UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

 

Form 10-K

ANNUAL REPORT PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

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, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” 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).
o  Yes     þ  No

 

The aggregate market value of Class A Common Stock of the Company held by non-affiliates of the Company was $1,281,982,175 on June 30, 2006, which was the last business day of the Company’s second fiscal quarter in 2006. 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 23, 2007, 50,295,386 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 2007 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^tm, GoLite^®, and Howies^® 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. 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 footwear business globally through an increased focus on consumer segment development and technological innovation, (ii) expanding our global apparel business by leveraging the brand’s rugged heritage and consumer trust, (iii) extending enterprise reach through the development of new brand platforms such as SmartWool^®, Timberland Boot Company^tm, Miōn^tm, GoLite^®, and Howies^®, (iv) expanding our brands geographically, (v) driving operational and financial excellence, (vi) setting the standard for commitment to the community and (vii) striving to be a global employer of choice.

 

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. We continued our focus on developing products to meet the needs of distinct consumer groups in 2006 with the development of 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. Similarly, in 2005 we introduced Timberland Boot Company^tm work-wear inspired footwear that is featured in our Timberland Boot

Company^tm concept stores in the United Kingdom and also introduced Miōn^tm outdoor performance footwear designed to meet the needs of water adventurers. We intend to continue our efforts to extend our brand reach through these and other initiatives. This extension of the brand’s reach through complementary sub-brands and new brands like the Timberland PRO^® series, Timberland Boot Company^tm, Miōn^tm, and GoLite^® brands and our development of our core footwear business is intended 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 such as our new GoLite^® brand for high-altitude trail runners and our cross-category technology developments, including our new PreciseFit^tm system which was included in certain footwear products for the first time in 2006. Technology that is or will be incorporated in most of our footwear products is discussed below in Footwear Technology.

 

Boots

 

Our key boots categories include Classic Boots, in basic, premium, chukka and oxford versions, as well as Roll-Tops and 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, Bromilly and Euro Dub Hiker, which are light and flexible, built to be rugged and durable, while still allowing for enhanced agility. Some of the principal features of these boot products include premium waterproof leather, direct-attach and seam-sealed waterproof construction, rubber lug outsoles for superior traction and abrasion resistance, shock diffusion plates, durable laces, padded collars for comfortable fit, enhanced insulation, rustproof hardware for durability and moisture-wicking components for comfort and breathability. We continued our focus on reducing the seasonality of our boots business by introducing a new 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 2006. In late 2006 we reintroduced key boot styles from past seasons in their exact form, detail for detail, under our Timberland Authentics line. Lifestyle footwear, as well as active and casual based sandals, broadens the core product range. Regional programs such as Rugged Street 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 Mirney and Winter Groove, which blend functional practicality with fashion elements.

 

Men’s Casual

 

Our Timberland^® men’s casual footwear series includes Boat, Casual, Rugged Casual, Work Casual, Casual Sport, Sandals and Timberland^® LTD. Featured footwear products in these categories include boat shoes, casual bucks, loafers, sandals, oxfords, chukkas, boots and slip-ons for use in the office, home or outdoors. Our focus in the development of this line of footwear is to combine the rugged heritage of Timberland with premium leathers and functional offerings. Men’s casual footwear is rooted in craftsmanship and innovation, creating products that possess superior materials and enhanced comfort. Many of our men’s footwear products incorporate our innovative Smart Comfort^® system, which provides superior comfort while preserving the shape and style of the footwear. Expanding the reach of our casual product, in 2005 we introduced the Timberland Boot Company^tm line in the United Kingdom to provide a relevant assortment with distinctive leathers and silhouettes built upon our heritage of leather innovation.

 

Women’s Casual

 

Timberland^® women’s CasualGear 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. 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 is 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 Comforia^tm 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^® 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 2006, we added more technology and more innovation to our versatile collection of performance footwear. We continued to partner with elite athletes in the design and development of key programs. World-renowned high altitude adventurer Ed Viesturs helped to develop the Cadion hiking program, which has won acclaim as a market-leading lightweight hiker. We also marked 2006 with the continuation of the successful Power Lounger series — versatile after-sport shoes featuring a SmartWool^® lining, an industry first. The line continues to be built upon the Timberland^® Agile IQ platform, which addresses key areas of traction, shock absorption and fit to deliver out of the box comfort and enhance control and position sense on the trail.

 

Building on the Company’s long-term initiative to offer 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^tm Footwear

 

Our performance water line was first introduced in 2005 under the Miōn^tm brand name. Miōn^tm water shoes include a performance water shoe, a performance sandal, a guide slide and a pro thong for men, women and children. Miōn^tm footwear is designed for comfort and versatility in all wet conditions for the outdoor adventurer’s active lifestyle. Miōn^tm footwear features an Ergomorphic^tm footbed that 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 that improves the runner’s stability and ability to remain vertical. This new line will appear in the market in early 2007. In

connection with this new line, we acquired certain assets of GoLite LLC, including trademarks. GoLite LLC continues to market apparel, equipment and accessories as an independent company not affiliated with us.

