UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark one)

 

x

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

 

 

EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2007

 

OR

 

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

 

 

EXCHANGE ACT OF 1934

 

 

For the transition period from                    to                   

 

Commission File Number: 0-22446

 

DECKERS OUTDOOR CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware

 

95-3015862

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

495-A South Fairview Avenue, Goleta, California

 

93117

(Address of principal executive offices)

 

(zip code)

 

(805) 967-7611

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

Accelerated filer x

Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  Nox

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class

 

Outstanding at
November 5, 2007

 

 

 

Common Stock, $0.01 par value

 

12,982,948

 

 



 

DECKERS OUTDOOR CORPORATION

AND SUBSIDIARIES

Table of Contents

 

 

 

Page

 

 

 

Part I.     Financial Information

 

 

 

 

Item 1.

Financial Statements (Unaudited):

 

 

 

 

 

Condensed Consolidated Balance Sheets as of September 30, 2007 and December 31, 2006

1

 

 

 

 

Condensed Consolidated Statements of Income for the Three Months Ended September 30, 2007
and 2006 (as Restated)

2

 

 

 

 

Condensed Consolidated Statements of Income for the Nine Months Ended September 30, 2007
and 2006 (as Restated)

3

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2007
and 2006 (as Restated)

4

 

 

 

 

Notes to Condensed Consolidated Financial Statements

5

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

18

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

35

 

 

 

Item 4.

Controls and Procedures

36

 

 

 

Part II.      Other Information

 

 

 

 

Item 1.

Legal Proceedings

37

 

 

 

Item 1A.

Risk Factors

37

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

37

 

 

 

Item 3.

Defaults Upon Senior Securities

37

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

37

 

 

 

Item 5.

Other Information

37

 

 

 

Item 6.

Exhibits

37

 

 

 

Signatures

 

38

 

 

 

Exhibit Index

 

39

Exhibit 31.1

 

Exhibit 31.2

 

Exhibit 32

 

 



 

DECKERS OUTDOOR CORPORATION

AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(Unaudited)

(amounts in thousands, except par value)

 

 

 

September 30,

 

December 31,

 

 

 

2007

 

2006

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

39,308

 

$

34,255

 

Restricted cash

 

250

 

 

Short-term investments

 

35,405

 

64,637

 

Trade accounts receivable, net of allowances of $5,620 and $6,100 as of September 30, 2007 and December 31, 2006, respectively

 

74,354

 

49,571

 

Inventories

 

88,050

 

32,375

 

Prepaid expenses and other current assets

 

2,935

 

2,199

 

Deferred tax assets

 

4,386

 

4,386

 

Total current assets

 

244,688

 

187,423

 

 

 

 

 

 

 

Restricted cash

 

1,000

 

 

Property and equipment, at cost, net

 

8,711

 

7,770

 

Intangible assets, net

 

54,166

 

54,399

 

Deferred tax assets

 

327

 

327

 

Other assets, net

 

73

 

54

 

Total assets

 

$

308,965

 

$

249,973

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Trade accounts payable

 

$

31,146

 

$

21,053

 

Accrued sales commissions

 

1,438

 

833

 

Accrued payroll

 

8,509

 

6,735

 

Other accrued expenses

 

3,807

 

3,381

 

Income taxes payable

 

5,096

 

7,561

 

Total current liabilities

 

49,996

 

39,563

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock, $0.01 par value. Authorized 20,000 shares; 12,979 and 12,588 shares issued and outstanding at September 30, 2007 and December 31, 2006, respectively

 

130

 

126

 

Additional paid-in capital

 

99,439

 

81,761

 

Retained earnings

 

159,178

 

128,130

 

Accumulated other comprehensive income

 

222

 

393

 

Total stockholders’ equity

 

258,969

 

210,410

 

Total liabilities and stockholders’ equity

 

$

308,965

 

$

249,973

 

 

See accompanying notes to condensed consolidated financial statements.

