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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period endedOctober 1, 2010
OR
__ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number1-9548
The Timberland Company
(Exact name of registrant as specified in its charter)
Delaware | 02-0312554 | |||
(State or other jurisdiction of | (I.R.S. Employer Identification No.) | |||
incorporation or organization) | ||||
200 Domain Drive, Stratham, New Hampshire | 03885 | |||
(Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code: (603) 772-9500
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.
x Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
x Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filerx | Accelerated Filero | |
Non-Accelerated Filero (Do not check if a smaller reporting company) | Smaller Reporting Companyo |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes x No
On October 29, 2010, 39,898,956 shares of the registrant’s Class A Common Stock were outstanding and 10,889,160 shares of the registrant’s Class B Common Stock were outstanding.
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THE TIMBERLAND COMPANY
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EX-101 CALCULATION LINKBASE DOCUMENT | ||||||||
EX-101 LABELS LINKBASE DOCUMENT | ||||||||
EX-101 PRESENTATION LINKBASE DOCUMENT | ||||||||
EX-101 DEFINITION LINKBASE DOCUMENT |
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Cautionary Note Regarding Forward-Looking Statements
The Timberland Company (the “Company”) wishes to take advantage of The Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act of 1934, which provide a “safe harbor” for certain written and oral 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 discussion in Part I, Item 1A, Risk Factors, of our Annual Report on Form 10-K for the year ended December 31, 2009 (the “Form 10-K”) and Part II, Item 1A, Risk Factors, of this Quarterly Report on Form 10-Q 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 risks included in Part I, Item 1A, Risk Factors, of the Form 10-K and Part II, Item 1A of this Quarterly Report are not exhaustive. Other sections of the Form 10-K as well as this Quarterly Report may include additional factors which could adversely affect the Company’s business and financial performance. Moreover, the Company operates in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for management to predict all such risk factors, nor can it assess the impact of all such risk factors on the Company’s business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. The Company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
Forward-looking Information
As discussed above and in Part I, Item 1A, Risk Factors, of the Form 10-K and Part II, Item 1A of this Quarterly Report, 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. Statements containing the words “may,” “assumes,” “forecasts,” “positions,” “predicts,” “strategy,” “will,” “expects,” “estimates,” “anticipates,” “believes,” “projects,” “intends,” “plans,” “budgets,” “potential,” “continue,” “target” and variations thereof, and other statements contained in this Quarterly Report regarding matters that are not historical facts are forward-looking statements. 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:
• Our ability to successfully market and sell our products in a highly competitive industry and in view of changing consumer trends and preferences, consumer acceptance of products, and other factors affecting retail market conditions, including the current global economic environment and global political uncertainties resulting from the continuing war on terrorism;
• Our ability to execute key strategic initiatives;
• Our ability to adapt to potential changes in duty structures in countries of import and export, including anti-dumping measures imposed by the European Union with respect to leather footwear imported from China and Vietnam;
• Our ability to manage our foreign exchange rate risks, and taxes, duties, import restrictions and other risks related to doing business internationally;
• Our ability to locate and retain independent manufacturers to produce lower cost, high-quality products with rapid turnaround times;
• Our reliance on a limited number of key suppliers and a global supply chain;
• Our ability to obtain adequate materials at competitive prices;
• Our reliance on the financial health of, and the appeal of our products to, our customers;
• Our reliance on the financial stability of third parties with which we do business, including customers, suppliers and distributors;
• Our ability to successfully invest in our infrastructure and products based upon advance sales forecasts;
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• Our ability to recover our investment in, and expenditures of, our retail organization through adequate sales at such retail locations; and
• Our ability to respond to actions of our competitors, some of whom have substantially greater resources than we have.
We undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
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PART I FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
THE TIMBERLAND COMPANY
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
October 1, | December 31, | October 2, | ||||||||||
2010 | 2009 | 2009 | ||||||||||
Assets | ||||||||||||
Current assets | ||||||||||||
Cash and equivalents | $108,815 | $289,839 | $112,851 | |||||||||
Accounts receivable, net of allowance for doubtful accounts of $13,692 at October 1, 2010, $12,175 at December 31, 2009 and $13,578 at October 2, 2009 | 268,985 | 149,178 | 270,272 | |||||||||
Inventory, net | 239,805 | 158,541 | 201,733 | |||||||||
Prepaid expense | 30,917 | 32,863 | 32,919 | |||||||||
Prepaid income taxes | 27,822 | 11,793 | 18,287 | |||||||||
Deferred income taxes | 27,551 | 26,769 | 23,512 | |||||||||
Derivative assets | 120 | 1,354 | 839 | |||||||||
Total current assets | 704,015 | 670,337 | 660,413 | |||||||||
Property, plant and equipment, net | 64,985 | 69,820 | 70,664 | |||||||||
Deferred income taxes | 17,070 | 14,903 | 13,825 | |||||||||
Goodwill | 38,958 | 44,353 | 44,353 | |||||||||
Intangible assets, net | 35,883 | 45,532 | 45,948 | |||||||||
Other assets, net | 13,546 | 14,962 | 15,161 | |||||||||
Total assets | $874,457 | $859,907 | $850,364 | |||||||||
Liabilities and Stockholders’ Equity | ||||||||||||
Current liabilities | ||||||||||||
Accounts payable | $101,874 | $79,911 | $ 89,681 | |||||||||
Accrued expense | ||||||||||||
Payroll and related | 36,125 | 43,512 | 30,478 | |||||||||
Other | 94,076 | 81,988 | 88,256 | |||||||||
Income taxes payable | 29,683 | 21,959 | 18,224 | |||||||||
Deferred income taxes | - | 48 | - | |||||||||
Derivative liabilities | 4,308 | 389 | 3,994 | |||||||||
Total current liabilities | 266,066 | 227,807 | 230,633 | |||||||||
Other long-term liabilities | 34,680 | 36,483 | 36,146 | |||||||||
Commitments and contingencies | ||||||||||||
Stockholders’ equity | ||||||||||||
Preferred Stock, $.01 par value; 2,000,000 shares authorized; none issued | - | - | - | |||||||||
Class A Common Stock, $.01 par value (1 vote per share); 120,000,000 shares authorized; 75,100,342 shares issued at October 1, 2010, 74,570,388 shares issued at December 31, 2009 and 74,265,471 shares issued at October 2, 2009 | 751 | 746 | 743 | |||||||||
Class B Common Stock, $.01 par value (10 votes per share); convertible into Class A shares on a one-for-one basis; 20,000,000 shares authorized; 10,889,160 shares issued and outstanding at October 1, 2010, 11,089,160 shares issued and outstanding at December 31, 2009 and 11,339,160 shares issued and outstanding at October 2, 2009 | 109 | 111 | 113 | |||||||||
Additional paid-in capital | 275,049 | 266,457 | 264,484 | |||||||||
Retained earnings | 1,029,173 | 974,683 | 952,429 | |||||||||
Accumulated other comprehensive income | 6,002 | 15,048 | 12,195 | |||||||||
Treasury Stock at cost; 35,206,038 Class A shares at October 1, 2010, 31,131,253 Class A shares at December 31, 2009 and 30,257,800 Class A shares at October 2, 2009 | (737,373 | ) | (661,428 | ) | (646,379 | ) | ||||||
Total stockholders’ equity | 573,711 | 595,617 | 583,585 | |||||||||
Total liabilities and stockholders’ equity | $874,457 | $859,907 | $850,364 | |||||||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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THE TIMBERLAND COMPANY
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in Thousands, Except Per Share Data)
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in Thousands, Except Per Share Data)
For the Quarter Ended | For the Nine Months Ended | |||||||||||||||
October 1, | October 2, | October 1, | October 2, | |||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Revenue | $432,344 | $421,766 | $938,340 | $898,116 | ||||||||||||
Cost of goods sold | 225,775 | 227,254 | 480,280 | 491,407 | ||||||||||||
Gross profit | 206,569 | 194,512 | 458,060 | 406,709 | ||||||||||||
Operating expense | ||||||||||||||||
Selling | 106,637 | 107,314 | 285,457 | 284,609 | ||||||||||||
General and administrative | 33,397 | 28,805 | 89,738 | 81,118 | ||||||||||||
Impairment of goodwill | - | - | 5,395 | - | ||||||||||||
Impairment of intangible assets | - | - | 7,854 | 925 | ||||||||||||
Gain on termination of licensing agreements | - | - | (3,000 | ) | - | |||||||||||
Restructuring | - | (88 | ) | - | (209 | ) | ||||||||||
Total operating expense | 140,034 | 136,031 | 385,444 | 366,443 | ||||||||||||
Operating income | 66,535 | 58,481 | 72,616 | 40,266 | ||||||||||||
Other income/(expense), net | ||||||||||||||||
Interest income | 84 | 106 | 305 | 845 | ||||||||||||
Interest expense | (133 | ) | (117 | ) | (414 | ) | (355 | ) | ||||||||
Other, net | 5,603 | 2,626 | 5,739 | 3,629 | ||||||||||||
Total other income/(expense), net | 5,554 | 2,615 | 5,630 | 4,119 | ||||||||||||
Income before income taxes | 72,089 | 61,096 | 78,246 | 44,385 | ||||||||||||
Income tax provision | 19,894 | 23,339 | 23,756 | 9,995 | ||||||||||||
Net income | $52,195 | $37,757 | $54,490 | $34,390 | ||||||||||||
Earnings per share | ||||||||||||||||
Basic | $ 1.01 | $ .68 | $ 1.03 | $ .61 | ||||||||||||
Diluted | $ 1.00 | $ .68 | $ 1.02 | $ .61 | ||||||||||||
Weighted-average shares outstanding | ||||||||||||||||
Basic | 51,892 | 55,744 | 53,098 | 56,385 | ||||||||||||
Diluted | 52,225 | 55,908 | 53,531 | 56,692 |
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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THE TIMBERLAND COMPANY
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
For the Nine Months Ended | ||||||||
October 1, 2010 | October 2, 2009 | |||||||
Cash flows from operating activities: | ||||||||
Net income | $54,490 | $34,390 | ||||||
Adjustments to reconcile net income to net cash used by operating activities: | ||||||||
Deferred income taxes | (2,819 | ) | 5,041 | |||||
Share-based compensation | 5,913 | 4,163 | ||||||
Depreciation and amortization | 19,179 | 21,582 | ||||||
Provision for losses on accounts receivable | 3,392 | 4,180 | ||||||
Impairment of goodwill | 5,395 | - | ||||||
Impairment of intangible assets | 7,854 | 925 | ||||||
Tax expense from share-based compensation, net of excess benefit | (520 | ) | (1,804 | ) | ||||
Unrealized loss on derivatives | 1,008 | 554 | ||||||
Other non-cash (credits)/charges, net | (55 | ) | 930 | |||||
Increase/(decrease) in cash from changes in operating assets and liabilities, net of the effect of business combinations: | ||||||||
Accounts receivable | (123,993 | ) | (103,264 | ) | ||||
Inventory | (80,146 | ) | (18,891 | ) | ||||
Prepaid expense and other assets | 3,205 | 1,265 | ||||||
Accounts payable | 21,872 | (8,099 | ) | |||||
Accrued expense | 1,994 | 5,263 | ||||||
Prepaid income taxes | (16,028 | ) | (1,600 | ) | ||||
Income taxes payable | 5,573 | (7,208 | ) | |||||
Other liabilities | (221 | ) | (175 | ) | ||||
Net cash used by operating activities | (93,907 | ) | (62,748 | ) | ||||
Cash flows from investing activities: | ||||||||
Acquisition of business, net of cash acquired | - | (1,554 | ) | |||||
Additions to property, plant and equipment | (11,318 | ) | (11,078 | ) | ||||
Other | (209 | ) | (601 | ) | ||||
Net cash used by investing activities | (11,527 | ) | (13,233 | ) | ||||
Cash flows from financing activities: | ||||||||
Common stock repurchases | (73,734 | ) | (29,285 | ) | ||||
Issuance of common stock | 2,621 | 1,373 | ||||||
Excess tax benefit from share-based compensation | 609 | 136 | ||||||
Other | (909 | ) | (1,248 | ) | ||||
Net cash used by financing activities | (71,413 | ) | (29,024 | ) | ||||
Effect of exchange rate changes on cash and equivalents | (4,177 | ) | 667 | |||||
Net decrease in cash and equivalents | (181,024 | ) | (104,338 | ) | ||||
Cash and equivalents at beginning of period | 289,839 | 217,189 | ||||||
Cash and equivalents at end of period | $108,815 | $112,851 | ||||||
Supplemental disclosures of cash flow information: | ||||||||
Interest paid | $368 | $309 | ||||||
Income taxes paid | $37,017 | $15,460 | ||||||
Non-cash investing activity (purchase of software licenses on account) | $1,500 | $ - |
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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THE TIMBERLAND COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in Thousands, Except Share and Per Share Data)
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in Thousands, Except Share and Per Share Data)
Note 1. Summary of Significant Accounting Policies
Basis of Presentation
The unaudited condensed consolidated financial statements include the accounts of The Timberland Company and its subsidiaries (“we”, “our”, “us”, “its”, “Timberland” or the “Company”). These unaudited condensed consolidated financial statements should be read in conjunction with our consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2009.
The financial statements included in this Quarterly Report on Form 10-Q are unaudited, but in the opinion of management, such financial statements include the adjustments, consisting of normal recurring adjustments, necessary to present fairly the Company’s financial position, results of operations and changes in cash flows for the interim periods presented. The results reported in these financial statements are not necessarily indicative of the results that may be expected for the full year due, in part, to seasonal factors. Historically, our revenue has been more heavily weighted to the second half of the year.