 

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 2006, we introduced the PowerWelt boot with Timberland PRO^® Ever-Guard^tm genuine leather. This revolutionary leather is ten times more abrasion resistant than traditional leather, heat resistant up to 346ºF and waterproof. This product is targeted to the general construction market and provides the ultimate protection against the most extreme environments. The PowerWelt boot comes with the PowerFit^tm comfort system which we first successfully introduced under our TiTAN^® collection. The PowerWelt boot launch was supported with a consumer and safety manager print campaign, as well as with 285 billboard advertisements placed in the United States market to support key regional and independent retailers in attracting our target consumer. We continued to offer the TiTAN^® collection, targeted at those who prefer lightweight comfort, with various hiking silhouettes and oxford styles. All TiTAN^® styles feature the innovative TiTAN^® safety toe and our exclusive PowerFit^tm comfort system, which provides superior fit, cushioning and shock absorption. In addition to the TiTAN^® styles, the Timberland PRO^® series offering continues to include waterproof models in the industrial hiking category — a fast growing part of the work footwear market serving the younger tradesperson and workers in the light duty job category. We also continued to offer our first metatarsal protection footwear, MetGuard, which provides ultimate protection in heavy duty environments such as foundries and steel mills and FlexShield, which has built-in metatarsal protection aimed at those who work with heavy equipment. All of our waterproof styles utilize seam-sealed or membrane constructions and temperature regulating foot beds, and all of our safety toe styles meet ANSI/ASTM standards. Most styles also come with slip, abrasion and oil-resistant outsoles, as well as electrical hazard protection.

 

Footwear Technology

 

We continue to incorporate our patent pending, technological innovation, the Smart Comfort^® 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 new patent-pending Timberland^® PreciseFit^tm system was incorporated into select styles of men’s footwear lines in 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. In 2005 we realigned our personnel, processes and products to re-establish the core positioning of the apparel offer in each geographical region to position the business for growth. With a goal to elevate the apparel offer of the brand from the grass roots up, we re-evaluated the price value equation of every existing product and redefined the materials and signature details that would tell a unique Timberland story and set criteria for future execution on all product lines. This involved a new focus on our design and manufacturing processes, resulting in a consolidation of our essentials, or basics, program, ensuring a global consistency in our design language, and creating economies of scale, without compromising our commitment to regional geographic differentiation. We also continued to leverage our International Design Centre (IDC) in London, which enables us to get closer to the target consumer to evaluate their needs.

 

During 2006, 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.

 

On February 7, 2007, we announced that beginning in 2008 our Timberland^® brand apparel line will be offered in North America pursuant to a licensing arrangement. We will reintroduce 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.

 

SmartWool

 

Our acquisition of SmartWool Corporation at the end of 2005 reflects our ongoing efforts to extend our enterprise’s reach by offering our customers an expanded line of apparel and accessories. SmartWool is a leading provider of premium performance wool-based socks, apparel and accessories for men, women and children. Our key SmartWool^® product categories are performance and lifestyle socks for men, women and children and 100% SmartWool^® Next-to-Skin apparel in core base layer styles for men and women. Our classic outdoor socks includes the Hiking Light Crew and Hiking Medium Crew for the outdoor and snow-sport consumer. SmartWool has also expanded its apparel line through its Versawear offering of the men’s Synergy Jacket, a breathable, wind-resistant piece offering ultimate layering options and women’s Spectrum Hoodie, which provide users a natural fiber alternative to synthetic materials. 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. Our Timberland^® accessories products for men, women and children include all products other than footwear and apparel products. Many of these products, including packs and travel gear, watches, men’s belts, wallets, socks, gloves, sunglasses, eyewear and ophthalmic frames, and hats and caps, are designed, manufactured and distributed pursuant to licensing agreements with third parties. We also license rights to children’s apparel in the United States, Europe and Asia. We continue to focus on improving our licensed products and distribution and to build better integration across these products to present a seamless brand worldwide. In 2006, we launched a new assortment of watches and packs under new licensing agreements with worldwide leaders in those product categories. On February 7, 2007, we announced that beginning in 2008 our Timberland^® brand apparel line will be offered in North America pursuant to a licensing arrangement. In addition, we entered into an agreement for the reintroduction of Timberland PRO^® apparel in the United States and Canada to complement our successful Timberland PRO^® footwear business. We continue to offer Timberland PRO^® footwear and apparel in Europe under a license agreement which enables us to leverage our licensee’s knowledge of the European safety market, as well as their existing customer relationships.

 

Product Sales: Business Segments and Operations by Geographic Area

 

Our products are sold in the United States and internationally primarily through independent retailers, better-grade department stores, athletic stores and other national retailers, which reinforce the high level of quality, performance and service associated with Timberland. In addition, our products are sold in Timberland^® specialty stores and Timberland^® factory outlet stores dedicated exclusively to selling Timberland^® 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.

 

We operate in an industry, which includes the designing, engineering, marketing and distribution of footwear and apparel and accessories products for men, women and children. We manage our business in the following three reportable segments, each segment sharing similar product, distribution and marketing: U.S. Wholesale, U.S. Consumer Direct and International.

 

The U.S. Wholesale segment is comprised of the sale of products to wholesale customers in the United States. The U.S. Wholesale segment also includes royalties from licensed products sold in the United States, 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 and factory outlet stores in the United States as well as our e-commerce business. The International segment consists of the marketing, selling and distribution of footwear, apparel and accessories and licensed products outside of the United States. Products are sold outside of the United States through our subsidiaries (which use wholesale and retail channels to sell footwear and apparel and accessories), independent distributors and licensees.

 

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

 

 

More detailed information regarding these reportable segments, and each of the geographic areas in which we operate, is set forth in Note 17 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

 

At December 31, 2006, we operated 20 specialty stores and 61 factory outlet stores in the United States. We also sell products through our internet stores timberland.com and smartwool.com.

