2 million in 2006, driven by declines in both revenue and gross margin and increased operating expense. Revenue was down 2.9%, driven by decreases in boots and kids’ footwear sales. Gross margin fell 130 basis points, pressured by negative product mix impacts related to lower sales of boots and kids’ footwear and increased off-price sales, partially offset by favorable impacts from new businesses. Operating expense increased 22.6% primarily due to the addition of SmartWool.

 

Operating income for our U.S. Consumer Direct segment was $16.6 million for 2006 compared to $36.1 million in 2005. Revenue decreased 7.0%, reflecting a 9.6% decline in comparable store sales. Gross margin was down 440 basis points primarily due to lower U.S. outlet store margins, reflecting higher levels of off-price and discounted sales and negative product mix impacts related to lower boot sales. Operating expense increased 5.7%, impacted by costs associated with operating three additional stores in 2006.

 

International operating income was down 7.3% to $146.2 million in 2006, driven by an 8.0% increase in operating expense reflecting costs associated with International expansion and costs related to operating the new European finance shared service center. Additionally, gross margin was down 185 basis points, pressured by higher comparable product costs, including the effects of EU anti-dumping duties, and increased levels of off-price sales.

 

Our Unallocated Corporate operating loss increased $11.7 million, or 6.9%, to $180.4 million in 2006. Unallocated Corporate operating loss as a percentage of total revenue increased 70 basis points to 11.5% of total revenue. Excluding restructuring costs in both 2006 and 2005 and increased share-based employee compensation costs of $9.4 million in 2006, Unallocated Corporate operating loss increased $5.3 million or 3.2% from the prior year and represents 10.8% of total revenue. This increase was driven primarily by $5.1 million in unfavorable product cost variances reflecting decreased volume and higher than planned material costs, $2.1 million in global support services, $1.2 million in product management expenses and $1.0 million in one-time costs related to establishing the new European finance shared service center, offset by a $4.6 million reduction in worldwide incentive compensation costs.

 

Other Income and Taxes

 

Interest income, 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 $1.0 million and $3.3 million in 2006 and 2005, respectively. The decrease was primarily due to reduced cash balances resulting from our SmartWool acquisition, share repurchases and reduced profitability.

 

Other, net, included $(8.4) million and $23.1 million of foreign exchange gains/(losses) for 2006 and 2005, respectively, resulting from changes in the fair value of financial derivatives, specifically forward contracts, and the timing of settlement of local currency denominated assets and liabilities. 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 35.8% in 2006, compared to 32.5% in 2005 (see Note 12 to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K). This increase reflects the geographic mix of our profits and provisions for specific tax reserves.

Reconciliation of Total Company, Total International, Europe and Asia Revenue Changes to Constant Dollar Revenue Changes

 

 

The difference between changes in reported revenue (the most comparable GAAP measure) and constant dollar revenue changes is the impact of foreign currency. We provide constant dollar revenue changes for total Company, total International, Europe and Asia results because we use the measure to understand the underlying growth rate of revenue excluding the impact of items that are not under management’s direct control, such as changes in foreign exchange rates.

 

Reconciliation of Operating Expense to Operating Expense Excluding Restructuring and Related Costs and Including Share-Based Employee Compensation Costs Related to Stock Option and Employee Stock Purchase Plans

 

Management provides operating expense excluding restructuring and related costs and including share-based employee compensation costs related to stock option and employee stock purchase plans because it is used to analyze the operating expenses of the Company. Management believes this measure is a reasonable reflection of the underlying expense levels and trends from core business activities and provides comparability to reported results that include share-based employee compensation costs as prescribed by SFAS 123(R).

 

Reconciliation of Operating Income to Operating Income Excluding Restructuring and Related Costs and Including Share-Based Employee Compensation Costs Related to Stock Option and Employee Stock Purchase Plans

 

 

Management provides operating income excluding restructuring and related costs and including share-based employee compensation costs related to stock option and employee stock purchase plans because it is used to analyze the operating income of the Company. Management believes this measure is a reasonable reflection of the underlying income levels and trends from core business activities and provides comparability to reported results that include share-based employee compensation costs as prescribed by SFAS 123(R).

 

Reconciliation of Net Income to Net Income Excluding Restructuring and Related Costs and Including Share-Based Employee Compensation Costs Related to Stock Option and Employee Stock Purchase Plans

 

 

Management provides net income excluding restructuring and related costs and including share-based employee compensation costs related to stock option and employee stock purchase plans because it is used to

analyze net income of the Company. Management believes this measure is a reasonable reflection of the underlying net income levels and trends from core business activities and provides comparability to reported results that include share-based employee compensation costs as prescribed by SFAS 123(R).

 

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

 

 

Management provides diluted EPS excluding restructuring and related costs and including share-based employee compensation costs related to stock option and employee stock purchase plans because it is used to analyze the earnings of the Company. Management believes this measure is a reasonable reflection of the underlying earnings levels and trends from core business activities and provides comparability to reported results that include share-based employee compensation costs as prescribed by SFAS 123(R).