 

1



 

DECKERS OUTDOOR CORPORATION

AND SUBSIDIARIES

Condensed Consolidated Statements of Income

(Unaudited)

(amounts in thousands, except per share data)

 

 

 

Three Months Ended
September 30,

 

 

 

2007

 

2006

 

 

 

 

 

As Restated

 

Net sales

 

$

129,381

 

$

82,322

 

Cost of sales

 

70,666

 

45,266

 

Gross profit

 

58,715

 

37,056

 

 

 

 

 

 

 

Selling, general and administrative expenses

 

28,055

 

19,865

 

Income from operations

 

30,660

 

17,191

 

 

 

 

 

 

 

Other (income) expense, net:

 

 

 

 

 

Interest income

 

(851

)

(688

)

Interest and other expense, net

 

207

 

163

 

 

 

(644

)

(525

)

Income before income taxes

 

31,304

 

17,716

 

 

 

 

 

 

 

Income taxes

 

11,974

 

7,336

 

Net income

 

$

19,330

 

$

10,380

 

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

Basic

 

$

1.49

 

$

0.83

 

Diluted

 

$

1.47

 

$

0.81

 

 

 

 

 

 

 

Weighted-average common shares outstanding:

 

 

 

 

 

Basic

 

12,973

 

12,531

 

Diluted

 

13,117

 

12,831

 

 

See accompanying notes to condensed consolidated financial statements.

 

2



 

DECKERS OUTDOOR CORPORATION

AND SUBSIDIARIES

Condensed Consolidated Statements of Income

(Unaudited)

(amounts in thousands, except per share data)

 

 

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

 

 

 

 

As Restated

 

Net sales

 

$

254,686

 

$

180,047

 

Cost of sales

 

140,865

 

99,436

 

Gross profit

 

113,821

 

80,611

 

 

 

 

 

 

 

Selling, general and administrative expenses

 

65,225

 

50,684

 

Income from operations

 

48,596

 

29,927

 

 

 

 

 

 

 

Other (income) expense, net:

 

 

 

 

 

Interest income

 

(3,504

)

(1,985

)

Interest and other expense, net

 

781

 

356

 

 

 

(2,723

)

(1,629

)

Income before income taxes

 

51,319

 

31,556

 

 

 

 

 

 

 

Income taxes

 

20,271

 

13,178

 

Net income

 

$

31,048

 

$

18,378

 

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

Basic

 

$

2.43

 

$

1.47

 

Diluted

 

$

2.37

 

$

1.44

 

 

 

 

 

 

 

Weighted-average common shares outstanding:

 

 

 

 

 

Basic

 

12,784

 

12,503

 

Diluted

 

13,095

 

12,805

 

 

See accompanying notes to condensed consolidated financial statements.

 

3



 

DECKERS OUTDOOR CORPORATION

AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(amounts in thousands)

 

 

 

Nine months ended

 

 

 

September 30,

 

 

 

2007

 

2006

 

 

 

 

 

As Restated

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

31,048

 

$

18,378

 

Adjustments to reconcile net income to net cash used in operating activities:

 

 

 

 

 

Depreciation and amortization

 

2,846

 

2,264

 

(Recovery of) provision for doubtful accounts, net

 

(229

)

487

 

Write-down of inventory

 

2,688

 

1,972

 

Gain on sale of property and equipment

 

(19

)

(7

)

Stock-based compensation

 

3,585

 

1,555

 

Changes in operating assets and liabilities:

 

 

 

 

 

Trade accounts receivable

 

(24,554

)

(9,852

)

Inventories

 

(58,363

)

(20,128

)

Prepaid expenses and other current assets

 

(333

)

(875

)

Restricted cash

 

(1,250

)

 

Other assets

 

(19

)

 

Trade accounts payable

 

10,093

 

(4,202

)

Accrued expenses

 

2,820

 

1,462

 

Income taxes payable

 

(2,028

)

2,411

 

Net cash used in operating activities

 

(33,715

)

(6,535

)

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of short-term investments

 

(146,004

)

(90,684

)

Proceeds from sales of short-term investments

 

174,833

 

65,150

 

Purchases of property and equipment

 

(3,734

)

(3,329

)

Proceeds from sale of property and equipment

 

54

 

32

 

