Evaluating Financial Evaluating Financial PerformancePerformance

FinanceFinance

Jaime F. ZenderJaime F. Zender

Note: Because I have found no better presentation of this material, this closelyfollows the discussion in the Higgins book.

Financial PerformanceFinancial Performance

• One of the most fundamental facts about One of the most fundamental facts about businesses is that the operating performance businesses is that the operating performance of the firm shapes its financial structure.of the firm shapes its financial structure.

• It is also true that the financial situation of It is also true that the financial situation of the firm can also determine its operating the firm can also determine its operating performance.performance.

• The financial statements are therefore The financial statements are therefore important diagnostic tools for the informed important diagnostic tools for the informed manager.manager.– To keep the discussion grounded, we will use the To keep the discussion grounded, we will use the

1997-98 financial statement for the Timberland 1997-98 financial statement for the Timberland Company as illustrations.Company as illustrations.

The Timberland Company, Balance Sheets ($ millions)12/31/1997 12/31/1998 Change

AssetsCash and marketable securities 98.8 151.9 53.1Accounts receivable 75.8 79.0 3.2Inventories 142.6 131.2 (11.4)Prepaid expenses and other current assets 24.9 25.4 0.5 Total current assets 342.1 387.5Property, plant, and equipment 116.5 131.2 14.7Less accumulated depreciation and amortization (63.6) (74.3) (10.7) Net property, plant, and equipment 52.9 56.9 4.0Intangible assets 20.9 19.2 (1.7)Other assets 4.2 5.8 1.6 Total assets $420.1 $469.4

Liabilities and Shareholders' EquityAccounts Payable 20.4 25.9 5.5Wages payable 28.2 22.1 (6.1)Income taxes payable 17.7 18.2 0.5Other accrued expenses 32.8 29.5 (3.3) Total current liabilities 99.1 95.7Long-term debt 100.0 100.0 --Deferred income taxes 6.0 7.5 1.5 Total liabilities 205.1 203.2Common stock 0.1 0.1Additional paid-in capital 68.6 74.7Retained earnings 146.3 207.7Less treasury stock (0.1) (16.3) Total shareholders' equity 214.9 266.2 51.3Total liabilities and shareholders' equity $420.1 469.4

The Timberland Company, Income Statements ($ millions)12/31/1997 12/31/1998

Net sales 796.5 862.2Cost of sales 464.2 501.1 Gross profit 332.3 361.1Selling expenses 174.7 195.7General and administrative expenses 51.7 50.9Depreciation and amortization 20.3 18.2Amortization of goodwill 1.7 1.7 Total operating expenses 248.4 266.5Operating income 83.9 94.6Interest expense 14.8 9.5Other expense (income) 1.4 (1.9) Total nonoperating expenses 16.2 7.6Income before income taxes 67.7 87.0Provision for income taxes 20.3 27.8Net income $47.4 $59.2

The Timberland Company, Statement of Cash Flow, 1998 ($ millions)

Cash Flows from Operating ActivitiesNet income 59.2Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization 18.2Loss on disposal of property, plant, and equipment 1.3Changes in current assets and liabilities Increase in accounts receivable -2.8 Decrease in inventories 11.6 Decrease in prepaid expenses 1.1 Increase in accounts payable 5.1 Increase in accrued expenses -10 Increase in accrued income taxes 0.5Net cash provided by operating activities 84.2

Cash Flows from Investing ActivitiesProceeds from sale of property, plant, and equipment 0.1Additions to property, plant, and equipment -20.7Other -1.2Net cash provided by investing activities -21.8

Cash Flows from Financing ActivitiesCommon stock repurchases -16.2Issuance of common stock, including tax benefit 6.1Net cash provided by financing activities -10.1

Effect of exchange rate changes on cash 0.9

Net increase in cash 53.2Cash at beginning of year 98.8Cash at end of year $152.0

Return On EquityReturn On Equity

• The most popular measure of financial The most popular measure of financial performance (for many audiences) is ROE.performance (for many audiences) is ROE.

