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The Timberland Company (NYSE:TBL)

Q4 2007 Earnings Call

February 7, 2008 8:25 am ET

Executives

Karen Blomquist - Timberland’s Senior Manager of Investor Relations.

John Crimmins - Acting Chief Financial Officer

Jeffrey Swartz - President, Chief Executive Officer

Analysts

Brian McGough - Morgan Stanley

John Shanley - Susquehanna

Jeff Edelman – UBS

Steven Margin - Slatten Capital Management

Virginia Genereux - Merrill Lynch

Operator

You are listening to The Timberland Company’s fourth quarter and full year 2007 analyst conference call. (Operator Instructions) Now for the opening remarks, I will turn the call over to Karen Blomquist, Timberland’s Senior Manager of Investor Relations.

Karen Blomquist

Good morning and welcome to Timberland’s fourth quarter 2007 conference call. Speaking today will be Jeffrey Swartz, our President and Chief Executive Officer; and John Crimmins, our Chief Financial Officer. John will be discussing our financial results for the quarter; Jeff will then discuss our performance within the context of our longer-term strategic direction.

This presentation includes -- and our responses to your questions may include -- forward-looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Any such statements are subject to risks and uncertainties that could cause actual results to differ materially. These risks and uncertainties are discussed in today’s press release and in the company’s filings with the SEC. Copies of our SEC reports are available upon request from Timberland.

This presentation also includes a discussion of constant dollar revenue change, diluted EPS, operating income, and operating expense excluding restructuring costs which are non-GAAP financial measures. As required by the SEC rules, we have provided a reconciliation of these measures and additional information on the presentations tab found in the investor relations section of our website, www.Timberland.com.

Thank you and now I will turn the call over to John.

John Crimmins

Thanks, Karen and good morning, everyone. The fourth quarter marked the culmination of a very challenging and disappointing year for Timberland. Weak retail market conditions, exacerbated fashion shifts away from our products, resulted in profitability deleverage and full year revenue declines for the first time in the company’s history.

Despite these headwinds, we have made significant progress towards right-sizing our business to provide further flexibility in a challenging market and to set the foundation to begin the return to acceptable profitability levels going forward.

Today I will review our results for the quarter, update you on the steps we have taken to streamline our global operations to save an additional $30 million in annual operating expenses and discuss our current outlook for 2008.

I will begin with a review of fourth quarter results. Fourth quarter global revenues decreased 9% to $443 million as declines in U.S. and international constant dollar revenues offset benefits from favorable foreign exchange rate changes. For the quarter, foreign exchange rate changes added 3% to overall revenues.

Global footwear revenues decreased 14% to $304 million as greater than anticipated declines in boots and kids sales offset moderate growth in casual and pro footwear and benefits from the addition of IPATH.

Global apparel and accessory revenue grew 3% to $133 million as growth in SmartWool, the addition of Howies, and benefits from favorable exchange rates offset declines in Timberland-branded casual apparel.

By channel, global wholesale revenues decreased 15% to $289 million. Global retail revenues increased 3% to $153 million as benefits from our global door expansion and favorable exchange rates offset a 6% decline in comparable store sales.

International revenues, benefiting from the weaker dollar, increased 5% to a $184 million for the quarter but decreased 2% in constant dollars. Europe revenues decreased 3% on a constant dollar basis as anticipated pressure on boots and kids footwear, as well as moderate declines in outdoor performance wear offset gains in Timberland SmartWool apparel and accessories and benefits from the addition of Howies.

Europe results reflected declines in most major European markets, offsetting strong growth in our distributor operating markets. Asia sales fell 3% on a constant dollar basis, due primarily to declines in Japan, Taiwan and Malaysia offset by gains in key distributor markets including China. We continue to expand Timberland’s global brand franchise in Asia with a particular focus on China. So far we have opened 58 wholesale doors in China and are pleased with our progress.

Timberland’s U.S. sales fell 17% to $259 million for the quarter. U.S. wholesale revenues declined 22% to $178 million, driven by greater than anticipated declines in boots and kids footwear, decreases in Timberland-branded apparel and moderate declines in men’s casual and outdoor performance footwear.

These declines offset double-digit gains in SmartWool, solid growth in Timberland Pro and benefits from the addition of IPATH. Timberland’s U.S. retail revenues declined approximately 6%in the fourth quarter, driven by a 9% decline in comp store sales.

As we announced last fall, we have completed a comprehensive review of our global retail portfolio which has resulted in our decision to close the majority of our U.S. specialty stores. We are in the process of negotiating these closures and now anticipate that all will be closed by the end of the second quarter. We are also continuing to test our newer smaller Footwear First format. To date we have two new stores opened in our Boston area test market and have converted our Garden State Plaza New Jersey store to this new format.

Timberland's operating income for the fourth quarter was $32 million. These results include restructuring costs of $10 million; $7 million resulting from actions taken to rationalize and streamline our operating expense structure and $3 million related to our retail closure plan. The results also reflect the impact of approximately $8 million of accruals that we were reversed during the fourth quarter, primarily related to incentive compensation accruals as the company’s annual operating performance fell below minimum requirements.

Operating income, excluding restructuring charges, fell $19 million to $42 million and operating margin fell 300 basis points to 9.5%. For the quarter, EPS was $0.40 or $0.52 excluding restructuring charges, compared with $0.61 excluding restructuring charges for the fourth quarter of 2006.