 

Accounts Receivable and Inventory

 

Accounts receivable were $188.1 million as of December 31, 2007, compared to $204.0 million as of December 31, 2006 and $168.8 million as of December 31, 2005. Days sales outstanding were 38 days as of both December 31, 2007 and 2006, and 33 days as of December 31, 2005. Wholesale days sales outstanding were 49 days, 45 days and 39 days at the end of 2007, 2006 and 2005, respectively. Days sales outstanding were flat as the increase in wholesale days outstanding were offset by an increase in consumer direct revenue, as a percentage of total revenue, for 2007. The increase in wholesale days outstanding is primarily due to a higher international business mix in the wholesale channel for 2007. The increase in 2006 accounts receivable and days sales outstanding were driven by sales timing and, to a lesser extent, some erosion in the timeliness of collections.

 

Inventory increased 8.1% to $201.9 million as of December 31, 2007 from $186.8 million as of December 31, 2006 and $167.1 million as of December 31, 2005. The increase in inventory for 2007 reflects increased costs, foreign exchange impacts, the addition of new brands and slightly higher inventory levels associated with soft market conditions. The increase in inventory in 2006 is primarily related to increased retail inventory in the U.S. and Europe due to unseasonably warm weather and investments made in Asian retail operations to prepare for the Asian holiday season in January and February 2007.

 

Liquidity and Capital Resources

 

2007 Compared to 2006

 

Net cash provided by operations for 2007 was $38.6 million, compared with $111.7 million in 2006. The reduction in cash provided in 2007 compared with 2006 was primarily due to reduced profitability combined with an increase in cash used for working capital. In 2007, our investment in working capital was $55.9 million, compared to $40.8 million in 2006. The increase in working capital investment was driven by lower accounts receivable, resulting from reduced sales, and higher inventory which was offset by a reduction in accounts payable driven by the timing of shipments. Our cash provided by operations was also negatively

impacted by reduced accruals and income taxes payable, which resulted from lower profitability. These reductions in operating cash were partially offset by reduced share-based compensation and other non-cash charges as well as lower prepaid expenses.

 

Net cash used for investing activities amounted to $44.4 million in 2007, compared with $47.4 million in 2006. Net cash used for investing activities in 2007 included $12.8 million, net of cash acquired, primarily related to the acquisition of the assets of IPATH, LLC. Net cash used for investing activities in 2006 included $6.4 million, net of cash acquired, primarily related to the acquisition of Howies Limited and $4.4 million of other outflows related to our acquisition of certain assets of GoLite LLC, including trademarks. Capital expenditures in 2007 were $30.5 million, compared to $36.6 million in 2006. The decrease was primarily attributable to reduced investments in retail stores and product tooling.

 

Net cash used for financing activities was $34.1 million in 2007, compared with $99.9 million in 2006. Cash flows from financing activities reflected share repurchases of $47.7 million in 2007, compared with $120.7 million in 2006. We received cash inflows of $12.6 million in 2007 from the issuance of common stock related to the exercise of employee stock options and employee stock purchases, compared with $16.4 million in 2006. An excess tax benefit from share-based compensation provided $1.1 million in cash flows in 2007 compared to $4.4 million in 2006.

 

2006 Compared to 2005

 

Net cash provided by operations for 2006 was $111.7 million, compared with $182.3 million in 2005. The reduction in cash provided in 2006 compared with 2005 was primarily due to reduced net income and an increase in our investment in working capital. In 2006, our net investment in working capital was $40.8 million, compared to $7.9 million in 2005. Working capital increases primarily reflect higher quarter-end receivable balances, impacted by sales timing and, to a lesser extent, some erosion in the timeliness of collections in the U.S. and Europe, and higher retail inventory levels related to warm weather in the U.S. and Europe as well as Asian retail investment. Growth in accounts receivable and inventory was partially offset by increased payables. Our cash provided by operations was positively impacted by increased accruals associated with the timing of VAT and other expenses.

 

Net cash used for investing activities amounted to $47.4 million in 2006, compared with $107.7 million in 2005. Net cash used for investing activities in 2006 included $6.4 million, net of cash acquired, primarily related to the acquisition of Howies Limited and $4.4 million of other outflows related to our acquisition of certain assets of GoLite LLC, including trademarks. Net cash used for investing activities in 2005 included $81.3 million, net of cash acquired, for the acquisition of SmartWool. Capital expenditures in 2006 were $36.6 million, compared to $26.2 million in 2005. The increase was primarily attributable to higher investments in retail stores and product related investments.

 

Net cash used for financing activities was $99.9 million in 2006, compared with $160.6 million in 2005. Cash flows from financing activities reflected share repurchases of $120.7 million in 2006, compared with $181.5 million in 2005. We received cash inflows of $16.4 million in 2006 from the issuance of common stock related to the exercise of employee stock options and employee stock purchases, compared with $20.8 million in 2005. An excess tax benefit from share-based compensation provided $4.4 million in cash inflows in 2006.