• ROE measures accounting earnings for a ROE measures accounting earnings for a period per dollar of shareholders’ equity period per dollar of shareholders’ equity invested.invested.

• For Timberland 1998 ROE was:For Timberland 1998 ROE was:

EquityrsShareholde

IncomeNetROE

'

%2.222.266$

2.59$ROE

Dissecting ROEDissecting ROE

• ROE is so popular because it is, in a sense, a ROE is so popular because it is, in a sense, a summary of the information on the income summary of the information on the income statement and both sides of the balance statement and both sides of the balance sheet. It provides an “accounting” measure sheet. It provides an “accounting” measure of the “returns” to shareholders’ of the “returns” to shareholders’ investment.investment.

• The three determinants of ROE:The three determinants of ROE:– Profit Margin = Net Income/SalesProfit Margin = Net Income/Sales– Asset Turnover = Sales/AssetsAsset Turnover = Sales/Assets– Financial Leverage = Assets/Shareholders’ equityFinancial Leverage = Assets/Shareholders’ equity

• ROE comes from the joint inputs of these ROE comes from the joint inputs of these three pieces. 22.2% = 6.9% × 1.8 × 1.8three pieces. 22.2% = 6.9% × 1.8 × 1.8

Return on Assets (ROA)Return on Assets (ROA)

• When we multiply the profit margin times When we multiply the profit margin times the asset turnover we arrive at return on the asset turnover we arrive at return on assets.assets.

• ROA doesn’t distinguish between capital ROA doesn’t distinguish between capital raised from shareholders and that raised raised from shareholders and that raised from creditors. (ROE considers only equity from creditors. (ROE considers only equity capital.)capital.)

• As such ROA measures the “return” on As such ROA measures the “return” on each dollar invested in assets.each dollar invested in assets. %6.12

4.469$

2.59$

Assets

incomeNet Assetson Return

ROEs and "Levers" of Performance for 10 Diverse Companies, 1998Return on

Equity (%) =

Profit Margin

(%) ×

Asset Turnover (times) ×

Financial Leverage (times)

BankAmerica Corp 14.6 10.8 0.1 13.5Carolina Power and Light 14.3 12.8 0.4 2.8Exxon Corporation 14.6 6.3 1.1 2.1Food Lion, Inc. 17 2.7 2.8 2.3Harley-Davidson, Inc. 20.7 9.9 1.1 1.9Intel Corporation 24 23.1 0.8 1.3Nike, Inc. 12.9 4.2 1.8 1.7Southwest Airlines Co. 18.1 10.4 0.9 2Tiffany & Company 16.9 7.7 1.1 2The Timberland Company 22.2 6.9 1.8 1.8

ROE Across CompaniesROE Across Companies

• Generally speaking ROE is reasonably Generally speaking ROE is reasonably similar across companies. Why?similar across companies. Why?

• One would like to have a company with a One would like to have a company with a high profit margin and a high asset high profit margin and a high asset turnover. Typically one of these will be turnover. Typically one of these will be relatively high and one relatively low. Why?relatively high and one relatively low. Why?

• What determines the firm’s choice of What determines the firm’s choice of financial leverage?financial leverage?

• Now let’s look at each component in Now let’s look at each component in isolation.isolation.

Profit MarginProfit Margin

• This ratio measures the fraction of each dollar This ratio measures the fraction of each dollar of sales that makes it through to net income.of sales that makes it through to net income.– It is of primary importance to an operating officer It is of primary importance to an operating officer

as it reflects the company’s pricing strategy and its as it reflects the company’s pricing strategy and its ability to control costs.ability to control costs.

