Summary of TIMBERLAND CO - Yahoo! Finance

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is management's discussion and analysis of the financial condition and results of operations of The Timberland Company ("we", "our", "us", "Timberland" or the "Company"), as well as our liquidity and capital resources. The discussion, including known trends and uncertainties identified by management, should be read in conjunction with the Company's unaudited condensed consolidated financial statements and related notes included in this Quarterly Report on Form 10-Q, as well as our audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2007.
Included herein are discussions and reconciliations of (i) total Company, Europe and Asia revenue changes to constant dollar revenue changes and (ii) diluted EPS to diluted EPS excluding restructuring and related costs. Constant dollar revenue changes, which exclude the impact of changes in foreign exchange rates, and diluted EPS excluding restructuring and related costs are not Generally Accepted Accounting Principle (''GAAP'') performance measures. The difference between changes in reported revenue (the most comparable GAAP measure) and constant dollar revenue changes is the impact of foreign currency exchange rate fluctuations. We provide constant dollar revenue changes for total Company, Europe and Asia results because we use the measure to understand the underlying growth rate of revenue excluding the impact of items that are not under management's direct control, such as changes in foreign exchange rates. The limitation of this measure is that it excludes items that have an impact on the Company's revenue. This limitation is best addressed by using constant dollar revenue changes in combination with the GAAP numbers. We provide diluted EPS excluding restructuring and related costs because we use this measure to analyze the earnings of the Company. Management believes this measure is a reasonable reflection of the underlying earnings levels and trends from core business activities, and more indicative of future results. The difference between diluted EPS excluding restructuring and related costs and its most comparable GAAP measure (diluted EPS) is the impact of restructuring and related charges that may mask our underlying operating results and/or business trends. The limitation of this measure is that it excludes items that would otherwise decrease the Company's diluted EPS. This limitation is best addressed by using diluted EPS excluding restructuring and related costs in combination with diluted EPS in order to better understand the amounts, character and impact, if any, of any increase or decrease on reported results. Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed 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

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Form 10-Q Page 16 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, share-based compensation and 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, or that result from, applying our critical accounting policies. Our significant accounting policies are described in Note 1 to the Company's consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2007. Our estimates, assumptions and judgments involved in applying the critical accounting policies are described in the Management's Discussion and Analysis of Financial Condition and Results of Operations section of our Annual Report on Form 10-K for the year ended December 31, 2007. 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 Timberlandā 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 brand building licensing arrangements, expanding geographically and driving operational and financial excellence while setting the standard for commitment to the community and striving to be a global employer of choice.
A summary of our third quarter of 2008 financial performance, compared to the third quarter of 2007, follows:
• Third quarter revenue decreased 2.2%, or 4.4% on a constant dollar basis, to $423.6 million.

• Gross margin decreased from 46.9% to 46.5%.

• Operating expenses were $143.8 million, down 9.4% from $158.7 million in the prior year period.

• We recorded operating income of $53.2 million in the third quarter of 2008, compared to $44.7 million in the prior year period.

• Net income was $30.7 million in the third quarter of 2008, compared to $25.9 million in the third quarter of 2007.

• Diluted earnings per share increased from $.42 in the third quarter of 2007 to $.52 in the third quarter of 2008. Excluding restructuring and related costs in both periods, diluted earnings per share increased from $.49 to $.52.

• Cash at the end of the quarter was $62.7 million with no debt outstanding.

For the full year, the Company is still targeting mid-single digit revenue declines, consistent with economic conditions and due in part to its closure of certain underperforming retail stores and the licensing of its North America wholesale apparel business. The Company expects that weaker consumer spending globally will result in additional margin pressure and now anticipates flat to modest declines in operating margins for the full year. It continues to expect an effective tax rate in the range of 40%.
Results of Operations for the Quarter Ended September 26, 2008 as Compared to the Quarter Ended September 28, 2007
Revenue
Consolidated revenue of $423.6 million decreased $9.7 million, or 2.2%, compared to the third quarter of 2007. The current