The Company’s fiscal quarters end on the Friday closest to the day on which the calendar quarter ends, except that the fourth quarter and fiscal year end on December 31. The third quarters and first nine months of our fiscal year in 2010 and 2009 ended on October 1, 2010 and October 2, 2009, respectively.
New Accounting Pronouncements
In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2010-06 (“ASU No. 2010-06”), Improving Disclosures About Fair Value Measurements. This accounting standard update adds new requirements for fair value measurement disclosures about transfers into and out of Levels 1 and 2 and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurements. It also clarifies existing fair value disclosures about the level of disaggregation and inputs and valuation techniques used to measure fair value. ASU No. 2010-06 was effective for the Company beginning January 1, 2010 and its adoption did not have a material impact on the Company’s existing disclosures.
Note 2. Fair Value Measurements
Accounting Standards Codification Topic 820, Fair Value Measurements and Disclosures, establishes a fair value hierarchy that ranks the quality and reliability of the information used to determine fair value. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Fair values determined by Level 2 inputs utilize data points that are observable such as quoted prices, interest rates and yield curves. Level 3 inputs are unobservable data points for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. The Company recognizes and reports significant transfers between Level 1 and Level 2, and into and out of Level 3, as of the actual date of the event or change in circumstances that caused the transfer.
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Financial Assets and Liabilities
The following tables present information about our assets and liabilities measured at fair value on a recurring basis as of October 1, 2010 and December 31, 2009:
Description | ||||||||||||||||||||
Level 1 | Level 2 | Level 3 | Impact of Netting | October 1, 2010 | ||||||||||||||||
Assets: | ||||||||||||||||||||
Cash equivalents: | ||||||||||||||||||||
Time deposits | $ | - | $ | - | $ | - | $ | - | $ | - | ||||||||||
Mutual funds | $ | - | $ | 5,103 | $ | - | $ | - | $ | 5,103 | ||||||||||
Foreign exchange forward contracts: | ||||||||||||||||||||
Derivative assets | $ | - | $ | 926 | $ | - | $ | (806 | ) | $ | 120 | |||||||||
Cash surrender value of life insurance | $ | - | $ | 7,444 | $ | - | $ | - | $ | 7,444 | ||||||||||
Liabilities: | ||||||||||||||||||||
Foreign exchange forward contracts: | ||||||||||||||||||||
Derivative liabilities | $ | - | $ | 6,294 | $ | - | $ | (806 | ) | $ | 5,488 | |||||||||
Description | ||||||||||||||||||||
Level 1 | Level 2 | Level 3 | Impact of Netting | December 31, 2009 | ||||||||||||||||
Assets: | ||||||||||||||||||||
Cash equivalents: | ||||||||||||||||||||
Time deposits | $ | - | $ | 70,041 | $ | - | $ | - | $ | 70,041 | ||||||||||
Mutual funds | $ | - | $ | 95,871 | $ | - | $ | - | $ | 95,871 | ||||||||||
Foreign exchange forward contracts: | ||||||||||||||||||||
Derivative assets | $ | - | $ | 1,768 | $ | - | $ | (230 | ) | $ | 1,538 | |||||||||
Cash surrender value of life insurance | $ | - | $ | 8,036 | $ | - | $ | - | $ | 8,036 | ||||||||||
Liabilities: | ||||||||||||||||||||
Foreign exchange forward contracts: | ||||||||||||||||||||
Derivative liabilities | $ | - | $ | 621 | $ | - | $ | (230 | ) | $ | 391 |
Cash equivalents, included in cash and equivalents on our unaudited condensed consolidated balance sheets, include money market mutual funds and time deposits placed with a variety of high credit quality financial institutions. Time deposits are valued based on current interest rates and mutual funds are valued at the net asset value of the fund. The carrying values of accounts receivable and accounts payable approximate their fair values due to their short-term maturities.
The fair value of the derivative contracts in the table above is reported on a gross basis by level based on the fair value hierarchy with a corresponding adjustment for netting for financial statement presentation purposes, where appropriate. The Company often enters into derivative contracts with a single counterparty and certain of these contracts are covered under a master netting agreement. The fair values of our foreign currency forward contracts are based on quoted market prices or pricing models using current market rates. As of October 1, 2010, the derivative contracts above include $1,179 of liabilities included in other long-term liabilities on our unaudited condensed consolidated balance sheet. As of December 31, 2009, the derivative contracts above include $184 of assets and $2 of liabilities included in other assets, net and other long-term liabilities, respectively, on our unaudited condensed consolidated balance sheet.
The cash surrender value of life insurance represents insurance contracts held as assets in a rabbi trust to fund the Company’s deferred compensation plan. These assets are included in other assets, net on our unaudited condensed consolidated balance sheet. The cash surrender value of life insurance is based on the net asset values of the underlying funds available to plan participants.
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Nonfinancial Assets
Goodwill and indefinite-lived intangible assets are tested for impairment annually at the end of our second quarter and when events occur or circumstances change that would, more likely than not, reduce the fair value of a business unit or an intangible asset with an indefinite-life below its carrying value. Events or changes in circumstances that may trigger interim impairment reviews include significant changes in business climate, operating results, planned investment in the business unit or an expectation that the carrying amount may not be recoverable, among other factors.
During the quarter ended July 2, 2010, management concluded that the carrying value of goodwill exceeded the estimated fair value for its IPath, North America Retail and Europe Retail reporting units and, accordingly, recorded an impairment charge of $5,395. Management also concluded that the carrying value of the IPath and howies trademarks and other intangible assets exceeded their estimated fair value and, accordingly, recorded an impairment charge of $7,854. The Company’s North America Wholesale and Europe Wholesale business units have fair values substantially in excess of their carrying value. See Note 9 to the unaudited condensed consolidated financial statements.
Impairment charges included in the second quarter of 2010 unaudited condensed consolidated statement of operations, by segment, are as follows:
North America | Sub- | Europe | Sub- | Total | ||||||||||||||||||||||||||||
IPath | Retail | Total | IPath | howies | Retail | Total | Company | |||||||||||||||||||||||||
Goodwill | $4,118 | $794 | $4,912 | $ - | $ - | $483 | $483 | $5,395 | ||||||||||||||||||||||||
Trademarks | 2,032 | - | 2,032 | 1,169 | 3,181 | - | 4,350 | 6,382 | ||||||||||||||||||||||||
Other intangibles | 1,228 | - | 1,228 | - | 244 | - | 244 | 1,472 | ||||||||||||||||||||||||
$7,378 | $794 | $8,172 | $1,169 | $3,425 | $483 | $5,077 | $13,249 | |||||||||||||||||||||||||
These non-recurring fair value measurements were developed using significant unobservable inputs (Level 3). For goodwill, the primary valuation technique used was the discounted cash flow analysis based on management’s estimates of forecasted cash flows for each business unit, with those cash flows discounted to present value using rates proportionate with the risks of those cash flows. In addition, management used a market-based valuation method involving analysis of market multiples of revenues and earnings before interest, taxes, depreciation and amortization for a group of similar publicly traded companies and, if applicable, recent transactions involving comparable companies. The Company believes the blended use of these models balances the inherent risk associated with either model if used on a stand-alone basis, and this combination is indicative of the factors a market participant would consider when performing a similar valuation. For trademark intangible assets, management used the relief-from-royalty method in which fair value is the discounted value of forecasted royalty revenue arising from a trademark using a royalty rate that an independent third party would pay for use of that trademark. Further information regarding the fair value measurements is provided below.
IPath
The IPath business unit has not met the revenue and earnings growth forecasted at its acquisition in April 2007. Accordingly, during the second quarter of 2010, management reassessed the financial expectations of this business as part of its long-range planning process. The revenue and earnings growth assumptions were developed based on near term trends, potential opportunities and planned investment in the IPath® brand. Management’s business plans and projections were used to develop the expected cash flows for the next five years and a 4% residual revenue growth rate applied thereafter. The analysis reflects a market royalty rate of 1.5% and a weighted average discount rate of 22%, derived primarily from published sources and adjusted for increased market risk. After the charges in the table above, there was $720 of finite-lived trademark intangible assets remaining at July 2, 2010. The carrying value of Ipath’s goodwill was reduced to zero.
The IPath business unit has not met the revenue and earnings growth forecasted at its acquisition in April 2007. Accordingly, during the second quarter of 2010, management reassessed the financial expectations of this business as part of its long-range planning process. The revenue and earnings growth assumptions were developed based on near term trends, potential opportunities and planned investment in the IPath® brand. Management’s business plans and projections were used to develop the expected cash flows for the next five years and a 4% residual revenue growth rate applied thereafter. The analysis reflects a market royalty rate of 1.5% and a weighted average discount rate of 22%, derived primarily from published sources and adjusted for increased market risk. After the charges in the table above, there was $720 of finite-lived trademark intangible assets remaining at July 2, 2010. The carrying value of Ipath’s goodwill was reduced to zero.
howies
howies has not met the revenue and earnings growth forecasted at its acquisition in December 2006. Accordingly, during the second quarter of 2010, management reassessed the financial expectations of this business as part of its long-range planning process. The revenue and earnings growth assumptions were developed based on near term trends, potential opportunities and planned investment in the howies® brand. Management’s business plans and projections were used to develop the expected cash flows for the next five years and a 4% residual revenue growth rate applied thereafter. The analysis reflects a market royalty rate of 2% and a weighted average discount rate of 24%, derived primarily from published sources and adjusted for increased market risk. After the charges in the table above, there was $1,200 of indefinite-lived trademark intangible assets remaining at July 2, 2010.
howies has not met the revenue and earnings growth forecasted at its acquisition in December 2006. Accordingly, during the second quarter of 2010, management reassessed the financial expectations of this business as part of its long-range planning process. The revenue and earnings growth assumptions were developed based on near term trends, potential opportunities and planned investment in the howies® brand. Management’s business plans and projections were used to develop the expected cash flows for the next five years and a 4% residual revenue growth rate applied thereafter. The analysis reflects a market royalty rate of 2% and a weighted average discount rate of 24%, derived primarily from published sources and adjusted for increased market risk. After the charges in the table above, there was $1,200 of indefinite-lived trademark intangible assets remaining at July 2, 2010.
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North America and Europe Retail
The Company’s retail businesses in North America and Europe have been negatively impacted by continued weakness in the macroeconomic environment, low consumer spending and a longer than expected economic recovery. The fair value of these businesses using the discounted cash flow analysis were based on management’s business plans and projections for the next five years and a 4% residual growth thereafter. The analysis reflects a weighted average discount rate in the range of 19%, derived primarily from published sources and adjusted for increased market risk. After the charges in the table above, the carrying value of the goodwill was zero at July 2, 2010.
The Company’s retail businesses in North America and Europe have been negatively impacted by continued weakness in the macroeconomic environment, low consumer spending and a longer than expected economic recovery. The fair value of these businesses using the discounted cash flow analysis were based on management’s business plans and projections for the next five years and a 4% residual growth thereafter. The analysis reflects a weighted average discount rate in the range of 19%, derived primarily from published sources and adjusted for increased market risk. After the charges in the table above, the carrying value of the goodwill was zero at July 2, 2010.
On an ongoing basis, the Company evaluated the carrying value of the GoLite trademark, which is licensed to a third party, for events or changes in circumstances indicating the carrying value of the asset may not be recoverable. Factors considered include the ability of the licensee to obtain necessary financing, the impact of changes in economic conditions and an assessment of the Company’s ability to recover all contractual payments when due under the licensing arrangement. During the first quarter of 2009, using Level 3 input factors noted above, the Company determined that the carrying value of the GoLite trademark was impaired and recorded a pre-tax, non-cash charge of approximately $925, which reduced the carrying value of the trademark to zero at April 3, 2009. The charge is reflected in our Europe segment.
During the third quarter of 2010 and 2009, the Company evaluated the carrying value of certain long-lived fixed assets, specifically certain footwear molds used in our production process. Based on an evaluation that included Level 3 input factors such as actual and planned production levels and style changes, the Company determined that the carrying value of the molds was impaired and we recorded a pre-tax, non-cash charge of approximately $485 and $740 in the quarters ended October 1, 2010 and October 2, 2009, respectively, which reduced the carrying value of the molds to zero. The charge, included in cost of sales in our statement of operations, is reflected in Unallocated Corporate in our segment reporting.
Note 3. Derivatives
In the normal course of business, the financial position and results of operations of the Company are impacted by currency rate movements in foreign currency denominated assets, liabilities and cash flows as we purchase and sell goods in local currencies. We have established policies and business practices that are intended to mitigate a portion of the effect of these exposures. We use derivative financial instruments, specifically forward contracts, to manage our currency exposures. These derivative instruments are viewed as risk management tools and are not used for trading or speculative purposes. Derivatives entered into by the Company are either designated as cash flow hedges of forecasted foreign currency transactions or are undesignated economic hedges of existing intercompany assets and liabilities, certain third party assets and liabilities, and non-US dollar-denominated cash balances.
Derivative instruments expose us to credit and market risk. The market risk associated with these instruments resulting from currency exchange movements is expected to offset the market risk of the underlying transactions being hedged. We do not believe there is a significant risk of loss in the event of non-performance by the counterparties associated with these instruments because these transactions are executed with a group of major financial institutions and have varying maturities through January 2012. As a matter of policy, we enter into these contracts only with counterparties having a minimum investment-grade or better credit rating. Credit risk is managed through the continuous monitoring of exposures to such counterparties.