– Timberland’s profit margin = Net Income/Sales = Timberland’s profit margin = Net Income/Sales = $59.2/862.2 = 6.9%$59.2/862.2 = 6.9%

• The “gross margin” measures profitability The “gross margin” measures profitability relative to variable costs = Gross Profits/Salesrelative to variable costs = Gross Profits/Sales– Gross profit is sales less cost of goods sold. Gross profit is sales less cost of goods sold.

Timberland’s gross margin is = $361.1/$862.2 = Timberland’s gross margin is = $361.1/$862.2 = 41.9% indicating that about 42% of each dollar in 41.9% indicating that about 42% of each dollar in sales is available to cover fixed costs and profits.sales is available to cover fixed costs and profits.

Asset TurnoverAsset Turnover

• This ratio measures the sales generated per dollar This ratio measures the sales generated per dollar of assets employed.of assets employed.– Measures capital intensity with a low asset turnover Measures capital intensity with a low asset turnover

indicating a capital intensive business.indicating a capital intensive business.– Nice illustration that more assets is not always better.Nice illustration that more assets is not always better.– Control of a company’s assets is critical and control of Control of a company’s assets is critical and control of

current assets is especially critical to success.current assets is especially critical to success.– Asset turnover = sales/assets = $862.2/$469.4 = 1.8 Asset turnover = sales/assets = $862.2/$469.4 = 1.8

timestimes

• Analyzing the turnover of each type of asset on a Analyzing the turnover of each type of asset on a company’s balance sheet gives rise to what are company’s balance sheet gives rise to what are known as control ratios.known as control ratios.

Control Ratios – Fixed-Asset Control Ratios – Fixed-Asset TurnoverTurnover

• Fixed-Asset Turnover is perhaps a “purer” Fixed-Asset Turnover is perhaps a “purer” reflection of the capital intensity of a firm.reflection of the capital intensity of a firm.

• Fixed-Asset Turnover = Sales/Net PP&EFixed-Asset Turnover = Sales/Net PP&E

= $862.2/$56.9 = 15.2 times= $862.2/$56.9 = 15.2 times

• Timberland generates $15.20 in sales for Timberland generates $15.20 in sales for each dollar of plant, property, and each dollar of plant, property, and equipment they invest in.equipment they invest in.

Control Ratios – Inventory Control Ratios – Inventory TurnoverTurnover

• Inventory turnover = COGS/Ending Inventory turnover = COGS/Ending Inventory = $501.1/$131.2 = 3.8 timesInventory = $501.1/$131.2 = 3.8 times– One might also use average inventory rather One might also use average inventory rather

than ending inventory.than ending inventory.

• This indicates that items in Timberland’s This indicates that items in Timberland’s inventory turn over 3.8 times per year on inventory turn over 3.8 times per year on average.average.

• Alternatively, 12 months/3.8 times=3.15 Alternatively, 12 months/3.8 times=3.15 months indicating that the typical item sits months indicating that the typical item sits in inventory for just over 3 months.in inventory for just over 3 months.

Control Ratios – Collection Control Ratios – Collection PeriodPeriod

• Collection period highlights a company’s Collection period highlights a company’s management of its accounts receivable.management of its accounts receivable.

• Note that what is desired here is credit sales. Note that what is desired here is credit sales. Outsiders rarely know this so commonly all Outsiders rarely know this so commonly all sales are assumed to be for credit.sales are assumed to be for credit.

• Timberland’s customers are taking just over a Timberland’s customers are taking just over a month to pay their bills. Good or bad?month to pay their bills. Good or bad?

days4.33days365/2.862$

0.79$

dayper salesCredit

ReceivableAccountsPeriodCollection

Control Ratios – Days’ Sales in Control Ratios – Days’ Sales in CashCash

• Timberland currently has 64.3 days’ worth of Timberland currently has 64.3 days’ worth of sales in cash and securities.sales in cash and securities.

• Too much or too little?Too much or too little?