Net cash provided by (used in) investing activities

 

25,149

 

(28,831

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Excess tax benefits from stock-based compensation

 

11,690

 

728

 

Cash received from issuances of common stock

 

1,970

 

1,072

 

Net cash provided by financing activities

 

13,660

 

1,800

 

 

 

 

 

 

 

Effect of exchange rates on cash

 

(41

)

(42

)

 

 

 

 

 

 

Net change in cash and cash equivalents

 

5,053

 

(33,608

)

Cash and cash equivalents at beginning of period

 

34,255

 

50,749

 

Cash and cash equivalents at end of period

 

$

39,308

 

$

17,141

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Income taxes

 

$

10,610

 

$

10,442

 

 

 

 

 

 

 

Non-cash investing activity:

 

 

 

 

 

Accruals for purchases of property and equipment

 

$

145

 

$

 

 

See accompanying notes to condensed consolidated financial statements.

 

4



 

DECKERS OUTDOOR CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

(amounts in thousands, except share quantity and per share data)

 

(1)                      General

 

(a)          Basis of Presentation

 

The unaudited condensed consolidated financial statements have been prepared on the same basis as the annual audited consolidated financial statements and, in the opinion of management, reflect all adjustments necessary for a fair presentation for each of the periods presented. The results of operations for interim periods are not necessarily indicative of results to be achieved for full fiscal years. Our business is seasonal, with the highest percentage of Teva® brand net sales occurring in the first and second quarters of each year and the highest percentage of UGG® brand net sales occurring in the third and fourth quarters, while the quarter with the highest percentage of annual net sales for the Simple® brand has varied from year to year.

 

As contemplated by the Securities and Exchange Commission (the “SEC”) under Rule 10-01 of Regulation S-X, the accompanying condensed consolidated financial statements and related footnotes have been condensed and do not contain certain information that will be included in the Company’s annual consolidated financial statements and footnotes thereto. For further information, refer to the consolidated financial statements and related footnotes for the year ended December 31, 2006 included in the Company’s Amended Annual Report on Form 10-K/A for the year ended December 31, 2006.

 

(b)         Use of Estimates

 

The preparation of the Company’s condensed consolidated financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in these financial statements and accompanying notes. Significant areas requiring the use of management estimates relate to inventory reserves, allowances for bad debts, returns, markdowns and discounts, impairment assessments and charges, deferred taxes, depreciation and amortization, litigation and other contingency reserves, fair value of share-based awards, fair value of financial instruments, fair value of acquired intangibles, assets and liabilities. Actual results could differ materially from these estimates.

 

(c)          Reclassifications

 

Certain items in the prior year’s consolidated financial statements have been reclassified to conform to the current year presentation.

 

(2)                      Restatement

 

On September 4, 2007, management and the Audit Committee of the Board of Directors of Deckers Outdoor Corporation (the “Company”) concluded that it was necessary to restate the Company’s previously issued consolidated financial statements for the fiscal years 2004 through 2006 as well as certain financial information related to fiscal 2002 and 2003 contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 and the condensed consolidated financial statements for the periods ended March 31, 2007 and 2006 contained in its Quarterly Report on Form 10-Q. The Company has restated such financial statements and certain financial information as contained in the Company’s Form 10-K/A and Form 10-Q/A filed on October 11, 2007. The Company has also concluded that the condensed consolidated financial statements for the three and nine month periods ended September 30, 2006 as contained in this Form

 

5



 

DECKERS OUTDOOR CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

(amounts in thousands, except share quantity and per share data)

 

 

10-Q, should be restated. Accordingly, such prior condensed consolidated financial statements as contained in the Form 10-Q for the period ended September 30, 2006 should no longer be relied upon. The restatement is the result of material misstatements due to the underreporting of employee payroll expense and underpayment of certain tax obligations to authorities in China for one of the Company’s foreign subsidiaries, Holbrook Limited, a Hong Kong company.