Cash Flow Hedges
The Company principally uses foreign currency forward contracts as cash flow hedges to offset a portion of the effects of exchange rate fluctuations on certain of its forecasted foreign currency denominated sales transactions. The Company’s cash flow exposures include anticipated foreign currency transactions, such as foreign currency denominated sales, costs, expenses and inter-company charges, as well as collections and payments. The risk in these exposures is the potential for losses associated with the remeasurement of non-functional currency cash flows into the functional currency. The Company has a hedging program to aid in mitigating its foreign currency exposures and to decrease the volatility in earnings. Under this hedging program, the Company performs a quarterly assessment of the effectiveness of the hedge relationship and measures and recognizes any hedge ineffectiveness in earnings. A hedge is effective if the changes in the fair value of the derivative provide offset of at least 80 percent and not more than 125 percent of the changes in the fair value or cash flows of the hedged item attributable to the risk being hedged. The Company uses regression analysis to assess the effectiveness of a hedge relationship.
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Forward contracts designated as cash flow hedging instruments are recorded in our unaudited condensed consolidated balance sheets at fair value. The effective portion of gains and losses resulting from changes in the fair value of these hedge instruments are deferred in accumulated other comprehensive income (“OCI”) and reclassified to earnings, in cost of goods sold, in the period that the hedged transaction is recognized in earnings. Cash flows associated with these contracts are classified as operating cash flows in the unaudited condensed consolidated statements of cash flows. Hedge ineffectiveness is evaluated using the hypothetical derivative method, and the ineffective portion of the hedge is reported in our unaudited condensed consolidated statements of operations in other, net. The amount of hedge ineffectiveness reported in other, net for the quarters and nine months ended October 1, 2010 and October 2, 2009 was not material.
The notional value of foreign currency forward sell contracts entered into as cash flow hedges is as follows:
Notional Amount | ||||||||||||
December 31, | ||||||||||||
Currency | October 1, 2010 | 2009 | October 2, 2009 | |||||||||
Pound Sterling | $ | 23,685 | $ | 20,657 | $ | 20,746 | ||||||
Euro | 69,283 | 64,398 | 64,986 | |||||||||
Japanese Yen | 22,856 | 16,083 | 23,312 | |||||||||
Total | $ | 115,824 | $ | 101,138 | $ | 109,044 | ||||||
Latest Maturity Date | January 2012 | January 2011 | January 2011 |
Other Derivative Contracts
We also enter into derivative contracts to manage foreign currency exchange risk on intercompany accounts receivable and payable, third-party accounts receivable and payable, and non-U.S. dollar-denominated cash balances using forward contracts. These forward contracts, which are undesignated hedges of economic risk, are recorded at fair value on the unaudited condensed consolidated balance sheets, with changes in the fair value of these instruments recognized in earnings immediately. The gains or losses related to the contracts largely offset the remeasurement of those assets and liabilities. Cash flows associated with these contracts are classified as operating cash flows in the unaudited condensed consolidated statements of cash flows.
The notional value of foreign currency forward (buy) and sell contracts entered into to mitigate the foreign currency risk associated with certain balance sheet items is as follows (the contract amount represents the net amount of all purchase and sale contracts of a foreign currency):
Notional Amount | ||||||||||||
Currency | October 1, 2010 | December 31, 2009 | October 2, 2009 | |||||||||
Pound Sterling | $ | 15,814 | $(12,922) | $(15,901) | ||||||||
Euro | 37,024 | 14,122 | 25,577 | |||||||||
Japanese Yen | 18,641 | 8,013 | 14,493 | |||||||||
Canadian Dollar | 7,404 | 8,204 | 10,403 | |||||||||
Norwegian Kroner | 7,651 | 2,335 | 5,145 | |||||||||
Swedish Krona | 5,193 | 1,969 | 3,694 | |||||||||
Total | $ | 91,727 | $21,721 | $43,411 | ||||||||
Sell Contracts | $ | 91,727 | $44,293 | $59,312 | ||||||||
Buy Contracts | - | (22,572) | (15,901) | |||||||||
Total Contracts | $ | 91,727 | $21,721 | $43,411 | ||||||||
Latest Maturity Date | January 2011 | April 2010 | January 2010 |
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Fair Value of Derivative Instruments
The following table summarizes the fair values and presentation in the unaudited condensed consolidated balance sheets for derivative instruments, which consist of foreign exchange forward contracts, as of October 1, 2010, December 31, 2009 and October 2, 2009:
The following table summarizes the fair values and presentation in the unaudited condensed consolidated balance sheets for derivative instruments, which consist of foreign exchange forward contracts, as of October 1, 2010, December 31, 2009 and October 2, 2009:
Asset Derivatives | Liability Derivatives | |||||||||||||||||||||||
Fair Value | Fair Value | |||||||||||||||||||||||
October 1, | December 31, | October 2, | October 1, | December 31, | October 2, | |||||||||||||||||||
Balance Sheet Location | 2010 | 2009 | 2009 | 2010 | 2009 | 2009 | ||||||||||||||||||
Derivatives designated as hedge instruments: | ||||||||||||||||||||||||
Derivative assets | $ | 255 | $ | 1,313 | $ | 831 | $ | 135 | $ | 224 | $ | - | ||||||||||||
Derivative liabilities | 635 | 6 | 154 | 4,446 | 335 | 3,998 | ||||||||||||||||||
Other assets, net | - | 184 | 127 | - | - | 18 | ||||||||||||||||||
Other long-term liabilities | 21 | - | 6 | 1,200 | 2 | 236 | ||||||||||||||||||
$ | 911 | $ | 1,503 | $ | 1,118 | $ | 5,781 | $ | 561 | $ | 4,252 | |||||||||||||
Derivatives not designated as hedge instruments: | ||||||||||||||||||||||||
Derivative assets | $ | - | $ | 265 | $ | 8 | $ | - | $ | - | $ | - | ||||||||||||
Derivative liabilities | 15 | - | - | 513 | 60 | 150 | ||||||||||||||||||
$ | 15 | $ | 265 | $ | 8 | $ | 513 | $ | 60 | $ | 150 | |||||||||||||
Total derivatives | $ | 926 | $ | 1,768 | $ | 1,126 | $ | 6,294 | $ | 621 | $ | 4,402 | ||||||||||||
The Effect of Derivative Instruments on the Statements of Operations for the Quarters Ended October 1, 2010 and October 2, 2009
Amount of | ||||||||||||||||||||
Gain/(Loss) | ||||||||||||||||||||
Amount of Gain/(Loss) | Location of Gain/(Loss) | Reclassified from | ||||||||||||||||||
Recognized in OCI on | Reclassified from | Accumulated OCI into | ||||||||||||||||||
Derivatives in | Derivatives, Net of Taxes | Accumulated OCI into | Income | |||||||||||||||||
Cash Flow | (Effective Portion) | Income | (Effective Portion) | |||||||||||||||||
Hedging Relationships | 2010 | 2009 | (Effective Portion) | 2010 | 2009 | |||||||||||||||
Foreign exchange forward contracts | $ | (4,604 | ) | $ | (2,939 | ) | Cost of goods sold | $ | 2,947 | $ | (3,794 | ) |
The Company expects to reclassify pre-tax losses of $4,242 to the statement of operations within the next twelve months.
Amount of Gain/(Loss) | ||||||||||||
Recognized in | ||||||||||||
Derivatives not Designated | Location of Gain/(Loss) Recognized | Income on Derivatives | ||||||||||
as Hedging Instruments | In Income on Derivatives | 2010 | 2009 | |||||||||
Foreign exchange forward contracts | Other, net | $ | (1,691 | ) | $ | (1,651 | ) |
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The Effect of Derivative Instruments on the Statements of Operations for the Nine Months Ended October 1, 2010 and October 2, 2009
Amount of | ||||||||||||||||||||
Gain/(Loss) | ||||||||||||||||||||
Amount of Gain/(Loss) | Location of Gain/(Loss) | Reclassified from | ||||||||||||||||||
Recognized in OCI on | Reclassified from | Accumulated OCI into | ||||||||||||||||||
Derivatives in | Derivatives, Net of Taxes | Accumulated OCI into | Income | |||||||||||||||||
Cash Flow | (Effective Portion) | Income | (Effective Portion) | |||||||||||||||||
Hedging Relationships | 2010 | 2009 | (Effective Portion) | 2010 | 2009 | |||||||||||||||
Foreign exchange forward contracts | $ | (4,604 | ) | $ | (2,939 | ) | Cost of goods sold | $ | 4,553 | $ | 3,865 |
Amount of Gain/(Loss) | ||||||||||||
Recognized in | ||||||||||||
Derivatives not Designated | Location of Gain/(Loss) Recognized | Income on Derivatives | ||||||||||
as Hedging Instruments | In Income on Derivatives | 2010 | 2009 | |||||||||
Foreign exchange forward contracts | Other, net | $ | (2,313 | ) | $ | 996 |
During the nine months ended October 2, 2009, the Company de-designated certain cash flow hedges due to settle in the quarter that related to its Japanese yen exposure. Included in other, net above is a net loss of approximately $14 related to these contracts.
Note 4. Share-Based Compensation
Share-based compensation costs were as follows in the quarters and nine months ended October 1, 2010 and October 2, 2009, respectively:
For the Quarter Ended | ||||||||
October 1, | October 2, | |||||||
2010 | 2009 | |||||||
Cost of goods sold | $ | 112 | $ | 252 | ||||
Selling expense | 737 | 846 | ||||||
General and administrative expense | 1,416 | 485 | ||||||
Total share-based compensation | $ | 2,265 | $ | 1,583 | ||||
For the Nine Months Ended | ||||||||
October 1, | October 2, | |||||||
2010 | 2009 | |||||||
Cost of goods sold | $ | 301 | $ | 611 | ||||
Selling expense | 1,909 | 2,270 | ||||||
General and administrative expense | 3,703 | 1,282 | ||||||
Total share-based compensation | $ | 5,913 | $ | 4,163 | ||||
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Long Term Incentive Programs
2010 Executive Long Term Incentive Program
On March 3, 2010, the Management Development and Compensation Committee of the Board of Directors approved the terms of The Timberland Company 2010 Executive Long Term Incentive Program (“2010 LTIP”) with respect to equity awards to be made to certain of the Company’s executives and employees. On March 4, 2010, the Board of Directors also approved the 2010 LTIP with respect to the Company’s Chief Executive Officer. The 2010 LTIP was established under the Company’s 2007 Incentive Plan. The awards are subject to future performance, and consist of performance stock units (“PSUs”) equal in value to one share of the Company’s Class A Common Stock, and performance stock options (“PSOs”) with an exercise price of $19.45 (the closing price of the Company’s Class A Common Stock as quoted on the New York Stock Exchange on March 4, 2010, the date of grant). On May 13, 2010, additional awards were made under the 2010 LTIP consisting of PSUs equal in value to one share of the Company’s Class A Common Stock, and PSOs with an exercise price of $22.55 (the closing price of the Company’s Class A Common Stock as quoted on the New York Stock Exchange on May 13, 2010, the date of grant). Shares with respect to the PSUs will be granted and will vest following the end of the applicable performance period and approval by the Board of Directors, or a committee thereof, of the achievement of the applicable performance metric. The PSOs will vest in three equal annual installments following the end of the applicable performance period and approval by the Board of Directors, or a committee thereof, of the achievement of the applicable performance metric. The payout of the performance awards will be based on the Company’s achievement of certain levels of revenue growth and earnings before interest, taxes, depreciation and amortization (“EBITDA”), with threshold, budget, target and maximum award levels based upon actual revenue growth and EBITDA of the Company during the applicable performance periods equaling or exceeding such levels. The performance period for the PSUs is the three-year period from January 1, 2010 through December 31, 2012, and the performance period for the PSOs is the twelve-month period from January 1, 2010 through December 31, 2010. No awards shall be made or earned, as the case may be, unless the threshold goal is attained, and the maximum payout may not exceed 200% of the target award.
On March 3, 2010, the Management Development and Compensation Committee of the Board of Directors approved the terms of The Timberland Company 2010 Executive Long Term Incentive Program (“2010 LTIP”) with respect to equity awards to be made to certain of the Company’s executives and employees. On March 4, 2010, the Board of Directors also approved the 2010 LTIP with respect to the Company’s Chief Executive Officer. The 2010 LTIP was established under the Company’s 2007 Incentive Plan. The awards are subject to future performance, and consist of performance stock units (“PSUs”) equal in value to one share of the Company’s Class A Common Stock, and performance stock options (“PSOs”) with an exercise price of $19.45 (the closing price of the Company’s Class A Common Stock as quoted on the New York Stock Exchange on March 4, 2010, the date of grant). On May 13, 2010, additional awards were made under the 2010 LTIP consisting of PSUs equal in value to one share of the Company’s Class A Common Stock, and PSOs with an exercise price of $22.55 (the closing price of the Company’s Class A Common Stock as quoted on the New York Stock Exchange on May 13, 2010, the date of grant). Shares with respect to the PSUs will be granted and will vest following the end of the applicable performance period and approval by the Board of Directors, or a committee thereof, of the achievement of the applicable performance metric. The PSOs will vest in three equal annual installments following the end of the applicable performance period and approval by the Board of Directors, or a committee thereof, of the achievement of the applicable performance metric. The payout of the performance awards will be based on the Company’s achievement of certain levels of revenue growth and earnings before interest, taxes, depreciation and amortization (“EBITDA”), with threshold, budget, target and maximum award levels based upon actual revenue growth and EBITDA of the Company during the applicable performance periods equaling or exceeding such levels. The performance period for the PSUs is the three-year period from January 1, 2010 through December 31, 2012, and the performance period for the PSOs is the twelve-month period from January 1, 2010 through December 31, 2010. No awards shall be made or earned, as the case may be, unless the threshold goal is attained, and the maximum payout may not exceed 200% of the target award.