• Question really is how much liquidity does the Question really is how much liquidity does the firm require for efficient operations. While firm require for efficient operations. While more might always seem better, think about more might always seem better, think about the return the asset “cash” generates for you.the return the asset “cash” generates for you.

days 3.64days365/2.862$

9.151$

dayper Sales

securities andCash ' CashinSalesDays

Control Ratios – Payables Control Ratios – Payables PeriodPeriod• This is a control ratio for a liability.This is a control ratio for a liability.

• The proper calculation uses credit purchases which, The proper calculation uses credit purchases which, again, an outsider rarely knows. Usually COGS is used again, an outsider rarely knows. Usually COGS is used as a substitute. COGS differs from credit sales as a substitute. COGS differs from credit sales because:because:– Firm may be adding or depleting inventory; purchasing at a Firm may be adding or depleting inventory; purchasing at a

different rate than it is selling.different rate than it is selling.– COGS includes a mark-up for depreciation and labor making COGS includes a mark-up for depreciation and labor making

COGS larger than credit purchases so this ratio is, on average, COGS larger than credit purchases so this ratio is, on average, artificially small.artificially small.

– Thus it is difficult to compare the 18.9 days to its credit terms. Thus it is difficult to compare the 18.9 days to its credit terms. It is, however, reasonable to compare this to last year’s ratio.It is, however, reasonable to compare this to last year’s ratio.

days 9.18days365/1.501$

9.25$

dayper purchasesCredit

payable AccountsPeriodPayables

Financial LeverageFinancial Leverage

• Timberland has $1.80 in assets for every Timberland has $1.80 in assets for every dollar that shareholders have invested.dollar that shareholders have invested.

• This is a relatively modest amount of This is a relatively modest amount of leverage for a manufacturing company.leverage for a manufacturing company.

• Other leverage ratios tell us the same thing:Other leverage ratios tell us the same thing:– Debt to assets – 43.3%Debt to assets – 43.3%– Debt to equity – 76.3%Debt to equity – 76.3%

8.12.266$

4.469$

equity rs'Shareholde

AssetsLeverageFinancial

Coverage RatiosCoverage Ratios

• Often more informative than the leverage Often more informative than the leverage ratios are “coverage ratios.”ratios are “coverage ratios.”

• These ratios tell us what the firm is These ratios tell us what the firm is earning each year relative to the burden earning each year relative to the burden the debt imposes.the debt imposes.

times2.105.9$

5.96$

ExpenseInterest

EBITearnedinterest Times

times2.10)0.87/8.271/(0.0$5.9$

5.96$

rateTax 1

repayment PrincialInterest

EBITcoveredburden Times

Liquidity RatiosLiquidity Ratios

• A further determinant of a firm’s debt A further determinant of a firm’s debt capacity is the liquidity of its assets capacity is the liquidity of its assets relative to its liabilities.relative to its liabilities.

• The two common ratios used to measure The two common ratios used to measure liquidity are the current ratio and the quick liquidity are the current ratio and the quick ratio (also called the “acid test”).ratio (also called the “acid test”).

times0.47.95$

5.387$

sliabilitieCurrent

assetsCurrent ratioCurrent

times7.27.95$

2.131$5.387$

sliabilitieCurrent

Inventory - assetsCurrent ratioQuick

Limitations of Ratio AnalysisLimitations of Ratio Analysis

• We have been talking as if management We have been talking as if management always wants to increase ROE or as if a always wants to increase ROE or as if a high ROE is always better.high ROE is always better.– If company A has a higher ROE than company If company A has a higher ROE than company

B is company A necessarily better?B is company A necessarily better?– If a company increases its ROE is it necessarily If a company increases its ROE is it necessarily

evidence of improved performance?evidence of improved performance?

• There are three critical problems with ROE.There are three critical problems with ROE.– Often called the timing problem, the value Often called the timing problem, the value

problem, and the risk problem.problem, and the risk problem.