 

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

 

 

Timberland^® Factory Outlet Stores.  These stores serve as a primary channel for the sale of excess, damaged or discontinued products 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.com.  Our online store allows U.S. consumers to purchase current season, first quality merchandise over the internet. This internet site also provides information about Timberland, including the reports we file with or furnish to the Securities and Exchange Commission, investor relations, corporate governance, community involvement initiatives and employment opportunity information. Additionally, the site serves to reinforce our marketing efforts.

 

International

 

We sell our products internationally through operating divisions in the United Kingdom, Italy, France, Germany, Switzerland, Spain, Japan, Hong Kong, Singapore, Taiwan, Malaysia and Canada. Most of these operating divisions provide support for the sale of our products to wholesale customers and operate Timberland^® specialty stores and factory outlet stores in their respective countries. At December 31, 2006, we operated 133 company-owned specialty stores and shops and 32 factory outlet stores in Europe and Asia. Two

of our specialty stores in the United Kingdom focus 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. 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 expanded the Timberland^® brand in China during 2006 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 are increasingly delivered throughout the year, rather than only during select seasons as has historically been the case.

 

In 2006, we further developed our consumer segmentation approach that we initiated in 2005. This approach helps us identify target consumers and provides insight into the needs and purchasing behavior of each unique consumer group that we target. Our deeper understanding of consumers enables us to focus our product development and go-to-market execution and further differentiate Timberland^® products for consumers where they shop. We also continued to elevate our brand voice through the Make it better^tm marketing campaign. This integrated communications platform spanned print, outdoor, internet, and point-of-sale with an overarching goal to inspire and engage our consumers through brand, values and product communication, demonstrated by our global launch of an award-winning PreciseFit^tm footwear system proven to give the consumer a perfect fit.

 

In the spirit of our Make it better^tm campaign, we launched several consumer engagement programs including:

 

 

Our print campaign focused on publications like Outside, Men’s Journal, Men’s Health, Backpacker and Bicycling. We also ran out-of-home advertising in markets such as New York, Washington, D.C., and Philadelphia. Our internet campaign utilized websites such as weather.com, askmen.com and yahoo.com. 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 2006, 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 2006 than in the last two quarters of 2006. We expect this seasonality to continue in 2007.

 

Backlog

 

At December 31, 2006, our backlog of orders from our customers was $372 million compared to $381 million at December 31, 2005 and $386 million at December 31, 2004. While all orders in the backlog are subject to cancellation by customers, we expect that the majority of such orders will be filled in 2007. We believe that backlog at year-end is an imprecise indicator of total revenue that may be achieved for the full year because backlog only relates to wholesale orders for the next season, is affected by the timing of customers’ orders and product availability and excludes potential sales in our retail stores during the year.

 

Manufacturing

 

We operate manufacturing facilities in the Dominican Republic. As we have previously reported, we closed our Puerto Rico footwear manufacturing facility at the end of 2005 and relocated some of the manufacturing capacity to our state-of-the-art footwear manufacturing facility in the Dominican Republic. We also expanded production capability in that location, including the manufacture of three different construction footwear types for 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 2006, we manufactured approximately 9% of our footwear unit volume in the Dominican Republic. We manufactured approximately 10% and 9% of our footwear unit volume during 2005 and 2004, respectively, 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 91% of the Company’s 2006 footwear unit volume was produced in Asia by independent manufacturers in China, Vietnam, Thailand, and Indonesia. Two of these manufacturers together produced approximately 44% of the Company’s 2006 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 2006, eleven suppliers provided, in the aggregate, approximately 82% of our leather purchases. Two of these suppliers together provided approximately 30% of our leather purchases in 2006. We historically have not experienced significant difficulties in obtaining leather or other materials in quantities sufficient for our operations. However, our gross profit margins are adversely affected to the extent that the selling prices of our products do not increase proportionately with increases in the costs of leather and other materials. Any significant, unanticipated increase or decrease in the prices of these commodities could materially affect our results of operations. We attempt to manage this risk, as we do with all other footwear and non-footwear materials, on an ongoing basis by monitoring related market prices, working with our suppliers to achieve the maximum level of stability in their costs and related pricing, seeking alternative supply sources when necessary and passing increases in commodity costs to our customers, to the maximum extent possible, when they occur. No assurances can be given that such factors will protect us from future changes in the prices for such materials.

 

In addition, we have established a central network of suppliers through which our footwear manufacturing facilities and independent footwear manufacturers can purchase materials. We seek sources of materials local to manufacturers, in an effort to reduce lead times while maintaining our high quality standards. We believe

that key strategic alliances with leading materials vendors help reduce the cost and provide greater consistency of materials procured to produce Timberland^® products and improve compliance with our production standards. In 2006, we renewed contracts with global vendors for hand-sewn thread, leather laces, waterproof membrane gasket material, waterproof seam-seal adhesives and topline reinforcement tape. Global contracts remained in effect for 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, Anywhere Anyweather, ArchLogic, Balm Proofer, Boot Sauce, B.S.F.P., Cast-Bond, Comforia, Earthkeepers, EasyDry, Ergomorphic, Ever-Guard, Free to GoLite, GoLite, Green Index, Gripstick, GSR, Howies, Independent Suspension Technology, IntraMet, 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, Pull On Your Boots, Pull On Your Boots and Make a Difference, QuadCut, Renewbuck, SafeGrip, Smart Comfort, SmartWool, Splash Blaster, TBL, Timberland Boot Company, Timberland PRO, Timber Trail, TiTAN, Trail Grip, Weathergear, Waximum, Whole Body Stability, and Workboots For The Professional.