The maximum number of shares to be awarded with respect to PSUs under the 2010 LTIP is 527,800, which, if earned, will be settled in early 2013. Based on current estimates, unrecognized compensation expense with respect to the 2010 PSUs was $1,968 as of October 1, 2010. This expense is expected to be recognized over a weighted-average remaining period of 2.4 years.
The maximum number of shares subject to exercise with respect to PSOs under the 2010 LTIP is 737,640, which, if earned, will be settled, subject to the vesting schedule noted above, in early 2011. Based on current estimates, unrecognized compensation expense related to the 2010 PSOs was $2,214 as of October 1, 2010. This expense is expected to be recognized over a weighted-average remaining period of 2.4 years.
2009 Executive Long Term Incentive Program
On March 4, 2009, the Management Development and Compensation Committee of the Board of Directors approved the terms of The Timberland Company 2009 Executive Long Term Incentive Program (“2009 LTIP”) with respect to equity awards to be made to certain of the Company’s executives and employees. On March 5, 2009, the Board of Directors also approved the 2009 LTIP with respect to the Company’s Chief Executive Officer. The 2009 LTIP was established under the Company’s 2007 Incentive Plan. The awards are subject to future performance, and consist of PSUs equal in value to one share of the Company’s Class A Common Stock, and PSOs with an exercise price of $9.34 (the closing price of the Company’s Class A Common Stock as quoted on the New York Stock Exchange on March 5, 2009, the date of grant). On May 21, 2009, additional awards were made under the 2009 LTIP consisting of PSUs equal in value to one share of the Company’s Class A Common Stock, and PSOs with an exercise price of $12.93 (the closing price of the Company’s Class A Common Stock as quoted on the New York Stock Exchange on May 21, 2009, the date of grant). Shares with respect to the PSUs will be granted and will vest following the end of the applicable performance period and approval by the Board of Directors, or a committee thereof, of the achievement of the applicable performance metric. The PSOs will vest in three equal annual installments following the end of the applicable performance period and approval by the Board of Directors, or a committee thereof, of the achievement of the applicable performance metric. The payout of the performance awards will be based on the Company’s achievement of certain levels of EBITDA, with threshold, budget, target and maximum award levels based upon actual EBITDA of the Company during the applicable performance periods equaling or exceeding such levels. The performance period for the PSUs is the three-year period from January 1, 2009 through December 31, 2011, and the performance period for the PSOs was the twelve-month period from January 1, 2009 through December 31, 2009. No
On March 4, 2009, the Management Development and Compensation Committee of the Board of Directors approved the terms of The Timberland Company 2009 Executive Long Term Incentive Program (“2009 LTIP”) with respect to equity awards to be made to certain of the Company’s executives and employees. On March 5, 2009, the Board of Directors also approved the 2009 LTIP with respect to the Company’s Chief Executive Officer. The 2009 LTIP was established under the Company’s 2007 Incentive Plan. The awards are subject to future performance, and consist of PSUs equal in value to one share of the Company’s Class A Common Stock, and PSOs with an exercise price of $9.34 (the closing price of the Company’s Class A Common Stock as quoted on the New York Stock Exchange on March 5, 2009, the date of grant). On May 21, 2009, additional awards were made under the 2009 LTIP consisting of PSUs equal in value to one share of the Company’s Class A Common Stock, and PSOs with an exercise price of $12.93 (the closing price of the Company’s Class A Common Stock as quoted on the New York Stock Exchange on May 21, 2009, the date of grant). Shares with respect to the PSUs will be granted and will vest following the end of the applicable performance period and approval by the Board of Directors, or a committee thereof, of the achievement of the applicable performance metric. The PSOs will vest in three equal annual installments following the end of the applicable performance period and approval by the Board of Directors, or a committee thereof, of the achievement of the applicable performance metric. The payout of the performance awards will be based on the Company’s achievement of certain levels of EBITDA, with threshold, budget, target and maximum award levels based upon actual EBITDA of the Company during the applicable performance periods equaling or exceeding such levels. The performance period for the PSUs is the three-year period from January 1, 2009 through December 31, 2011, and the performance period for the PSOs was the twelve-month period from January 1, 2009 through December 31, 2009. No
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awards shall be made or earned, as the case may be, unless the threshold goal is attained, and the maximum payout may not exceed 200% of the target award.
The maximum number of shares to be awarded with respect to PSUs under the 2009 LTIP is 750,000, which, if earned, will be settled in early 2012. Based on current estimates, unrecognized compensation expense with respect to the 2009 PSUs was $1,581 as of October 1, 2010. This expense is expected to be recognized over a weighted-average remaining period of 1.4 years.
Based on actual performance, the number of shares subject to exercise with respect to PSOs under the 2009 LTIP is 599,619, which shares were settled on March 4, 2010, subject to the vesting schedule noted above.
The Company estimates the fair value of its PSOs on the date of grant using the Black-Scholes option valuation model, which employs the following assumptions:
2010 LTIP | 2009 LTIP | |||||||
For the Nine Months Ended | For the Nine Months Ended | |||||||
October 1, 2010 | October 2, 2009 | |||||||
Expected volatility | 47.7 | % | 41.9 | % | ||||
Risk-free interest rate | 2.7 | % | 1.9 | % | ||||
Expected life (in years) | 6.1 | 6.4 | ||||||
Expected dividends | - | - |
The following summarizes activity associated with stock options earned under the Company’s 2009 LTIP and excludes the performance-based awards noted above under the 2010 LTIP for which performance conditions have not been met:
Weighted- | ||||||||||||||||
Weighted- | Average | |||||||||||||||
Average | Remaining | Aggregate | ||||||||||||||
Exercise | Contractual | Intrinsic | ||||||||||||||
Shares | Price | Term | Value | |||||||||||||
Outstanding at January 1, 2010 | - | $ | - | |||||||||||||
Settled | 599,619 | 9.52 | ||||||||||||||
Exercised | - | - | ||||||||||||||
Expired or forfeited | (26,735 | ) | 9.34 | |||||||||||||
Outstanding at October 1, 2010 | 572,884 | $ | 9.53 | 8.44 | $ | 5,929 | ||||||||||
Vested or expected to vest at October 1, 2010 | 536,524 | $ | 9.52 | 8.44 | $ | 5,556 | ||||||||||
Exercisable at October 1, 2010 | - | - | - | - | ||||||||||||
Unrecognized compensation expense related to the 2009 PSOs was $940 as of October 1, 2010. This expense is expected to be recognized over a weighted-average remaining period of 1.6 years.
Stock Options
The Company estimates the fair value of its stock option awards on the date of grant using the Black-Scholes option valuation model, which employs the assumptions noted in the following table, for stock option awards excluding awards issued under the Company’s Long Term Incentive Programs discussed above:
For the Quarter Ended | For the Nine Months Ended | |||||||||||||||
October 1, | October 2, | October 1, | October 2, | |||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Expected volatility | 49.6 | % | 45.9 | % | 49.0 | % | 43.3 | % | ||||||||
Risk-free interest rate | 1.7 | % | 2.5 | % | 2.2 | % | 2.0 | % | ||||||||
Expected life (in years) | 5.0 | 5.0 | 5.0 | 6.2 | ||||||||||||
Expected dividends | - | - | - | - |
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The following summarizes transactions for the nine months ended October 1, 2010, under stock option arrangements excluding awards issued under the Company’s Long Term Incentive Programs discussed above:
Weighted- | ||||||||||||||||
Weighted- | Average | |||||||||||||||
Average | Remaining | |||||||||||||||
Exercise | Contractual | Aggregate | ||||||||||||||
Shares | Price | Term | Intrinsic Value | |||||||||||||
Outstanding at January 1, 2010 | 3,908,270 | $ | 25.05 | |||||||||||||
Granted | 184,700 | 20.76 | ||||||||||||||
Exercised | (139,206 | ) | 15.06 | |||||||||||||
Expired or forfeited | (193,051 | ) | 27.30 | |||||||||||||
Outstanding at October 1, 2010 | 3,760,713 | $ | 25.10 | 4.89 | $ | 5,284 | ||||||||||
Vested or expected to vest at October 1, 2010 | 3,708,577 | $ | 25.20 | 4.83 | $ | 5,149 | ||||||||||
Exercisable at October 1, 2010 | 3,236,061 | $ | 26.66 | 4.25 | $ | 2,678 | ||||||||||
Unrecognized compensation expense related to nonvested stock options was $2,165 as of October 1, 2010. This expense is expected to be recognized over a weighted-average remaining period of 1.6 years.
Nonvested Shares
Changes in the Company’s nonvested shares and restricted stock units, excluding awards under the Company’s Long Term Incentive Programs discussed above, for the nine months ended October 1, 2010 are as follows:
Weighted- | Weighted- | |||||||||||||||
Average | Average | |||||||||||||||
Stock | Grant Date | Stock | Grant Date | |||||||||||||
Awards | Fair Value | Units | Fair Value | |||||||||||||
Nonvested at January 1, 2010 | 86,102 | $15.59 | 297,758 | $13.74 | ||||||||||||
Awarded | - | - | 119,922 | 21.33 | ||||||||||||
Vested | (61,142 | ) | 18.14 | (152,491 | ) | 13.68 | ||||||||||
Forfeited | - | - | (15,850 | ) | 15.29 | |||||||||||
Nonvested at October 1, 2010 | 24,960 | $9.34 | 249,339 | $17.33 | ||||||||||||
Expected to vest at October 1, 2010 | 24,960 | $9.34 | 225,501 | $17.22 | ||||||||||||
Unrecognized compensation expense related to nonvested restricted stock awards was $37 as of October 1, 2010. The expense is expected to be recognized over a weighted-average remaining period of 0.4 years. Unrecognized compensation expense related to nonvested restricted stock units was $2,894 as of October 1, 2010. The expense is expected to be recognized over a weighted-average remaining period of 1.4 years.
Note 5. Earnings Per Share
Basic earnings per share (“EPS”) excludes common stock equivalents and is computed by dividing net income by the weighted-average number of common shares outstanding for the periods presented. Diluted EPS reflects the potential dilution that would occur if potentially dilutive securities such as stock options were exercised and nonvested shares vested, to the extent such securities would not be anti-dilutive.
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The following is a reconciliation of the number of shares (in thousands) for the basic and diluted EPS computations for the quarters and nine months ended October 1, 2010 and October 2, 2009:
For the Quarter Ended | ||||||||||||||||||||||||
October 1, 2010 | October 2, 2009 | |||||||||||||||||||||||
Weighted- | Per- | Weighted- | Per- | |||||||||||||||||||||
Net | Average | Share | Net | Average | Share | |||||||||||||||||||
Income | Shares | Amount | Income | Shares | Amount | |||||||||||||||||||
Basic EPS | $ | 52,195 | 51,892 | $ | 1.01 | $ | 37,757 | 55,744 | $ | .68 | ||||||||||||||
Effect of dilutive securities: | ||||||||||||||||||||||||
Stock options and employee stock purchase plan shares | - | 249 | (.01 | ) | - | 26 | - | |||||||||||||||||
Nonvested shares | - | 84 | - | - | 138 | - | ||||||||||||||||||
Diluted EPS | $ | 52,195 | 52,225 | $ | 1.00 | $ | 37,757 | 55,908 | $ | .68 | ||||||||||||||
For the Nine Months Ended | ||||||||||||||||||||||||
October 1, 2010 | October 2, 2009 | |||||||||||||||||||||||
Weighted- | Per- | Weighted- | Per- | |||||||||||||||||||||
Net | Average | Share | Net | Average | Share | |||||||||||||||||||
Income | Shares | Amount | Income | Shares | Amount | |||||||||||||||||||
Basic EPS | $ | 54,490 | 53,098 | $ | 1.03 | $ | 34,390 | 56,385 | $ | .61 | ||||||||||||||
Effect of dilutive securities: | ||||||||||||||||||||||||
Stock options and employee stock purchase plan shares | - | 297 | (.01 | ) | - | 23 | - | |||||||||||||||||
Nonvested shares | - | 136 | - | - | 284 | - | ||||||||||||||||||
Diluted EPS | $ | 54,490 | 53,531 | $ | 1.02 | $ | 34,390 | 56,692 | $ | .61 | ||||||||||||||
The following securities (in thousands) were outstanding as of October 1, 2010 and October 2, 2009, but were not included in the computation of diluted EPS as their inclusion would be anti-dilutive:
For the Quarter Ended | For the Nine Months Ended | |||||||||||||||
October 1, 2010 | October 2, 2009 | October 1, 2010 | October 2, 2009 | |||||||||||||
Anti-dilutive securities | 3,213 | 3,994 | 2,861 | 4,056 |
Note 6. Comprehensive Income
Comprehensive income for the quarters and nine months ended October 1, 2010 and October 2, 2009 is as follows:
For the Quarter Ended | For the Nine Months Ended | |||||||||||||||
October 2, | ||||||||||||||||
October 1, 2010 | October 2, 2009 | October 1, 2010 | 2009 | |||||||||||||
Net income | $52,195 | $37,757 | $54,490 | $34,390 | ||||||||||||
Change in cumulative translation adjustment | 8,462 | 3,838 | (3,528 | ) | 7,220 | |||||||||||
Change in fair value of cash flow hedges, net of taxes | (11,974 | ) | (731 | ) | (5,508 | ) | (7,568 | ) | ||||||||
Change in other adjustments, net of taxes | 36 | - | (10 | ) | - | |||||||||||
Comprehensive income | $48,719 | $40,864 | $45,444 | $34,042 | ||||||||||||
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The components of accumulated other comprehensive income as of October 1, 2010, December 31, 2009 and October 2, 2009 were:
October 1, 2010 | December 31, 2009 | October 2, 2009 | ||||||||||
Cumulative translation adjustment | $10,125 | $ | 13,653 | $ | 14,996 | |||||||
Fair value of cash flow hedges, net of taxes of $(242) at October 1, 2010, $47 at December 31, 2009 and $(155) at October 2, 2009 | (4,604 | ) | 904 | (2,939 | ) | |||||||
Other adjustments, net of taxes of $110 at October 1, 2010, $147 at December 31, 2009 and $7 at October 2, 2009 | 481 | 491 | 138 | |||||||||
Total | $6,002 | $ | 15,048 | $ | 12,195 | |||||||
Note 7. Business Segments and Geographic Information
The Company has three reportable segments: North America, Europe and Asia. The composition of the segments is consistent with that used by the Company’s chief operating decision maker.