Gross margin for the quarter was 45.3%, 130 basis points below the prior-year period, reflecting unfavorable impacts from lower boot sales in the U.S. and Europe; increased levels of off-priced sales and markdowns; and higher comparable product costs, including $1 million of EU duties. Foreign exchange rate changes added 120 basis points to gross margins and $3 million to operating profits for the quarter.

Operating expenses, excluding restructuring charges, fell 5% to $159 million. The decrease in operating expenses includes the reversal of approximately $7 million in incentive compensation accruals, lower spending with administrative and support functions, and decreases in share-based compensation expense. These decreases offset increased spending on advertising and the addition of new businesses.

As we have been saying, we recognize the need to drive efficiencies across our organization to deliver stronger financial returns for our business. During 2007, we announced our agreement to license our North American apparel business, our intent to close underperforming retail stores and steps taken to streamline our U.S. product and sales organizations. These actions will reduce our annual 2008 operating expenses by approximately $35 million globally.

Following a review of each function in our entire global organization, we identified and have taken actions during the fourth quarter that we expect will result in an additional annual operating expense savings of $30 million.

Overall, we are anticipating a recalibrated operating expense base of $550 million, reflecting the $65 million in annual cost savings which will be partially offset by incremental spending to support consumer-facing marketing, retail store expansions, and other growth initiatives. We will begin 2008 with a more efficient organization that we believe is right-sized for our business.

We ended the year with $143 million in cash and no debt. Inventory in the fourth quarter increased 8% to $202 million, largely reflecting impacts from increased product costs, foreign exchange and the addition of new brands. Accounts receivable in the fourth quarter decreased 8% to $188 million as the impact of lower wholesale revenues was partially offset by a shift towards the higher international business mix. Reported wholesale DSOs for the quarter increased five days to 49 days. Capital spending for the quarter was $10 million.

In the fourth quarter, we repurchased 1.1 million shares under our current share repurchase program. We continue to believe that share repurchases are a good way to return excess cash to our shareholders. Timberland has 1.3 million shares remaining under current share repurchase authorizations.

The tax rate for the fourth quarter of 2007 was 24% compared to 36% in the prior-year period. The rate for the quarter was affected by the release of $8 million in tax reserves related to the closure of certain audits as we had anticipated. Timberland expects its full year 2008 tax rate to be in the range of 40%.

For 2008, Timberland is targeting low single-digit revenue declines, operating expenses in the range of $550 million and flat to modest operating margin improvement compared with 2007 comparable results as actions taken to rationalize the company’s operating expense structure will offset continued soft market trends.

We continue to target mid single-digit revenue declines and improved operating contribution for the first half of 2008 compared with 2007 first half comparable results. Our outlook excludes approximately $6 million in restructuring charges that are related to the final closure of stores and are anticipated to occur in the first half of 2008.

We now estimate the full restructuring impact of store closures to be in the range of $16 million, or $1 million below our initial estimate. The shift in timing versus our original estimate reflects later closure dates for a number of stores. We now anticipate all stores to be closed by the end of the second quarter.

Both 2008 targets and 2007 comparable results exclude restructuring costs. 2007 comparable results also exclude the impact of stores targeted for closure by the end of the first half of 2008.

Thank you. Now I’ll pass the call over to Jeff.

Jeffrey Swartz

Thanks, John. 2007 was a disappointing year at Timberland. Given the value of our brand, given its authenticity and its unique position with consumers worldwide, and given the amount of effort invested by a very passionate and committed business community at Timberland;; given all of this, the results we earned were below standard and unacceptable.

My purpose in these brief remarks is to assure you that we have a clear sense of where our strategy has missed the mark and a simple and concrete plan to address the challenges we are confronting.

The sharp decline in our boot business is a central subject we have discussed at length with shareholders. A combination of overfeeding a hot marketplace and of a subsequent sharp cooling in that marketplace has led to the loss of $200 million plus of very profitable boot sales over the last 30 months.

I have consistently reported to your our efforts over the last four to six seasons to stop the slide and to protect our relationship with youthful consumers. Even as fashion has veered from Timberland, we have worked to preserve our relationship with the youth consumer. We believe now that we are at or near the bottom of the boot decline; that is the good news.

In terms of next in the boot business, our plan is very simple. We intend to control and thoughtfully limit our exposure to this marketplace of street fashion. We do not expect to earn back the revenues that we once enjoyed in the boot business. Instead, we expect to grow other parts of our product portfolio in order to deliver profitable top line growth.

Is our exposure to the boot fashion cycle complete? From the vantage point of today, I believe that the worst part of this experience is surely behind us and that while there remains some exposure to fashion risk in the boot business, that segment of our overall portfolio is sufficiently reduced to follow into a normal business exposure rather than a central business concern.

The question that follows is then, how will Timberland grow its consumer franchise? Our answer is simple. For more than 30 years we have been the authentic outdoor brand, rooted in industrial strength from the soil of New Hampshire. For more than 30 years, our values – outdoor proven, industrial strength, environmentally thoughtful – have distinguished us, now in 85 countries around the world. We don’t need a new brand positioning, we need to focus maniacally on the brand values that brought us to global leadership with demanding consumers from London to Tokyo and San Francisco.