 

 

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

 

We conduct research, design and development efforts for our products, including field testing of a number of our products to evaluate and improve product performance. Our Invention Factory, an advanced concepts footwear team, continued its efforts in 2006 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^tm, GoLite^®, and Howies^® 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 and 5,800 full and part-time employees worldwide at December 31, 2006 and 2005, respectively. Our management considers our employee relations to be good. None of our employees is represented by a labor union, and we have never suffered a material interruption of business caused by labor disputes involving our own employees.

 

Available Information

 

Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, exhibits and amendments to those reports that are filed with or furnished to the Securities and Exchange Commission are made available free of charge through our website www.timberland.com, as soon as reasonably practicable after we electronically file them with, or furnish them to, the Securities and Exchange Commission. The charters for the Audit, Governance and Nominating, and Management Development and Compensation committees of our Board of Directors as well as our Corporate Governance Principles and Code of Ethics 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 2006 the CEO certification required by Section 303A.12(a) of the New York Stock Exchange Listed Company Manual.

 

Executive Officers of the Registrant

 

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

 

 

 

 

ITEM 1A.  RISK FACTORS

 

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

 

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

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

 

Risks Related to Our Business

 

We operate in a highly competitive industry.

 

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

 

Our products may not appeal to consumers.

 

As we continue to market established products and develop new products, our success depends in large part on our ability to anticipate, understand and react to changing consumer demands. 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 two years as fashion trends have favored lower profile, casual footwear. Revenue declines associated with lower boot sales has 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.

 

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. Our estimate is that the implementation of these duties will likely reduce our 2007 operating profits in the range of $10 million.

 

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 2006, we manufactured approximately 9% 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 and Indonesia produced approximately 91% of our 2006 footwear unit volume. Two of these manufacturers together produced approximately 44% of our 2006 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 2006, eleven suppliers provided, in the aggregate, approximately 82% of our leather purchases. Two of these suppliers provided approximately 30% of our leather purchases in 2006. 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.

 

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

 

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

 

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

 

Sidney W. Swartz, our Chairman, Jeffrey B. Swartz, our President and Chief Executive Officer, and other executives have been key to the success of our business to date. The loss or retirement of these or other key executives could adversely affect us. Sidney W. Swartz, Jeffrey B. Swartz and various trusts established for the benefit of their families or for charitable purposes, hold approximately 71% 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.

 

We cannot assure the successful implementation of our strategy.

 

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

 

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

 

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

 

Risks Related to Our Industry

 

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

 

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

 

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

 

The industries in which we operate are cyclical. Many factors affect the level of consumer spending in the footwear and apparel industries, including, among others, general business conditions, interest rates, the availability of consumer credit, weather, taxation and consumer confidence in future economic conditions.

Consumer purchases of discretionary items, including our products, may decline during recessionary periods and also may decline at other times when disposable income is lower. A downturn in the economies in which we, or our licensing partners, sell our products, whether in the United States or abroad, may adversely affect our sales. Our gross margin could also be adversely affected if off-price sales increase as a percentage of revenue.

 

Retail trends could result in downward pressure on our prices.

 

With the growing trend toward retail trade consolidation, we increasingly depend upon a reduced number of key retailers whose bargaining strength is growing. Changes in the policies of these retail trade customers, such as increased at-once ordering, limitations on access to shelf space and other conditions may result in lower net sales. Further consolidations in the retail industry could result in price and other competition that could damage our business.

 

 

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.

 

 

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, 2006, 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 23, 2007, the number of record holders of our Class A Common Stock was 821 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 23, 2007 was $28.41 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 Standard & Poor’s Footwear Index and the Standard & Poor’s 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, 2001

ISSUER PURCHASES OF EQUITY SECURITIES(1)

 

For the Three Fiscal Months Ended December 31, 2006

 

 

Footnote(1)

 

 

No existing programs expired or were terminated during the reporting period. See Note 14 to our consolidated financial statements, entitled “Stockholders’ Equity”, in Item 8 of this Annual Report on Form 10-K for additional information.

 

 

 

Selected Statement of Income Data

 

 

 

Selected Consolidated Balance Sheet Data

 

 

 

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

 

Recent Developments

 

Global Reorganization

 

As part of our commitment to better serve our consumers and improve our performance, in December 2006 we made a series of organizational changes that will better align our go-to-market infrastructure with the consumers we seek to serve. In this context we are assessing our business segment definitions and anticipate that beginning in the second quarter of 2007, we will shift to a reporting structure that mirrors the newly established consumer categories — Authentic Youth, CasualGear, Outdoor Group and Industrial. Each of these categories will be led by a President, along with dedicated resources against merchandising, design, sales planning, category marketing and global sales. The President of each group will report directly to the Chief Executive Officer.

 

North American Apparel Licensing Agreement

 

In February, 2007, we announced that we entered into a 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. Excluded from the agreement with Phillips-Van Heusen are Timberland^® Outdoor Performance apparel, which Timberland will continue to design, source and market worldwide, as well as Timberland PRO^® apparel, which is the subject of an exclusive license agreement with Block Corporation for the United States and Canada. As a result of our decision to license Timberland^® brand apparel in North America, we will incur a pre-tax restructuring charge in the range of $4 million in 2007 to cover severance, outplacement services and asset disposal costs associated with implementation of this strategy. We anticipate

that this action will result in cost savings in the range of $4 – $5 million in 2007, weighted towards the second half of the year. These savings have been factored into the Company’s financial outlook.