The North America segment is comprised of the sale of products to wholesale and retail customers in North America. It includes Company-operated specialty and factory outlet stores in the United States and our United States e-commerce business. This segment also includes royalties from licensed products sold worldwide, the related management costs and expenses associated with our worldwide licensing efforts, and certain marketing expenses and value-added services. Beginning in the first quarter of 2010, results for the North America segment include certain U.S. distribution expenses, customer operations and service costs, credit management and short-term incentive compensation costs that were recorded in Unallocated Corporate in prior quarters. These costs in prior periods have been reclassified to North America to conform to the current period presentation.
The Europe and Asia segments each consist of the marketing, selling and distribution of footwear, apparel and accessories outside of the United States. Products are sold outside of the United States through our subsidiaries (which use wholesale, retail and e-commerce channels to sell footwear, apparel and accessories), franchisees and independent distributors. Certain distributor revenue and operating income reflected in our Europe segment in prior periods has been reclassified to Asia to conform to the current period presentation. Additionally, certain expenses, primarily related to short-term incentive compensation costs previously reported in Unallocated Corporate, have been reclassified to Europe and Asia to conform to the current period presentation.
Unallocated Corporate consists primarily of corporate finance, information services, legal and administrative expenses, share-based compensation costs, global marketing support expenses, worldwide product development costs and other costs incurred in support of Company-wide activities. Unallocated Corporate also includes certain value chain costs such as sourcing and logistics, as well as inventory variances. Beginning in the first quarter of 2010, certain U.S. distribution and other customer related expenses, and short-term incentive compensation costs previously reported in Unallocated Corporate were reclassified to North America, Europe and Asia. Additionally, Unallocated Corporate includes total other income/(expense), net, which is comprised of interest income, interest expense, and other, net, which includes foreign exchange gains and losses resulting from changes in the fair value of financial derivatives not designated as hedges, currency gains and losses incurred on the settlement of local currency denominated assets and liabilities, and other miscellaneous non-operating income/(expense). Such income/(expense) is not allocated among the reportable business segments.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies. We evaluate segment performance based on revenue and operating income. Total assets are disaggregated to the extent that assets apply specifically to a single segment. Unallocated Corporate assets primarily consist of cash and equivalents, tax assets, manufacturing/sourcing assets, computers and related equipment, and transportation and distribution equipment.
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Operating income/(loss) shown below for the nine months ended October 1, 2010 includes impairment charges of $8,172 and $5,077 in North America and Europe, respectively, related to goodwill and certain other intangible assets. Operating income for North America for the nine months ended October 1, 2010 also includes gains related to the termination of licensing agreements of $3,000. Operating income for Europe for the nine months ended October 2, 2009 includes an impairment charge of $925 related to a certain intangible asset. See Notes 2 and 9 to the unaudited condensed consolidated financial statements for additional information.
For the Quarters Ended October 1, 2010 and October 2, 2009
Unallocated | ||||||||||||||||||||
North America | Europe | Asia | Corporate | Consolidated | ||||||||||||||||
2010 | ||||||||||||||||||||
Revenue | $181,501 | $ | 204,154 | $ | 46,689 | $ | - | $ | 432,344 | |||||||||||
Operating income/(loss) | 43,520 | 51,320 | 6,174 | (34,479 | ) | 66,535 | ||||||||||||||
Income/(loss) before income taxes | 43,520 | 51,320 | 6,174 | (28,925 | ) | 72,089 | ||||||||||||||
Total assets | 316,962 | 349,825 | 74,966 | 132,704 | 874,457 | |||||||||||||||
Goodwill | 31,964 | 6,994 | - | - | 38,958 | |||||||||||||||
2009 | ||||||||||||||||||||
Revenue | $188,247 | $ | 194,511 | $ | 39,008 | $ | - | $ | 421,766 | |||||||||||
Operating income/(loss) | 41,607 | 41,488 | 4,275 | (28,889 | ) | 58,481 | ||||||||||||||
Income/(loss) before income taxes | 41,607 | 41,488 | 4,275 | (26,274 | ) | 61,096 | ||||||||||||||
Total assets | 320,014 | 341,065 | 60,675 | 128,610 | 850,364 | |||||||||||||||
Goodwill | 36,876 | 7,477 | - | - | 44,353 |
For the Nine Months Ended October 1, 2010 and October 2, 2009
Unallocated | ||||||||||||||||||||
North America | Europe | Asia | Corporate | Consolidated | ||||||||||||||||
2010 | ||||||||||||||||||||
Revenue | $395,354 | $ | 422,534 | $ | 120,452 | $ | - | $ | 938,340 | |||||||||||
Operating income/(loss) | 68,083 | 76,776 | 15,651 | (87,894 | ) | 72,616 | ||||||||||||||
Income/(loss) before income taxes | 68,083 | 76,776 | 15,651 | (82,264 | ) | 78,246 | ||||||||||||||
2009 | ||||||||||||||||||||
Revenue | $394,419 | $ | 399,869 | $ | 103,828 | $ | - | $ | 898,116 | |||||||||||
Operating income/(loss) | 52,377 | 60,615 | 5,477 | (78,203 | ) | 40,266 | ||||||||||||||
Income/(loss) before income taxes | 52,377 | 60,615 | 5,477 | (74,084 | ) | 44,385 |
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The following summarizes our revenue by product for the quarters and nine months ended October 1, 2010 and October 2, 2009:
For the Quarter Ended | For the Nine Months Ended | |||||||||||||||
October 1, | October 2, | October 1, | October 2, | |||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Footwear | $319,766 | $319,145 | $676,916 | $657,739 | ||||||||||||
Apparel and accessories | 106,450 | 95,824 | 244,208 | 221,729 | ||||||||||||
Royalty and other | 6,128 | 6,797 | 17,216 | 18,648 | ||||||||||||
$432,344 | $421,766 | $938,340 | $898,116 | |||||||||||||
Note 8. Inventory, net
Inventory, net consists of the following:
October 1, 2010 | December 31, 2009 | October 2, 2009 | ||||||||||
Materials | $ | 10,300 | $ | 7,944 | $ | 8,824 | ||||||
Work-in-process | 1,247 | 740 | 935 | |||||||||
Finished goods | 228,258 | 149,857 | 191,974 | |||||||||
Total | $ | 239,805 | $ | 158,541 | $ | 201,733 | ||||||
Note 9. Goodwill and Intangibles
The Company completed its annual impairment testing for goodwill and indefinite-lived intangible assets in the second quarter of 2010, and determined that the carrying values of certain goodwill and intangible assets, primarily related to its IPath® and howies® brands, exceeded fair value. Accordingly, the Company recorded non-cash impairment charges of $5,395 and $7,854 for goodwill and intangible assets, respectively, in its consolidated statement of operations. The impairment charge reduced the goodwill related to the IPath, North America retail, and Europe retail reporting units to zero. The charge of $7,854 reduced the trademark and other intangible assets of IPath and howies to their respective fair values of $720 and $1,200. See Note 2 to the unaudited condensed consolidated financial statements for additional information.
A summary of goodwill activity by segment follows:
North America | Europe | Asia | Total | |||||||||||||
Balance at December 31, 2009 | $ | 36,876 | $ | 7,477 | - | $ | 44,353 | |||||||||
Q2 impairment charges | (4,912 | ) | (483 | ) | - | (5,395 | ) | |||||||||
Balance at October 1, 2010 | $ | 31,964 | $ | 6,994 | - | $ | 38,958 | |||||||||
Intangible assets consist of trademarks and other intangible assets. Other intangible assets consist of customer, patent and non-competition related intangible assets. Intangible assets consist of the following:
October 1, 2010 | December 31, 2009 | |||||||||||||||||||||||
Accumulated | Net Book | Accumulated | Net Book | |||||||||||||||||||||
Gross | Amortization | Value | Gross | Amortization | Value | |||||||||||||||||||
Trademarks (indefinite-lived) | $ | 32,420 | $ - | $ | 32,420 | $ | 35,841 | $ - | $ | 35,841 | ||||||||||||||
Trademarks (finite-lived) | 4,699 | (2,312 | ) | 2,387 | 10,239 | (4,149 | ) | 6,090 | ||||||||||||||||
Other intangible assets (finite-lived) | 5,976 | (4,900 | ) | 1,076 | 10,723 | (7,122 | ) | 3,601 | ||||||||||||||||
Total | $ | 43,095 | $(7,212 | ) | $ | 35,883 | $ | 56,803 | $(11,271 | ) | $ | 45,532 | ||||||||||||
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Note 10. Acquisition
On March 16, 2009, we acquired 100% of the stock of Glaudio Fashion B.V. (“Glaudio”) for approximately $1,500, net of cash acquired. Glaudio operates nine Timberland® retail stores in the Netherlands and Belgium which sell Timberland® footwear, apparel, leather goods and product-care products for men, women and kids. The acquisition was effective March 1, 2009, and its results have been included in our Europe segment from the effective date of the acquisition. The acquisition of Glaudio was not material to the results of operations, financial position or cash flows of the Company.
Note 11. Income Taxes
In February 2009, the Company received notification that our U.S. federal tax examinations for 2006 and 2007 had been completed. Accordingly, in the first quarter of 2009, we reversed approximately $6,400 of accruals related to uncertain tax positions. During the second quarter of 2009, we recorded a net benefit of approximately $140 in our tax provision related to the settlement of certain foreign tax audits.
In December 2009, we received a Notice of Assessment from the Internal Revenue Department of Hong Kong for approximately $17,600 with respect to the tax years 2004 through 2008. In connection with the assessment, the Company was required to make payments to the Internal Revenue Department of Hong Kong totaling approximately $900 in the first quarter of 2010 and $7,500 in the second quarter of 2010. We believe we have a sound defense to the proposed adjustment and will continue to firmly oppose the assessment. We believe that the assessment does not impact the level of liabilities for our income tax contingencies. However, actual resolution may differ from our current estimates, and such differences could have a material impact on our future effective tax rate and our results of operations.
In the third quarter of 2010, we received final approval associated with tax clearance for certain closed foreign operations, as well as the lapse of certain statutes of limitation and, accordingly, recorded a net benefit of approximately $3,900 in our tax provision related to uncertain tax positions.
Note 12. Share Repurchase
On March 10, 2008, our Board of Directors approved the repurchase of up to 6,000,000 shares of our Class A Common Stock. Shares repurchased under this authorization totaled 1,324,259 for the nine months ended October 1, 2010. As of October 1, 2010, there were no shares remaining available for repurchase under this authorization.
On December 3, 2009, our Board of Directors approved the repurchase of up to an additional 6,000,000 shares of our Class A Common Stock. Shares repurchased under this authorization totaled 1,678,256 and 2,701,023, respectively, for the quarter and nine months ended October 1, 2010. As of October 1, 2010, 3,298,977 shares remained available for repurchase under this authorization.
From time to time, we use plans adopted under Rule 10b5-1 promulgated by the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, to facilitate share repurchases.
During the first quarter of 2010, 200,000 shares of our Class B Common Stock were converted to an equivalent amount of our Class A Common Stock.
Note 13. Litigation
We are involved in various litigation and legal proceedings that have arisen in the ordinary course of business. Management believes that the ultimate resolution of any such matters will not have a material adverse effect on our unaudited condensed consolidated financial statements.
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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 and its subsidiaries (“we”, “our”, “us”, “its”, “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, 2009.
Included herein are discussions and reconciliations of Total Company, Europe and Asia revenue changes to constant dollar revenue changes. Constant dollar revenue changes, which exclude the impact of changes in foreign exchange rates, 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 calculate constant dollar revenue changes by recalculating current year revenue using the prior year’s exchange rates and comparing it to the prior year revenue reported on a GAAP basis. We provide constant dollar revenue changes for Total Company, Europe and Asia results because we use the measure to understand the underlying results and trends of the business segments excluding the impact of exchange rate changes that are not under management’s direct control. The limitation of this measure is that it excludes exchange rate changes that have an impact on the Company’s revenue. This limitation is best addressed by using constant dollar revenue changes in combination with revenue reported on a GAAP basis. We have a foreign exchange rate risk management program intended to minimize both the positive and negative effects of currency fluctuations on our reported consolidated results of operations, financial position and cash flows. The actions taken by us to mitigate foreign exchange risk are reflected in cost of goods sold and other, net.