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Form 10-Q Page 17 global economic conditions have adversely impacted consumer confidence and, combined with already difficult wholesale and retail markets globally, are reflected in the Company's top-line results in the third quarter. Gains from foreign exchange rates, along with strong growth in Timberland PRO® footwear and apparel and SmartWool® apparel and accessories, were offset by anticipated declines in Timberland® brand apparel, as well as men's casual and performance footwear, and kids' boots. On a constant dollar basis, consolidated revenues were down 4.4%. North America revenue totaled $184.5 million for the third quarter of 2008, an 8.8% decline from the third quarter of 2007. Europe revenues were $199.9 million in the third quarter of 2008, a 4.4% increase over the same period in 2007, and remained relatively flat as compared to the prior year quarter on a constant dollar basis. Asia revenues were $39.2 million for the third quarter of 2008, relatively flat from the same period in 2007, but declined 5.4% on a constant dollar basis. Segments Review
We have three reportable business segments (see Note 7 to the unaudited condensed consolidated financial statements): North America, Europe and Asia. North America revenues decreased 8.8% to $184.5 million in the third quarter of 2008 as compared to the same period in 2007, driven by anticipated declines in Timberland® brand apparel, due in part to the transition of the North American apparel business to a licensing arrangement, as well as declines in boots, kids' footwear, and casual footwear. These declines were partially offset by strong growth in Timberland PRO® footwear and apparel and SmartWool® apparel and accessories. Within North America, our retail business had revenue declines of 17.9%, driven by a 13.8% decrease in comparable store sales and the impact of our decision to close certain retail locations.
Europe recorded revenues of $199.9 million in the third quarter of 2008, which was a 4.4% increase from the third quarter of 2007, but remained relatively flat on a constant dollar basis. A difficult wholesale market across Southern Europe, particularly Spain, Italy and France, was offset by growth in our distributor business, primarily in the Middle East and Eastern Europe, and in our businesses in the Benelux region, the United Kingdom and Germany, and by our retail business, where comparable store sales grew approximately 3.0%.
In Asia, revenues decreased slightly to $39.2 million in the third quarter of 2008, but declined 5.4% in constant dollars, as compared to the third quarter of 2007, as softness in our retail business combined with continued softness in wholesale markets, principally in Japan, was only partially offset by growth in our distributor markets. Retail sales in Asia declined, as the benefit of changes in foreign exchange rates could not offset a decline of 2.2% in comparable store sales and the impact of our decision to close certain retail locations.
Products
Worldwide footwear revenue was $313.5 million in the third quarter of 2008, up $3.2 million, or 1.0%, from the third quarter of 2007. Gains in the Timberland PRO® series were partially offset by declines in casual footwear and men's performance footwear. We saw encouraging signs during the quarter relative to our boot business, particularly men's boots, with a slight increase in revenue over the prior year period in Europe and Asia. Worldwide apparel and accessories revenue fell 11.7% to $102.7 million in the third quarter of 2008, driven by an anticipated decline in Timberland® brand apparel in North America, as well as in Europe. In February 2007, the Company announced it would transition the North American apparel business to a licensing arrangement, and it ceased sales of in-house Timberland® brand apparel in North America through the wholesale channel during the second quarter of 2008. Royalty and other revenue was $7.4 million in the third quarter of 2008, compared to $6.8 million in the prior year quarter, primarily due to our new apparel licensing arrangement in North America, offset by a decline in licensed kids' apparel and Timberland PRO® products.
Channels
Wholesale revenue was $340.6 million in the third quarter of 2008, a 1.0% decrease compared to the prior year quarter. Continued softness in the wholesale market was the primary driver of sales declines in men's casual and performance footwear in North America, Europe and Asia. Anticipated declines in Timberland® brand apparel were due in part to the transition of the North American apparel business to a licensing arrangement. These declines offset growth from Timberland PRO and SmartWool.
Retail revenues decreased 6.9% to $83.0 million in the third quarter of 2008. Overall, comparable store sales were down 6.4% on a global basis as compared to the third quarter of 2007, as declines in North America and Asia were partially offset