The excitement and energy of the boot experience created lots of shareholder value and brand buzz. That the boot story with young consumers proves after ten years to have a natural size is a reality we are adjusted to.

We have demonstrated in 2007 that we are capable of organizing to build our brand profitably, even absent the hyper consumer. We began the serious work of reorganizing the company to compete against our original consumer proposition in a more single-minded way. We simplified the organization, we made hard, consequential choices about where to compete and how to compete and I can report to you, even amidst the disappointing results that we report, some indications that the hard choices we are making are the right choices.

The choice to license apparel in the U.S. was hard because 70 people lost their jobs in New Hampshire when we made this choice; and it was hard because in the stub period between announcing the licensing deal and the planned first shipments from Phillips-Van Heusen, the first shipments which will be occurring sometime soon, we managed a lame duck business in a very tough retail environment. We got battered in the apparel business last year in the U.S., but we knew that the pain of transition was right to absorb because we knew that our brand plus the competence and the strength of the Phillips-Van Heusen operation would yield a more robust, brand-right apparel business in the U.S. As PVH is now well into their market launch sell-in of fall ’08 apparel, the order book they are generating validates our hard choice.

The product line is stronger, the price value of the product is more coherent and compelling, the business case for the retailers more powerful, and as a consequence PVH with the Timberland brand has already secured substantially more square footage in Macy’s doors across the U.S. than we had secured in fall ’07. PVH has already generated a substantial increase in forward orders for fall ’08 on a like-for-like basis.

Think about it: after a terrible fall ’07 performance at retail, into the teeth of a well-discussed consumer downturn right now, to post these kind of sell-in results is a tribute both to the PVH team and to the power of our brand.

Licensing apparel in the U.S. was a hard choice, but it was the right choice and it is a choice that is going to be very good for the brand and for the shareholders in the medium and long term.

We made another hard choice in 2007, namely to invest marketing funds in brand-building during the second half of last year, notwithstanding an order book that was disappointing and a retail climate that was horrendous. We stuck by that hard choice, even as we made very painful reductions in operating expenses in almost every other corner of our business.

Even as we consolidated operations and people left the business, we stuck by the choice to invest in brand building. In my estimation, we have underinvested in telling our story to consumers. In fall ’07, we began the concrete process of rebuilding our marketing voice. In the U.S., this meant television advertising in one market; globally, this meant executing the same television efforts in 29 countries.

For fall 2008 what we learned in fall 2007 is being applied with confidence and focus. We are expanding to six television markets in the U.S. and we are redoubling our marketing efforts globally with a particular focus on leadership markets like the UK, Italy and Japan. As we announced earlier this week, we have engaged a new creative agency to help us raise the creative content of our marketing. We have worked with Leagas Delaney before; they were our agency when we launched the brand in the UK nearly 20 years ago. Tim Delaney is a creative who gets our brand. I am very confident with his creative edge, we can extend sharply the marketing shadow of our brand building in a market that is as directionless and moribund as this one seems to be, the time is now to be clear and bold and confident with consumers. We plan to be a more effective and powerful marketer.

Fall ’08 contains more indications that our plans to restore the vitality and energy of the core Timberland brand will work; not only is our apparel order book much stronger in the U.S.; not only is our commitment to marketing concretely expanded in the U.S. and globally; our core footwear business is better informed, better focused, less complex and more coherent than our recent seasons.

Last year I told you about the introduction of the Earthkeepers collection of footwear during the second half of 2007. Earthkeepers footwear, rugged, handsome for men and women, outdoor tough and consumer relevant built with recycled materials and earth-friendly thinking and backed by the advertising I described.

In Boston, we even executed a pop-up retail store in the main commuter railway station downtown. We drove consumers to this collection and we sold it through well on a global basis.

In fall 2008 we have expanded the idea of Earthkeepers with a broader selection of footwear and the introduction of Earthkeepers apparel in the PVH collection. Even as we build on this idea, as we expand Earthkeepers, we are in the market in fall 2008 with a footwear range that contains 20% fewer SKUs than the comparable fall 2007 line. This reduction in SKUs is one solid concrete indication that our efforts to informed product creation with actionable consumer insight is beginning to payoff.

I have been describing to you our focus on consumer insight for some time. In fall 2008 I think the more focused footwear offering across men's, women's and kids is a reflection of this sharper focus on the consumer. This reduction in footwear SKUs even as we expand important ideas like Earthkeepers reflects our belief that the key to growing our core footwear business is to do fewer things at a much higher standard; fewer new products but executed with much more excellence.

This is why we took the hard choice to sharply prune our retail store portfolio globally during 2007. We know that retail presentation of our brand globally is essential, but we are not going to accept anything less than excellence both in terms of brand-building but also in terms of financial performance. So we closed the stores that were not performing and at the same time, we made consequential investments in refocusing our retail presence where it makes sense, with footwear-focused stores opening in England, Germany and the U.S. We also opened an e-commerce site in the UK, which is our second e-store; initial results were positive. In the meanwhile we are executing the store closure program with care as John described to you. Of the stores we slated for closure, we have completed roughly three quarters of the negotiations and are in process with the remainder. Our efforts to negotiate the most favorable lease buyouts possible have kept us under our original budget.