 

Executive Departures

 

In February, 2007, the Company also announced that Kenneth P. Pucker, Executive Vice President and Chief Operating Officer, and Brian McKeon, Executive Vice President — Finance and Administration and Chief Financial Officer, will be leaving the Company effective March 31, 2007. Mr. Pucker has entered into a separation agreement with the Company, which provides for a cash payment and the vesting of certain shares previously awarded under the Company’s incentive compensation plans. The Company will incur a restructuring charge of approximately $3.3 million in 2007 to record these items, including a recovery of approximately $0.8 million associated with the forfeiture of other shares awarded to Mr. Pucker but not vested upon termination.

 

Overview

 

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

 

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

 

Highlights of our 2006 financial performance include the following:

 

 

For 2007, we are targeting solid growth across our casual, outdoor and industrial categories. We are also committed to improving performance in our boots and kids’ businesses, supported by a disciplined product supply and distribution strategy that is aligned with the premium position the Company seeks to maintain with consumers. In this context, we expect to see continued significant declines in boots and kids’ sales in 2007, likely in excess of $100 million globally. These impacts will likely limit overall revenue to prior year levels for the full year.

 

Lower boots and kids’ sales and impacts from higher relative product costs are expected to place continued pressure on operating margins, with expectations for potential full-year declines in the range of 300 basis points compared to prior year levels excluding restructuring costs. We expect sales and operating margin pressures will be greater early in 2007 given warm winter weather conditions, the lapping of prior year results and macro factors such as the implementation of European Union (“EU”) anti-dumping duties. We estimate these factors will contribute to a decline in operating profits excluding restructuring costs in the range of $40 million in the first half of 2007, with most of this decline in the first quarter.

 

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. 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 $35.9 million and $38.2 million at December 31, 2006 and 2005, 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 $12.1 million and $8.8 million at December 31, 2006 and 2005, respectively. The increase in our allowances for doubtful accounts reflects erosion in the timeliness of collections in the U.S. and Europe. Historically, losses have been within our expectations. If the financial condition of our customers were to change, adjustments may be required to these estimates. Furthermore, we provide for estimated losses resulting from disputes, which arise with respect to the gross carrying value of our receivables. The settlement or resolution of these differences could result in future changes to these estimates. If we determine that increases or decreases to the allowance for doubtful accounts are appropriate, we record either an increase or decrease to selling expense in the period in which we make such a determination.

 

Inventory Valuation

 

We value our inventory at the lower of cost (first-in, first-out) or market value. Market value is estimated based upon assumptions made about future demand and retail market conditions. If we determine that the estimated market value of our inventory is less than the carrying value of the inventory, we provide a reserve for the difference as a charge to cost of sales. Our reserves related to inventory valuation totaled $9.9 million and $10.8 million at December 31, 2006 and 2005, 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 income as we purchase and sell goods in foreign markets in their local currencies. We use derivative instruments, specifically forward contracts, to hedge a portion of our forecasted foreign currency transactions. We use our operating budget and forecasts to estimate future economic exposure and to determine the appropriate levels and timing of related hedging transactions. We closely monitor our foreign currency exposure and adjust our hedge positions accordingly. Our estimates of anticipated transactions could fluctuate over time and could vary from the ultimate transactions (see Note 3 to our consolidated financial statements in Item 8 of this Annual Report on Form 10-K). Future operating results could be impacted by adjustments to these estimates.

 

Contingencies

 

In the ordinary course of business, we are involved in legal proceedings involving contractual and employment relationships, product liabilities, trademark rights and a variety of other matters. We record contingent liabilities when it is probable that a liability has been incurred and the amount of the loss is estimable. We disclose a contingent liability when there is at least a reasonable possibility that a loss has been incurred. Estimating probable losses requires analysis and judgment about the potential actions. Therefore, actual losses in any future period are inherently uncertain. We do not believe that any pending legal proceeding or claims will have a material impact on our 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 2006 and 2005, no significant impairment related to the carrying value of our long-lived assets has been recorded.

 

Incentive Compensation Accruals

 

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

 

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 15 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 adoption of SFAS 123(R).

 

In accordance with Financial Accounting Standards Board Staff Position FAS 123(R)-3, “Transition Election to Accounting for the Tax Effects of Share-Based Payment Awards”, in the fourth quarter of 2006 the Company elected to adopt the alternative transition method for purposes of calculating the pool of excess tax benefits available to absorb tax deficiencies recognized subsequent to the adoption of SFAS 123(R).

 

Income Taxes

 

We record deferred tax assets and liabilities based upon temporary book to tax differences. The carrying value of our net deferred tax assets assumes that we will be able to generate sufficient future taxable income in certain tax jurisdictions to realize the value of these assets. If we were unable to generate sufficient future taxable income in these jurisdictions, an adjustment could be required in the net carrying value of the deferred tax assets, which would result in additional income tax expense in our consolidated statements of income. Management evaluates the realizability of the deferred tax assets and assesses the need for any valuation adjustment quarterly.

 

We estimate 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. In the fourth quarter of 2006, we adjusted our effective tax rate estimate to 35.0% from our previous full year estimate of 35.6%.

 

We have provided reserves for certain tax matters, both domestic and foreign, which we believe could result in additional tax being due. Our tax reserves total approximately $16.0 million at December 31, 2006. Any additional assessment or reduction of these contingent liabilities will be reflected in the Company’s effective tax rate.