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Form 10-Q Page 18 by increases in Europe. The benefit from foreign exchange rates partially offset a difficult worldwide retail environment and revenue declines associated with our decision to close certain retail locations. As of the end of the third quarter of 2008, we had completed the closure of 41 of the 50 specialty and outlet stores identified for closure as part of our Global Retail Portfolio Review. We anticipate that 3 of the remaining stores that were identified for closure under the program will be closed in the first half of 2009, and that 6 stores will remain open. We had 210 stores, shops and outlets worldwide at the end of the third quarter of 2008.
Gross Profit
Gross profit as a percentage of sales, or gross margin, was 46.5% for the third quarter of 2008, 40 basis points lower than in the third quarter of 2007. The decline in gross margins was driven by increased product costs and changes in channel mix, partly related to store closures, partially offset by favorable foreign exchange rate changes.
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 $20.5 million and $25.1 million for the third quarter of 2008 and 2007, respectively. The decrease was primarily driven by lower costs associated with our apparel business as we transitioned to a licensing arrangement. Operating Expense
Operating expense for the third quarter of 2008 was $143.8 million, a decrease of $15.0 million, or 9.4%, over the third quarter of 2007. The decrease was driven by an $8.2 million decrease in selling expense, as well as a decrease of $7.3 million in restructuring charges, partially offset by an increase of $0.5 million in general and administrative costs. Overall, changes in foreign exchange rates added approximately $3.0 million to operating expense in the third quarter of 2008.
Selling expense was $114.1 million in the third quarter of 2008, a decrease of $8.2 million, or 6.7%, over the same period in 2007. This decline was driven by $3.6 million of provisions for bad debts in 2007 primarily related to certain franchisees, cost savings of $3.5 million in retail expenses primarily as a result of store closures in the United States and Asia, $3.1 million in selling and product management cost savings, and $2.2 million in savings associated with the transitioning of our North American apparel business to a licensing arrangement and the winding down of certain specialty brands. These savings were partially offset by $5.8 million of incremental investment in our global consumer-facing marketing and branding initiatives, demonstrating our continued commitment to strengthen our premium brand position despite adverse economic conditions.
We include the costs of physically managing inventory (warehousing and handling costs) in selling expense. These costs totaled $11.3 million and $11.4 million in the third quarters of 2008 and 2007, respectively.
In the third quarters of 2008 and 2007, we recorded $0.9 million and $1.0 million, respectively, of reimbursed shipping expenses within revenues and the related shipping costs within selling expense. Shipping costs are included in selling expense and were $5.8 million and $5.4 million for the quarters ended September 26, 2008 and September 28, 2007, respectively.
Advertising expense, which is included in selling expense, was $11.1 million and $5.4 million in the third quarter of 2008 and 2007, respectively. Advertising expense includes co-op advertising costs, consumer-facing advertising costs such as print, television and internet campaigns, production costs including agency fees, and catalog costs. The increase in advertising expense reflects our investment in consumer-facing marketing programs, primarily television (such as our Podium commercial) and production costs, as well as higher levels of co-op advertising. Advertising costs are expensed at the time the advertising is used, predominantly in the season that the advertising costs are incurred. Prepaid advertising recorded on our unaudited condensed consolidated balance sheets as of September 26, 2008 and September 28, 2007 was $4.7 million and $0.8 million, respectively.
General and administrative expense for the third quarter of 2008 was $29.5 million, relatively flat compared to the $28.9 million reported in the third quarter of 2007. Reductions in corporate support and administrative costs of $1.5 million, North American retail costs of $0.7 million, and costs associated with a product recall in 2007 of $0.7 million, were offset by compensation related costs of $1.9 million and expenses related to certain specialty businesses in North America of $1.0 million.