Pressures on other pieces of the business have masked some success stories in 2007. Timberland Pro and SmartWool are clear and relatively spectacular wins. Timberland Pro continues to outgrow the category and to deliver superior financial results. This business Pro is consistent within the enterprise to the overall 15% operating margin I have described as the financial goal for our overall company. SmartWool continues to grow rapidly and to deliver superior financial results as well.

2007 was a disappointing year. We are hard at work in 2008 on delivering against our commitments and on demonstrating that the hard strategic choices we put into work in 2007 will lead us to the brand-building and financial performance for which we are accountable.

We are glad now to answer any questions that you have.

Question-and-Answer Session

Operator

Our first question comes from Brian McGough - Morgan Stanley.

Brian McGough - Morgan Stanley

Big picture about the evolution of where you are right now, so '07 was a really big year, was a very big transition year; you ramped up the investment rate in your Authentic youth business which took down margins. You hired a big organization under Gene and that’s at the same time while you are being offensive in pulling back product from the market. SKUs narrowed and exclusives by customers went up pretty materially.

Could you just talk about where you are in both the investment process and also are there any anecdotes about how certain high end product that came out around holiday worked or did not work?

Jeffrey Swartz

Brian, lot of things to say back. Let’s start at the back and work forward. The high end products, you referred to some of the exclusive stuff that was part of the AY re-imagine efforts. We saw good results, we saw better results frankly with high end and special stuff than we saw with sort of middle of the road stuff. That’s true across our brand broadly.

So if you think about Boot Co., which is a very limited and very high end product, this is not an Authentic Youth proposition it is highest expedition of casual gear. We were very successful and very pleased with how this is very limited -- and small from a financial perspective -- with how this business retailed at places like Barney’s in the U.S. and continues to retail. Within the efforts that the AYT made, similar anecdotes to report to you but they are anecdotes because it’s high end and it’s small business.

We did make a substantial investment, more about hard choices than dollars. We didn’t build a huge organization in AOI. We did deploy across Timberland structure that said we are going to create multiple general managers to manage within the Timberland brand. I reported to you recently that as we looked at what needs to be done strategically, we took the choice to reconsolidate the Timberland tree under the leadership of Mike Harrison and Gene as Co-President’s. The two of them are in fall ’08, they pulled together an integrated tree and in spring ’09 they are building an integrated approach to brand-building, product distribution and marketing.

The net of pulling together the separate genius of these two guys is that we were able to flatten out the organization from a product development perspective. We have a leaner, flatter, I think faster, better consumer-connected organization than we did before. We’ve done the same thing within the sales organizations. We are not complete with all the work that needs to be done, but I feel confident that under Gene’s leadership in this regard, the U.S. and the European and Asian teams, the selling teams are better focused.

I’m confident under Mike’s leadership that we are doing a better job of taking consumer insight and turning it into product. I think the fact that there are 20% fewer SKUs in fall’08 which is an important indicator of sharpening focus and being able to do not more with less, to be able to do less much better. It is not an operating expense reduction strategy, it’s a brand-building strategy that happens to have an operating reduction that goes with it so I think it’s a double win.

I think that its clear that there is plenty of challenge ahead. We do not have the fall order book built yet on footwear; we have a good anecdotal sense of where things are but we don’t have hard facts yet and we obviously have a very difficult marketplace. So we are very focused and I’m confident in the leadership and I’m concerned about the marketplace.

Brian McGough - Morgan Stanley

Jeff, how will you change the incentive structure of your executive team, and even one or two levels down in order to achieve the goals that you want to?

Jeffrey Swartz

It’s a good question. Last year, we went to a one-system incentive for the whole company that was focused on shareholder metrics. John reported to you that in the fourth quarter we recognized that we weren’t going to achieve those goals and so the pain of not earning a short-term incentive was broadly felt by our whole community: senior executives right down to every member of the company felt the pain of 2007. Given the results, we earned the circumstance that we experienced.

In terms of 2008, our incentive structure is simple and clear and what we are going reward is I hope what you would expect in terms of operating income and in terms of management of working capital. That is our focus. Our focus is operating income and operating working capital because these are very challenging times and I said to you we are responsible, we are accountable for two things: brand-building and delivering markedly better results for shareholders.

It’s well and good to tot over 15% operating margin. Having delivered a 6% operating margin, there is a plenty of room for improvement and I want to make sure that everyone at Timberland is very clearly focused on closing that gap.

Operator

Your next question comes from John Shanley - Susquehanna.

John Shanley - Susquehanna

Jeff, can you give us an idea of what your turnaround timeframe is for both the boot and the kids business? Are we looking at something that could show some marked improvement by the fall’08 period or are we looking really sometime in the ‘09 selling seasons?

Jeffrey Swartz

We are being really clear, John, that within the tree, within Timberland brand, the business that we have described in the past as boots is part of the responsibility that Gene and Mike have to deliver against in U.S. and Asia and in Europe. I said in my script that we think we are near the bottom of that business. Our view of the way forward is I am not sitting here believing that given new product introductions, given thoughtful strategy that we are going to recapture the ground that was lost.

I talked about $200 million plus of very profitable revenues in men’s, some in women’s and in kids that’s off our income statement. We sit here looking the next three years thinking that our focus should be in other parts of the portfolio to grow our top line and our bottom line. So you will see our product focus and you will see our marketing focus be much more single-minded against the consumer that is the original traditional Timberland consumer.