The Timing ProblemThe Timing Problem

• As a decision-maker in a business environment As a decision-maker in a business environment you are often encouraged to focus your you are often encouraged to focus your attention on the past and particularly on one attention on the past and particularly on one period in the past – correct?period in the past – correct?

• Sounds silly, but this is exactly what ROE does.Sounds silly, but this is exactly what ROE does.• Clearly last year’s ROE must be taken in Clearly last year’s ROE must be taken in

context.context.– If not it is virtually meaningless.If not it is virtually meaningless.– If company ROE was lower last year than it was two If company ROE was lower last year than it was two

years ago the company years ago the company mustmust be doing worse – be doing worse – correct?correct?

The Risk ProblemThe Risk Problem

• We talked a lot about how risk and return go We talked a lot about how risk and return go together. ROE is a “return” like measure so together. ROE is a “return” like measure so where is the risk dimension?where is the risk dimension?

• This problem alone makes ROE an inaccurate This problem alone makes ROE an inaccurate and possibly misleading indicator of financial and possibly misleading indicator of financial performance.performance.

• One has to realize that the risk dimension is One has to realize that the risk dimension is missing and so be particularly wary of making missing and so be particularly wary of making comparisons across companies using ROE comparisons across companies using ROE alone.alone.

The Value ProblemThe Value Problem

• ROE measures a “return” figure but it is ROE measures a “return” figure but it is based on two accounting figures.based on two accounting figures.

• The numerator is net income and this is not The numerator is net income and this is not free cash flow (the cash flow that the free cash flow (the cash flow that the company could payout to its investors).company could payout to its investors).

• Secondly, even if net income is close to free Secondly, even if net income is close to free cash flow, ROE is measured relative to book cash flow, ROE is measured relative to book value of equity not the market value of value of equity not the market value of equity.equity.

• It is the market value investors must pay to It is the market value investors must pay to purchase a share of the firm’s equity and this purchase a share of the firm’s equity and this is generally higher than the book value.is generally higher than the book value.

Ratio Analysis For Ratio Analysis For TimberlandTimberland• Given the limitations of ratio analysis the Given the limitations of ratio analysis the

most useful way to evaluate financial ratios is most useful way to evaluate financial ratios is by examining their changes over time.by examining their changes over time.

• Comparing the ratios to industry averages Comparing the ratios to industry averages provides an interesting benchmark but provides an interesting benchmark but differences between companies in a given differences between companies in a given industry can make the exercise misleading.industry can make the exercise misleading.

• A systematic approach will also help alleviate A systematic approach will also help alleviate the information overload that results from the information overload that results from the random calculation of countless ratios.the random calculation of countless ratios.

A Systematic ApproachA Systematic Approach

• At the top tier of ratios lie ROE and ROA.At the top tier of ratios lie ROE and ROA.• The major levers of performance are in the The major levers of performance are in the

next tier, followed by more narrowly focused next tier, followed by more narrowly focused ratios:ratios:– Profit margin:Profit margin:

• Gross margin, tax rate, normalized income statementGross margin, tax rate, normalized income statement

– Asset turnover:Asset turnover:• Control ratios (inventory turnover, fixed asset turnover, Control ratios (inventory turnover, fixed asset turnover,

collection period, days sales in cash, payables period), collection period, days sales in cash, payables period), normalized balance sheetnormalized balance sheet

– Financial leverage:Financial leverage:• Leverage ratios, coverage ratios, liquidity ratiosLeverage ratios, coverage ratios, liquidity ratios