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Form 10-Q Page 19 We recorded net restructuring charges during the third quarter of 2008 of $0.2 million, compared to $7.5 million in the third quarter of 2007. Net charges in 2008 primarily reflect costs associated with our decision in 2007 to close certain retail locations. Charges to be recorded in connection with the remaining stores to be closed under the retail store closure program are not expected to be material. The 2007 charges are principally comprised of costs associated with our decision to close certain retail stores in the U.S., Europe and Asia as a result of our Global Retail Portfolio Review. Operating Income/(Loss)
We recorded operating income of $53.2 million in the third quarter of 2008, compared to operating income of $44.7 million in the prior year period. Operating income included restructuring charges of $0.2 million in the third quarter of 2008 and $7.5 million in the third quarter of 2007.
Operating income for our North America segment was $44.9 million, up 19.5% from the third quarter of 2007. The increase was driven by a 23.3% decrease in operating expenses principally due to a $4.5 million decline in restructuring charges, $3.3 million in costs savings related to the closure of certain retail locations, $1.2 million in cost savings associated with initiatives to streamline our operations and $1.2 million in savings associated with the transitioning of our apparel business to a licensing arrangement. Benefits from changes in channel mix and the lack of expenses related to a product recall in 2007 offset increased product costs to result in a 210 basis point improvement in gross margin, which helped to offset the impact of an 8.8% revenue decline. Timberland's European segment recorded operating income of $51.5 million in the third quarter of 2008, compared to operating income of $47.1 million in the third quarter of 2007, principally due to a 5.0% reduction in operating expenses driven primarily by a $2.1 million decline in restructuring costs. Reduced bad debt expense in the third quarter of 2008 due to specific provisions made for certain franchisees in the same period in 2007 was partially offset by an increase in marketing costs. Gross margin declined 160 basis points in the third quarter of 2008 as compared to the same period in 2007, as the impact of favorable foreign exchange rate changes was offset by higher product costs, a higher mix of distributor sales, and the impact of specialty retail store closures.
We had an operating loss in our Asia segment of $0.8 million for the third quarter of 2008 compared to operating income of $1.3 million for the third quarter of 2007. The decrease over the prior year was driven by the impact of increased close-out activity, partly related to store closures, as well as expansion into China, along with slightly higher operating expenses, where investments in marketing and compensation-related charges were partially offset by reduced retail related expenses due to store closures and lower distribution and restructuring costs.
Our Unallocated Corporate expenses, which include central support and administrative costs not allocated to our business segments, increased 2.4% to $42.3 million. The main driver of the increase was the impact of certain costs that are not allocated to the operating segments, such as provisions for sourced inventory, foreign exchange associated with purchase price variances, and certain compensation costs. Corporate operating expenses decreased slightly as the benefits from certain activities that were undertaken to achieve operating expense savings and rationalize our operating expense structure, along with reduced provisions for bad debts and restructuring charges, were partially offset by increases in marketing and compensation-related costs. Other Income/(Expense) and Taxes
Interest income/(expense), net, which is comprised of interest income offset by fees related to the establishment and maintenance of our revolving credit facility and interest paid on short-term borrowings, was $0.3 million and $(0.4) million for the third quarter of 2008 and 2007, respectively. For the quarters ended September 26, 2008 and September 28, 2007, we recorded $0.1 million and $0.7 million, respectively, in fees associated with our credit facilities and interest paid on short-term borrowings outstanding during the quarter in interest income/(expense), net in our unaudited condensed consolidated statements of operations.
Other income/(expense), net, included foreign exchange losses of $(1.9) million and $(1.5) million in the third quarters of 2008 and 2007, respectively, resulting from changes in the fair value of financial derivatives, specifically forward contracts not designated as cash flow hedges, and the currency gains and losses incurred on the settlement of local currency denominated receivables and payables. These losses were driven by the volatility of exchange rates within the third quarters of 2008 and 2007 and should not be considered indicative of expected future results.