I have demonstrated to you, John, that we have the ability to be respectful of and connected to a hyper consumer but that isn’t our business. That isn’t our business competence either. The youth consumer is an important part of our portfolio but it’s not a central focus of our strategy. We believe that we can grow the top line in the ways that we’ve outlined to you. I don’t think in fall ’08 will we see what we used to call the boot business better or worse. I sure hope better, but I don’t want to leave the impression in your mind that there is an expectation here that we are going to capture back those $200 million of lost sales any time soon.

John Shanley - Susquehanna

We are looking at something beyond the near-term horizons like 18 months out or more than that before you start seeing a meaningful increase in those two product categories, boots and kids. Is that a fair assessment?

Jeffrey Swartz

No, I think I am not doing a good job of communicating with you. I feel bad because I’m trying. I don’t know if what I am calling the hyper consumer will ever come back to the brand. I’m not saying that they will and I’m not saying that they won’t. I’m saying to you that as a matter of strategic focus, our strategic focus is not on chasing that marketplace. In fact, our best success John will a young consumer was when we stayed true to our brand building and didn’t chase.

I said in the script that I wrote the overfeeding of a hot market and then the sharp cooling of that market. The overfeeding was us; the cooling of it had nothing to do with us, that has to do with fashion trends that exist in the world and I cannot predict to you whether those fashion trends are going to come back to favor the look of big denim looks that go with big, heavy Timberland boots. If it does -- if it does -- there would be a consumer response that we will be prepared to support.

The fact that looks are more tailored from a fashion perspective, I can place the strengths within our other parts of our brand portfolio. For example, boat shoes; we are still the biggest and I think the darn best boat shoe provider on earth and to the extent that young consumers or old consumers wear our boat shoes, that’s good because that is what Timberland wants, that’s part of our product strategy.

I’m saying to you I don’t have a prediction for when or if the youthful consumers will readopt Timberland as a central fashion element of his or her wardrobe. I don’t have a prediction of that.

John Shanley - Susquehanna

Can you give us a little bit more detail on the $65 million of restructuring cost savings that you mentioned? Where is that going to be focused primarily and what’s the timeframe in terms of the benefit that the restructuring, cost savings is likely to hit the bottom line?

John Crimmins

John, I will take that one. The $65 million, we have already taken the actions to remove $65 million from our annual operating expense base. I tried to give you some math that explained how it would come down. Take $65 million out and then reinvest in marketing, in retail expansion, in some of our growth businesses that would net us out at the $550 million OpEx base.

I can tell you that the $65 million is an accumulation of some actions that we had announced previously, the licensing of our apparel business, the refinement of our retail portfolio and at the end of the third quarter, we talked about some organizational changes that we have completed related to our global product organization and our U.S. sales organization.

During the fourth quarter, we completed the review of every part of our global enterprise, every function, every geographic region and identified a number of different actions that we have already executed to remove costs from our annual operating expense base. A little less than half of that was people-related costs; everything else was other expenses that we were able to identify opportunities to reduce our spend level, including consulting and professional fees, travel, meetings, just about every category that you could take them out of the P&L.

So it is a pretty comprehensive exercise that we have been working on for the balance of the year. Most of the actions that produced the savings as far as organizational efficiencies took place during the fourth quarter of 2007.

John Shanley - Susquehanna

That is very helpful. Jeff, you mentioned the PVH transition of the domestic apparel business. Can you give us an idea of how well that has been received by retailers other than Macy’s? We are kind of curious as to why PVH has decided to focus in on Macy’s which right now has issues and problems of their own, rather than some of the outdoor retailers like REI and Eastern Mountain Sports?

Jeffrey Swartz

Three things to say. I illustrate I was using Macy’s as an illustration. I would say that PVH’s focus is not exclusively on the department store channel in the U.S. but they have great strength and serious competence against that channel. Macy’s is an indication of I think progress made. Actually I am really impressed; I am impressed with the product; I am impressed with the investments they are making which are, as they have reported, they are very consequential investments; the leadership of the company from the CEO down have been involved in our brand and I appreciate that. That commitment to brand-building is real and I deeply appreciate it because I think it would be easy under the circumstances to pull back and they are not; they are being honorable and hard-nosed about building the business. They just did Market Week ten days ago and so Macy’s results were very encouraging. That is why I reported it to you. But it is not exclusively by any means a Macy’s conversation.

There are other major players in the department store channel that we would love to report you the progress we are going to make with other folks because there is more to be done.

When you speak about the specialty outdoor channel, I would say that EMS and REI are not likely points of distribution for Timberland apparel the way the line is constructed right now. Dick’s is; there is an extraordinary powerful retailer where I think the outdoor performance part of our apparel collection would be very relevant.

I look forward to reporting to you on I hope PVH will as well, progress we make not just in the department store channels because you are absolutely right. It’s not the only place either to do business, it is a challenged place but it’s clearly a place of progress.

REI and EMS, REI in particular, it’s one of SmartWool’s most important distribution partners and it’s more of a hard-edged performance set from an apparel perspective. I don’t think they would consider Timberland apparel the way it’s currently posed. We do some footwear with them. We were much more successful with SmartWool there than we are even with Timberland’s footwear there because they continue to push for notwithstanding our environmental posture, et cetera, et cetera, they continue to push for more specialty performance stuff and less broad democratic outdoor stuff.