Ratio Analysis of Timberland Company 1994 - 1998

1994 1995 1996 1997 1998Industry Median

Major Ratios ROE 11.9 (8.2) 12.3 22.1 22.2 12.3 ROA 3.8 (2.8) 4.5 11.3 12.6 7.4 ROIC 7.1 0.7 9.6 18.3 17.9 9.7Profitability Ratios Profit Margin 2.8 (1.8) 3.0 5.9 6.9 4.2 Gross Margin 35.0 33.7 39.4 41.7 41.9 38.4 Price to earnings ratio 13.5 NA 20.7 13.9 8.5 15.0Turnover and Control Ratios Asset Turnover 1.3 1.6 1.5 1.9 1.8 1.8 Fixed-asset Turnover 9.3 12.5 14.1 15.1 15.2 9.2 Inventory Turnover 1.9 2.4 2.6 3.3 3.8 2.7 Collection Period 73.5 53.4 53.2 34.7 33.4 39.1 Days' Sales in Cash 3.7 21.4 49.4 45.3 64.3 10.8 Payables Period 32.6 21.2 18.6 16.0 18.9 36.3Leverage and Liquidity Ratios Assets to Equity 3.2 3.0 2.7 2.0 1.8 1.7 Debt to Assets 68.5 66.2 63.2 48.8 43.3 39.6 Debt to Equity 217.4 196.3 171.9 95.4 76.3 65.5 Times Interest Earned 2.9 0.2 2.5 5.6 10.2 9.1 Times Burden Covered 1.6 0.1 1.1 5.6 10.2 7.4 Current Ratio 3.5 4.8 3.7 3.5 4.0 3.0 Acid Test 1.5 2.3 2.1 2.0 2.7 1.5

Ratio Analysis of TimberlandRatio Analysis of Timberland

• ROE:ROE:– After a loss in ’95 the ROE is up to a strong After a loss in ’95 the ROE is up to a strong

22.2% in ’98. This is strong relative to its 22.2% in ’98. This is strong relative to its industry and to the median firm in the S&P500 industry and to the median firm in the S&P500 that year which had an ROE of 14.8%.that year which had an ROE of 14.8%.

– The other major ratios show similar patterns.The other major ratios show similar patterns.

• The rise in ROE is coming from the The rise in ROE is coming from the increase in its profit margin and asset increase in its profit margin and asset turnover and is somewhat offset by the turnover and is somewhat offset by the reduction in its financial leverage.reduction in its financial leverage.

Ratio Analysis of TimberlandRatio Analysis of Timberland

• The increased profit margin is coming The increased profit margin is coming primarily from a rising gross margin primarily from a rising gross margin indicating that it is some combination of indicating that it is some combination of more aggressive pricing and cost control more aggressive pricing and cost control that has driven the increase.that has driven the increase.

• Improved asset turnover reflects overall Improved asset turnover reflects overall improved asset management.improved asset management.– Inventory turnover and fixed asset turnover are Inventory turnover and fixed asset turnover are

strongly higher.strongly higher.– The only asset rising relative to sales is cash. Is The only asset rising relative to sales is cash. Is

this good or bad?this good or bad?• Leverage and liquidity ratios all show Leverage and liquidity ratios all show

increasing financial conservatism.increasing financial conservatism.

Normalized Financial Normalized Financial StatementsStatements• Note on the normalized balance sheet that Note on the normalized balance sheet that

80% of the firm’s assets are current assets.80% of the firm’s assets are current assets.– This highlights the importance of working capital This highlights the importance of working capital

management.management.– Note the reduction in inventories and accounts Note the reduction in inventories and accounts

receivable noted above.receivable noted above.• The normalized income statement is The normalized income statement is

pleasant reading.pleasant reading.– Profit margin and gross margin are up since ’95.Profit margin and gross margin are up since ’95.– Results would have been better except for the Results would have been better except for the

rise in SG&A expenses.rise in SG&A expenses.