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Form 10-Q Page 20 The effective income tax rate for the third quarter of 2008 was 40.0%. Based on our full year estimate of global income and the geographical mix of our profits as well as provisions for certain tax reserves, our full year tax rate would be in the range of 40.0%. This rate may vary if actual results differ from our current estimates, or there are changes in our liability for uncertain tax positions. The effective income tax rate for the third quarter of 2007 was 40.0%. During the third quarter of 2007, it was determined that it was more likely than not that net operating loss carryforwards in Luxembourg would not be utilized in the future and, accordingly, a valuation allowance of $1.7 million was recorded on the related deferred tax asset.
Results of Operations for the Nine Months Ended September 26, 2008 as Compared to the Nine Months Ended September 28, 2007 Revenue
Consolidated revenue for the first nine months of 2008 was $973.9 million, a decrease of $19.8 million, or 2.0%, compared to the first nine months of 2007, as gains from foreign exchange rates, strong growth in Timberland PRO® footwear and apparel and SmartWool® apparel and accessories were offset by anticipated declines in Timberland® brand apparel, as well as boots, performance footwear and casual footwear. On a constant dollar basis, consolidated revenues were down 5.5%. North America revenue totaled $421.8 million for the first nine months of 2008, an 8.7% decline from the same period in 2007. Europe revenues were $443.4 million for the first nine months of 2008, a 4.2% increase over the same period in 2007, but down 2.0% on a constant dollar basis. Asia revenues increased 2.3% to $108.7 million for the first nine months of 2008, but declined 4.8% on a constant dollar basis over the same period in 2007. Segments Review
The Company's North America revenues decreased 8.7% to $421.8 million for the first nine months of 2008, primarily driven by anticipated sales declines in boots and kids' footwear, driven by a reduction of sales through off-price channels in the wholesale market as compared to the first nine months of 2007, declines in Timberland® brand apparel, due in part to the transition of the North American apparel business to a licensing arrangement, and lower sales of men's casual and performance footwear. These declines were partially offset by strong growth in Timberland PRO® footwear and apparel, and SmartWool® apparel and accessories. Within North America, our retail business had revenue declines of 10.6% in the first nine months of 2008 as compared to the same period in 2007, driven by a 7.4% decrease in comparable store sales and the impact of our decision to close certain retail locations.
Our Europe segment increased to $443.4 million in the first nine months of 2008 from the $425.5 million reported in the first nine months of 2007, but decreased 2.0% in constant dollars. Softness in wholesale sales was partially offset by strong comparable store revenue growth in our retail business. A difficult wholesale market across the European Union, particularly Spain, Italy, France and the Benelux region, was partially offset by growth in our distributor business, primarily in Eastern Europe, and in our wholesale and retail business in the United Kingdom.
Asia revenues for the first nine months of 2008 were $108.7 million, compared to $106.3 million for the first nine months of 2007. On a constant dollar basis, Asia revenues were down 4.8%. Growth in distributor markets and flat comparable store revenue was offset by softness in our wholesale business, principally in Japan, and the impact of store closures. Products
Worldwide footwear revenue was $693.1 million for the first nine months of 2008, down $7.3 million, or 1.0%, from the same period in 2007. Worldwide apparel and accessories revenue fell 5.4% to $263.2 million, as strong growth from SmartWool and Howies was offset by an anticipated decline in Timberland® brand apparel. Royalty and other revenue was $17.6 million in the first nine months of 2008, compared to $15.2 million in the prior year period, reflecting our licensing arrangement for apparel in North America and increased sales primarily of kids' apparel in Europe and accessories.
Channels
Wholesale revenue was $732.2 million, a 3.0% decrease compared to the first nine months of 2007. A soft wholesale market worldwide was the primary driver of sales declines in men's casual footwear globally, as well as declines in boots in North America. Anticipated declines in Timberland® brand apparel were due in part to the transition of the North American apparel business to a licensing arrangement. These declines were partially offset by the benefit of foreign exchange rate changes on

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Form 10-Q Page 21 revenues in Europe and Asia.
Retail revenue grew 1.1% to $241.7 million. Comparable store sales decreased by almost 1.0%, with increases in Europe offset by a decline in North America. Europe and Asia also benefited from the impact of favorable foreign exchange rate changes, which help to offset revenue declines associated with our decision to close certain retail locations.
Gross Profit
Gross profit as a percentage of sales, or gross margin, was 45.9% for the first nine months of 2008, or 80 basis points lower than the prior year period. The decline in gross margins was driven by a higher level of close-out activity and markdowns and allowances, in part related to retail store closures in North . . .