John Shanley - Susquehanna

John, maybe you can give us an update in terms of the store counts both domestically and internationally? We’ve kind of lost track with all the closings. What is the current store count?

Karen Blomquist

About 11 closed so far. So that will bring the total down from 820 down 11.

John Crimmins

810 on a global basis, Karen?

Karen Blomquist

Yes.

John Crimmins

810, John. Does that sound right?

John Shanley - Susquehanna

That’s distributors, franchise and retail.

Karen Blomquist

As of the end of December. We have made some closures during the first quarter. I will get you details on that.

John Crimmins

In the range of 810 stores opened and operating around the world right now.

John Shanley - Susquehanna

How many of those are owned stores?

John Crimmins

About 240.

Operator

Your next question comes from Jeff Edelman - UBS.

Jeff Edelman - UBS

My first question is gross margins are down about 300 basis points over the last few years. John, could you give us a sense how much of that reflects markdowns, how much mix and how much reflects your inability to pass through higher costs?

John Crimmins

I can talk specifically to this year. The single biggest factor affecting our gross margin rate this year was related to a level of markdowns and off-price activity. We also still continue to feel the effect of the change in product mix moving away from the impact of lower boots and kids products, which were higher margin for us.

Outside cost increases are also a significant component. In 2007 the single biggest piece though, close to 190 basis points of downward pressure was related to markdowns and off-price activity.

Jeffrey Swartz

A lot of that had to be related to the apparel business in the U.S.

John Crimmins

Absolutely.

Jeff Edelman - UBS

Jeff, as we look at what’s happening out there in retail, there are a lot of brands selling a lot more footwear. You keep talking about the strength of the Timberland brand, have you done sufficient research to reinforce your conviction that the Timberland brand does connect with the consumer and resonates with them? And willing to buy a Timberland product if you can get the right one to them, or is it sort of just drifting off, out to no where? I am perplexed on that part?

Jeffrey Swartz

I am not perplexed in that regard at all, Jeff, because we have very fresh data that we do update. That is, it’s not general preference it is much sharper data than that that talks to consumers who are purchasers and consumers who never were purchasers. Right? It’s principally men at this moment but we’ve done some with women and we’ve done it on a global basis. We’ve done it in the United States, we’ve done it in the UK. I think we’ve done it in Japan, I am not positive. I know we’ve done it in a second market in Europe as well, I am pretty sure. In Italy, and maybe even in Germany.

So the point is we feel this conversation not in soft terms and we have sharp questions about purchase intent. I would say, Jeff, the big learning from the conversation is first to answer your question directly is, what’s the consideration? The consideration is high.

But, what is the constraint? The largest shift in consumer attitude is less to do with product and more to do with storytelling. I don’t know if that strikes you as interesting, but it did strike me as interesting, meaning when we take a consumer into the Regent Street store where we will do this kind of research and we take them through the store and they look at what is on the walls, and you have a conversation about – okay. Let’s say for example that you are a consumer that purchased Timberland in the last six months, what is your inclination to buy something you have seen here in the next six months? There is a certain percentage that says yes, I am for it and it is not 100%.

Then you have a conversation with the consumer and you measure and you tell them the story about stuff that they don’t understand in the store, whether it is about the features and benefits of the products or other elements of the Timberland story. The shift in the data from aware of the brand, bought the shoes, liked the brand to heard the story, they walked through the store again, the shift in purchase intent is extraordinary. It is very, they tell me statistically significant, which is why I said in my remarks in my estimation we have undertold our story.

The fact is Jeff, brand shoes is a very well-served marketplace. You are accurate about that point. It is better served now then it was ten years ago. The brand sits in a warm place in consumers’ hearts, but warm is not the same thing as active, right? So we don’t get in presidential politics terms, our negatives are very low. Our positives are very high. Meaning when you ask a consumer what do you think about the brand? You get back very positive feeling.

When you ask people what don’t you like about the brand, you get back very little negative. But when you ask a consumer, how compelled are you to buy? You get the kind of results that we are reporting in revenues, which is I wouldn’t say tepid, but I certainly wouldn’t say a must buy. When we tell story against that consumer, we give them the romance of the brand, facts and figures, the shift is sharp and that’s why we stuck with the marketing in fall ’07.

To be clear, Jeff, the marketing ’07 I don’t know if you saw the rain ad. The thesis of the rain ad is when it rains, zip up your jacket, lace up your boots and Timberland will keep you dry. Not particularly romantic, not extraordinarily insightful. One could say a message from 20 years ago, right? Timberland, the waterproof guy in the fourth quarter. Yet the response to the ad in the places that we ran it from Moscow to London to Boston was very positive. Meaning the consumer said, “oh, yeah, that’s right. Timberland does this for me” and we sold Earthkeepers.

I am not making a big math point about this. I am just saying we had good product. Earthkeepers is a good product and we put good marketing against it. The rain ad was a good ad and we saw good results. My thesis continues to be, and I think it’s supported by the data, if you do great product and you do great marketing we will sell through against this consumer.