 

The errors generated in the periods ended September 30, 2006 and related interest and penalties accrued in the periods ended September 30, 2007 have been recorded as an adjustment to cost of sales, interest and other expense, net, and income taxes in the condensed consolidated statements of income. In accordance with Financial Accounting Standards Board (the “FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 5, “Accounting for Contingencies,” management has determined the range of loss for such matters to be $4.5 million to $7.4 million. Management has determined that there is no amount within this range that is more likely to occur than any other, accordingly the lower end of the expected range has been accrued. The range of loss has increased from prior periods and may continue to increase in future periods as a result of the accrual of penalties and interest charges that may continue to be incurred through settlement. Because these matters relate in part to employment related tax matters, there is a level of subjectivity utilized in the interpretation of the application of tax and employment related laws and regulations. Accordingly, the amounts as ultimately negotiated and settled may differ from the Company’s estimates. The effects of the restatement for the three and nine months ended September 30, 2006 are reflected in the table below. The restatement had no effect on net cash flows from operating, investing or financing activities as shown in the condensed consolidated statements of cash flows.

 

 

 

Three Months ended September 30, 2006

 

Nine Months ended September 30, 2006

 

(In thousands, except per share data)

 

Previously
Reported

 

Adjustments

 

As
Restated

 

Previously Reported

 

Adjustments

 

As
Restated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Condensed Consolidated Statements of Income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

82,322

 

$

 

$

82,322

 

$

180,047

 

$

 

$

180,047

 

Cost of sales

 

45,149

 

117

 

45,266

 

99,133

 

303

 

99,436

 

Gross profit

 

37,173

 

(117

)

37,056

 

80,914

 

(303

)

80,611

 

Selling, general and administrative expenses

 

19,865

 

 

19,865

 

50,684

 

 

50,684

 

Income from operations

 

17,308

 

(117

)

17,191

 

30,230

 

(303

)

29,927

 

Other (income) expense, net

 

(643

)

118

 

(525

)

(1,927

)

298

 

(1,629

)

Income before income taxes

 

17,951

 

(235

)

17,716

 

32,157

 

(601

)

31,556

 

Income taxes

 

7,352

 

(16

)

7,336

 

13,178

 

 

13,178

 

Net income

 

$

10,599

 

$

(219

)

$

10,380

 

$

18,979

 

$

(601

)

$

18,378

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic income per share

 

$

0.85

 

$

(0.02

)

$

0.83

 

$

1.52

 

$

(0.05

)

$

1.47

 

Diluted income per share

 

$

0.83

 

$

(0.02

)

$

0.81

 

$

1.48

 

$

(0.04

)

$

1.44

 

 

(3)                      Stock Compensation

 

The Company’s 1993 Stock Incentive Plan (the “1993 Plan”) provided for 3,000,000 shares of common stock that were reserved for issuance to officers, directors, employees, and consultants of the Company. Awards to

 

6



 

DECKERS OUTDOOR CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

(amounts in thousands, except share quantity and per share data)

 

1993 Plan participants were not restricted to any specified form which included stock options and nonvested stock units (“NSUs”). No stock options were granted during the three and nine months ended September 30, 2007 and 2006. The 1993 Plan was terminated in May 2006 and no new awards have been granted under this plan.

 

In August 1995, the Company adopted the 1995 Employee Stock Purchase Plan (the “ESPP”). The ESPP was intended to qualify as an Employee Stock Purchase Plan under Section 423 of the Internal Revenue Code. Under the terms of the ESPP, as amended, 300,000 shares of common stock were reserved for issuance to employees who had been employed by the Company for at least six months. The ESPP provided for employees to purchase the Company’s common stock at a discount below market value, as defined by the ESPP. The ESPP was terminated in September 2006, and no new shares have been issued under the ESPP after that date.

 

In May 2006, the Company adopted the 2006 Equity Incentive Plan, which was amended by Amendment No. 1 dated May 9, 2007 (as amended, the “2006 Plan”). The primary purpose of the 2006 Plan is to encourage ownership in the Company by key personnel, whose long-term service is considered essential to the Company’s continued progress. The 2006 Plan provides for 2,000,000 new shares of the Company’s common stock that are reserved for issuance to employees, directors, or consultants. The maximum aggregate number of shares that may be issued under the 2006 Plan through the exercise of incentive stock options is 1,500,000. The 2006 Plan supersedes the 1993 Plan, which was subsequently terminated for new grants.