 

Results of Operations

 

 

2006 Compared to 2005

 

Revenue

 

Consolidated revenue of $1,567.6 million was flat with the prior year. 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

 

We have three reportable business segments (see Note 17 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 $640.0 million in 2006, down 3.0% 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 5.3% to $730.0 million in 2006, reflecting growth across Europe, Asia and Canada. Overall, International revenues grew to 46.6% of consolidated revenues. Europe’s revenue increased 2.6%, or 1.8% in constant dollars, to $547.1 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 $145.4 million, up 9.0%, or 11.0% in constant dollars, over the prior year. Revenue increases are attributed to strong gains in Japan; our Asian distributor business, reflecting our continued expansion in China; and Taiwan. Asia’s growth is supported by sales gains in all product categories. We continue 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 re-acquisition 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 the prior year. 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 the prior year, 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 the prior year. 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 the prior year. 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 the prior year. 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 47.3% in 2006, compared to 49.6% 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 $97.9 million and $101.4 million in 2006 and 2005, respectively.

 

Operating Expense

 

Total operating expense was $582.4 million in 2006, $50.9 million, or 9.6% higher than in 2005. As a percentage of revenue, operating expense was 37.2%, up 330 basis points from the 33.9% 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 $38.7 million, or 7.2%, 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 $12.1 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 $453.0 million, an increase of $35.6 million or 8.5% compared to the prior year. 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 $8.2 million in share-based employee compensation costs. These increases were partially offset by decreases of $10.4 million in marketing costs and $5.3 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 $125.5 million, an increase of $15.7 million or 14.3% over 2005. The increase was driven by $4.9 million related to new business initiatives, $3.9 million of share-based employee compensation costs, $2.9 million in costs associated with operating the new European finance shared service center and $2.4 million in legal and compliance 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 $159.7 million in 2006 compared to $245.4 million in 2005. Operating income as a percentage of revenue fell from 15.7% in 2005 to 10.2% 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 17.6% to $170.6 million in 2006, driven by declines in both revenue and gross margin and increased operating expense. Revenue was down 3.0%, driven by decreases in boots and kids’ footwear sales. Gross margin fell 160 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 22.4%, primarily due to the addition of SmartWool.

 

Operating income for our U.S. Consumer Direct segment was $16.8 million for 2006 compared to $36.3 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 $155.9 million in 2006, driven by an 8.4% 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 200 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 expenses increased $17.3 million, or 10.4%, to $183.6 million in 2006. Unallocated Corporate expenses as a percentage of total revenue increased 110 basis points to 11.7% of total revenue. Excluding restructuring costs in both 2006 and 2005 and increased share-based employee compensation costs of $14.5 million in 2006, Unallocated Corporate expenses increased $5.8 million or 3.6% from the prior year and represent 10.7% of total revenue. This increase was driven by $5.3 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 is primarily due to reduced cash balances resulting from our SmartWool acquisition, share repurchases and reduced profitability.

 

Other, net, included $2.0 million and $(0.2) million of foreign exchange gains/(losses) for 2006 and 2005, respectively, resulting from the timing of settlement of local currency denominated assets and payables. 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 35.0% in 2006, compared to 33.9% in 2005 (see Note 13 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. The effective tax rate was adjusted in the fourth quarter of 2006 to decrease our full year 2006 tax rate estimate from 35.6% to 35.0%.

 

2005 Compared to 2004

 

Revenue

 

Consolidated revenue growth of 4.3% in 2005 reflected strong gains in our International operations, offset by a slight decline in our U.S. business. Revenue from the U.S. business totaled $872.4 million in 2005, down 0.8% from the prior year. International revenues were $693.3 million, 11.6% ahead of 2004, up 11.4% in constant dollars.

 

Segments Review

 

Revenues for our U.S. Wholesale business decreased 0.8% to $659.8 million. Growth in Timberland PRO^® series footwear, apparel, men’s casual footwear, kids’ footwear and accessories was offset by significant declines in our women’s casual business, and moderate declines in boots. Declines in sales to independent accounts and department stores were partially offset by increases in sales through discount channels and athletic/national accounts.

 

The U.S. Consumer Direct business recorded $212.6 million in sales, down $1.5 million or 0.7% compared with 2004. Overall, comparable store sales excluding our e-commerce business were down 0.8%. Declines in women’s casual footwear, apparel, boots and kids’ footwear were partially offset by gains in outdoor performance footwear, men’s casual footwear and apparel.

 

International revenues increased 11.6% to $693.3 million benefiting from the execution of our growth strategies in Europe and Asia, as well as the continued growth of our Canadian subsidiary. Overall, International revenues increased to 44.3% of total consolidated revenues. The European business produced $533.1 million of revenue, growing 11.3%, or 11.0% on a constant dollar basis, driven by strong gains in the U.K., pan-European accounts and our European distributor business and growth in Italy, Germany, Scandinavia and Spain. Growth in Europe was driven by strong gains in footwear across major product categories and solid gains in apparel sales.

 

In Asia, revenues grew 10.0% to $133.4 million, up 11.1% excluding foreign exchange, driven by double-digit gains in Taiwan, Hong Kong, our Asian distributor business, Singapore and Malaysia and moderate growth in Japan. This growth reflects benefits from our efforts to upgrade Timberland’s retail and wholesale distribution throughout the region. Asia’s growth reflected strong gains in footwear and apparel sales.

 

Products

 

Worldwide footwear revenue was $1,200.1 million in 2005, up $46.8 million or 4.1% from 2004. Growth was driven by gains in kids’, men’s casual, outdoor performance, boots, and Timberland PRO^® series footwear offset by a significant decline in our U.S. women’s casual footwear business. Worldwide footwear unit sales were up 3.9% while the average price increased by 0.1%, reflecting impacts from product and geographic mix.

