EX-13 3 a2106481zex-13.txt EXHIBIT 13 [Timberland Logo Appears Here] Table of Contents FINANCIAL REVIEW Five Year Summary of Selected Financial Data..................... 30 Management's Discussion and Analysis of Financial Condition and Results of Operations........................................ 31 Consolidated Balance Sheets...................................... 39 Consolidated Statements of Income................................ 40 Consolidated Statements of Changes in Stockholders' Equity....... 41 Consolidated Statements of Cash Flows............................ 42 Notes to Consolidated Financial Statements....................... 43 INDEPENDENT AUDITORS' REPORT............................................. 55 CORPORATE INFORMATION.................................................... 56 29 FINANCIAL REVIEW FIVE YEAR SUMMARY OF SELECTED FINANCIAL DATA Selected Statement of Income Data (Dollars in Thousands, Except Per Share Data)
Years Ended December 31, 2002 2001 2000 1999 1998 ------------------------ ------ ------ ------ ------ ------ Revenue $1,190,896 $1,183,623 $1,091,478 $917,216 $862,168 Net income before extraordinary item and cumulative effect of change in accounting principle 90,200 106,741 124,124 75,247 59,156 Net income(1) 95,113 106,741 121,998 75,247 59,156 Earnings per share before extraordinary item and cumulative effect of change in accounting principle Basic $2.42 $2.73 $3.09 $1.75 $1.29 Diluted $2.36 $2.65 $2.91 $1.70 $1.26 Earnings per share after extraordinary item and cumulative effect of change in accounting principle Basic $2.55 $2.73 $3.04 $1.75 $1.29 Diluted $2.49 $2.65 $2.86 $1.70 $1.26 ---------- ---------- --------- ------- -------
(1) In 2002, the Company recorded a $4,913 after-tax cumulative effect of change in accounting principle gain. In 2000, the Company recorded a $2,126 after-tax extraordinary loss related to the early redemption of $100,000 in senior notes. Selected Balance Sheet Data (Dollars in Thousands)
December 31, 2002 2001 2000 1999 1998 ------------ ------ ------ ------ ------ ------ Cash and equivalents $141,195 $105,658 $114,852 $196,085 $151,889 Working capital 286,027 277,041 236,687 302,286 291,835 Total assets 538,671 504,612 476,311 493,311 469,467 Total long-term debt - - - 100,000 100,000 Stockholders' equity 372,785 359,238 316,751 272,368 266,193 -------- -------- -------- -------- --------
30 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discusses The Timberland Company's (the "Company") results of operations and liquidity and capital resources. The discussion, including known trends and uncertainties identified by management, should be read in conjunction with the consolidated financial statements and related notes. Critical Accounting Policies The Company's discussion and analysis of its financial condition and results of operations are based upon the Company's 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 the Company 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, the Company evaluates its estimates, including those related to sales returns and allowances, realizability of outstanding accounts receivable, the carrying value of inventories, derivatives, other contingencies, impairment of assets and the provision for income taxes. The Company bases its 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 the Company's estimates. However, results may differ from these estimates under different assumptions or conditions. The Company's significant accounting policies are described in Note 1 to the Company's consolidated financial statements. The Company has identified the following as critical accounting policies, based on the significant judgments and estimates used in determining the amounts reported in its consolidated financial statements: Sales Returns and Allowances The Company's revenue consists of sales to customers, license fees and royalties. Revenue is recognized either upon shipment of product to customers or, for retail customers, at point of sale. License fees and royalties are recognized when earned. The Company records reductions to revenue for estimated customer returns and allowances. The Company bases its estimates on historical rates of customer returns and allowances, as well as the specific identification of outstanding returns and allowances, which are known to the Company but which have not yet been received. The actual amount of customer returns or allowances, which is inherently uncertain, may differ from the Company's estimates. If the Company were to determine that increases or decreases to sales returns and allowances were appropriate, the Company would record either a reduction or increase to net sales in the period in which it made such a determination. Accounts Receivable The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. The Company estimates potential losses primarily based upon the Company's historical rate of credit losses and its knowledge of the financial condition of its customers. Historically, losses have been within the Company's expectations. If the financial condition of the Company's customers were to change, adjustments may be required to these estimates. Furthermore, the Company provides for estimated losses resulting from disputes which arise with respect to the gross carrying value of its receivables and the amounts which customers estimate are owed to the Company. The settlement or resolution of these differences could result in future changes to these estimates. If the Company were to determine that increases or decreases to the allowance for doubtful accounts were appropriate, the Company would record either an increase or decrease to selling expense in the period the Company made such a determination. Inventory Valuation The Company values its inventory at the lower of cost (first-in, first-out) or market. Market value is estimated based upon assumptions made about future demand and retail market conditions. If the Company were to determine that the estimated market value of its inventory is less than the carrying value of such inventory, the Company would provide a reserve for such difference as a charge to cost of sales. If actual market conditions are more or less favorable than those projected by the Company, adjustments to those inventory reserves may be required. The adjustments would decrease or increase the Company's cost of sales and net income in the period in which they were realized or recorded. Derivatives The Company is routinely subject to currency rate movements on non-U.S. dollar denominated assets, liabilities and income as the Company purchases and sells goods in local currencies. Derivative instruments, specifically forward contracts, are used by the Company in its hedging of forecasted foreign currency transactions. The Company uses its operating budget and periodic forecasts to estimate its future economic exposure and to determine the appropriate levels and timing of its related hedging transactions. The 31 Company closely monitors its foreign currency exposure and adjusts its hedge positions accordingly. By their very nature, the Company's estimates of anticipated transactions may fluctuate over time and may vary from the ultimate transactions (see Note 2). Future operating results may be impacted by adjustments to these estimates. Contingencies In the ordinary course of business, the Company is involved in legal proceedings involving contractual and employment relationships, product liability claims, trademark rights and a variety of other matters. The Company records contingent liabilities resulting from claims when it is probable that a liability has been incurred and the amount of the loss is reasonably estimable. Estimating probable losses requires analysis of multiple factors, in some cases including judgments about the potential actions of third party claimants and courts. Therefore, actual losses in any future period are inherently uncertain. The Company believes that its contingent liabilities adequately reserve for any pending legal proceedings or claims. However, if actual or estimated probable future losses exceed, or are less than, the recorded liability for such claims, the Company would record an adjustment during the period in which the actual loss or change in estimate occurred. Long-lived Assets When events or circumstances indicate that the carrying value of a long-lived asset may be impaired, the Company estimates the future undiscounted cash flows to be derived from the asset to determine whether or not a potential impairment exists. If the carrying value exceeds the estimate of future undiscounted cash flows, an impairment is calculated as the excess of the carrying value of the asset over the estimate of its fair market value. The Company estimates future undiscounted cash flows using assumptions about expected future operating performance. Those estimates of undiscounted cash flows may differ from actual cash flows due to, among other things, technological changes, economic conditions, or changes to business operations. For fiscal 2002, other than immaterial retail store closing charges, no significant impairment related to the carrying value of the Company's long-lived assets has been recorded. Goodwill The Company is required to test its goodwill for impairment at least on an annual basis. That test requires that the fair value of a reporting unit is compared with its carrying amount, including goodwill. The Company establishes fair value by calculating the present value of the future cash flows of the reporting unit. The Company uses assumptions about expected future operating performance in determining estimates of those cash flows. Those estimates of cash flows may differ from actual cash flows. For fiscal 2002, there was no impairment of the Company's goodwill. Income Taxes The Company generates deferred tax assets and liabilities based upon book to tax differences. The carrying value of the Company's net deferred tax assets assumes that the Company will be able to generate sufficient future taxable income in certain tax jurisdictions to realize the value of these assets. If the Company is unable to generate sufficient future taxable income in these jurisdictions, an adjustment may be required in the net carrying value of the deferred tax assets, which would result in additional income tax expense in the Company's consolidated statements of income. Management evaluates the realizability of the deferred tax assets and assesses the need for any valuation adjustment quarterly. On an interim basis, the Company estimates what the effective tax rate will be for the full fiscal year and records a quarterly income tax provision in accordance with the anticipated annual rate. As the fiscal year progresses, that estimate is continually refined based upon actual events and earnings by jurisdiction during the year. This continual estimation process periodically results in a change to the expected effective tax rate for the fiscal year. When this occurs, the Company adjusts the income tax provision during the quarter in which the change in estimate occurs so that the year-to-date provision equals the expected annual rate (see Note 12). 32 RESULTS OF OPERATIONS (Amounts in Thousands, Except Per Share Data)
Years Ended December 31, 2002 2001 2000 --------------------- --------------------- ----------------------- Revenue $1,190,896 100.0% $1,183,623 100.0% $1,091,478 100.0% Gross profit 518,286 43.5 520,775 44.0 508,512 46.6 Operating expense 379,461 31.9 357,682 30.2 324,340 29.7 Operating income 138,825 11.7 163,093 13.8 184,172 16.9 Interest expense 884 0.1 1,560 0.1 5,648 0.5 Other, net (828) 0.1 (196) 0.0 (8,128) 0.7 Net income before extraordinary item and cumulative effect of change in accounting principle ---------- -------- --------- ------ --------- ------ 90,200 7.6 106,741 9.0 124,124 11.4 Extraordinary item - loss on debt extinguishment, net of tax benefit of $1,071 - - - - (2,126) (0.2) Cumulative effect of change in accounting principle 4,913 0.4 - - - - ---------- -------- --------- ------ --------- ------ Net income $ 95,113 8.0 $ 106,741 9.0 $ 121,998 11.2 ========== ======== ========= ====== ========= ====== Earnings per share before extraordinary item and cumulative effect of change in accounting principle Basic $2.42 $2.73 $3.09 Diluted $2.36 $2.65 $2.91 Earnings per share after extraordinary item and cumulative effect of change in accounting principle Basic $2.55 $2.73 $3.04 Diluted $2.49 $2.65 $2.86 Weighted-average shares outstanding Basic 37,208 39,043 40,119 Diluted 38,142 40,247 42,647 ---------- --------- ---------