Common-Sized Balance Sheet for Timberland and Industry

1994 1995 1996 1997 1998Industry Average

AssetsCash and marketable securities 1.3% 9.1% 20.8% 23.5% 32.4% 7.4%Accounts receivable 27.1 22.7 22.4 18.0 16.8 22.7Inventories 46.1 42.9 35.4 34.0 28.0 37.1Prepaid expenses and other current assets 4.4 5.5 4.1 5.9 5.4 5.5 Total current assets 79.0 80.2 82.6 81.4 82.6 72.0Property, plant, and equipment 23.4 22.8 23.1 27.7 28.0 31.5Less accumulated depreciation and amortization 9.0 10.3 12.2 15.1 15.8 13.6 Net property, plant, and equipment 14.4 12.4 10.9 12.6 12.1 17.9Intangible assets 5.5 5.8 5.0 5.0 4.1 3.2Other assets 1.1 1.6 1.5 1.0 1.2 6.9

Total assets 100% 100% 100% 100% 100% 100%

Liabilities and Shareholders' EquityAccounts payable 7.8% 6.0% 4.7% 4.9% 5.5% 11.2%Notes payable 4.8 -- -- -- -- 2.0Current portion of long-term debt 1.7 1.8 4.0 -- -- 1.0Wages payable 1.9 0.2 2.6 4.2 3.9 --Accrued expenses 6.4 8.5 11.3 14.5 11.0 10.0 Total current liabilities 22.6 16.5 22.7 23.6 20.4 24.2Long-term debt 43.7 47.3 38.2 23.8 21.3 14.8Deferred income taxes 2.2 2.4 2.4 1.4 1.6 1.0 Total liabilities 68.5 66.3 63.2 48.8 43.3 39.9Common stock 0.0 0.0 0.0 0.0 0.0 4.6Additional paid-in capital 12.2 14.2 13.7 16.3 15.9 10.8Retained earnings 19.3 19.6 23.0 34.8 44.2 54.8Less treasury stock 0.0 0.0 0.0 0.0 3.5 10.2 Total shareholders' equity 31.5 33.7 36.8 51.2 56.7 60.1

Total liabilities and shareholders' equity 100% 100% 100% 100% 100% 100%

Normalized Income Statement for Timberland and Industry

1994 1995 1996 1997 1998Industry Average

Net sales 100% 100% 100% 100% 100% 100%Cost of sales 65.0 66.3 60.6 58.5 58.3 60.8 Gross profit 35.0 33.7 39.4 41.5 41.7 39.2S,G,& A expenses 25.8 29.4 28.9 28.4 28.6 29.3Depreciation and amortization 2.4 2.9 3.1 2.5 2.1 1.8 Total operating expenses 28.2 32.3 32.0 31.0 30.7 31.0Operating income 6.8 1.4 7.4 10.5 11.0 8.2Interest expense 2.4 3.5 3.0 1.9 1.1 0.7Other expense (income) -- 0.2 (0.1) 0.2 (0.2) (0.2)Extraordinary expense (income) -- 0.6 -- -- -- 0.4 Total nonoperating expenses 2.3 4.2 2.9 2.0 0.9 0.9Income before income taxes 4.4 (2.9) 4.5 8.5 10.1 7.3Provision for income taxes 1.6 (1.1) 1.5 2.5 3.2 2.7Net income 2.8 (1.8) 3.0 5.9 6.9 4.6

SummarySummary

• What is being reflected here is a robust What is being reflected here is a robust recovery from a difficult period in the firm’s recovery from a difficult period in the firm’s history.history.– In ’94 the firm experienced a 50% increase in In ’94 the firm experienced a 50% increase in

sales driven by “fad” demand for its product.sales driven by “fad” demand for its product.– In response Timberland over-expanded and lost In response Timberland over-expanded and lost

control of assets, particularly inventory and control of assets, particularly inventory and accounts receivable.accounts receivable.

– The bubble burst in ’95.The bubble burst in ’95.– Since then they have aggressively managed Since then they have aggressively managed

assets and reduced debt.assets and reduced debt.– Challenge ahead is what to do with all the Challenge ahead is what to do with all the

excess cash being generated and a question of excess cash being generated and a question of whether they can rekindle growth.whether they can rekindle growth.