I conclude by saying this Jeff, nothing is drifting here. Not our attention, not our passion. I believe the difference between the kind of results that we are getting and the kind of results that we aspire to is very much in our hands. It’s not about our competitors. It’s about our ability to execute.

I tried to articulate a relatively simple plan: make great products and tell the story. We don’t need new distribution. We need to do a better job in the distribution that we are in. We don’t need reorganizations and big speeches. We need to make great shoes, tell people that we make great shoes and then sell them great shoes. I believe that’s what’s going to happen.

Operator

Your next question comes from Steven Margin - Slatten Capital Management.

Steven Margin - Slatten Capital Management

Jeff, it’s all fine and dandy to use a whole lot of words about connecting with consumers but you have been at the helm for a long time and the profitability of the company has been declining for the last couple of years and there is no progress or light at the end of the tunnel.

When do you -- as opposed to terminating a whole bunch of people below you -- when do you decide that you are not the right person to lead this company?

Jeffrey Swartz

It won’t be my decision only. We believe in our performance – pay for performance and an accountable environment and we have a board of independent directors who take this notion seriously and I do as well. I dispute your point that there is no progress and there is no light at the end of the tunnel, but I don’t dispute the point that says accountability is something that everybody lives at Timberland, starting with me.

I don’t want to make overly aggressive statements about timelines; I have tried to indicate to the shareholders of which we are principal shareholders still, undiversified shareholders that there is not just skin in the game here, there is everything in the game here. In card terms this is a little bit “all in” and I believe in our strategy and our team and I believe we will demonstrate both progress and what you described as light at the end of the tunnel and we are fixated on nothing else.

Steven Margin - Slatten Capital Management

In all fairness, the compensation, I don’t think compensation is the only issue.

Jeffrey Swartz

Nor do I. Am I not being responsive, Steve?

Steven Margin - Slatten Capital Management

No, no, no, no, that’s fine. I just think at some point greater changes are required and the board has a fiduciary responsibility to the rest of our shareholders away from your family to make tougher decisions.

Jeffrey Swartz

I have confidence that the governance structure at Timberland is an accountable and responsible one and I have confidence that they will do their job.

Operator

Your next question comes from Virginia Genereux - Merrill Lynch.

Virginia Genereux - Merrill Lynch

Can you talk a little bit Jeff about the SKU count? You guys had I think six presidents or six sector heads that have been consolidated to two. Is that right? Or to a Co-President structure?

Jeffrey Swartz

There were four that went to two, Virginia.

Virginia Genereux - Merrill Lynch

Has there been a reduction in the SKUs?

Jeffrey Swartz

Yes. We reported that in fall ‘08 compared to fall ’07 in footwear within tree, we have a 20% reduction in what’s in the market now, fall-on-fall, and our spring ‘09 is not yet complete. We are targeting double-digits season-on-season reductions in spring ’09, and I believe that there is plenty of opportunity as we continue to be clearer about consumer insight and idea building; ideas first and shoes second, that we can make further reductions in the breadth of our line which will augur well for our gross margin management and for profitability.

Virginia Genereux - Merrill Lynch

How does that SKU reductions square with what I think is your low single-digit full-year revenue decline outlook? Why wouldn’t revenues be down more?

Jeffrey Swartz

My thesis continues to be do less much better, Virginia. We are not chopping SKUs for numbers games, we made fewer. It wasn’t that we brought them to the market and decided to just parse them down because of low volume. We didn’t bring them to the market because we started with a better sense of what we wanted for an outcome.

Earthkeepers is an example of there are more SKUs in the Earthkeepers collection ’08 than ’07 and revenues are up because that’s an idea. The idea carries familiar product. There are kinds of footwear that we’ve offered. For example, women’s footwear for the office. There have been shoes in our line that a woman could wear in the office. Those shoes are not in our line for fall ’08. We’ve started at the beginning of the season and said we can’t at this moment compete there successfully; let’s not offer that.

We did that before the season. So we said to our sales teams here are where we are going to focus, here is where the markets are going to be. Their response has been good. Fewer things better done ought to translate into capturing share back against the question that Jeff asked.

Virginia Genereux - Merrill Lynch

Can you give me a force ranking then or any color on the proportionate mix that you guys envision in calendar ’08 or second half of calendar ’08, first half of calendar ’09? By the categories as you’ve talked about them. Either Authentic Youth, so it would be easier for me to understand boots, kids, outdoor performance, casual. How do you see the business breaking down?

Jeffrey Swartz

The casual business continues to be the most important business at Timberland and it will be the most important business in fall ’08. The men’s casual business is much bigger than the women’s casual business and the kids. So it goes men’s, women’s, kids -- I think that’s right. It certainly goes Men’s, then it is women’s and kids in casual. In outdoor performance it’s still a men’s conversation but there is good news in hand sewn in the women’s business there. In the boot business it continues to be a men’s and kids business with some women’s.

Virginia Genereux - Merrill Lynch

That’s the sort of the force ranking? Casual is the biggest, followed by outdoor performance followed by boots? So boots is the smallest?

Jeffrey Swartz

No, no, no. Sorry, sorry, I was talking about all three categories and I wasn’t ranking them. Casual is the biggest business, yes; but the next biggest business is still what you would call boots and then the third biggest business is what you call outdoor performance.