Revenue Overview Revenue increased to $1,190.9 million in 2002, from $1,183.6 million in 2001 and $1,091.5 million in 2000. This represents an increase of 0.6% in 2002 and an 8.4% increase in 2001, each compared with the prior year. In 2002, compared with 2001, domestic revenue, which comprised 66.0% of the Company's business, declined 5.8%. This decline, which occurred primarily in the wholesale boot business, reflects the steps the Company has taken to control supply in order to position for future growth. The mix impact of the boot decline adversely impacted the Company's average selling prices. Additionally, U.S. Consumer Direct revenue declined 6.5%, in part due to aggressive promotions by competitors and the overall weakness in the U.S. retail climate. Offsetting these declines domestically, the U.S. wholesale apparel business increased by 9.2%. Internationally, revenue increased 16.0%, primarily due to Europe's growth across all products, channels and markets. Additionally, the increased strength of the euro, in relation to the dollar, resulted in revenue improvement related to foreign exchange. Asia had mid single-digit growth for the year. In 2001, compared with 2000, domestic revenue, which comprised 70.5% of the Company's business, increased 6.0%. This increase occurred primarily in the wholesale boot business and reflected a strong first-half performance. In the second half of 2001, softness in U.S. market conditions and a negative impact from the Company's disciplined approach to the management of the boot business led to a lesser increase in boot revenue than in the first-half of 2001. That impacted sales allowances and affected product mix, reducing wholesale footwear average selling prices for the year, compared with 2000. In apparel and accessories, the domestic wholesale business had strong performance, with a 24.9% revenue improvement over 2000. U.S. Consumer Direct revenue increased 2.2% in 2001, compared with 2000. Although unit volumes increased in both footwear and apparel and accessories, average selling prices declined, primarily as a result of the Company's focus on managing inventory levels and, to a lesser degree, product mix, both in part resulting from the soft U.S. market conditions. Internationally, the 14.7% revenue increase reflected increases in apparel and accessories and footwear across all channels and markets. These increases were partially offset by a negative impact from the euro weakening in relation to the dollar, when compared with 2000. Segments The Company has three reportable business segments (see Note 15): U.S. Wholesale, U.S. Consumer Direct (formerly U.S. Retail-commencing in 2001, U.S. Consumer Direct includes the Company's e-commerce business) and International. Domestic revenue, comprised of the U.S. Wholesale and U.S. Consumer Direct segments, amounted to $785.7 million in 2002, $834.2 million in 2001 and $787.0 million in 2000, or 66.0%, 70.5% and 72.1% of total revenue for each of the three years, respectively. U.S. Wholesale segment revenue decreased to $595.2 33 million in 2002, from $630.6 million in 2001, and increased from $587.7 million in 2000. This represents a decrease of 5.6% in 2002, compared with 2001, primarily due to footwear average selling prices, resulting from the mix of product sold, primarily reflecting a reduction in boot revenue, driven by the steps that the Company has taken to control the supply of boot products in order to position the boot business for future growth. Additionally, the Company experienced increased off-price sales in a difficult retail market. The increase of 7.3% in 2001, compared with 2000, was primarily due to footwear unit sales and, to a lesser degree, apparel and accessories unit sales. The increases in 2001, compared with 2000, were partially offset by a reduction in footwear average selling prices, primarily due to sales and allowances and, to a lesser degree, product mix. U.S. Consumer Direct segment revenue decreased to $190.4 million in 2002, from $203.6 million in 2001 and $199.3 million in 2000. This represents a decrease of 6.5% in 2002, compared with 2001. The decrease was primarily due to a reduction in apparel and accessories unit sales, in part due to aggressive promotions by competitors and overall weakness in the U.S. retail climate. Given the economic conditions in the U.S., the Company intends to control store growth in its U.S. retail business and focus on enhancing returns at current locations. U.S. Consumer Direct segment revenue increased 2.2% in 2001, compared with 2000, primarily due to footwear unit sales and, to a lesser degree, apparel and accessories unit sales, primarily offset by a reduction in average selling prices. This reduction in average selling prices was primarily the result of the Company's effort to manage inventory levels and, to a lesser degree, mix of product sold. Comparable domestic store sales decreased 8.5% in 2002, compared with 2001, and decreased 4.5% in 2001, compared with 2000. International segment revenue increased to $405.2 million in 2002, from $349.4 million in 2001 and $304.5 million in 2000. This represents an increase of 16.0% in 2002, compared with 2001, and 14.7% in 2001, compared with 2000. The increase in 2002, compared with 2001, was primarily due to European footwear and, to a lesser degree, apparel and accessories unit volume increases across all channels and markets, most predominantly in wholesale, and to the impact of foreign exchange. Asia had mid single-digit growth for the year. The increase in 2001, compared with 2000, was due to unit volume increases in apparel and accessories and footwear across all channels, partially offset by the impact of foreign exchange. On a constant dollar basis, which restates current year revenue at prior year foreign exchange rates, International segment revenue increased 12.3% in 2002 and 19.6% in 2001, each compared to the prior year. Products Worldwide footwear revenue was $888.6 million in 2002, $898.7 million in 2001 and $838.0 million in 2000. This represents a decrease of 1.1% in 2002 and an increase of 7.2% in 2001, each compared with the prior year. The revenue decrease in 2002, compared with 2001, was primarily related to lower U.S. Boot revenue, which contributed to an overall reduction in U.S. Wholesale average selling prices, as discussed previously, partially offset by increased unit sales in worldwide wholesale and International retail and, to a lesser degree, the impact of foreign exchange. By product, the decrease was primarily attributable to unit volume declines in U.S. Wholesale Boots and, to a lesser degree, Outdoor Performance. These decreases were partially offset by revenue increases in worldwide Kids', Women's casual and the Timberland PRO(TM) series. The revenue increase in 2001, compared with 2000, was primarily due to U.S. Wholesale unit sales and, to a lesser degree, International wholesale unit sales. These increases were partially offset by a decline in average selling prices, primarily due to sales allowances and, to a lesser degree, product mix and the impact of foreign exchange. By product, the increase in 2001 was primarily attributable to unit volume growth in U.S. Wholesale Boots and, to a lesser degree, Kids', the Timberland PRO(TM) series, Boots within U.S. Consumer Direct and European Men's casual. These increases were partially offset by revenue declines in worldwide Outdoor Performance and domestic Men's casual. Worldwide footwear revenue represented 75.6%, 76.8% and 77.5% of total product revenue in 2002, 2001 and 2000, respectively. Revenue attributable to apparel and accessories was $287.4 million in 2002, $272.0 million in 2001 and $242.9 million in 2000. The revenue increase of 5.7% in 2002, compared with 2001, was primarily due to unit volume growth in Europe and, to a lesser degree, the impact of foreign exchange, partially offset by the unit volume decline in the U.S. Consumer Direct segment, as discussed previously. The revenue increase of 12.0% in 2001, compared with 2000, reflects double-digit increases in worldwide wholesale and, to a lesser degree, International retail. These increases were partially offset by a reduction in U.S. Consumer Direct average selling prices and, to a lesser degree, the impact of foreign exchange. The reduction in average selling prices was primarily due to product mix and to markdowns related to inventory control efforts. Worldwide apparel and accessories revenue represented 24.4%, 23.2% and 22.5% of total product revenue in 2002, 2001 and 2000, respectively. Channels Worldwide wholesale revenue was $886.8 million in 2002, $879.1 million in 2001 and $810.8 million in 2000. This represents an increase of 0.9% in 2002 and 8.4% in 2001, each compared with the prior year. The increase in 2002, compared with 2001, was primarily due to worldwide footwear and, to a lesser degree, International apparel and accessories unit sales and the impact of foreign exchange. These increases were primarily offset by the decline in U.S. Wholesale footwear average selling prices, as discussed previously. Both domestic and International footwear and apparel and accessories wholesale businesses increased in 2001, compared with the prior year. The increase in footwear was primarily due to U.S. Wholesale footwear unit volume increases, partially offset by a decline in average selling prices primarily due to sales allowances and, to a lesser degree, product mix. The increase in apparel and accessories wholesale revenue was primarily due to European and U.S. Wholesale unit volumes. 34 Worldwide revenue from Company-operated specialty and factory outlet stores, along with the Company's e-commerce business, was $304.1 million in 2002, $304.6 million in 2001 and $280.7 million in 2000. This represents a decrease of 0.1% in 2002 and an increase of 8.5% in 2001, each compared with the prior year. The decrease in 2002, compared with 2001, was primarily due to U.S. Consumer Direct apparel and accessories unit sales, as discussed previously, partially offset by increased International footwear and apparel and accessories unit volumes and, to a lesser degree, the impact of foreign exchange. The Company intends to control store growth in its U.S. retail business and to focus on enhancing returns at current locations. The increase in revenue in 2001, compared with 2000, was primarily due to footwear and, to a lesser degree, apparel and accessories unit volumes, partially offset by lower domestic average selling prices and the impact of foreign exchange. These increases were partially due to the addition of new retail locations. Worldwide retail revenue represented 25.5%, 25.7% and 25.7% of total revenue in 2002, 2001 and 2000, respectively. Worldwide, the Company opened 27 stores and closed 9 stores in 2002, opened 22 stores and closed 7 stores in 2001 and opened 27 stores and closed 3 stores in 2000. Gross Profit Gross profit as a percentage of revenue was 43.5% in 2002, 44.0% in 2001 and 46.6% in 2000. The decrease in 2002, compared with 2001, was primarily due to a 0.8 percentage point year over year impact of foreign currency hedging, a 0.7 percentage point impact of increased U.S. Wholesale footwear off-price sales and a 0.5 percentage point impact of incremental transportation costs related to the U.S. west coast port work stoppage during the fourth quarter of 2002. These were partially offset by a 0.5 percentage point impact from leather cost decreases and other cost reductions. At current levels, the Company expects recent improvements in foreign exchange rates to yield incremental benefits in 2003. The decrease in margin percentage in 2001, compared with 2000, was primarily due to increases in leather costs, U.S. Wholesale footwear sales returns and allowances and pressure from foreign exchange declines. Each lowered the gross margin rate by approximately 1.1 percentage points. These declines in gross margin were partially offset by the impact of mix and other cost reductions. The Company continues to review, develop and implement cost efficiencies across the supply chain in its efforts to improve gross margins. Operating Expense Operating expense was $379.5 million, or 31.9% of revenue in 2002, $357.7 million, or 30.2% of revenue in 2001 and $324.3 million, or 29.7% of revenue in 2000. The 6.1% increase in operating expense in 2002, compared with 2001, was primarily due to incentive compensation related charges (see Note 13), investment in the Company's International business, the impact of foreign exchange and other costs related to company-wide activities. Going forward, the Company expects that its initiatives to grow the International and U.S. Wholesale apparel businesses, as well as support for the Company's global brand initiatives, will likely drive expense increases at or above the rate of revenue growth. The 10.3% increase in operating expense in 2001, compared with 2000, was primarily due to investments in key growth drivers such as the expansion of the Company's Asian business, the expansion of its domestic retail business and additional sales and marketing efforts. Operating Income Operating income, which is pretax earnings before interest expense and other, net, was $138.8 million in 2002, $163.1 million in 2001 and $184.2 million in 2000. As a percentage of revenue, operating income was 11.7% in 2002, 13.8% in 2001 and 16.9% in 2000. The Company is targeting modest improvement in operating margins in 2003, excluding comparisons to the one-time U.S. west coast port work stoppage impact, as discussed previously. Segment operating income decreased in the U.S. Wholesale segment in 2002, compared with 2001. The decrease was primarily driven by a 6.5% decrease in footwear revenue, as discussed previously, on a 0.7 percentage point decrease in gross margin rates, primarily due to increased off-price sales, and an increase in operating expense rates. This decrease was partially offset by improved performance in apparel revenue, gross margin rates and operating expense rates. In the U.S. Consumer Direct segment, although revenue decreased 6.5%, improved gross margin rates generated an 8.2% increase in operating income. These improvements reflect benefits from proactive strategies to improve margins through reduced discounting and lower product costs. In the International segment, a 12.3% constant dollar revenue increase, primarily attributable to European performance, along with improved gross margin and expense rates, drove the 26.1% improvement in operating income. This performance was partially offset by the year over year impact of foreign currency hedging. The increase in the Unallocated Corporate operating loss was primarily due to incentive compensation related charges and other costs incurred in support of company-wide activities. Segment operating income decreased in the domestic segments in 2001 and improved in the International