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 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 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, 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 Part II, Item 8: Financial Statements and Supplementary Data, of our Annual Report on Form 10-K for the year ended December 31, 2009. Our estimates, assumptions and judgments involved in applying the critical accounting policies are described in Part II, Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations, of our Annual Report on Form 10-K for the year ended December 31, 2009.
During the quarter ended July 2, 2010, management concluded that the carrying value of goodwill exceeded the estimated fair value for its IPath, North America Retail and Europe Retail reporting units and, accordingly, recorded an impairment charge of $5.4 million. Management also concluded that the carrying value of the IPath and howies trademarks and other intangible assets exceeded the estimated fair value and, accordingly, recorded an impairment charge of $7.8 million. The Company’s North America Wholesale and Europe Wholesale business units have fair values substantially in excess of their carrying value. See Notes 2 and 9 to the unaudited condensed consolidated financial statements for additional information.
These non-recurring fair value measurements were developed using significant unobservable inputs (Level 3). For goodwill, the primary valuation technique used was the discounted cash flow analysis based on management’s estimates of forecasted cash flows for each business unit, with those cash flows discounted to present value using rates proportionate with the risks of those cash flows. In addition, management used a market-based valuation method involving analysis of market multiples of revenues and earnings before interest, taxes, depreciation and amortization for a group of similar publicly
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traded companies and, if applicable, recent transactions involving comparable companies. The Company believes the blended use of these models balances the inherent risk associated with either model if used on a stand-alone basis, and this combination is indicative of the factors a market participant would consider when performing a similar valuation. For trademark intangible assets, management used the relief-from-royalty method in which fair value is the discounted value of forecasted royalty revenue arising from a trademark using a royalty rate that an independent third party would pay for use of that trademark.
Our estimates of fair value are sensitive to changes in the assumptions used in our valuation analyses and, as a result, actual performance in the near and longer-term could be different from these expectations and assumptions. These differences could be caused by events such as strategic decisions made in response to economic and competitive conditions and the impact of economic factors on our customer base. If our future actual results are significantly lower than our current operating results or our estimates and assumptions used to calculate fair value are materially different, the value determined using the discounted cash flow analysis could result in a lower value. A significant decrease in value could result in a fair value lower than carrying value, which could result in impairment of our remaining goodwill. While we believe we have made reasonable estimates and assumptions used to calculate the fair value of the reporting units and other intangible assets, it is possible a material change could occur, which may ultimately result in the recording of an additional non-cash impairment charge.
These non-cash impairment charges do not have any direct impact on our liquidity, compliance with any covenants under our debt agreements or potential future results of operations. Our historical operating results may not be indicative of our future operating results. We will revise our estimates used in calculating the fair value of our reporting units as needed.
Overview
Our principal strategic goal is to become the #1 Outdoor Brand on Earth by offering an integrated product selection that equips consumers to enjoy the experience of being in the outdoors. 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 Timberlandâ brand.
Our ongoing efforts to achieve this goal include (i) enhancing our leadership position in our core Timberland® footwear business through an increased focus on technological innovation and “big idea” initiatives like Earthkeepers, (ii) expanding our global apparel and accessories business by leveraging the brand’s equity and initiatives through a combination of in-house development and licensing arrangements with trusted partners, (iii) expanding our brands geographically, (iv) driving operational and financial excellence, (v) setting the standard for social and environmental responsibility and (vi) striving to be an employer of choice.
A summary of our third quarter of 2010 financial performance, compared to the third quarter of 2009, follows:
• | Third quarter revenue increased 2.5%, or 5.2% on a constant dollar basis, to $432.3 million. | ||
• | Gross margin increased 170 basis points to 47.8%. | ||
• | Operating expenses increased $4.0 million, or 2.9%, to $140.0 million. | ||
• | Operating income increased $8.0 million to $66.5 million. | ||
• | Net income increased from $37.8 million to $52.2 million. | ||
• | Diluted earnings per share increased from $.68 to $1.00. | ||
• | Cash at the end of the quarter was $108.8 million with no debt outstanding. |
We are undertaking a multi-year Business Transformation Initiative, pursuant to which we will develop and implement an integrated enterprise resource planning (“ERP”) system to better support our business model and further streamline our operations. The Company incurred incremental costs of approximately $2 million during the quarter ended October 1, 2010 related to initiatives in preparation for this ERP implementation.
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Results of Operations for the Quarter Ended October 1, 2010 Compared to the Quarter Ended October 2, 2009
Revenue
In the third quarter of 2010, our consolidated revenues grew 2.5% to $432.3 million, reflecting growth in Europe and Asia, partially offset by a decline in North America. Double-digit growth in Scandinavia and our distributor business was partially offset by declines in the Benelux region. China and Taiwan continued to post strong growth, leading the favorable quarter over quarter comparison in Asia. On a constant dollar basis, consolidated revenues increased 5.2%.
Products
By product group, our footwear revenue was relatively flat at $319.8 million, and apparel and accessories revenues grew 11.1% to $106.4 million. In footwear, improved wholesale revenue in Europe, reflecting higher sales of women’s and kids’ footwear, was offset by a decline in North America, where growth in Timberland PRO® footwear was offset by decreases in kids’ footwear. The improvement in apparel and accessories revenues compared to the prior year reflects revenue growth driven by apparel in Asia and by SmartWool® accessories in North America. Royalty and other revenue decreased 9.8% to $6.1 million compared to the prior year period primarily due to a decline in licensed kids’ apparel.
Channels
Wholesale revenue was $348.7 million in the third quarter of 2010, an increase of 1.9% compared to the prior year quarter, driven by growth in Europe and Asia, partially offset by a decline in North America.
Retail revenues grew 5.2% to $83.6 million in the third quarter of 2010, driven by growth in Asia and Europe. Comparable store sales increased 7.2% compared to the third quarter of 2009, with growth in specialty and outlet stores across our global locations. We had 225 and 217 Company-owned stores, shops and outlets worldwide at the end of the third quarters of 2010 and 2009, respectively.
Gross Profit
Gross profit as a percentage of sales, or gross margin, was 47.8% for the third quarter of 2010, a 170 basis point improvement compared to the third quarter of 2009. We saw gross margin improvement for the quarter in all regions, driven by more profitable close-out sales, favorable product and region mix, and lower product costs. These improvements were partially offset by adverse foreign exchange impacts. While the benefits from mix and lower product costs continued in the third quarter, we believe that increased product costs as a result of higher leather, transportation and labor costs will adversely impact gross margin in the fourth quarter of 2010 and through 2011.
Operating Expense
Operating expense for the third quarter of 2010 was $140.0 million, an increase of $4.0 million, or 2.9%, when compared to the third quarter of 2009. The increase in operating expense was driven by an increase in general and administrative expense of $4.6 million, or 15.9%. Foreign exchange rate impacts reduced operating expense by approximately 2% in the third quarter of 2010.
Selling expense was $106.6 million in the third quarter of 2010, compared to $107.3 million the same period in 2009. The change in selling expense reflects declines in selling and employee related costs.
We include the costs of physically managing inventory (warehousing and handling costs) in selling expense. These costs totaled $9.8 million and $10.2 million in the third quarters of 2010 and 2009, respectively.
In the third quarters of 2010 and 2009, we recorded $0.8 million and $0.7 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 $6.7 million and $5.2 million for the quarters ended October 1, 2010 and October 2, 2009, respectively.
Advertising expense, which is included in selling expense, remained relatively flat at $8.9 million in the third quarter of 2010. 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. Advertising costs are expensed at the time
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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 October 1, 2010 and October 2, 2009 was $2.5 million and $2.4 million, respectively.
General and administrative expense for the third quarter of 2010 was $33.4 million, an increase of 15.9% compared to the $28.8 million reported in the third quarter of 2009, driven by increases of $2.4 million in employee related costs, primarily share-based and incentive compensation, and $1.9 million in incremental costs related to a multi-year ERP system implementation.
Operating Income
We recorded operating income of $66.5 million in the third quarter of 2010, an increase of 13.8% compared to operating income of $58.5 million in the prior year period, driven by revenue and margin improvement partially offset by increases in operating expenses.
Other Income/(Expense) and Taxes
Interest income was $0.1 million in each of the third quarters of 2010 and 2009. Interest expense, which is comprised of fees related to the establishment and maintenance of our revolving credit facility and bank guarantees, was $0.1 million in each of the third quarters of 2010 and 2009.
Other, net, included foreign exchange gains of $4.8 million and $1.5 million in the third quarters of 2010 and 2009, 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 foreign currency denominated receivables and payables. These results were driven by the volatility of exchange rates within the third quarters of 2010 and 2009 and should not be considered indicative of expected future results.
The effective income tax rate for the third quarter of 2010 was 27.6%. The rate was impacted by the release of approximately $3.9 million in tax accruals associated with tax clearance for certain closed foreign operations, as well as the lapse of certain statutes of limitation, in the third quarter of 2010. The effective income tax rate for the third quarter of 2009 was 38.2%. The rate in 2009 was impacted by the release of approximately $0.8 million in tax accruals as a result of the lapse of certain statutes of limitation in the third quarter of 2009.
Segments Review
We have three reportable business segments (see Note 7 to the unaudited condensed consolidated financial statements contained herein for additional information): North America, Europe and Asia. Beginning in the first quarter of 2010, certain U.S. distribution expenses and short-term incentive compensation costs previously reported in Unallocated Corporate were reclassified to North America, Europe and Asia to conform to the current period presentation. Additionally, certain distributor revenue and operating income reflected in our Europe segment in prior periods has been reclassified to Asia to conform to the current period presentation.
Revenue by segment for the quarter ended October 1, 2010 compared to the quarter ended October 2, 2009 is as follows (dollars in millions):
For the Quarter Ended | ||||||||||||
October 1, | October 2, | |||||||||||
2010 | 2009 | % Change | ||||||||||
North America | $ | 181.5 | $ | 188.3 | (3.6) | % | ||||||
Europe | 204.1 | 194.5 | 5.0 | % | ||||||||
Asia | 46.7 | 39.0 | 19.7 | % | ||||||||
$ | 432.3 | $ | 421.8 | 2.5 | % | |||||||
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Operating income/(loss) by segment and as a percentage of revenue for the quarters ended October 1, 2010 and October 2, 2009 are included in the table below (dollars in millions). Segment operating income/(loss) is presented as a percentage of its respective segment revenue. Unallocated Corporate expenses are presented as a percentage of total revenue.
For the Quarter Ended | ||||||||||||||||
October 1, | October 2, | |||||||||||||||
2010 | 2009 | |||||||||||||||
North America | $ | 43.5 | 24.0 | % | $ | 41.6 | 22.1 | % | ||||||||
Europe | 51.3 | 25.1 | % | 41.5 | 21.3 | % | ||||||||||
Asia | 6.2 | 13.2 | % | 4.3 | 11.0 | % | ||||||||||
Unallocated Corporate | (34.5 | ) | (8.0) | % | (28.9 | ) | (6.8 | )% | ||||||||
$ | 66.5 | 15.4 | % | $ | 58.5 | 13.9 | % | |||||||||
North America
North America revenues were $181.5 million in the third quarter of 2010, a decrease of 3.6% compared to the same period in 2009. Growth in apparel and accessories and our Timberland PRO® footwear line was offset by declines in women’s and kids’ footwear. Within North America, our retail business was relatively flat. A 3.7% increase in comparable store sales, with growth in both our specialty and outlet stores, was offset by the net closure of 4 stores. We had 66 stores at October 1, 2010 compared to 70 stores at October 2, 2009.
Operating income for our North America segment was $43.5 million compared to $41.6 million for the third quarter of 2009, as margin improvement across all channels offset declines in revenue and an increase in operating expenses. The increase was driven by a 350 basis point improvement in gross margin due primarily to lower product costs, higher margin on reduced close-out revenue, and favorable product mix. Operating expense increased 4.0%, driven by higher sales and advertising spend.
Europe
Europe recorded revenues of $204.1 million in the third quarter of 2010, a 5.0% increase from the third quarter of 2009, and an increase of 12.3% on a constant dollar basis. Double-digit growth in Scandinavia and our distributor business, as well as growth in Central Europe and France, was partially offset by unfavorable foreign exchange rate impacts and declines in the Benelux region. Double-digit growth in kids’ and women’s footwear through the wholesale channel was complemented by an increase of 2.8% in retail revenue. Retail improvements were driven by comparable store sales increases of 9.8%, partially offset by unfavorable foreign exchange rate impacts. We had 64 stores at October 1, 2010 compared to 62 stores at October 2, 2009.
Timberland’s Europe segment recorded operating income of $51.3 million in the third quarter of 2010, compared to $41.5 million in the third quarter of 2009. A 50 basis point increase in gross margin was driven by lower product costs and improved profitability on close-outs, partially offset by unfavorable mix and foreign exchange rate impacts. In addition, Europe had a 7.7% decrease in operating expenses, driven by favorable foreign exchange impacts. A decrease in government taxes on certain foreign investments was offset by incremental store related, employee and labor related costs.