Virginia Genereux - Merrill Lynch

Can you talk a little bit about what you contemplate for international? Asia, you mentioned Japan, I mean that’s weakened macro. Is your expectation that Asia can, I mean if you looked at revenue growth, is Europe going to be up and in constant currency, what gets better there than trend? Is Asia weakening on you?

Jeffrey Swartz

No. I wouldn’t say Asia is weakening, I’m excited about the partners we are making in China with 58 retail presentations in China and that’s a growing business. We have a portfolio of results in Europe if you look across the portfolio. By that I mean geographies and then within geographies obviously there is product line portfolio. Our Scandinavian business as a for instance is very strong this minute and that’s a business that’s more outdoor dominated then our Southern European business, which is more casually dominated.

Spain is challenging, Italy is good, UK is mixed. We have some very positive results and some challenging points. France , our market has been down, down, down and I believe they have stopped the slide and are beginning to turn that business. The so-called [DAS] territories -- Deutschland, Austria and Switzerland -- the team there is doing a very good job of building a solid global base and also we don’t talk much about but we should make reference to the fact that we have a brand presence in a whole lot of countries using third-party partners, distributors and agents and that business is, we are adding in that business nearly a store a week and that’s on other people’s balance sheets. Powerful independent thinkers, that are doing I think a fantastic job of brand-building in very next order marketplaces.

I was in Timberland stores in St. Petersburg in Moscow, Timberland stores in Brazil. The brand-building and business that’s going on there is quite substantial and I think it is consistent with the fact that we’ve been doing this outside the United States since 1979 and we have I believe a much more institutional standing with our global consumers then some of our competitors do.

Virginia Genereux - Merrill Lynch

On the SG&A, Jeff, you’ve taken $65 million from the $580 million run rate. So you are spending an incremental $35 million. Can you tell us exactly what you are spending on?

Jeffrey Swartz

The principal point that John has made and he will give you more details if you want it, but the principal point is we said there are two things we have to do. One is we had to set ourselves an operating base that was cognizant of the fact that the boot phenomenon that we enjoyed for ten-plus years has a natural size; or at least we are saying that it has a natural size, Virginia. Somebody asked me earlier when is that coming back? I said back to that I don’t know, but we are not presuming it is coming back. We are going to organize our operating expenses as if it is not coming back.

That is why John Crimmins said things like, tried to set the operating structure to the right size. I hate the phrase but I understand the point which is that instead of hoping that the hyper consumer is going to rejoin our conversation we are going to set up as if he and she had not gone. That was the reason that we made the hard choices in '07 some of which continued into '08 as John described. That was one point. The hyper consumer is not here now and we are not sure if he or she is coming back.

The second point though was that our brand and our enterprise does not depend simply on the hyper consumer. In fact our brand franchise depends upon the consumer that is the traditional Timberland consumer and by traditional I don't want you to hear traditional like old. I mean traditional meaning the original Timberland premise of outdoor inspired and it’s how we built our brand and it is how we are going to build our brand. In order to do that I said to Jeff Edelman we have to spend marketing money.

So two things: one is we had to rationalize the operating expense structure to be mindful of the fact that the hyper consumer is not here and we have to make investments in marketing, incremental investments in marketing in order to make sure that we can compete against our original brand franchise.

By the way, does that strategy lend itself to the hyper consumer? Parenthetically it does, but I continue to insist that our focus isn’t on that consumer, our focus is on the traditional Timberland consumer who brought us to the party and build a brand in 85 countries around the world.

John, do you want to say more about the operating expense detail?

John Crimmins

Well, just in case Virginia missed it on the earlier part, that $35 million of incremental spend is focused on increased consumer-facing marketing; a focus on retail expansion, part of that is our scaled back expansion plans for 2008. There is also an annualization factor related to retail expansion we did in ‘07.

Then there are investments in our growth businesses, particularly in SmartWool and Pro and in China where we are aggressively working to grow the business. Then there is a small organic growth component. So those four elements together did show the $35 million of incremental investments, if you will.

Virginia Genereux - Merrill Lynch

The consumer marketing, is that image advertising or is that advertising behind specific product? I see that in the release?

Jeffrey Swartz

We would be excited to show you the work that Leagas Delaney has created. We sat with four of the most talented and creative companies on earth in the last 45 days and selected Leagas. I have a relationship with Tim Delaney that goes back 20 years when he put our brand on the map in the UK. He was working for the then distributor. So I admire and respect the work he did then. I believe that his team, led by Tim personally, is going to create -- I said it in my remarks, Virginia -- it will extend the shadow of the brand.

I think the guy is borderline brilliant creative guy – don’t tell him I said that. He did a spectacular job with Adidas which is a running shoe brand or a soccer brand actually that they played a large role in the turn of Adidas. I believe that bringing his perspective which is pretty iconoclastic and you know tyrannical from a creative perspective to our brand essence we’ll create a different kind of excitement.

I don’t think you should expect image advertising and I don’t think you should expect ‘buy my boot’ advertising. I think you should expect exciting creative but I don’t want to oversell that point; I would rather sneak up on you and show it to you. I’m very excited about what we have in plan from a consumer marketing perspective.

Operator

I would now like to turn the call back over to Jeff Swartz. Please proceed.

Jeffrey Swartz

Thank you and have a good day.

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Source: The Timberland Company Q4 2007 Earnings Call Transcript
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