 

Worldwide apparel and accessories revenue increased by 4.7% to $348.9 million. Apparel and accessories unit sales increased by 4.4%, while average selling prices increased 0.2%, reflecting product and channel mix.

 

Royalty and other revenue was $16.7 million, up 19.0% from the prior year, driven by gains in licensed kids’ apparel worldwide and growth in licensed Timberland PRO^® series in Europe.

 

Channels

 

Revenue growth reflected global gains across both our wholesale and consumer direct channels. Globally, our wholesale business recorded $1,178.0 million of revenue in 2005, a 4.7% increase. Consumer direct revenues were up 3.4% to $387.7 million. We opened 29 stores, shops and outlets worldwide in 2005 and closed 14.

 

Gross Profit

 

Our gross profit as a percentage of sales for 2005 was 49.6% as compared to 49.3% for 2004, an improvement of 30 basis points. Favorable foreign exchange benefits and international mix benefits were partially offset by U.S. product mix impacts and impacts from higher levels of off-price and discounted sales.

 

The costs of procuring inventory, included in cost of goods sold, amounted to $101.4 million and $97.3 million for 2005 and 2004, respectively.

 

Operating Expense

 

Operating expense was $531.5 million in 2005, $26.3 million, or 5.2% higher than the $505.2 million reported in 2004. The operating expense increase was driven by a $12.0 million increase in selling expense, a $10.0 million increase in general and administrative expense and restructuring and related costs of $4.3 million related to the consolidation of our Caribbean manufacturing facilities. Foreign exchange rate changes offset total operating expense growth by $1.9 million, or 0.4%. As a percentage of revenue, operating expense increased 20 basis points to 33.9% compared to 33.7% in 2004. Excluding restructuring and related costs, operating expense as a percentage of revenue was unchanged, and growth was controlled to 4.4%, with spending increases related primarily to growth in our International business.

 

Selling expense was $417.4 million, an increase of $12.0 million, or 3.0% compared with the prior year. The increase was driven by $8.7 million of costs related to International retail expansion, $5.6 million in distribution costs and $3.2 million in product development costs, offset by a decrease of $8.3 million in global incentive compensation programs. Foreign exchange rate changes also decreased selling expense by $1.9 million or 0.5%.

 

The costs of physically managing inventory, included in selling expense, totaled $37.8 million and $33.9 million in 2005 and 2004, respectively.

 

Advertising expense, which is also included in selling expense, was $36.6 million and $42.4 million in 2005 and 2004, respectively. The decrease primarily reflected reductions in U.S. cooperative advertising costs. Prepaid advertising recorded on our consolidated balance sheets was $1.2 million and $0.7 million as of December 31, 2005 and December 31, 2004, respectively.

 

General and administrative expense was $109.8 million, an increase of $10.0 million, or 10.1% compared with last year. As a percentage of revenue, general and administrative expense increased 30 basis points over 2004. The increase was driven by $3.8 million in investments in organizational capability, $3.0 million in legal and compliance costs and $2.2 million in global support services and business development costs. Foreign exchange rate changes had little impact on general and administrative expense.

 

Operating Income

 

Operating income was $245.4 million in 2005 and $233.9 million in 2004. As a percentage of revenue, operating income was 15.7% in 2005 and 15.6% in 2004. Excluding restructuring cost impacts, operating income as a percentage of revenue was 15.9% in 2005.

 

Operating income for our U.S. Wholesale segment was $207.2 million, $6.1 million or 2.9% lower than the prior year. Revenue declines of 0.8% and gross margin deterioration of 140 basis points were offset by a 6.8% decline in operating expenses resulting from cost control measures. The margin deterioration was driven by a shift in product mix, impacted by lower U.S. boot sales, and relatively higher levels of off-price and discount sales.

 

Our U.S. Consumer Direct segment’s operating income increased by 2.7% to $36.3 million. Revenue was down 0.7% to $212.6 million, reflecting a comparable stores sales decline of 0.8%. The sales decline was offset as gross margin improved by 80 basis points, reflecting less promotional activity than the prior year. Operating expenses remained flat to the prior year.

 

Operating income for our International segment grew by 28.7% to $168.2 million. Revenue growth of 11.6% and gross margin improvement of 220 basis points drove much of the increase. Both benefited from favorable foreign exchange rate changes. Lower product related costs and more favorable product mix also supported the margin improvement. Operating expense rates for our International segment decreased by 100 basis points as strong revenue growth enabled operating expense leverage despite continued investment in International retail expansion and organizational capability.

 

Our Unallocated Corporate expenses increased to $166.3 million or 10.6% of total revenue, a 90 basis point increase over the prior year. Excluding restructuring and related costs of $4.3 million resulting from the consolidation of our Caribbean manufacturing operations, Unallocated Corporate expenses increased 70 basis points to 10.4% of revenue. This increase reflects investments in global organization capability, higher legal and compliance costs and costs associated with business development activities.

 

Other Income and Taxes

 

Interest income, net was $3.3 million and $1.1 million in 2005 and 2004, respectively. Higher interest rates supported the increase in net interest income.

 

Other, net included $0.2 million of foreign exchange losses resulting from the timing of settlement of local currency denominated assets and liabilities. In 2004, we had a gain of $1.0 million. 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 33.9% in 2005, compared to 35.5% in 2004 (see Note 13 to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K). We established a Hong Kong procurement company and an international treasury center in Switzerland in the fourth quarter of 2004, which better aligns our organizational structure with our expanding global presence and reduces our estimated taxes on foreign earnings.