 

The Company generally grants NSUs annually to key personnel. The NSUs granted pursuant to the 1993 Plan and the 2006 Plan entitle the employee recipients to receive shares of common stock in the Company, which generally vest in quarterly increments between the third and fourth anniversary of the grant. Many of these awards include vesting that is also subject to achievement of certain performance targets.

 

In May 2007, the Company’s Board of Directors, upon recommendation of its Compensation Committee, adopted four new types of long-term incentive award agreements under the 2006 Plan for issuance to the Company’s current and future executive officers.  The new award types consist of stock appreciation right (“SAR”) awards and restricted stock unit (“RSU”) awards.  These awards vest subject to certain long-term performance objectives and certain long-term service conditions. Provided that these conditions are met, one-half of the SAR and RSU awards vest 80% on December 31, 2010 and 20% on December 31, 2011, and one-half of the SAR and RSU awards vest 80% on December 31, 2015 and 20% on December 31, 2016. In accordance with SFAS No. 123R, “Share-Based Payment,” the Company recognizes expense only for those awards that management deems probable of achieving the performance and service objectives.

 

On a quarterly basis, the Company grants 400 fully-vested shares of its common stock to each of its outside directors. The fair value of such shares is expensed on the date of issuance.

 

7



 

DECKERS OUTDOOR CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

(amounts in thousands, except share quantity and per share data)

 

The table below summarizes stock compensation amounts recognized in the condensed consolidated statements of income:

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Compensation expense recorded for:

 

 

 

 

 

 

 

 

 

ESPP

 

$

 

$

56

 

$

 

$

119

 

Stock options

 

68

 

157

 

209

 

379

 

NSUs

 

771

 

329

 

1,735

 

1,008

 

SARs

 

503

 

 

846

 

 

RSUs

 

100

 

 

178

 

 

Directors’ shares

 

244

 

86

 

617

 

237

 

Total compensation expense

 

1,686

 

628

 

3,585

 

1,743

 

Income tax benefit recognized

 

(688

)

(268

)

(1,465

)

(724

)

Net compensation expense

 

$

998

 

$

360

 

$

2,120

 

$

1,019

 

 

The table below summarizes the total remaining unrecognized compensation cost related to nonvested awards and the weighted-average period over which the cost is expected to be recognized as of September 30, 2007:

 

 

 

Unrecognized
Compensation
Cost

 

Weighted-Average
Remaining Vesting
Period (Years)

 

Stock options

 

$

70

 

0.2

 

NSUs

 

4,769

 

2.3

 

SARs

 

6,903

 

3.5

 

RSUs

 

1,455

 

3.5

 

Total

 

$

13,197

 

 

 

 

8



 

 

 

DECKERS OUTDOOR CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

(amounts in thousands, except share quantity and per share data)

 

 

A summary of the activity under the 1993 Plan and 2006 Plan as of September 30, 2007, and changes during the period are presented below.

 

Summary Details for 1993 Plan Share Options

 

 

 

Number of
Shares

 

Weighted-
Average
Exercise
Price

 

Weighted-
Average
Remaining
Contractual
Term (Years)

 

Aggregate
Intrinsic
Value

 

Outstanding at January 1, 2007

 

466,000

 

$

6.59

 

3.9

 

$

24,896

 

Granted

 

 

 

 

 

 

 

Exercised

 

(383,000

)

5.13

 

 

 

 

 

Forfeited or expired

 

(1,000

)

19.00

 

 

 

 

 

Outstanding at September 30, 2007

 

82,000

 

$

13.24

 

5.3

 

$

7,903

 

 

 

 

 

 

 

 

 

 

 

Exercisable at September 30, 2007

 

56,000

 

$

10.55

 

4.9

 

$

5,535

 

Expected to vest and exercisable at September 30, 2007

 

81,000

 

$

13.22

 

5.3

 

$

7,871

 

 

During the nine months ended September 30, 2007 and 2006, stock options exercised totaled 383,000 and 97,000 shares, respectively, with a total intrinsic value of $30,317 and $2,468, respectively. Tax benefit realized from stock options exercised during the nine months ended September 30, 2007 and 2006 was $12,127 and $1,012, respectively. There were no stock options granted during the nine months ended September 30, 2007 and 2006.