Asia
In Asia, revenues increased 19.7%, or 13.3% in constant dollars, to $46.7 million in the third quarter of 2010 due to continued strong growth in China, Taiwan, and Hong Kong, and favorable foreign exchange rate impacts. Retail revenues were up 21.9%, driven by strong apparel sales. Comparable store sales grew 9.3% and we added 16 new stores and closed 6 stores year over year, leaving us with 95 stores at October 1, 2010 compared to 85 stores at October 2, 2009.
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Operating income in our Asia segment was $6.2 million for the third quarter of 2010, compared to $4.3 million for the third quarter of 2009, driven by strong revenue growth and margin improvement, partially offset by an increase in operating expenses. A 200 basis point improvement in gross margin reflects favorable mix impacts, lower product costs and favorable foreign exchange rate impacts, partially offset by increased provisions for sales returns and allowances. This improvement was partially offset by an increase in operating expenses of 18.9% due to unfavorable foreign exchange impacts, as well as higher store related and employee costs.
Unallocated Corporate
Our Unallocated Corporate expenses, which include central support and administrative costs not allocated to our reportable business segments, increased 19.3% to $34.5 million, which reflects an increase in incentive compensation costs and incremental costs associated with a multi-year ERP system implementation, as well as unfavorability in certain supply chain costs, primarily inventory cost variances, which are not allocated to our reportable segments.
Results of Operations for the Nine Months Ended October 1, 2010 Compared to the Nine Months Ended October 2, 2009
Revenue
In the first nine months of 2010, our consolidated revenues grew 4.5% to $938.3 million, reflecting strong growth in Europe and Asia, and relatively flat revenue in North America. The impact of changes in foreign exchange rates did not have a material impact on consolidated revenues. Nearly every market in Europe and Asia delivered top-line growth for the first nine months of 2010 compared to the prior year period. Growth in Scandinavia, Southern and Central Europe, and the UK was partially offset by declines in the Benelux region and our European distributor business. In the first nine months of 2010, revenue in China nearly doubled and Taiwan posted double-digit growth, in part due to new stores, leading the favorable year over year improvement in Asia.
Products
By product group, our footwear revenue increased 2.9% to $676.9 million compared to the prior year and apparel and accessories revenue grew 10.1% to $244.2 million. Footwear revenue growth was driven primarily by strong growth in Europe, with strength across all genders, and in Asia, reflecting growth in men’s footwear. This growth was partially offset by declines in North America, where strength in our Timberland PRO® footwear was offset by a decline in women’s and kids’ footwear. The improvement in apparel and accessories revenues compared to the prior year reflects revenue growth in Asia and North America in our own stores and through our wholesale partners. Royalty and other revenue decreased 7.7% to $17.2 million compared to the prior year period, primarily due to a decline in licensed kids’ apparel.
Channels
Wholesale revenue was $698.1 million in the first nine months of 2010, a 4.3% increase compared to the first nine months of 2009, driven primarily by growth in footwear in Europe and apparel and accessories in Asia. Retail revenues grew 5.0% to $240.2 million in the first nine months of 2010, driven by comparable store sales growth, the net addition of 8 stores, and favorable foreign exchange rate impacts in Asia. Global retail comparable store sales were up 3.8% compared to the first nine months of 2009, with growth in both our specialty and outlet stores.
Gross Profit
Gross profit as a percentage of sales, or gross margin, was 48.8% for the first nine months of 2010, a 350 basis point improvement compared to the first nine months of 2009. Gross margin improved for the first nine months of the year across all regions, and was driven by favorable mix impacts, lower product costs, better pricing, in part due to less promotional activity in retail, and reduced provisions for inventory and sales returns. While the benefits from mix may continue, we expect that increased product costs as a result of higher leather, transportation and labor costs will adversely impact gross margin in the fourth quarter of 2010 and through 2011.
Operating Expense
Operating expense for the first nine months of 2010 was $385.4 million, an increase of $19.0 million, or 5.2%, when
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compared to the first nine months of 2009. Foreign exchange rate impacts were not material in the first nine months of 2010. The change in operating expense was driven by increases of $12.3 million in impairment charges, $8.6 million in general and administrative expenses and $0.9 million in selling expense. These increases were partially offset by a $3.0 million gain related to the termination of licensing agreements during the first nine months of 2010.
Selling expense was $285.5 million in the first nine months of 2010, relatively flat when compared to the same period in 2009. Selling expense reflects decreased advertising spend and lower fixed asset write-offs compared to the prior year period offset by higher incentive compensation costs.
We include the costs of physically managing inventory (warehousing and handling costs) in selling expense. These costs totaled $25.3 million and $27.4 million in the first nine months of 2010 and 2009, respectively.
In the first nine months of 2010 and 2009, we recorded $2.0 million and $1.6 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 $14.6 million and $11.5 million for the nine months ended October 1, 2010 and October 2, 2009, respectively.
Advertising expense, which is included in selling expense, was $18.0 million and $19.0 million in the first nine months of 2010 and 2009, respectively. A decrease in television campaigns, and the associated production costs, was partially offset by continued investment in brand concept, Internet and other initiatives, and co-op advertising. 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.
General and administrative expense for the first nine months of 2010 was $89.7 million, an increase of 10.6% compared to the $81.1 million reported in the first nine months of 2009, driven by increases in incentive compensation and other employee related costs of $5.7 million, as well as $2.2 million in incremental costs related to initiatives in preparation for a multi-year ERP system implementation.
Total operating expense in the first nine months of 2010 also includes an impairment charge of $7.8 million related to certain intangible assets, an impairment charge of $5.4 million related to goodwill, and gains of $3.0 million associated with the termination of certain licensing agreements. Total operating expense in the first nine months of 2009 included a charge of $0.9 million for the impairment of a trademark. See Notes 2 and 9 to the unaudited condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information.
Operating Income
We recorded operating income of $72.6 million in the first nine months of 2010, compared to $40.3 million in the prior year period. The improvement year over year was driven by solid revenue growth and a 350 basis point improvement in gross margin. Operating income in the first nine months of 2010 included a goodwill and intangible asset impairment charge of $13.2 million and gains on termination of licensing agreements of $3.0 million, compared to a $0.9 million intangible asset impairment charge and restructuring credits of $0.2 million included in operating income in the first nine months of 2009.
Other Income/(Expense) and Taxes
Interest income was $0.3 million and $0.8 million in the first nine months of 2010 and 2009, respectively, reflecting lower interest rates. Interest expense, which is comprised of fees related to the establishment and maintenance of our revolving credit facility and bank guarantees, was $0.4 million in the first nine months of both 2010 and 2009.
Other, net, included foreign exchange gains of $5.4 million and $1.9 million in the first nine months of 2010 and 2009, 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 foreign currency denominated receivables and payables. These results were driven by the volatility of exchange rates within the first nine months of 2010 and 2009 and should not be considered indicative of expected future results.
The effective income tax rate for the first nine months of 2010 was 30.4%. The 2010 rate was impacted by the release of approximately $3.9 million in tax accruals as a result of final approval associated with tax clearance for certain closed foreign operations, as well as the lapse of certain statutes of limitation, in the third quarter of 2010. The effective income tax rate for
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the first nine months of 2009 was 22.5%. The 2009 rate was impacted by a benefit of approximately $7.3 million due to the closure of certain audits or the lapse of certain statutes of limitation in the first nine months of 2009.
In December 2009, we received a Notice of Assessment from the Internal Revenue Department of Hong Kong for approximately $17.6 million with respect to the tax years 2004 through 2008. In connection with the assessment, the Company made required payments to the Internal Revenue Department of Hong Kong totaling approximately $8.4 million in the first nine months of 2010. We believe we have a sound defense to the proposed adjustment and will continue to firmly oppose the assessment. We believe that the assessment does not impact the level of liabilities for our income tax contingencies. However, actual resolution may differ from our current estimates, and such differences could have a material impact on our future effective tax rate and our results of operations.
Segments Review
Revenue by segment for the nine months ended October 1, 2010 compared to the nine months ended October 2, 2009 is as follows (dollars in millions):
For the Nine Months Ended | ||||||||||||
October 1, | October 2, | |||||||||||
2010 | 2009 | % Change | ||||||||||
North America | $ | 395.3 | $ | 394.4 | 0.2 | % | ||||||
Europe | 422.5 | 399.9 | 5.7 | % | ||||||||
Asia | 120.5 | 103.8 | 16.0 | % | ||||||||
$ | 938.3 | $ | 898.1 | 4.5 | % | |||||||
Operating income/(loss) by segment and as a percentage of revenue for the nine months ended October 1, 2010 and October 2, 2009 are included in the table below (dollars in millions). Segment operating income is presented as a percentage of its respective segment revenue. Unallocated Corporate expenses are presented as a percentage of total revenue. North America includes impairment charges of $8.1 million and a gain related to the termination of licensing agreements of $3.0 million in the nine months ended October 1, 2010. Europe includes impairment charges of $5.1 million and $0.9 million in the nine months ended October 1, 2010 and October 2, 2009, respectively.
For the Nine Months Ended | ||||||||||||||||
October 1, | October 2, | |||||||||||||||
2010 | 2009 | |||||||||||||||
North America | $ | 68.1 | 17.2 | % | $ | 52.4 | 13.3 | % | ||||||||
Europe | 76.8 | 18.2 | % | 60.6 | 15.2 | % | ||||||||||
Asia | 15.6 | 13.0 | % | 5.5 | 5.3 | % | ||||||||||
Unallocated Corporate | (87.9 | ) | (9.4 | )% | (78.2 | ) | (8.7 | )% | ||||||||
$ | 72.6 | 7.7 | % | $ | 40.3 | 4.5 | % | |||||||||
North America
North America revenues were $395.3 million in the first nine months of 2010, flat compared to the same period in 2009. Growth in SmartWool® accessories and Timberland® apparel, as well as strong growth in our Timberland PRO® footwear line was partially offset by declines in other footwear across all genders. Within North America, our retail business was relatively
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flat, as a 1.0% increase in comparable store sales was partially offset by the closure of 4 stores.
Operating income for our North America segment was $68.1 million, compared to $52.4 million for the first nine months of 2009. The increase was driven by a 585 basis point improvement in gross margin, due primarily to favorable mix impacts, reduced product costs, less promotional activity in retail, and lower provisions for inventory and sales returns and allowances. Operating expenses increased 7.3% reflecting goodwill and intangible asset impairment charges of $8.1 million, primarily related to IPath, and increases in certain marketing initiatives and selling related costs. These items were partially offset by a gain of $3.0 million associated with the termination of licensing agreements and a reduction of $0.7 million associated with fixed asset write-offs taken in 2009 related to our e-commerce business and underperforming retail stores.
Europe
Europe recorded revenues of $422.5 million in the first nine months of 2010, which was a 5.7% increase from the first nine months of 2009, and an increase of 7.9% on a constant dollar basis. Growth across our major markets in Europe, in particular Scandinavia, Southern Europe and Central Europe, was partially offset by declines in the Benelux region and certain distributor markets, such as Greece and the Middle East. The increases were driven by strong growth in footwear sales through the wholesale channel, as well as modest growth in our retail stores. Strength in retail apparel and wholesale accessories sales was partially offset by wholesale apparel revenue declines. Retail growth of 3.6% was driven by comparable store sales growth of 4.0%, and impacted by unfavorable foreign exchange rate changes.
Timberland’s Europe segment recorded operating income of $76.8 million in the first nine months of 2010, compared to $60.6 million in the first nine months of 2009. Improvement in Europe was driven by revenue growth as well as a 120 basis point increase in gross margin from lower product costs and favorable channel mix, partially offset by unfavorable foreign exchange rate impacts. Operating expenses were flat year over year, as the impact of a $5.1 million impairment charge related primarily to our howies and IPath trademarks was offset by favorable foreign exchange rate impacts and a decrease in government taxes on certain foreign investments. Operating expense for the 2009 period included a charge of $0.9 million for the impairment of the GoLite trademark.
Asia
In Asia, revenues increased 16.0%, or 10.8% in constant dollars, to $120.5 million in the first nine months of 2010 due to strong growth in apparel and men’s footwear in both wholesale and retail channels. Retail revenues were up 15.1%, driven by comparable store sales growth of 8.4%, the net addition of 10 stores, and favorable foreign exchange rate impacts.
Asia had operating income of $15.6 million for the first nine months of 2010, compared to $5.5 million for the first nine months of 2009, driven by revenue growth and a 365 basis point improvement in gross margin, reflecting favorable foreign exchange rate impacts, lower levels of sales returns and allowances and reduced product costs. Operating expenses increased 6.1% driven primarily by unfavorable foreign exchange rate impacts and higher selling related and incentive compensation costs.
Unallocated Corporate
Our Unallocated Corporate expenses, which include central support and administrative costs not allocated to our reportable business segments, increased 12.4% to $87.9 million in the first nine months of 2010, which reflects higher incentive compensation and other employee related costs, incremental costs related to a multi-year ERP system implementation, and unfavorability in certain supply chain costs, primarily inventory cost variances, which are not allocated to our reportable segments, partially offset by decreased advertising costs.