segment, compared with the prior year. In the U.S. Wholesale segment, mid single-digit revenue increases in footwear were offset by lower gross margin rates, as discussed previously, and higher expense rates, which reduced operating income by 3.0%, compared with the prior year. In the U.S. Consumer Direct segment, a 2.2% increase in revenue, combined with a decrease in gross margin rates and an increase in operating expense rates, lowered operating income by 21.1%, compared with the prior year. Internationally, segment operating income increased by 5.1% over the prior year. This increase was primarily due to improved gross margin dollars on double-digit increases in apparel and accessories and footwear revenue and, to a lesser degree, improved operating expense rates. The increase in the Unallocated Corporate operating loss in 2001, compared with 2000, was 35 primarily due to increased marketing and other costs incurred in support of company-wide activities. Interest, Other, Net and Taxes Interest expense, which is comprised of fees related to the establishment and maintenance of the Company's revolving credit facility plus interest paid on short-term borrowings and interest on long-term debt, was $0.9 million in 2002, compared with $1.6 million in 2001 and $5.6 million in 2000. The decrease in interest expense in 2002, compared with 2001, was due to lower average borrowings at lower interest rates. In 2001, the decrease in interest expense was primarily due to the prepayment of the $100.0 million senior notes in 2000 (see Note 6). Other, net includes interest income of $1.0 million in 2002, $1.2 million in 2001 and $4.9 million in 2000. Interest income in 2002 reflects lower average interest rates but higher average investments than in 2001. The decrease in interest income in 2001, compared with 2000, reflects lower cash balances resulting from the prepayment of the senior notes in 2000 and the generation of lower cash flow from operations in 2001, compared with 2000. Other, net in 2001 includes the negative impact of foreign exchange and, in 2000, reflects the receipt of $5.1 million from the Company's former Asian distributor (see Note 5). The effective income tax rate was 35.0% in 2002, 34.0% in 2001 and 33.5% in 2000. The increase in the rate is primarily due to a combination of a federal tax law change, which reduced the tax benefits associated with the Company's Puerto Rico operations and to U.S. federal tax exempt Puerto Rico income comprising a lower percentage of consolidated income. For an analysis of the effective tax rate, see the "Income Taxes" note (Note 12) to the Company's consolidated financial statements. The Company believes that inflation has not had a significant impact on the Company's operations over the past three years. LIQUIDITY AND CAPITAL RESOURCES Cash generated by operations amounted to $137.9 million in 2002, $88.9 million in 2001 and $141.3 million in 2000. The increase in cash generated in 2002, compared with 2001, was primarily due to a higher level of expense accruals and a lower receivable balance, net of the impact of foreign exchange. The increase in accruals was primarily due to incentive compensation accruals being at approximately 2000 levels, in comparison to low 2001 levels, and, to a lesser degree, accrued hedging contract losses in 2002 whose trades had not settled, compared with receivable balances in previous years, and higher cooperative advertising activity. These increases in cash were partially offset by lower earnings in 2002, compared with the prior years. In 2001, compared with 2000, higher working capital, primarily from decreases in accounts payable and accrued expense, and lower earnings were the principal causes of the reduction in cash generated by operations. The reduction in accounts payable was primarily due to the timing of receipt and payment of inventory in the fourth quarter of 2001, compared with 2000, while the reduction in accrued expense primarily reflects lower compensation related accruals, compared with the prior year. In 2001, compared with 2000, the increase in receivables primarily reflects sales timing changes in the U.S., as retailers ordered closer to need, as well as some erosion in collections. Inventory position improved in 2001, compared with 2000, as a result of disciplined inventory management in the challenging U.S. market. Inventory turns were 4.6 times in 2002, compared with 4.2 times in 2001 and 4.0 times in 2000. Days sales outstanding at December 31, 2002 were 33 days, compared with 35 days at December 31, 2001 and 29 days at December 31, 2000. Wholesale days sales outstanding were 43 days, 44 days and 32 days at the end of 2002, 2001 and 2000, respectively. Net cash used by investing activities amounted to $17.6 million in 2002, $24.6 million in 2001 and $32.4 million in 2000. Of the net cash used by investing activities, capital expenditures were $17.9 million in 2002, $22.4 million in 2001 and $35.4 million in 2000. A majority of capital expenditures during the three years ended December 31, 2002, 2001 and 2000 were for retail store additions and building improvements, transportation and distribution equipment, manufacturing machinery and equipment and information system enhancements. In 2000, the acquisition of the Asian subsidiaries generated $5.2 million of cash (see Note 5). During 2002, 2001 and 2000, net cash used in financing activities amounted to $88.7 million, $71.9 million and $188.5 million, respectively. In 2002, 2001 and 2000, $101.2 million, $80.4 million and $101.7 million was used to repurchase outstanding shares of the Company's Class A Common Stock, respectively. Financing activities in 2001 include costs related to the establishment of the Company's new revolving credit facility. On May 3, 2001, the Company entered into a new, unsecured committed revolving credit agreement (the "Agreement") with a group of banks, effective until May 3, 2004. The Agreement provides for $200.0 million of committed borrowings, of which up to $125.0 million may be used for letters of credit (see Note 7). Financing activities in 2000 include the prepayment of $100.0 million in senior notes. The extraordinary item associated with this debt prepayment is included in financing activities (see Note 6). The Company had no outstanding debt at December 31, 2002, 2001 and 2000. As of December 31, 2002, 2001 and 2000, the Company had letters of credit outstanding of $23.0 million, $39.0 million and $56.0 million, respectively. All were issued for the purchase of inventory. 36 The Company has the following off-balance sheet contractual obligations due by period: (Dollars in Millions)
Less Than December 31, 2002 Total 1 Year 1-3 Years 4-5 Years After 5 Years ------- ----------- ---------- ---------- ------------- Long-term debt $ - $ - $ - $ - $ - Operating leases (see Note 14) 134.6 27.9 43.5 27.2 36.0 ------ ----- ----- ----- ----- Total $134.6 $27.9 $43.5 $27.2 $36.0 ------ ----- ----- ----- -----
The Company has the following off-balance sheet commercial commitments by expiration period: (Dollars in Millions)
Total Amounts Less Than December 31, 2002 Committed 1 Year 1-3 Years 4-5 Years After 5 Years ------------- ---------- ---------- ---------- ------------- Lines of credit $ - $ - $ - $ - $ - Letters of credit 23.0 23.0 - - - Hedging contracts (see Note 2) 152.3 126.7 25.6 - - ------ ------ ----- ------ ------ Total $175.3 $149.7 $25.6 $ - $ - ------ ------ ----- ------ ------
The Company uses funds from operations and unsecured revolving and committed lines of credit as the primary sources of financing for its seasonal and other working capital requirements. Long-term debt, if required, is generally used to finance long-term investments. The Company's principal risks to these sources of financing are the impact on the Company's financial condition from economic downturns, a decrease in the demand for the Company's products, increases in the prices of raw materials and a variety of other factors. The Company anticipates that capital requirements for 2003 will be met through the use of its current cash balances, through its existing credit facilities (which places certain limitations on additional debt, stock repurchases, acquisitions and on the amount of dividends the Company may pay, and also contains certain other financial and operating covenants) and through cash flow from operations, without the need for additional permanent financing. However, if the need arises, the Company's ability to obtain any additional credit facilities will depend upon prevailing market conditions, the Company's financial condition and the terms and conditions of such additional facilities. NEW ACCOUNTING PRONOUNCEMENTS A discussion of new accounting pronouncements is included in the "Summary of Significant Accounting Policies" note (Note 1) to the Company's consolidated financial statements. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK In the normal course of business, the financial position and results of operations of the Company are routinely subject to a variety of risks, including market risk associated with interest rate movements on borrowings and investments and currency rate movements on non-U.S. dollar denominated assets, liabilities and income. The Company regularly assesses these risks and has established policies and business practices that should result in an appropriate level of protection against the adverse effect of these and other potential exposures. The Company utilizes cash from operations and U.S. dollar denominated borrowings to fund its 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, derivative instruments are used by the Company in its hedging of foreign currency transactions. These debt instruments and derivative instruments are viewed as risk management tools and are not used for trading or speculative purposes. Cash balances are invested in high-grade securities with terms under three months. The Company has available unsecured committed and uncommitted lines of credit as sources of financing for its working capital requirements. Borrowings under these credit agreements bear interest at variable rates based on either lenders' cost of funds, plus an applicable spread, or prevailing money market rates. At December 31, 2002, December 31, 2001 and December 31, 2000, the Company had no short-term or long-term debt outstanding. The Company's foreign currency exposure is generated primarily from its European operating subsidiaries and, to a lesser degree, its Asian operating subsidiaries. The Company seeks to minimize the impact of these foreign currency fluctuations by hedging the related transactions with foreign currency forward contracts. Currently, these foreign currency forward contracts will expire in 15 months or less. Based upon sensitivity analysis as of December 31, 2002, a 10% change in foreign exchange rates would cause the fair value of the Company's financial instruments to increase/decrease by approximately $16.6 million, compared with $12.3 million at December 31, 2001. The increase at December 31, 2002 is primarily due to the amount of foreign currency contracts held at December 31, 2002, compared with December 31, 2001. EURO Effective January 1, 1999, the European Monetary Union created a single currency, the euro, for its member countries. A transition period, from January 1, 1999 through December 31, 2001, allowed the member countries 37 to methodically eliminate their local currencies and to convert to the euro. As of December 31, 2001, the Company was completely euro compliant. The Company has monitored, and will continue to monitor, the euro conversion. The Company has not experienced any material business disruptions as a result of the euro conversion. FORWARD-LOOKING INFORMATION As discussed in Exhibit 99.3, entitled "Cautionary Statements for Purposes of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995," investors should be aware of 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. These factors include, but are not limited to: (i) the Company's ability to successfully market and sell its products in view of changing consumer trends, consumer acceptance of products, and other factors affecting retail market conditions, including the current U.S. economic environment and the global economic and political uncertainties resulting from the continuing war on terrorism; (ii) the Company's ability to manage its foreign exchange rate risks; (iii) the Company's ability to obtain adequate raw materials at competitive prices; (iv) the Company's ability to successfully invest in its infrastructure and product based upon its advance sales forecasts; (v) the Company's ability to locate and retain independent manufacturers to produce lower cost, high-quality products with rapid turnaround times; (vi) the Company's ability to recover its investment in, and expenditures of, its retail organization through adequate sales at such retail locations; and (vii) the Company's ability to respond to actions of the Company's competitors, some of whom have substantially greater resources than those of the Company. The Company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. QUARTERLY MARKET INFORMATION AND RELATED MATTERS The Company's Class A Common Stock is traded on the New York Stock Exchange under the symbol TBL. There is no market for shares of the Company's Class B Common Stock; however, shares of Class B Common Stock may be converted into shares of Class A Common Stock on a one-for-one basis and will automatically be converted upon any transfer (except for estate planning transfers and transfers approved by the Board of Directors). The following table presents the high and low closing sales prices of the Company's Class A Common Stock for the past two years, as reported by the New York Stock Exchange. 2002 2001 ---------------- ----------------- High Low High Low ------ ------ ------ ------ First Quarter $42.25 $31.59 $73.25 $49.20 Second Quarter 45.89 35.16 52.10 38.70 Third Quarter 38.89 31.98 41.50 26.15 Fourth Quarter 38.99 27.07 38.25 26.84 As of February 21, 2003, the number of record holders of the Company's Class A Common Stock was approximately 830 and the number of record holders of the Company's Class B Common Stock was 7. The closing sales price of the Company's Class A Common Stock on February 21, 2003 was $38.26 per share. The Company has never declared a dividend on either the Company's Class A or Class B Common Stock. In addition, the Company's ability to pay cash dividends is limited pursuant to loan agreements (see notes to the Company's consolidated financial statements). 38 CONSOLIDATED BALANCE SHEETS As of December 31, 2002 and 2001 (Amounts in Thousands, Except Share and Per Share Data)