 

Credit Facilities

 

We have an unsecured committed revolving credit agreement with a group of banks which matures on June 2, 2011 (“Agreement”). The Agreement provides for $200 million of committed borrowings, of which up to $125 million may be used for letters of credit. Upon approval of the bank group, we may increase the committed borrowing limit by $100 million for a total commitment of $300 million. Under the terms of the Agreement, we may borrow at interest rates based on Eurodollar rates (approximately 4.7% as of December 31, 2007), plus an applicable margin of between 13.5 and 47.5 basis points based on a fixed-charge coverage grid that is adjusted quarterly. As of December 31, 2007, the applicable margin under the facility was 47.5 basis points. We will pay a utilization fee of an additional 5 basis points if our outstanding borrowings under the

facility exceed $100 million. We also pay a commitment fee of 6.5 to 15 basis points per annum on the total commitment, based on a fixed-charge coverage grid that is adjusted quarterly. As of December 31, 2007, 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 ratio of 2.25:1 and a maximum leverage ratio of 2:1. 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.

 

We had uncommitted lines of credit available from certain banks totaling $50 million as of December 31, 2007. Any borrowings under these lines would be at prevailing money market rates (approximately 5.3% as of December 31, 2007). 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, 2007 and 2006, we had no borrowings outstanding under any of our credit facilities.

 

Management believes that our operating needs, capital needs and our share repurchase program for 2008 will be funded through our current cash balances, our existing credit facilities (which place certain limitations on additional debt, stock repurchases, acquisitions and on the amount of dividends we may pay, and also contain certain other financial and operating covenants) and cash from operations, without the need for additional permanent financing. However, as discussed in Item 1A, Risk Factors, of this Annual Report on Form 10-K, 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. 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.

 

Aggregate Contractual Obligations

 

At December 31, 2007, we have the following contractual obligations due by period:

 

 

 

 

Off Balance Sheet Arrangements

 

As of December 31, 2007, 2006 and 2005, we had letters of credit outstanding of $24.5 million, $28.8 million and $24.6 million respectively. These letters of credit were issued predominantly for the

purchase of inventory. The decrease in letters of credit outstanding in 2007 was driven by reduced purchases resulting from lower sales.

 

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.

 

Quarterly Results of Operations (Unaudited)

 

 

 

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 of this Annual Report on 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 cash flows. We regularly assess these risks and have established policies and business practices that should mitigate a portion of 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 to manage the impact of foreign currency fluctuations on a portion of our foreign currency transactions. These 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. As of December 31, 2007, 2006 and 2005, 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 through a risk management program that includes the use of derivative financial instruments, primarily foreign currency forward contracts. These derivative instruments are carried at fair value on our balance sheet. Certain of these instruments, which related to 2007 exposures, do not qualify for hedge accounting and changes in their fair value were recorded in other income/(expense). These foreign currency forward contracts will expire in January 2008. The Company has implemented a program that qualifies for hedge accounting treatment to aid in mitigating our foreign currency exposures and decrease the volatility of our earnings. We began hedging the Company’s 2008 foreign currency exposure under this new hedging program in the third quarter of 2007. Under this hedging program the Company performs a quarterly assessment of the effectiveness of the hedge relationship and measures and recognizes any hedge ineffectiveness in earnings. The foreign currency forward contracts under this program will expire in 13 months or less. Based upon sensitivity analysis as of December 31, 2007, a 10% change in foreign exchange rates would cause the fair value of our financial instruments to increase/decrease by approximately $17.1 million, compared with an increase/decrease of $24.4 million as of December 31, 2006. The decrease as of December 31, 2007, compared to December 31, 2006, is primarily related to a reduction in our foreign currency denominated exposures as of December 31, 2007 compared with December 31, 2006, as well as our choice to hedge a lesser portion of our forecasted 2008 exposure at December 31, 2007 than the portion of our forecasted 2007 exposure that was hedged at December 31, 2006, as determined in accordance with our foreign exchange exposure management policy.

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders of The Timberland Company

Stratham, New Hampshire

 

We have audited the accompanying consolidated balance sheets of The Timberland Company and subsidiaries (the “Company”) as of December 31, 2007 and 2006, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007. Our audits also included the financial statement schedule listed in the Index at Item 15 (a)(2). These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of The Timberland Company and subsidiaries at December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

 

As discussed in Note 1, the Company adopted the provisions of Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109, effective January 1, 2007 and the provisions of Financial Accounting Standards No. 123R, Share-Based Payment, effective January 1, 2006.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2007, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 29, 2008 expressed an unqualified opinion on the Company’s internal control over financial reporting.

 

 

/S/ DELOITTE & TOUCHE LLP

 

Boston, Massachusetts

February 29, 2008

The Timberland Company

 

CONSOLIDATED BALANCE SHEETS

As of December 31, 2007 and 2006

 

 

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

 

The Timberland Company

 

CONSOLIDATED STATEMENTS OF INCOME

For the Years Ended December 31, 2007, 2006 and 2005

 

 

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

 

The Timberland Company

 

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

For the Years Ended December 31, 2007, 2006 and 2005