Reconciliation of Total Company, Europe and Asia Revenue Increases/(Decreases) To Constant Dollar Revenue Increases/(Decreases)
Total Company Revenue Reconciliation:
For the Quarter | For the Nine Months | |||||||||||||||
Ended October 1, 2010 | Ended October 1, 2010 | |||||||||||||||
$ Millions | $ Millions | % | ||||||||||||||
Change | % Change | Change | Change | |||||||||||||
Revenue increase (GAAP) | $ | 10.6 | 2.5 | % | $ | 40.2 | 4.5 | % | ||||||||
Decrease due to foreign exchange rate changes | (11.4 | ) | -2.7 | % | (1.7 | ) | -0.2 | % | ||||||||
Revenue increase in constant dollars | $ | 22.0 | 5.2 | % | $ | 41.9 | 4.7 | % |
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Europe Revenue Reconciliation:
For the Quarter | For the Nine Months | |||||||||||||||
Ended October 1, 2010 | Ended October 1, 2010 | |||||||||||||||
$ Millions | % | $ Millions | ||||||||||||||
Change | Change | Change | % Change | |||||||||||||
Revenue increase (GAAP) | $ | 9.6 | 5.0 | % | $ | 22.7 | 5.7 | % | ||||||||
Decrease due to foreign exchange rate changes | (14.3 | ) | -7.3 | % | (8.7 | ) | -2.2 | % | ||||||||
Revenue increase in constant dollars | $ | 23.9 | 12.3 | % | $ | 31.4 | 7.9 | % |
Asia Revenue Reconciliation:
For the Quarter | For the Nine Months | |||||||||||||||
Ended October 1, 2010 | Ended October 1, 2010 | |||||||||||||||
$ Millions | $ Millions | |||||||||||||||
Change | % Change | Change | % Change | |||||||||||||
Revenue increase (GAAP) | $ | 7.7 | 19.7 | % | $ | 16.6 | 16.0 | % | ||||||||
Increase due to foreign exchange rate changes | 2.5 | 6.4 | % | 5.4 | 5.2 | % | ||||||||||
Revenue increase in constant dollars | $ | 5.2 | 13.3 | % | $ | 11.2 | 10.8 | % |
The difference between changes in reported revenue (the most comparable GAAP measure) and constant dollar revenue changes is the impact of foreign currency exchange rates. We calculate constant dollar revenue changes by recalculating current year revenue using the prior year’s exchange rates and comparing it to the prior year revenue reported on a GAAP basis. We provide constant dollar revenue changes for Total Company, Europe and Asia results because we use the measure to understand the underlying results and trends of the business segments excluding the impact of exchange rate changes that are not under management’s direct control. We have a foreign exchange rate risk management program intended to minimize both the positive and negative effects of currency fluctuations on our reported consolidated results of operations, financial position and cash flows. The actions taken by us to mitigate foreign exchange risk are reflected in cost of goods sold and other, net.
Accounts Receivable and Inventory
Accounts receivable were $269.0 million at October 1, 2010, compared with $149.2 million as of December 31, 2009 and $270.3 million as of October 2, 2009. Days sales outstanding were 56 days as of October 1, 2010, compared with 35 days as of December 31, 2009 and 58 days as of October 2, 2009. Wholesale days sales outstanding were 61 days for the third quarter of 2010, 45 days at December 31, 2009 and 63 days for the third quarter of 2009.
Inventory was $239.8 million as of October 1, 2010, compared with $158.5 million at December 31, 2009 and $201.7 million as of October 2, 2009. The increase in inventory at the end of the third quarter of 2010 compared to the third quarter of 2009 is driven by the timing of inventory receipts and higher input costs.
Liquidity and Capital Resources
Net cash used by operations for the first nine months of 2010 was $93.9 million, compared to $62.7 million for the first nine months of 2009. The increase in cash use was due primarily to the timing of inventory receipts.
Net cash used for investing activities was $11.5 million in the first nine months of 2010, compared with $13.2 million in the first nine months of 2009. Cash used in the first nine months of 2009 included approximately $1.5 million for the acquisition of Glaudio.
Net cash used by financing activities was $71.4 million in the first nine months of 2010, compared with $29.0 million in the first nine months of 2009. Cash flows used for financing activities reflect share repurchases of $73.7 million in the first nine
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months of 2010, compared with $29.3 million in the first nine months of 2009. We received cash inflows of $2.6 million in the first nine months of 2010 from the exercise of employee stock options, compared with $1.4 million from such exercises in the first nine months of 2009.
We are exposed to the credit risk of those parties with which we do business, including counterparties on our derivative contracts and our customers. Derivative instruments expose us to credit and market risk. The market risk associated with these instruments resulting from currency exchange movements is expected to offset the market risk of the underlying transactions being hedged. We do not believe there is a significant risk of loss in the event of non-performance by the counterparties associated with these instruments because these transactions are executed with a group of major financial institutions and have varying maturities through January 2012. As a matter of policy, we enter into these contracts only with counterparties having a minimum investment-grade or better credit rating. Credit risk is managed through the continuous monitoring of exposures to such counterparties.
Additionally, consumer spending continues to be affected by the current macro-economic environment, particularly the disruption of the credit and stock markets and high unemployment. Continued deterioration, or lack of improvement, in the markets and economic conditions generally could adversely impact our customers and their ability to access credit.
We may utilize our committed and uncommitted lines of credit to fund our seasonal working capital needs. We have not experienced any restrictions on the availability of these lines and the adverse capital and credit market conditions are not expected to significantly affect our ability to meet our liquidity needs.
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. Any letters of credit outstanding under the Agreement ($1.6 million at October 1, 2010) reduce the amount available for borrowing under the Agreement. 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 0.4% at October 1, 2010), plus an applicable margin based on a fixed-charge coverage grid of between 13.5 and 47.5 basis points that is adjusted quarterly. As of October 1, 2010, the applicable margin under the facility was 47.5 basis points. We 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 October 1, 2010, the commitment fee was 15 basis points. The Agreement places certain limitations on additional debt, stock repurchases, acquisitions, and the amount of dividends we may pay, and includes certain other financial and non-financial covenants. The primary financial covenants relate to maintaining a minimum fixed-charge coverage ratio of 2.25:1 and a maximum leverage ratio of 2:1. We measure compliance with the financial and non-financial covenants and ratios as required by the terms of the Agreement on a fiscal quarter basis. The continued volatility in the credit markets could result in significant increases in borrowing costs for any new facility we may require. Our ability to obtain new financing with comparable terms upon the maturity of our existing facility will depend upon prevailing market conditions, our financial condition and the terms and conditions available at the time of such financing.
We have uncommitted lines of credit available from certain banks which totaled $30 million at October 1, 2010. Any borrowings under these lines would be at prevailing money market rates. Further, we have 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 at our option.
We had no borrowings outstanding under any of our credit facilities during, or as of, the quarters and nine months ended October 1, 2010 and October 2, 2009.
Management believes that our operating costs, capital requirements and funding for our share repurchase program for the balance of 2010 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 financing. We are undertaking a multi-year Business Transformation Initiative pursuant to which we will develop and implement an ERP system to better support our business model and further streamline our operations. It is the Company’s intent to finance these costs with cash from operations, without the need for additional financing. However, as discussed in the sections entitled “Cautionary Statements for Purposes of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995” and “Forward Looking Information” on page 2 of this Quarterly Report on Form 10-Q and in Part II, Item 1A, Risk
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Factors, of this Quarterly Report on Form 10-Q, several risks and uncertainties could require that the Company 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 financing will depend upon prevailing market conditions, our financial condition and the terms and conditions of such financing. The continued volatility in the credit markets could result in significant increases in borrowing costs for any new debt we may require.
Off-Balance Sheet Arrangements
Letters of Credit
Letters of Credit
As of October 1, 2010, December 31, 2009 and October 2, 2009, we had letters of credit outstanding of $15.8 million, $16.6 million and $16.9 million, respectively. These letters of credit were issued principally in support of real estate commitments.
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 related 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.
New Accounting Pronouncements
A discussion of new accounting pronouncements, none of which had a material impact on our operations, financial condition or liquidity, is included in Note 1 to the unaudited condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the normal course of business, our financial position and results of operations are routinely subject to a variety of risks, including market risk associated with interest rate movements on borrowings and investments and currency rate movements on non-U.S. dollar denominated assets, liabilities and cash flows. We regularly assess these risks and have established policies and business practices that should mitigate a portion of the adverse effect of these and other potential exposures.
We utilize cash from operations and U.S. dollar denominated borrowings to fund our working capital and investment needs. Short-term debt, if required, is used to meet working capital requirements and long-term debt, if required, is generally used to finance long-term investments. In addition, we use derivative instruments to manage the impact of foreign currency fluctuations on a portion of our foreign currency transactions. These derivative instruments are viewed as risk management tools and are not used for trading or speculative purposes. Cash balances are invested in high-grade securities with terms of 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 lender’s cost of funds, plus an applicable spread, or prevailing money market rates. As of October 1, 2010 and October 2, 2009, 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 mitigate the impact of these foreign currency fluctuations through a risk management program that includes the use of derivative financial instruments, primarily foreign currency forward contracts. These derivative instruments are carried at fair value on our balance sheet. The Company has implemented a program that qualifies for hedge accounting treatment to aid in mitigating our foreign currency exposures and decreasing the volatility of our earnings. The foreign currency forward contracts under this program will expire in 15 months or less. Based upon a sensitivity analysis as of October 1, 2010, a 10% change in foreign exchange rates would cause the fair value of our derivative instruments to increase/decrease by approximately $21.3 million, compared to an increase/decrease of $12.2 million at December 31, 2009 and an increase/decrease of $15.6 million at October 2, 2009.
Item 4. CONTROLS AND PROCEDURES
We maintain a system of disclosure controls and procedures which are designed to ensure that information required to be disclosed by us in reports we file or submit under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded,
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processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. These disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed under the federal securities laws is accumulated and communicated to our management on a timely basis to allow decisions regarding required disclosure.
Based on their evaluation, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, were effective as of the end of the period covered by this report.
There were no changes in our internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, that occurred during the quarter ended October 1, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Part II - OTHER INFORMATION
Item 1A. RISK FACTORS
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in the section entitled “Cautionary Statements for Purposes of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995” on page 2 of our Annual Report on Form 10-K for the year ended December 31, 2009 (our “Annual Report on Form 10-K”), in the section entitled “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K, and in the section entitled “Risk Factors” in Part II, Item 1A of any Quarterly Report on Form 10-Q filed subsequent to our Annual Report on Form 10-K, which could materially affect our business, financial condition or future results. The risks described in this Quarterly Report on Form 10-Q, in our Annual Report on Form 10-K, and in any Quarterly Report on Form 10-Q filed subsequent to our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or future results.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ISSUER PURCHASES OF EQUITY SECURITIES(1)
For the Three Fiscal Months Ended October 1, 2010
Total Number | Maximum Number | |||||||||||||||
of Shares | of Shares | |||||||||||||||
Purchased as Part | That May Yet | |||||||||||||||
Total Number | of Publicly | Be Purchased | ||||||||||||||
of Shares | Average Price | Announced | Under the Plans | |||||||||||||
Period* | Purchased ** | Paid per Share | Plans or Programs | or Programs | ||||||||||||
July 3 – July 30 | 24,850 | $ | 17.90 | 24,850 | 4,952,383 | |||||||||||
July 31 – August 27 | 611,235 | 17.33 | 611,235 | 4,341,148 | ||||||||||||
August 28 – October 1 | 1,042,171 | 18.17 | 1,042,171 | 3,298,977 | ||||||||||||
Q3 Total | 1,678,256 | $ | 17.86 | 1,678,256 |
Footnote (1)
Approved | ||||||||||||
Announcement | Program | Expiration | ||||||||||
Date | Size (Shares) | Date | ||||||||||
Program 1 | 12/09/2009 | 6,000,000 | None |
* Fiscal month
** Based on trade date - not settlement date
** Based on trade date - not settlement date
Table of Contents
Form 10-Q
Page 36
Page 36
Item 6. EXHIBITS
Exhibits.
Exhibit 31.1 – Principal Executive Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.
Exhibit 31.2 – Principal Financial Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.
Exhibit 32.1 – Chief Executive Officer Certification Pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, furnished herewith.
Exhibit 32.2 – Chief Financial Officer Certification Pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, furnished herewith.
Exhibit 101.INS – XBRL Instance Document
Exhibit 101.SCH – XBRL Taxonomy Extension Schema Document
Exhibit 101.CAL – XBRL Taxonomy Extension Calculation Linkbase Document
Exhibit 101.LAB – XBRL Taxonomy Extension Label Linkbase Document
Exhibit 101.PRE – XBRL Taxonomy Extension Presentation Linkbase Document
Exhibit 101.DEF – XBRL Taxonomy Extension Definition Linkbase Document
Table of Contents
Form 10-Q
Page 37
Page 37
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
THE TIMBERLAND COMPANY (Registrant) | ||||
Date: November 4, 2010 | By: | /s/ JEFFREY B. SWARTZ | ||
Jeffrey B. Swartz | ||||
Chief Executive Officer | ||||
Date: November 4, 2010 | By: | /s/ CARRIE W. TEFFNER | ||
Carrie W. Teffner | ||||
Chief Financial Officer |
Table of Contents
Form 10-Q
Page 38
Page 38
EXHIBIT INDEX
Exhibit | Description | |
Exhibit 31.1 | Principal Executive Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith. | |
Exhibit 31.2 | Principal Financial Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith. | |
Exhibit 32.1 | Chief Executive Officer Certification Pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, furnished herewith. | |
Exhibit 32.2 | Chief Financial Officer Certification Pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, furnished herewith. | |
Exhibit 101.INS | XBRL Instance Document | |
Exhibit 101.SCH | XBRL Taxonomy Extension Schema Document | |
Exhibit 101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | |
Exhibit 101.LAB | XBRL Taxonomy Extension Label Linkbase Document | |
Exhibit 101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document | |
Exhibit 101.DEF | XBRL Taxonomy Extension Definition Linkbase Document |