2002 2001 ---------- ---------- Assets Current assets Cash and equivalents $ 141,195 $105,658 Accounts receivable, net of allowance for doubtful accounts of $7,487 in 2002 and $5,934 in 2001 132,110 132,751 Inventory 122,417 127,172 Prepaid expense 21,493 17,093 Deferred income taxes 24,568 19,822 Derivative assets - 3,047 --------- --------- Total current assets 441,783 405,543 --------- --------- Property, plant and equipment 176,415 166,365 Less accumulated depreciation and amortization (103,045) (90,157) --------- --------- Net property, plant and equipment 73,370 76,208 Excess of cost over fair value of net assets acquired, net 14,163 14,163 Intangible assets 3,732 3,456 Other assets, net 5,623 5,242 --------- --------- Total assets $ 538,671 $ 504,612 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Accounts payable $ 33,678 $ 40,637 Accrued expense Payroll and related 39,879 23,918 Other and interest 49,551 42,611 Income taxes payable 20,134 21,336 Derivative liabilities 12,514 - --------- --------- Total current liabilities 155,756 128,502 --------- --------- Deferred compensation 3,072 2,610 Deferred income taxes 7,058 9,349 Excess of fair value of acquired assets over cost, net - 4,913 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; 41,518,667 shares issued at December 31, 2002 and 40,487,893 shares issued at December 31, 2001 415 405 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; 7,561,185 shares issued at December 31, 2002 and 7,911,185 shares issued at December 31, 2001 76 79 Additional paid-in capital 142,883 125,648 Deferred compensation (3,078) (3,226) Retained earnings 605,826 510,713 Accumulated other comprehensive income/(loss) (9,837) (9,372) Treasury stock at cost; 12,773,521 Class A shares at December 31, 2002 and 10,064,847 Class A shares at December 31, 2001 (363,500) (265,009) --------- --------- Total stockholders' equity 372,785 359,238 --------- --------- Total liabilities and stockholders' equity $ 538,671 $ 504,612 ========= =========
The accompanying notes are an integral part of these consolidated financial statements. 39 CONSOLIDATED STATEMENTS OF INCOME For the Years Ended December 31, 2002, 2001 and 2000 (Amounts in Thousands, Except Per Share Data)
2002 2001 2000 ---------- ---------- ---------- Revenue $1,190,896 $1,183,623 $1,091,478 Cost of goods sold 672,610 662,848 582,966 ---------- ---------- ---------- Gross profit 518,286 520,775 508,512 ---------- ---------- ---------- Operating expense Selling 306,962 291,953 258,081 General and administrative 72,499 64,644 65,129 Amortization of goodwill - 1,085 1,130 ---------- ---------- ---------- Total operating expense 379,461 357,682 324,340 ---------- ---------- ---------- Operating income 138,825 163,093 184,172 ---------- ---------- ---------- Other expense/(income) Interest expense 884 1,560 5,648 Other, net (828) (196) (8,128) ---------- ---------- ---------- Total other expense/(income) 56 1,364 (2,480) ---------- ---------- ---------- Income before income taxes 138,769 161,729 186,652 Provision for income taxes 48,569 54,988 62,528 ---------- ---------- ---------- Net income before extraordinary item and cumulative effect of change in accounting principle $ 90,200 $ 106,741 $ 124,124 ---------- ---------- ---------- Extraordinary item - loss on debt extinguishment, net of tax benefit of $1,071 (see Note 6) - - (2,126) Cumulative effect of change in accounting principle 4,913 - - ---------- ---------- ---------- Net income $ 95,113 $ 106,741 $ 121,998 ========== ========== ========== Earnings per share before extraordinary item and cumulative effect of change in accounting principle Basic $2.42 $2.73 $3.09 Diluted $2.36 $2.65 $2.91 Earnings per share after extraordinary item and cumulative effect of change in accounting principle Basic $2.55 $2.73 $3.04 Diluted $2.49 $2.65 $2.86 Weighted-average shares outstanding Basic 37,308 39,043 40,119 Diluted 38,142 40,247 42,647 ---------- ---------- ----------
The accompanying notes are an integral part of these consolidated financial statements. 40 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY For the Years Ended December 31, 2002, 2001 and 2000 (Dollars in Thousands) Accumulated
Class A Class B Additional Common Common Paid-in Deferred Retained Stock Stock Capital Compensation Earnings ------- ------- ---------- ------------ -------- Balance, January 1, 2000 $187 $47 $ 82,755 $(3,658) $282,209 ---- ---- -------- ------- -------- Issuance of shares under employee stock plans 17 (9) 14,401 (404) - Amortization of deferred compensation - - - 799 - Loan on restricted stock issuance - - - (1,110) - Repurchase of common stock - - - - - Tax benefit from stock option plans - - 12,600 - - 2-for-1 stock split 194 41 - - (235) Comprehensive income: Net income - - - - 121,998 Translation adjustment - - - - - Comprehensive income - - - - - ---- ---- -------- ------- -------- Balance, December 31, 2000 398 79 109,756 (4,373) 403,972 ---- ---- -------- ------- -------- Issuance of shares under employee stock plans 7 - 8,222 - - Amortization of deferred compensation - - - 822 - Reduction in loan on restricted stock - - - 325 - Repurchase of common stock - - - - - Tax benefit from stock option plans - - 7,670 - - Comprehensive income: Net income - - - - 106,741 Translation adjustment - - - - - Derivative transition adjustment - - - - - Change in fair value of derivatives, net of taxes - - - - - Comprehensive income - - - - - ---- ---- -------- ------- -------- Balance, December 31, 2001 405 79 125,648 (3,226) 510,713 ---- ---- -------- ------- -------- Issuance of shares under employee stock plans 10 (3) 11,024 (1,428) - Amortization of deferred compensation - - - 1,314 - Reduction in loan on restricted stock - - - 262 - Repurchase of common stock - - - - - Tax benefit from stock option plans - - 6,211 - - Comprehensive income: Net income - - - - 95,113 Translation adjustment - - - - - Change in fair value of derivatives, net of taxes - - - - - Comprehensive income - - - - - ---- ---- -------- ------- -------- Balance, December 31, 2002 $415 $76 $142,883 $(3,078) $605,826 ---- ---- -------- ------- --------
Accumulated Other Total Comprehensive Treasury Comprehensive Stockholders' Income/(Loss) Stock Income Equity ------------- -------- ------------- ------------- Balance, January 1, 2000 $(4,151) $ (85,021) $272,368 ------- --------- -------- --------- Issuance of shares under employee stock plans - 950 14,955 Amortization of deferred compensation - - 799 Loan on restricted stock issuance - - (1,110) Repurchase of common stock - (101,718) (101,718) Tax benefit from stock option plans - - 12,600 2-for-1 stock split - - - Comprehensive income: Net income - - $121,998 121,998 Translation adjustment (3,141) - (3,141) (3,141) -------- Comprehensive income - - $118,857 - ------- --------- -------- --------- Balance, December 31, 2000 (7,292) (185,789) 316,751 ------- --------- -------- --------- Issuance of shares under employee stock plans - 1,152 9,381 Amortization of deferred compensation - - 822 Reduction in loan on restricted stock - - 325 Repurchase of common stock - (80,372) (80,372) Tax benefit from stock option plans - - 7,670 Comprehensive income: Net income - - $106,741 106,741 Translation adjustment (3,924) - (3,924) (3,924) Derivative transition adjustment 577 - 577 577 Change in fair value of derivatives, net of taxes 1,267 - 1,267 1,267 -------- Comprehensive income - - $104,661 - ------- --------- -------- --------- Balance, December 31, 2001 (9,372) (265,009) 359,238 ------- --------- -------- --------- Issuance of shares under employee stock plans - 2,683 12,286 Amortization of deferred compensation - - 1,314 Reduction in loan on restricted stock - - 262 Repurchase of common stock - (101,174) (101,174) Tax benefit from stock option plans - - 6,211 Comprehensive income: Net income - - $ 95,113 95,113 Translation adjustment 9,013 - 9,013 9,013 Change in fair value of derivatives, net of taxes (9,478) - (9,478) (9,478) -------- Comprehensive income - - $ 94,648 - ------- --------- -------- --------- Balance, December 31, 2002 $(9,837) $(363,500) $372,785 ------- --------- -------- ---------
The accompanying notes are an integral part of these consolidated financial statements. 41 CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2002, 2001 and 2000 (Dollars in Thousands)
2002 2001 2000 -------- -------- -------- Cash flows from operating activities: Net income $ 95,113 $106,741 $121,998 Adjustments to reconcile net income to net cash provided by operating activities: Deferred income taxes (954) (5,104) 137 Depreciation and amortization 22,503 22,107 19,291 Loss/(gain) on disposal of property, plant and equipment 1,836 664 (131) Extraordinary item - - 2,126 Cumulative effect of change in accounting principle (4,913) - - Tax benefit from stock option plans 6,211 7,670 12,600 Increase/(decrease) in cash from changes in working capital: Accounts receivable 7,150 (29,574) (24,419) Inventory 6,313 3,772 (10,479) Prepaid expense (3,279) (3,706) (1,104) Accounts payable (11,088) (7,264) 14,120 Accrued expense 20,548 (8,919) 7,681 Income taxes (1,546) 2,496 (507) -------- -------- -------- Net cash provided by operating activities 137,894 88,883 141,313 -------- -------- -------- Cash flows from investing activities: Acquisition of Asian distributor business - - 5,237 Additions to property, plant and equipment (17,930) (22,428) (35,444) Other, net 291 (2,174) (2,169) -------- -------- -------- Net cash used by investing activities (17,639) (24,602) (32,376) -------- -------- -------- Cash flows from financing activities: Extinguishment of debt - - (100,000) Extraordinary item - - (2,126) Establishment of new revolving credit facility - (919) - Common stock repurchases (101,174) (80,372) (101,718) Issuance of common stock 12,478 9,381 15,359 -------- -------- -------- Net cash used by financing activities (88,696) (71,910) (188,485) -------- -------- -------- Effect of exchange rate changes on cash 3,978 (1,565) (1,685) -------- -------- -------- Net increase/(decrease) in cash and equivalents 35,537 (9,194) (81,233) Cash and equivalents at beginning of year 105,658 114,852 196,085 -------- -------- -------- Cash and equivalents at end of year $141,195 $105,658 $114,852 -------- -------- -------- Supplemental disclosures of cash flow information: Interest paid $ 567 $ 1,272 $ 5,863 Income taxes paid 44,512 50,435 55,471 -------- -------- --------
The accompanying notes are an integral part of these consolidated financial statements. 42 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in Thousands, Except Share and Per Share Data) 1. Summary of Significant Accounting Policies Basis of Consolidation The consolidated financial statements include the accounts of The Timberland Company and its subsidiaries (the "Company"). All material intercompany transactions have been eliminated in consolidation. Nature of Operations The Company designs, develops, engineers, markets and distributes premium-quality footwear, apparel and accessories products for men, women and children. The Company's products are sold primarily through independent retailers, better grade department stores and athletic stores. In addition, the Company's products are sold in Timberland(R) specialty stores, Timberland(R) factory outlet stores, on timberland.com and franchisees in Europe. The Company's products are sold throughout the U.S., Canada, Europe, Asia, Latin America and the Middle East. The Company's footwear, apparel and accessories products are marketed in highly competitive environments that are subject to change in consumer preferences. Historically, footwear has accounted for approximately 75% of the Company's revenue. Geographically, approximately two-thirds of the Company's revenue is from its domestic businesses. From a channel perspective, approximately 75% of the Company's revenue is from its wholesale business. The Company manages its business in three major segments, each sharing similar product, distribution, marketing and economic conditions: U.S. Wholesale, U.S. Consumer Direct, and International. The Company sources approximately 85% of its footwear products. The remainder are produced in the Company's manufacturing facilities in the Caribbean. All of the Company's apparel and accessories products are sourced. Recognition of Revenue Revenue consists of sales to customers, license fees and royalties. Sales are recognized either upon shipment of product to customers or, for retail customers, at the point of sale. License fees and royalties are recognized when earned. The Company records reductions to revenue for estimated sales returns and allowances. The Company bases its estimates on historical rates of customer returns and allowances, as well as the specific identification of outstanding returns and allowances. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. The Company estimates potential losses primarily based on the Company's historical rate of credit losses and its knowledge of the financial condition of its customers. Inventory Inventory is stated at the lower of cost (first-in, first-out) or market. Market value is estimated based upon assumptions made about future demand and retail market conditions. If the Company determines that the actual market value differs from the carrying value of its inventory, the Company will make an adjustment to reduce the value of its inventory. Translation of Foreign Currencies The Company translates financial statements denominated in foreign currencies by translating balance sheet accounts at the end of period exchange rates and statement of income accounts at the average exchange rates for the period. Translation gains and losses are recorded in stockholders' equity and reflected in other comprehensive income/(loss). Transaction gains and losses are reflected in net income. Derivatives The Company is exposed to foreign exchange risk when it purchases and sells goods in local currencies. It is the Company's policy to hedge a portion of this risk through forward sales of foreign currencies, thereby locking in the future exchange rates. Those derivative instruments are viewed as risk management tools and are not used for trading or speculative purposes. The Company uses its operating budget and periodic forecasts to estimate its economic exposure and to determine its hedging commitments, and the timing of those commitments. Derivatives are recognized at fair value and included in either "Derivative liabilities" or "Derivative assets" on the Company's balance sheet. Derivatives that are not designated as hedges are adjusted to fair value through income. If a derivative is designated as a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will either be offset by the change in fair value of the hedged asset, liability, or firm commitment through 43 earnings or recognized in other comprehensive income/(loss) until the hedged item is recognized in earnings. The ineffective portion, if any, of a derivative's change in fair value is immediately recognized in earnings. Income Taxes Income taxes are determined based on the income reported in the Company's financial statements, regardless of when such taxes are payable. Tax assets and liabilities are adjusted to reflect the changes in U.S. and applicable foreign income tax laws when enacted. Future tax benefits are recognized to the extent that realization of such benefits is more likely to occur than not. Cash and Equivalents Cash and equivalents consist of short-term, highly liquid investments that have original maturities to the Company of three months or less. Property, Plant and Equipment Property, plant and equipment are recorded at cost and depreciated using the straight-line method over the estimated useful lives of the assets or over the terms of the related leases, if such periods are shorter. The principal estimated useful lives are: building and improvements, 4 to 20 years; machinery and equipment, 3 to 12 years; lasts, patterns and dies, 3 years. Excess of Cost Over Fair Value of Net Assets Acquired In the second quarter of 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." The Company adopted this statement effective January 1, 2002. SFAS No. 142 requires the cessation of goodwill amortization and, instead, the carrying value of goodwill will be evaluated for impairment on at least an annual basis. The provisions of this statement require the completion of a transitional impairment test within six months of adoption, with any impairments identified treated as a cumulative effect of a change in accounting principle. The Company has completed that transitional impairment test and has determined that there was no impairment of reported goodwill existing at January 1, 2002. The statement also requires that an impairment test be completed at least annually. The Company completed its annual impairment test and, at June 28, 2002 determined that no impairment of reported goodwill had occurred (see Note 3). Excess of Fair Value of Acquired Assets Over Cost In the second quarter of 2001, the FASB issued SFAS No. 141, "Business Combinations." The Company adopted this statement effective January 1, 2002. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. In addition, SFAS No. 141 requires that any excess of fair value of net assets over cost arising from acquisitions occurring prior to adoption of this statement will be recognized as the cumulative effect of a change in accounting principle. Accordingly, in the first quarter of 2002, the Company recognized a cumulative effect of a change in accounting principle gain of $4,913 ($0.13 per share diluted and basic) for the unamortized balance of the excess of fair value of net assets over cost as of December 31, 2001. Accrued Insurance Costs The Company is self-insured for workers' compensation, healthcare and short-term disability up to certain specified limits. Expenses associated with such self-insurance programs are accrued based upon estimates of the amounts required to cover incurred incidents. Accounting for Estimates The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires the Company to make assumptions that affect the estimates reported in these consolidated financial statements. Actual results may differ from these estimates. Some of the more important assumptions and estimates made by the Company are for sales returns and allowances, allowance for doubtful accounts receivable, market value of inventory, contingent liabilities, impairment of long-lived assets and goodwill, realizable value of deferred tax assets and the Company's annual effective tax rate. Earnings Per Share Basic Earnings Per Share ("EPS") excludes dilution 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 44 dilution that would occur if securities such as stock options were exercised. Dilutive securities (see Note 18) included in the calculation of diluted weighted-average shares were 833,585 in 2002, 1,203,996 in 2001 and 2,527,353 in 2000. Anti-dilutive securities excluded from the calculation of diluted weighted-average shares were 764,649 in 2002, 693,580 in 2001 and 0 in 2000. Long-lived Assets The Company periodically evaluates the carrying values and estimated useful lives of its long-lived assets, primarily property, plant and equipment and intangible assets. When factors indicate that such assets should be evaluated for possible impairment, the Company uses estimates of future operating results and cash flows to determine whether the assets are recoverable. The Company adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," on January 1, 2002. This statement supersedes SFAS No. 121 but retains the fundamental provisions of SFAS No. 121 for recognition and measurement of the impairment of long-lived assets to be held and used and measurement of long-lived assets to be disposed of by sale. However, SFAS No. 144 applies the fair value method for test of impairment, which differs from SFAS No. 121. SFAS No. 144 also supersedes the accounting and reporting provisions of Accounting Principles Board ("APB") Opinion No. 30, as it pertains to disposal of a business segment, but retains the requirement of that opinion to report discontinued operations separately from continuing operations and extends that reporting to a component of an entity that either has been disposed of or is classified as held for sale. Stock-based Compensation The Company accounts for stock-based compensation using the method prescribed by APB Opinion No. 25 and related interpretations. The Company follows SFAS No. 123 "Accounting for Stock-Based Compensation" and SFAS No. 148 "Accounting for Stock-Based Compensation - Transitional and Disclosure - An Amendment of FASB Statement No. 123" for disclosure purposes. SFAS No. 148, issued in December 2002, provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require disclosures in the annual and interim financial statements regarding the accounting method for stock-based employee compensation and the effect of the method used on reported results (see New Accounting Pronouncements). Comprehensive Income Comprehensive income, in the case of the Company, is the combination of reported net income and other comprehensive income/(loss), which is comprised of foreign currency translation adjustments and changes in the fair value of derivatives. Contingencies In the ordinary course of business, the Company is involved in legal proceedings involving contractual and employment relationships, product liability claims, trademark rights and a variety of other matters. The Company records contingent liabilities resulting from claims when it is probable that a liability has been incurred and the amount of the loss is reasonably estimable. New Accounting Pronouncements SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" became effective for the Company on January 1, 2002. SFAS No. 144 had no impact on the Company's financial statements. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." The rescission of Statement 4 refers to any gain or loss on extinguishment of debt classified as an extraordinary item in prior periods presented. If that does not meet the criteria in APB Opinion No. 30 for classification as an extraordinary item, it shall be reclassified. The provisions, which relate to the rescission of Statement 4, shall be applied in fiscal years beginning after May 15, 2002. The Company is currently evaluating its disclosure related to SFAS No. 145. The rescission of FASB Statements 4, 44 and 64, and the amendment of SFAS No. 13, had no impact on the Company's 2002 consolidated financial statements. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This statement supercedes Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF No. 94-3, a liability is recognized at the date an entity commits to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. The provisions of SFAS No. 146 are effective for any exit or disposal activities initiated after December 31, 2002. 45 In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transitional and Disclosure - An Amendment of FASB Statement No. 123." This statement is effective for fiscal years ending after December 15, 2002 and provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 to require disclosures in the annual and interim financial statements regarding the accounting method for stock-based employee compensation and the effect of the method used on reported results. The Company has not elected to transition to the fair value based method of accounting for stock-based employee compensation at this time. See Note 18 for a discussion and required disclosures. 2. Derivatives On January 1, 2001, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of SFAS No. 133 - An Amendment of SFAS No. 133," and SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities - An Amendment of SFAS No. 133" (collectively referred to as the "Statement"). The Statement requires the Company to recognize all derivatives on its balance sheet at fair value. Derivatives that are not designated as hedges must be adjusted to fair value through income. If the derivative is designated as a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will be either offset by the change in fair value of the hedged asset, liability, or firm commitment through earnings or recognized in other comprehensive income/(loss) until the hedged item is recognized in earnings. The Company measures hedge effectiveness based on changes in the fair value of those contracts and underlying exposures attributable to changes in the forward exchange rate. Changes in the expected future cash flows of the forecasted hedged transaction and changes in the fair value of the forward contract are both measured from the contract rate to the forward exchange rate associated with the forward contract's maturity date. The ineffective portion, if any, of a derivative's change in fair value will be immediately recognized in earnings. In the case of the Company, its hedges are considered effective under SFAS No.133 since the gains/(losses) on the hedges offset the gains/(losses) on the designated economic exposures. The application of SFAS No. 133 resulted in an increase in other comprehensive income/(loss) in 2001 of $1,844, which is net of taxes of $1,203. In the normal course of business, the financial position and results of operations of the Company are routinely subject to currency rate movements on non-U.S. dollar denominated assets, liabilities and income as the Company sells goods in local currencies. The Company has established policies and business practices that should result in an appropriate level of protection against the adverse effect of these exposures. Derivative instruments, specifically forward contracts, are used by the Company in its hedging of forecasted foreign currency transactions, typically for a period not greater than 24 months. Those derivative instruments are viewed as risk management tools and are not used for trading or speculative purposes. As of December 31, 2002, the Company had forward contracts maturing at various dates through 2004 to sell the equivalent of approximately $159,300 in foreign currencies at contracted rates and to buy the equivalent of approximately $7,000 in foreign currencies at contracted rates. As of December 31, 2001, the Company had forward contracts maturing at various dates through March 2004 to sell the equivalent of approximately $127,000 in foreign currencies at contracted rates. The increase in the value of contracts held at December 31, 