 

Nonvested Stock Units Issued Under the 1993 Plan and 2006 Plan

 

 

 

 

 

Number of
Shares

 

Weighted-
Average
Grant-Date
Fair Value

 

 

 

 

 

 

 

 

 

Nonvested at January 1, 2007

 

 

 

239,000

 

$

40.36

 

Granted

 

 

 

3,000

 

58.11

 

Vested

 

 

 

 

 

Forfeited

 

 

 

(3,000

)

40.30

 

Nonvested at September 30, 2007

 

 

 

239,000

 

$

40.56

 

 

During the nine months ended September 30, 2007, all NSU grants were granted under the 2006 Plan.

 

 

9



 

DECKERS OUTDOOR CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

(amounts in thousands, except share quantity and per share data)

 

Stock Appreciation Rights Issued Under the 2006 Plan

 

 

 

Number of
Shares

 

Weighted-
Average
Exercise
Price

 

Weighted-
Average
Remaining
Contractual
Term (Years)

 

Aggregate
Intrinsic
Value

 

Outstanding at January 1, 2007

 

 

$

 

 

 

$

 

Granted

 

450,000

 

80.20

 

 

 

 

 

Exercised

 

 

 

 

 

 

 

Forfeited or expired

 

 

 

 

 

 

 

Outstanding at September 30, 2007

 

450,000

 

$

80.20

 

12.1

 

$

13,320

 

 

 

 

 

 

 

 

 

 

 

Exercisable at September 30, 2007

 

 

$

 

 

$

 

Expected to vest and exercisable at September 30, 2007

 

154,000

 

$

80.20

 

12.1

 

$

4,558

 

 

The maximum contractual term is 10 and 15 years from the date of grant for those SARs with final vesting dates of December 31, 2011 and December 31, 2016, respectively. Not all SARs were expected to vest due to probabilities of achieving performance conditions and estimated forfeitures.

 

The per share fair value of SARs granted was $50.40 on the date of grant using the Black-Scholes pricing model with the following weighted average assumptions:  expected dividend yield of 0%, expected stock volatility of 59.0%, risk-free interest rate of 4.6%, and an expected life of 6.9 years.

 

Restricted Stock Units Issued Under the 2006 Plan

 

 

 

 

 

Number of
Shares

 

Weighted-
Average
Grant-Date
Fair Value

 

 

 

 

 

 

 

 

 

 

 

 

 

Nonvested at January 1, 2007

 

 

 

 

$

 

 

 

Granted

 

 

 

60,000

 

80.20

 

 

 

Vested

 

 

 

 

 

 

 

 

Forfeited

 

 

 

 

 

 

 

Nonvested at September 30, 2007

 

 

 

60,000

 

$

80.20

 

 

 

 

At September 30, 2007, 20,000 RSUs were expected to vest. Not all RSUs were expected to vest due to probabilities of achieving performance conditions and estimated forfeitures.

 

10



 

DECKERS OUTDOOR CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

(amounts in thousands, except share quantity and per share data)

 

(4)                      Comprehensive Income

 

Comprehensive income is the total of net income and all other non-owner changes in equity. At September 30, 2007 and December 31, 2006, accumulated other comprehensive income of $222 and $393, respectively, consisted of net unrealized gains (losses) on short-term investments and cumulative foreign currency translation adjustment.

 

Comprehensive income is determined as follows:

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

As Restated

 

 

 

As Restated

 

Net income

 

$

19,330

 

$

10,380

 

$

31,048

 

$

18,378

 

Unrealized loss on short-term investments

 

(234

)

(29

)

(237

)

(29

)

Cumulative foreign currency translation adjustment

 

56

 

(22

)

66

 

45

 

Total comprehensive income

 

$

19,152

 

$

10,329

 

$

30,877

 

$

18,394

 

 

(5)                      Income per Share

 

Basic income per share represents net income divided by the weighted-average number of common shares outstanding for the period. Diluted income per share represents net income divided by the weighted-average number of shares outstanding, including the dilutive impact of potential issuances of common stock. For the three and nine months ended September 30, 2007 and 2006, the difference between the weighted-average number of shares used in the basic computation and that used in the diluted computation resulted from the dilutive impact of options to purchase common stock and NSUs.