 

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

 

 

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

 

Reconciliation of 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 to understand operating expense excluding restructuring and related costs and to provide 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 to understand operating income excluding restructuring and related costs and to provide 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 to understand net income excluding restructuring and related costs and to provide 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 to understand earnings excluding restructuring and related costs and to provide comparability to reported results that include share-based employee compensation costs as prescribed by SFAS 123(R).

 

Accounts Receivable and Inventory

 

Accounts receivable was $204.4 million as of December 31, 2006, compared to $168.8 million as of December 31, 2005 and $155.0 million as of December 31, 2004. Days sales outstanding were 38 days as of December 31, 2006, compared with 33 days as of December 31, 2005 and 31 days as of December 31, 2004. Wholesale days sales outstanding were 45 days, 39 days and 38 days at the end of 2006, 2005 and 2004, respectively. 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. In 2005, excluding $12.8 million from SmartWool, the relatively flat accounts receivable reflected solid collection efforts and improved timing of shipments in the fourth quarter.

 

Inventory increased 11.8% to $186.8 million as of December 31, 2006 from $167.1 million as of December 31, 2005 and $128.3 million as of December 31, 2004. 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 to prepare for the Asian holiday season in January and February, 2007. In the fourth quarter of 2004, we established a Hong Kong procurement company and an international treasury center in Switzerland to better align our organizational structure with our expanding global presence and provide enhanced support to our global sourcing operations and International business. Related to the implementation of the new organizational structure, we modified certain sourcing arrangements, which resulted in earlier transfer of title for a portion of the Company’s third party sourced product in 2005. Earlier transfer of title resulted in offsetting higher quarter end inventory and accounts payable balances, as we recognized an inventory asset and related payable roughly two weeks earlier than in the prior year period. Had similar sourcing arrangements been in effect for 2004, we estimate that inventory and accounts payable balances would have increased by approximately $35.2 million.

 

Liquidity and Capital Resources

 

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 $31.8 million, compared to $13.0 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 somewhat offset by increased payables. Our cash provided by operations was positively impacted by increased accruals associated with the timing of VAT and other expenses. Timberland’s use of cash related to income taxes payable is due to reduced profitability and a lower resulting tax payable than at the end of 2005.

 

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.

 

2005 Compared to 2004

 

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

 

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

 

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

 

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 5.3% as of December 31, 2006), 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, 2006, the applicable margin under the facility was 35 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, 2006, the commitment fee was 10 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

3:1 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.

 

On December 20, 2005, we entered into a $4.5 million committed revolving credit agreement that matured on December 19, 2006 to provide for SmartWool’s working capital requirements. This facility was extended to March 19, 2007. Up to $3 million of the facility may be used for letters of credit.

 

We had uncommitted lines of credit available from certain banks totaling $50 million as of December 31, 2006. Any borrowings under these lines would be at prevailing money market rates (approximately 5.6% as of December 31, 2006). 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, 2006 and 2005, we had no borrowings outstanding under any of our credit facilities.

 

Management believes that our capital needs and our share repurchase program for 2007 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, 2006, we have the following contractual obligations due by period:

 

 

 

 

Off Balance Sheet Arrangements

 

As of December 31, 2006, 2005 and 2004, we had letters of credit outstanding of $28.8 million, $24.6 million and $35.1 million, respectively. These letters of credit were issued predominantly for the purchase of inventory. The increase in letters of credit outstanding in 2006 was driven by obligations associated with anti-dumping duties on European Union footwear sourced in China and Vietnam. As of December 31, 2006, the Company had $243.1 million in foreign currency contracts outstanding, all of which

are due to settle within the next 13 months (see Note 4 to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K).

 

We have the following off-balance sheet arrangements:

 

 

We use funds from operations and unsecured committed and uncommitted lines of credit as the primary sources of financing for our seasonal and other working capital requirements. Our principal risks to these sources of financing are the impact on our financial condition from economic downturns, a decrease in the demand for our products, increases in the prices of materials and a variety of other factors.

 

Quarterly Results of Operations (Unaudited)

 

The following is a tabulation of the quarterly results of operations for the years ended December 31, 2006 and 2005, respectively:

 

 

 

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 income. 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 in our hedging of 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, 2006, 2005 and 2004, 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 foreign currency forward contracts will expire in 13 months or less. Based upon sensitivity analysis as of December 31, 2006, a 10% change in foreign exchange rates would cause the fair value of our financial instruments to increase/decrease by approximately $24.4 million, compared with $14.9 million as of December 31, 2005. The increase as of December 31, 2006, compared with December 31, 2005, is primarily related to an increase in our foreign currency denominated net assets as of December 31, 2006, compared with December 31, 2005, as well as our choice to hedge a larger portion of our forecasted 2007 exposure at December 31, 2006 than the portion of our forecasted 2006 exposure that was hedged at December 31, 2005, 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, 2006 and 2005, 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, 2006. Our audits also included the financial statement schedule listed in the Index at Item 15. 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, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, 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 to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) 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 effectiveness of the Company’s internal control over financial reporting as of December 31, 2006, 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 March 1, 2007 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

 

 

Boston, Massachusetts

March 1, 2007

 

 

CONSOLIDATED BALANCE SHEETS
As of December 31, 2006 and 2005

 

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

CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31, 2006, 2005 and 2004

 

 

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

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
For the Years Ended December 31, 2006, 2005 and 2004