2002, compared with December 31, 2001, is the result of the Company having elected to hedge a greater portion of its forecasted 2003 foreign currency exposure at December 31, 2002 than the portion of its forecasted 2002 exposure that was hedged at December 31, 2001, as permitted in accordance with the Company's hedging policy, and to the growth in the International business. Forward contracts related to forecasted economic exposure are designated as cash flow hedges at acquisition with the changes in the fair value of those contracts recorded as a component of other comprehensive income/(loss) and subsequently recognized in cost of goods sold in the period in which the hedged forecasted economic exposure takes place. The Company also hedges the foreign currency exchange risk on existing intercompany assets and liabilities using forward contracts. Gains and losses related to forward contracts hedging foreign currency exchange risk on intercompany asset and liability balances are reflected in earnings immediately and largely offset the remeasurement of those assets and liabilities. On December 31, 2002, the Company had $12,514 in derivative liabilities on its balance sheet. On December 31, 2001, the Company had $3,047 in derivative assets on its balance sheet. Those amounts reflect the fair value of the Company's foreign exchange contracts, which hedge forecasted future economic exposure, as measured in accordance with SFAS No. 133. The fair value of the contracts is a liability when the Company's contract rates are below current forward foreign exchange rates and is an asset when the Company's contract rates are above current forward foreign exchange rates. The offset to those liabilities and assets is in other comprehensive income/(loss) and is discussed in Note 16 to the Company's consolidated financial statements. For the periods ended December 31, 2002, 2001 and 2000, the Company recorded, in its income statement, after tax hedging (losses)/gains of $(7,110), $5,594 and $7,753, respectively. For the periods ended December 31, 2002 and December 31, 2001, the after-tax hedging (losses)/gains reclassified to earnings were $(6,763) and $6,217 respectively. The Company estimates that the $12,514 in derivative liabilities on its balance sheet as of December 31, 2002 will be reclassified to earnings in 2003. 3. Goodwill and Other Intangible Assets The Company adopted SFAS No. 142 effective January 1, 2002. In conjunction with the adoption of this statement, goodwill has not been amortized. Additionally, the Company has completed both its transitional and annual 46 impairment tests and has determined that no impairment of reported goodwill has occurred. Had goodwill not been amortized in 2001 and 2000, the Company's net income, diluted earnings per share and basic earnings per share (after the cumulative effect of a change in accounting principle) for the years ended December 31, 2001 and 2000 would have been $107,457, $2.67 and $2.75, and $122,749, $2.88 and $3.06, respectively. There were no changes in the carrying amount of goodwill for the year ended December 31, 2002, compared with December 31, 2001. At December 31, 2002 and December 31, 2001, accumulated amortization of the excess of cost over the fair value of net assets acquired amounted to $17,612. Information regarding the Company's other intangible assets follows:
December 31, 2002 2001 --------------------------------- ----------------------------------- Carrying Accumulated Carrying Accumulated Amount Amortization Net Amount Amortization Net -------- ------------ ----- -------- ------------ ----- Trademarks and related expenses $7,537 $(3,805) $3,732 $7,038 $(3,582) $3,456 ------ -------- ------ ------ -------- ------
Amortization expense for 2002, 2001 and 2000 was $1,278, $1,128 and $971, respectively. The estimated amortization for existing intangible assets as of December 31, 2002, for each of the five succeeding fiscal years is as follows: 2003: $1,265; 2004: $1,041; 2005: $785; 2006: $485; 2007: $156. The amortization period for trademarks and related expenses is five years. 4. Deferred Compensation Plan On January 1, 2001, the Company set up an irrevocable grantor's trust to hold assets to cover benefit obligations under the Company's Deferred Compensation Plan (the "Plan"). The obligations of the Company under the Plan consist of the Company's unsecured contractual commitment to deliver, at a future date, any of the following: (i) deferred compensation credited to an account under the Plan, (ii) additional amounts, if any, that the Company may, from time to time, credit to the Plan, and (iii) notional earnings on the foregoing amounts. The obligations are payable in cash upon retirement, termination of employment and/or at certain other times in a lump-sum distribution or in installments, as elected by the participant in accordance with the Plan. The Plan assets and the Company's liability for those assets reside in long-term "Other assets, net" and "Deferred compensation," respectively, on the Company's consolidated balance sheet. The securities that comprise the Plan assets are designated as trading securities under SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." 5. Acquisition of Asian Distributor Business On February 18, 2000, the Company signed an agreement pursuant to which it reacquired the exclusive distribution rights for the sale of Timberland(R) brand products throughout the Asia-Pacific region from its former distributor, Inchcape plc. In connection with this transaction, the Company acquired the stock of its former distributor's subsidiaries in Japan, Hong Kong, Malaysia and Singapore (the "Asian subsidiaries"). The purchase price allocation is as follows: Acquisition of business: Fair value of assets acquired $ 21,852 Fair value of liabilities assumed (14,082) --------- Fair value of net assets acquired 7,770 Cash paid (1,223) Acquisition costs (480) --------- Excess of fair value of acquired net assets over cost $ 6,067 ========= The fair value of net assets acquired includes $6,460 of cash, resulting in net cash received of $5,237. This transaction was accounted for under the purchase method of accounting and, accordingly, the results of operations for the Asian subsidiaries, for the period from the acquisition date, are included in the accompanying consolidated financial statements. The purchase price has been allocated to the assets purchased and liabilities assumed based on fair values at the date of acquisition. This transaction resulted in the initial recording of excess of fair value of acquired net assets over cost. Subsequently, as a result of the Company's adoption of SFAS No. 141 on January 1, 2002, that excess of fair value of acquired net assets over cost has been recognized as the cumulative effect of a change in accounting principle on the Company's consolidated statements of income (see Note 1). As part of this transaction, the Company released the distributor from its obligations under the Distributorship, Supply and Retail Development Agreement dated January 26, 1995. As part of this transaction, the Company received $5,055, which represented a portion of the proceeds from the disposition of the assets in Australia, New Zealand, Thailand and Taiwan. All proceeds were recognized in other income. On July 31, 2000, the Company acquired Inchcape plc's Taiwan based net assets for $662. Taiwan is included in the Company's consolidated financial statements from the period of acquisition forward and does not have a material impact on those statements. Taiwan is included in all references to the Asian subsidiaries. 47 6. Long-term Debt and Extraordinary Loss As of December 31, 2002 and 2001, the Company had no long-term debt outstanding. On June 30, 2000, the Company prepaid $100,000 of 8.94% senior notes with a maturity of December 15, 2001. As a result of that prepayment, the Company recorded an extraordinary loss of $2,126 after taxes, or $0.05 per share diluted ($0.05 basic). The loss consisted of a prepayment penalty and costs associated with the early redemption of the debt combined with accelerated amortization of bond issuance costs, net of tax benefits of $1,071. 7. Notes Payable On May 3, 2001, the Company entered into a new, unsecured committed revolving credit agreement (the "Agreement") with a group of banks, effective until May 3, 2004. The Agreement provides for $200,000 of committed borrowings, of which up to $125,000 may be used for letters of credit. Under the terms of the Agreement, the Company may borrow at interest rates based on eurodollar rates (approximately 1.25% at December 31, 2002), plus an applicable margin based on a fixed-charge coverage grid of between 47.5 and 95 basis points that is adjusted quarterly. As of December 31, 2002, the applicable margin under the facility was 75 basis points. The Company will pay a commitment fee of 15 to 30 basis points per annum based on a fixed-charge coverage grid, that is adjusted quarterly on the full commitment. As of December 31, 2002, the fee was 25 basis points. The Agreement places certain limitations on additional debt, stock repurchases, acquisitions and on the amount of dividends the Company may pay, and also contains certain other financial and operating covenants. Additionally, the Company has uncommitted lines of credit available from certain banks totaling $30,000 at December 31, 2002. Borrowings under these lines are at prevailing money market rates (1.75% at December 31, 2002). These arrangements may be terminated at any time at the option of the banks or the Company. As of December 31, 2002, 2001 and 2000, the Company had letters of credit outstanding of $23,000, $39,000 and $56,000, respectively. All were issued for the purchase of inventory. 8. Financial Instruments and Concentration of Credit Risk The following table illustrates the U.S. dollar equivalent of foreign exchange contracts at December 31, 2002 and 2001 along with maturity dates, net unrealized gain/(loss) and net unrealized gain/(loss) deferred. Unrealized gains or losses are determined based on the difference between the settlement and year end foreign exchange rates. The contract amount represents the net amount of all purchase and sale contracts of a foreign currency.
Contract Net Amount Net Unrealized (U.S. $ Maturity Unrealized Unrealized Unrealized Gain/(Loss) December 31, 2002 Equivalent) Date Gross Gain Gross (Loss) Gain/(Loss) Deferred ----------------- ----------- -------- ---------- ------------ ----------- ----------- Pounds Sterling $ 10,250 2003 $ - $ (1,213) $ (1,213) $ (1,212) Pounds Sterling 3,259 2004 - (181) (181) (181) Euro 101,507 2003 - (9,584) (9,584) (9,576) Euro 16,387 2004 - (1,131) (1,131) (1,131) Japanese Yen 14,944 2003 16 (403) (387) (388) Japanese Yen 5,931 2004 87 (337) (250) (26) -------- ----- -------- -------- -------- Total $152,278 $ 103 $(12,849) $(12,746) $(12,514) ======== ===== ======== ======== ======== December 31, 2001 Pounds Sterling $ 15,608 2002 $ - $ (67) $ (67) $ (67) Pounds Sterling 4,773 2003 - (9) (9) (9) Euro 67,261 2002 1,179 (4) 1,175 1,179 Euro 9,107 2003 98 - 98 98 Japanese Yen 14,157 2002 1,414 - 1,414 1,414 Japanese Yen 5,337 2003 432 - 432 432 Japanese Yen 6,496 2004 37 - 37 - Hong Kong Dollars 3,846 2002 1 - 1 - -------- ----- -------- -------- -------- Total $126,585 $3,161 $ (80) $ 3,081 $ 3,047 ======== ===== ======== ======== ========
Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments and trade receivables. The Company places its temporary cash investments with high credit quality financial institutions, thereby minimizing exposure to concentrations of credit risk. Credit risk with respect to trade receivables is limited, due to the large number of customers included in the Company's customer base. The Company had an allowance for doubtful accounts receivable of $7,487 and $5,934 at December 31, 2002 and 2001, respectively. 9. Fair Value of Financial Instruments The estimated fair values of the Company's financial instruments are as follows:
December 31, 2002 2001 ------------ ------------------------ ------------------------ Carrying Carrying or Contract Fair or Contract Fair Amount Value Amount Value ----------- ------- ----------- ------- Cash and equivalents(1) $141,195 $141,195 $105,658 $105,658 Foreign currency contracts(2) 152,278 165,024 126,585 123,504 -------- -------- -------- --------
(1) The carrying amounts of cash and equivalents approximate their fair values. (2) The fair value of foreign currency contracts is estimated by obtaining the appropriate year end rates as of December 31, 2002 and 2001. 48 10. Inventory Inventory consists of the following: December 31, 2002 2001 ------------ ------ ------ Raw materials $ 2,065 $ 4,958 Work-in-process 1,745 1,566 Finished goods 118,607 120,648 -------- -------- Total $122,417 $127,172 ======== ======== 11. Property, Plant and Equipment Property, plant and equipment consists of the following: December 31, 2002 2001 ------------ ------ ------ Land and improvements $ 501 $ 501 Building and improvements 44,100 44,693 Machinery and equipment 111,501 104,023 Lasts, patterns and dies 20,313 17,148 -------- -------- Total $176,415 $166,365 ======== ======== Depreciation expense was $19,564, $18,819 and $16,356 for the three years ended December 31, 2002, 2001 and 2000, respectively. 12. Income Taxes The components of the provision for income taxes are as follows:
December 31, 2002 2001 2000 ------------ ----------------- ----------------- ----------------- Current Deferred Current Deferred Current Deferred ------- -------- ------- -------- ------- -------- Federal $36,240 $(1,254) $45,397 $(4,384) $43,758 $ 191 State 7,159 300 9,702 (720) 10,764 (54) Puerto Rico 420 - 498 - 469 - Foreign 5,704 - 4,495 - 6,329 - ------- ------- ------- ------- ------- ----- Total $49,523 $ (954) $60,092 $(5,104) $61,320 $ 137 ======= ======= ======= ======= ======= =====
The 2000 current provision includes the $1,071 tax benefit from the prepayment of the senior notes, which is reflected in the extraordinary item on the Company's consolidated statements of income. The provision for income taxes differs from the amount computed using the statutory federal income tax rate of 35% due to the following:
December 31, 2002 2001 2000 ------------ ----------------- ----------------- ----------------- Federal income tax at statutory rate $48,569 35.0% $56,605 35.0% $64,209 35.0% Federal tax exempt operations in Puerto Rico (3,734) (2.7) (5,506) (3.4) (7,231) (3.9) State taxes, net of applicable federal benefit 4,848 3.5 6,477 4.0 7,538 4.1 Other, net (1,114) (0.8) (2,588) (1.6) (3,059) (1.7) ------- ---- ------- ---- ------- ---- Total $48,569 35.0% $54,988 34.0% $61,457 33.5% ======= ==== ======= ==== ======= ====
The tax effects of temporary differences and carry-forwards that give rise to significant portions of prepaid tax assets and deferred tax liabilities consist of the following:
December 31, 2002 2001 ------------ --------------------- --------------------- Assets Liabilities Assets Liabilities ------ ----------- ------ ----------- Current: Inventory $ 4,124 $ - $ 4,847 $ - Receivable allowances 12,334 - 10,636 - Employee benefits accruals 1,547 - 3,895 - Forward currency contracts 4,880 - - (1,203) Other 1,683 - 1,647 - ------- -------- ------- -------- Total current $24,568 $ - $21,025 $ (1,203) ======= ======== ======= ======== Non-current: Accelerated depreciation and amortization $ 4,531 $ - $ 4,143 $ - Puerto Rico tollgate taxes - (2,470) - (2,470) Undistributed foreign earnings - (10,169) - (10,869) Other 1,050 - - (153) Net operating loss carry-forwards 141 - 129 - Less-valuation allowance (141) - (129) - ------- -------- ------- -------- Total non-current $ 5,581 $(12,639) $ 4,143 $(13,492) ======= ======== ======= ========
49 The Company's consolidated income before taxes included earnings from its subsidiary in Puerto Rico, which are substantially exempt from Puerto Rico income tax under an exemption which expires in 2012 and federal income taxes under an exemption which becomes limited after 2001 and currently expires after 2005. Deferred tollgate taxes have been provided on all of the accumulated earnings of the subsidiary in Puerto Rico which are subject to tollgate tax. Deferred income taxes are also provided on the undistributed earnings of the Company's foreign subsidiaries. 13. Accruals The Company's accrued liabilities are comprised of payroll related, freight, advertising, rents, hedging contracts and a variety of other categories of accruals. Specifically, incentive compensation accruals were $21,074 and $8,914 in 2002 and 2001, respectively. These accruals represent the expected company-wide bonus program payouts to be made in the subsequent year. The Company's bonus program, approved by the Board of Directors, is weighted heavily toward earnings per share and cash flow performance. The increase in 2002, compared with 2001, reflects the impact the Company's strong cash flow performance. 14. Lease Commitments The Company leases its corporate headquarters facility, manufacturing facilities, retail stores, showrooms, two distribution facilities and certain equipment under non-cancelable operating leases expiring at various dates through 2013. The approximate minimum rental commitments under all non-cancelable leases as of December 31, 2002 are as follows: 2003 $ 27,860 2004 24,085 2005 19,382 2006 15,253 2007 11,899 Thereafter 36,138 -------- Total $134,617 ======== Most of the leases for retail space provide for renewal options, contain normal escalation clauses and require the Company to pay real estate taxes, maintenance and other expenses. The aggregate base rent obligation for a lease is expensed on a straight-line basis over the term of the lease. Base rent expense for all operating leases was $31,877, $30,784 and $26,021 for the years ended December 31, 2002, 2001 and 2000, respectively. Percentage rent, based on sales levels, for the years ended December 31, 2002, 2001 and 2000 was $5,314, $7,438 and $6,488, respectively. 15. Business Segments and Geographic Information The Company manages its business in three reportable segments, each sharing similar product, distribution, marketing and economic conditions. The reportable segments are U.S. Wholesale, U.S. Consumer Direct (formerly U.S. Retail) and International. The U.S. Wholesale segment is comprised of the worldwide product development for footwear and apparel and accessories and the sale of such products to wholesale customers in the United States. This segment also includes royalties from licensed products sold in the United States and the management costs and expenses associated with the Company's worldwide licensing efforts. The U.S. Consumer Direct segment includes the Company-operated specialty and factory outlet stores in the United States and the Company's e-commerce business, which began operations in 2001. The International segment consists of the marketing, selling and distribution of footwear, apparel and accessories and licensed products outside of the United States. Products are sold outside of the United States through the Company's subsidiaries (which use wholesale and retail channels to sell footwear and apparel and accessories), independent distributors and licensees. The Unallocated Corporate component of segment reporting consists primarily of the corporate finance, legal, information services and administrative expenses, United States distribution expenses, a majority of United States marketing expenses and other costs incurred in support of company-wide activities. Unallocated Corporate also includes other expense/(income), which is primarily interest expense, interest income and other miscellaneous expense/(income). Such expenses are not allocated among the reported business segments. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates segment performances based on operating contribution, which represents pretax income before unallocated corporate expenses, interest and other expenses, net, and on operating cash flow measurements. Total assets are disaggregated to the extent that assets apply specifically to a single segment. Unallocated Corporate assets primarily consist of cash and equivalents, manufacturing/sourcing assets, computers and related equipment, and United States transportation and distribution equipment. 50
U.S. U.S. Consumer Unallocated Wholesale Direct International Corporate Consolidated --------- -------- ------------- ----------- ------------ 2002 Revenue $595,240 $190,434 $405,222 $ - $1,190,896 Depreciation and amortization 764 2,680 4,506 14,553 22,503 Operating income/(loss) 177,957 27,213 63,257 (129,602) 138,825 Interest expense - - - 884 884 Other, net - - - (828) (828) -------- -------- -------- --------- ---------- Income/(loss) before income taxes 177,957 27,213 63,257 (129,658) 138,769 -------- -------- -------- --------- ---------- Total assets 157,089 28,064 152,691 200,827 538,671 Goodwill 6,804 794 6,565 - 14,163 Expenditures for capital additions 188 2,339 5,555 9,848 17,930 -------- -------- -------- --------- ---------- 2001 Revenue $630,603 $203,578 $349,442 $ - $1,183,623 Depreciation and amortization 579 2,684 4,371 14,473 22,107 Operating income/(loss) 200,161 25,157 50,167 (112,392) 163,093 Interest expense - - - 1,560 1,560 Other, net - - - (196) (196) -------- -------- -------- --------- ---------- Income/(loss) before income taxes 200,161 25,157 50,167 (113,756) 161,729 -------- -------- -------- --------- ---------- Total assets 176,924 26,769 141,135 159,784 504,612 Goodwill 6,804 794 6,565 - 14,163 Expenditures for capital additions 378 3,362 6,099 12,589 22,428 -------- -------- -------- --------- ---------- 2000 Revenue $587,676 $199,274 $304,528 $ - $1,091,478 Depreciation and amortization 597 2,602 3,545 12,547 19,291 Operating income/(loss) 206,358 31,897 47,725 (101,808) 184,172 Interest expense - - - 5,648 5,648 Other, net - - - (8,128) (8,128) -------- -------- -------- --------- ---------- Income/(loss) before income taxes 206,358 31,897 47,725 (99,328) 186,652 -------- -------- -------- --------- ---------- Total assets 147,096 36,061 128,962 164,192 476,311 Goodwill 7,082 826 7,940 - 15,848 Expenditures for capital additions 651 2,689 6,127 25,977 35,444 -------- -------- -------- --------- ----------
The following summarizes the Company's operations in different geographic areas for the years ended December 31, 2002, 2001 and 2000, respectively:
United Other States Europe Foreign Consolidated ------ ------ ------- ------------ 2002 Revenue $785,675 $303,566 $101,655 $1,190,896 Long-lived assets 72,787 14,245 9,856 96,888 -------- -------- -------- ---------- 2001 Revenue $834,181 $249,323 $100,119 $1,183,623 Long-lived assets 74,943 14,366 9,760 99,069 -------- -------- -------- ---------- 2000 Revenue $786,950 $225,279 $ 79,249 $1,091,478 Long-lived assets 69,863 15,646 9,042 94,551 -------- -------- -------- ----------
The U.S. Wholesale and U.S. Consumer Direct segments and Unallocated Corporate comprise the United States geographic area. The International segment is divided into two geographic areas, Europe and Other Foreign. Other Foreign revenue consists primarily of the Company's Asian subsidiaries and, to a lesser degree, the Company's distributors. Other Foreign assets consist primarily of the Company's owned manufacturing facilities in the Caribbean, assets related to the Company's sourcing operations and the Company's Asian subsidiaries. 16. Accumulated Other Comprehensive Income/(Loss) The components of accumulated other comprehensive income/(loss) as of December 31, 2002, 2001 and 2000 were: 2002 2001 2000 ------ ------ ------ Cumulative translation adjustment $(2,203) $(11,216) $(7,292) Fair value of derivatives, net of taxes (7,634) 1,844 - ------- -------- ------- Total $(9,837) $ (9,372) $(7,292) ======= ======== ======= 17. Stockholders' Equity The Company's Class A Common Stock and Class B Common Stock are identical in all respects, except that shares of Class A Common Stock carry one vote per share, while shares of Class B Common Stock carry ten votes per share. In addition, holders of Class A Common Stock have the right, voting separately as a class, to elect 25% of the directors of the Company, and vote together with the holders of Class B Common Stock for the remaining directors. In 2002 and 2001, 350,000 and 21,715 shares of Class B Common Stock were converted to Class A Common Stock, respectively. On October 18, 2000, the Company's Board of Directors authorized the repurchase of up to 4,000,000 shares of the Company's Class A Common Stock. As of December 31, 2000, the Company had repurchased 318,300 shares under that authorization. During 2001 and 2002, the Company repurchased 1,958,500 and 1,723,200 shares under that authorization, respectively. On May 16, 2002, the Board of Directors approved an additional repurchase of up to 4,000,000 shares of the Company's Class A Common Stock. As of December 31, 2002, the Company had 51 repurchased 1,082,300 shares under that new authorization. The Company may use repurchased shares to offset shares that may be issued under the Company's stock-based employee incentive plans, or for other purposes. 18. Stock and Employee Benefit Plans Under the Company's 1997 Incentive Plan, as amended (the "1997 Plan"), 6,000,000 shares of Class A Common Stock have been reserved for issuance. In addition to stock options, any of the following incentives may be awarded to participants under the 1997 Plan: stock appreciation rights ("SAR"), restricted stock, unrestricted stock, awards entitling the recipient to delivery in the future of Class A Common Stock or other securities, securities which are convertible into, or exchangeable for, shares of Class A Common Stock and cash bonuses. The option price per share and vesting periods of stock options are determined by the Compensation Committee of the Board of Directors. All outstanding stock options granted under the 1997 Plan have been granted at fair market value, become exercisable in equal installments over four years beginning one year after the grant date, and expire ten years after the date of grant. Under the Company's 2001 Stock Option Plan for Non-Employee Directors (the "2001 Plan"), the Company has reserved 200,000 shares of Class A Common Stock for the granting of stock options to eligible non-employee directors of the Company. Under the terms of the 2001 Plan, stock option grants are awarded on a predetermined formula basis. Unless terminated by the Company's Board of Directors, the 2001 Plan will be in effect until all shares available for issuance have been issued, pursuant to the exercise of all options granted. The exercise price of options granted under the 2001 Plan is the fair market value of the stock on the date of the grant. Stock options granted under the 2001 Plan become exercisable in equal installments over four years, beginning one year after the grant date, and expire ten years after the date of grant. Options to purchase an aggregate of 1,647,976, 1,525,265 and 1,213,986 shares were exercisable under all option arrangements at December 31, 2002, 2001 and 2000, respectively. Under the existing stock option plans, there were 797,340 and 2,205,876 shares available for future grants at December 31, 2002 and 2001, respectively. The following summarizes transactions under all stock option arrangements for the years ended December 31, 2002, 2001 and 2000:
Range of Number of Excercise Weighted-Average Shares Prices Exercise Price --------- --------- ---------------- January 1, 2000 4,194,312 $ 1.60 - 24.63 $13.43 ---------- -------------- ------ Granted 1,063,95 18.75 - 57.81 26.01 Exercised (1,107,522) 1.60 - 23.75 11.48 Canceled (425,804) 4.34 - 34.94 15.64 ---------- -------------- ------ December 31, 2000 3,724,936 1.60 - 57.81 17.34 ---------- -------------- ------ Granted 739,330 26.84 - 57.00 52.91 Exercised (601,058) 3.34 - 24.63 13.12 Canceled (147,050) 5.13 - 57.81 26.73 ---------- -------------- ------ December 31, 2001 3,716,158 3.34 - 57.81 24.77 ---------- -------------- ------ Granted 1,272,579 28.25 - 45.60 36.15 Exercised (743,166) 3.82 - 34.94 14.55 Canceled (225,435) 15.19 - 57.00 39.82 ---------- -------------- ------ December 31, 2002 4,020,136 $ 3.82 - 57.00 $29.42 ---------- -------------- ------
The following summarizes information about all stock options outstanding at December 31, 2002:
Options Outstanding Options Excercisable ------------------------------------------------- ------------------------------ Weighted-Average Range of Number Remaining Weighted-Average Number Weighted-Average Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price --------------- ----------- ---------------- ---------------- ----------- ---------------- $ 4.34 - 12.53 354,637 3.29 Years $ 8.38 354,637 $ 8.38 12.59 - 15.19 553,350 6.13 15.16 343,350 15.14 16.00 - 20.52 454,650 5.40 18.38 425,950 18.42 20.73 - 22.75 518,375 7.07 22.61 213,125 22.55 23.31 - 34.94 398,485 8.06 31.27 142,662 30.23 35.05 - 35.48 816,194 9.16 35.48 949 35.36 35.61 - 50.35 419,750 9.17 39.90 33,021 42.72 52.28 - 54.44 29,500 7.94 54.40 14,561 54.42 55.35 - 55.35 5,500 8.20 55.35 1,375 55.35 57.00 - 57.00 469,695 8.16 57.00 118,346 57.00 -------------- --------- ---- ------ --------- ------ $ 4.34 - 57.00 4,020,136 7.30 $29.42 1,647,976 $20.75 -------------- --------- ---- ------ --------- ------
Pursuant to the terms of its 1991 Employee Stock Purchase Plan, as amended (the "ESP Plan"), the Company is authorized to issue up to an aggregate of 1,200,000 shares of its Class A Common Stock to eligible employees electing to participate in the ESP Plan. Eligible employees may contribute, through payroll withholdings, from 2% to 10% of their regular base compensation during six-month participation periods beginning January 1 and July 1 of each year. At the end of each participation period, the accumulated deductions are applied toward the purchase of Class A Common Stock at a price equal to 85% of the market price at the beginning or end of the participation period, whichever is lower. Employee purchases amounted to 51,826 shares in 2002, 44,692 shares in 2001 and 47,359 shares in 2000 at prices ranging from $21.20 to $33.59 per share. At December 31, 2002, a total of 282,710 shares were available for future purchases. The weighted-average fair values of those purchase rights granted in 2002, 2001 and 2000 were $8.73, $13.53 and $8.92, respectively. 52 The Company applies APB Opinion No. 25 and related interpretations in accounting for its stock plans. The Company follows SFAS No. 123 "Accounting for Stock-Based Compensation" and SFAS No. 148 "Accounting for Stock-Based Compensation-Transitional and Disclosure-An Amendment of FASB Statement No. 123" for disclosure purposes. SFAS No. 148, issued in December 2002, provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require disclosures in the annual and interim financial statements regarding the accounting method for stock-based employee compensation and the effect of the method used on reported results. In the Company's consolidated financial statements, no compensation cost has been recognized for stock option grants issued under any of the Company's stock option plans. Had compensation cost for stock option grants issued been determined under the fair value method of SFAS No. 123, the Company's net income and diluted earnings per share in 2002, 2001 and 2000 would have been: 2002 2001 2000 ------ ------ ------ Net income before cumulative effect of change in accounting principle and extraordinary item $80,554 $97,218 $117,392 Earnings per share before cumulative effect of change in accounting principle and extraordinary item $2.11 $2.42 $2.75 Net income after cumulative effect of change in accounting principle and extraordinary item $85,467 $97,218 $115,266 Earnings per share after cumulative effect of change in accounting principle and extraordinary item $2.24 $2.42 $2.70 ------- ------- ------- The fair value of each stock option granted in 2002, 2001 and 2000 under the Company's plans was estimated on the date of grant using the Black-Scholes option pricing model. The following weighted-average assumptions were used to value grants issued under the plans in 2002, 2001 and 2000, respectively: expected volatility of 48.3%, 54.8% and 54.1%; risk-free interest rates of 2.9%, 4.3% and 6.5%; expected lives of 4.6, 4.7 and 5.4 years; and no dividend payments. The weighted-average fair values per share of stock options granted during 2002, 2001 and 2000 were $15.53, $26.24 and $13.94, respectively. In October 2002, the Company issued 25,000 restricted shares of Class A Common Stock under the Company's 1997 Incentive Plan, as amended. These shares are subject to restrictions on sale and transferability, a risk of forfeiture and certain other terms and conditions. These restrictions lapse equally over the next three years. In the fourth quarter of 2002, based upon the market value of the shares at the date of the grant, unearned compensation was charged to stockholders' equity for the restricted shares. The weighted-average fair value of these shares was $26.37. In February 2002, the Company issued 20,000 restricted shares of Class A Common Stock under the Company's 1997 Incentive Plan, as amended. These shares are subject to restrictions on sale and transferability, a risk of forfeiture and certain other terms and conditions. These restrictions lapsed immediately on one-third of the shares and lapse equally over the next two years for the remaining two-thirds of the shares. Upon issuance of this stock, based upon the market value of the shares at the date of the grant, compensation expense was recognized for the unrestricted shares and unearned compensation was charged to stockholders' equity for the restricted shares. The weighted-average fair value of these shares was $20.61. In the second quarter of 2000, the Company made a loan of approximately $1,100 securitized by a restricted stock issuance in December 1999. That amount is included in deferred compensation in the consolidated balance sheets and resulted in the revaluation of unearned compensation. The unearned compensation, excluding the loan, is being amortized to expense over the five-year vesting period. In the first quarters of 2001 and 2002, the Board of Directors forgave $325 and $262 of principal payment on the loan, respectively. The Company maintains a contributory 401(k) Retirement Earnings Plan (the "401(k) Plan") for eligible salaried and hourly employees who are at least 18 years of age. Under the provisions of the 401(k) Plan, employees may contribute between 2% and 16% of their base salary up to certain limits. The 401(k) Plan provides for Company matching contributions not to exceed 3% of the employee's compensation or, if less, 50% of the employee's contribution. Vesting of the Company contribution begins at 25% after one year of service and increases by 25% each year until full vesting occurs. The Company maintains two contributory 165(e) Retirement Earnings Plans (the "165(e) Plans") for eligible salaried and hourly employees of its manufacturing facilities and a non-contributory profit sharing plan for eligible hourly employees not covered by the 401(k) or 165(e) Plans. The Company's contribution expense under all retirement plans was $1,552 in 2002, $1,403 in 2001 and $1,283 in 2000. 19. Litigation The Company is involved in various litigation and legal matters that have arisen in the ordinary course of business. Management believes that the ultimate resolution of any existing matter will not have a material adverse effect on the Company's consolidated financial statements. 53 20. Quarterly Results of Operations (Unaudited) The following is a tabulation of the quarterly results of operations for the years ended December 31, 2002, 2001 and 2000, respectively:
2002 Quarter Ended March 29(1) June 28 September 27 December 31 ------------------ ----------- ------- ------------ ----------- Revenue $225,697 $191,529 $416,641 $357,029 Gross profit 99,763 86,008 182,840 149,675 Net income before cumulative effect of change in accounting principle 8,980 4,923 49,166 27,131 Net income 13,893 4,923 49,166 27,131 Earnings per share before cumulative effect of change in accounting principle Basic $.24 $.13 $1.33 $.74 Diluted $.23 $.13 $1.30 $.73 Earnings per share after cumulative effect of change in accounting principle Basic $.37 $.13 $1.33 $.74 Diluted $.36 $.13 $1.30 $.73 -------- -------- -------- -------- 2001 Quarter Ended March 30 June 29 September 28 December 31 -------- ------- ------------ ----------- Revenue $245,429 $200,851 $396,219 $341,125 Gross profit 108,588 91,782 174,574 145,831 Net income 17,511 10,489 48,529 30,212 Basic earnings per share $.44 $.27 $1.25 $.79 Diluted earnings per share $.43 $.26 $1.22 $.77 -------- -------- -------- -------- 2000 Quarter Ended March 31 June 30(2) September 29 December 31 -------- ---------- ------------ ----------- Revenue $208,604 $177,064 $375,246 $330,564 Gross profit 95,421 82,400 178,152 152,540 Net income before extraordinary item 14,666 11,133 57,453 40,888 Net income 14,666 8,991 57,453 40,888 Earnings per share before extraordinary item Basic $.36 $.28 $1.44 $1.03 Diluted $.34 $.26 $1.35 $ .96 Earnings per share after extraordinary item Basic $.36 $.22 $1.44 $1.03 Diluted $.34 $.21 $1.35 $ .96 -------- -------- -------- --------
(1) In the first quarter of 2002, the Company recorded a $4,913 after-tax cumulative effect of change in accounting principle gain. The gain consisted of the unamortized balance of the excess of fair value of net assets over cost as of December 31, 2001. (2) In the second quarter of 2000, the Company recorded a $2,126 after-tax extraordinary loss. The loss consisted of a prepayment penalty and other costs associated with the early redemption of $100,000 in senior notes. 54 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of The Timberland Company: We have audited the accompanying consolidated balance sheets of The Timberland Company and subsidiaries as of December 31, 2002 and 2001 and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2002 and 2001, and the results of its operations and cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 1 to the consolidated financial statements, in 2002 the Company changed its method of accounting for the excess of fair value of acquired assets over cost to conform to the Statement of Financial Accounting Standards ("SFAS") No. 141, and goodwill to conform to SFAS No. 142. DELOITTE & TOUCHE LLP Boston, Massachusetts February 5, 2003 55 CORPORATE INFORMATION DIRECTORS Robert M. Agate Retired Senior Executive Vice President and Chief Financial Officer Colgate-Palmolive Company John E. Beard Of Counsel Ropes & Gray John F. Brennan President Green Mountain College Ian W. Diery President and Chief Executive Officer Electronic Scrip, Inc. John A. Fitzsimmons Retired Senior Vice President Circuit City Stores, Inc. Virginia H. Kent Former Chief Executive Officer reflect.com Bill Shore Founder and Executive Director Share Our Strength Jeffrey B. Swartz President and Chief Executive Officer The Timberland Company Sidney W. Swartz Chairman The Timberland Company Abraham Zaleznik Professor Emeritus Harvard Business School CORPORATE OFFICERS Sidney W. Swartz Chairman Jeffrey B. Swartz President and Chief Executive Officer Kenneth P. Pucker Executive Vice President and Chief Operating Officer Brian P. McKeon Chief Financial Officer and Executive Vice President - Finance and Administration Frank P. Bifulco, Jr. Senior Vice President and Chief Marketing Officer Fabian T. Garcia Senior Vice President - International Marc Schneider Senior Vice President - Product Management Gary S. Smith Senior Vice President - Supply Chain John Crimmins Vice President, Corporate Controller and Chief Accounting Officer Gregory M. Saltzberg Vice President and Treasurer Danette Wineberg Vice President and General Counsel and Secretary Thomas J. White Assistant Secretary CORPORATE COUNSEL Ropes & Gray Boston, Massachusetts INDEPENDENT ACCOUNTANTS Deloitte & Touche LLP Boston, Massachusetts ANNUAL MEETING OF SHAREHOLDERS Thursday, May 15, 2003, at 9:30 am The Timberland Company 200 Domain Drive Stratham, New Hampshire 03885 FINANCIAL INFORMATION To request information, such as this annual report and Form 10-K for the fiscal year ended December 31, 2002, as filed with the Securities and Exchange Commission, please visit our website, www.timberland.com, call our investor hotline at 603-773-1212, or send a written request to the attention of Investor Relations at our corporate address or e-mail address, investor_relations@timberland.com. CLASS A COMMON STOCK LISTING New York Stock Exchange: TBL STOCK SPLITS Record Date Effective Date Split 08/31/99 09/15/99 2 for 1 06/30/00 07/17/00 2 for 1 DIVIDEND POLICY The Company has never declared a dividend on its Common Stock, and the Company's ability to pay cash dividends is limited pursuant to loan agreements (see notes to the Company's consolidated financial statements). SSTOCK CERTIFICATE, NAME CHANGES, OR TRANSFERS Equiserve Trust Company, N.A. PO Box 43010 Providence, Rhode Island 02940-3010 800.730.6001 www.equiserve.com 56