 

The reconciliations of basic to diluted weighted-average common shares outstanding are as follows:

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Weighted-average shares used in basic computation

 

12,973,000

 

12,531,000

 

12,784,000

 

12,503,000

 

Dilutive effect of stock options and NSUs

 

144,000

 

300,000

 

311,000

 

302,000

 

Weighted-average shares used for diluted computation

 

13,117,000

 

12,831,000

 

13,095,000

 

12,805,000

 

 

All options outstanding as of September 30, 2007 and 2006 were included in the computation of diluted income per share for the three and nine months ended September 30, 2007 and 2006.

 

The Company excluded 77,000 contingently issuable shares of common stock underlying its NSUs and excluded all of its SARs and RSUs from the diluted income per share computations for both the three and nine months ended September 30, 2007, and excluded 80,000 contingently issuable shares underlying its NSUs for both the three and nine months ended September 30, 2006. The shares were excluded because the necessary conditions had not been satisfied for

 

11



 

DECKERS OUTDOOR CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

(amounts in thousands, except share quantity and per share data)

 

the shares to be issuable based on the Company’s performance through September 30, 2007 and 2006, respectively.

 

(6)                      Restricted Cash

 

In January 2007, the Company entered into an escrow agreement by and among Deckers Outdoor Corporation, MacGillivray Freeman Films, Inc., and Comerica Bank. The escrow agreement was initiated in conjunction with the Company’s purchase obligation with a movie production company for advertising services. As a result of the agreement, $1,250 of the Company’s cash and cash equivalents balance at December 31, 2006 became restricted cash in January 2007. Of the total restricted cash, $250 is short-term and is included as a current asset, and the remaining $1,000 is long-term and is included as a noncurrent asset in the Company’s condensed consolidated balance sheet at September 30, 2007. The escrow agreement contains a disbursement schedule according to when the funds will be disbursed to the production company, which is as follows:

 

January 2008

 

$

250

 

January 2009

 

300

 

January 2010

 

300

 

January 2011

 

200

 

January 2012

 

200

 

 

 

$

1,250

 

 

(7)                      Short-term Investments

 

Short-term investments are classified as available for sale under the provisions of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” Accordingly, the short-term investments are reported at fair value, with any unrealized gains and losses included as a separate component of stockholders’ equity. Interest and dividends are included in interest income in the condensed consolidated statements of income. Securities with original maturities of three months or less are classified as cash equivalents. Those that mature over three months are classified as short-term investments, as the funds are used for working capital requirements. The fair values of the Company’s short-term investments are shown in the table below. The Company has determined that the decline in fair values included in the table below are temporary, and therefore the unrealized losses have not been included in the condensed consolidated statements of income.

 

 

 

September 30, 2007

 

December 31, 2006

 

 

 

Unrealized
Losses

 

Fair Value

 

Unrealized
Gains

 

Fair Value

 

Certificates of deposit

 

$

(15

)

$

4,985

 

$

 

$

1,999

 

Government and agency securities

 

 

 

92

 

28,767

 

Corporate bonds

 

(130

)

26,870

 

 

 

Auction rate securities

 

 

3,550

 

 

33,871

 

Total

 

$

(145

)

$

35,405

 

$

92

 

$

64,637

 

 

12



 

DECKERS OUTDOOR CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

(amounts in thousands, except share quantity and per share data)

 

(8)                      Credit Facility

 

The Company’s revolving credit facility with Comerica Bank (the “Facility”) provides for a maximum availability of $20,000. Up to $10,000 of borrowings may be in the form of letters of credit. The Facility bears interest at the lender’s prime rate (7.75% at September 30, 2007) or, at the Company’s option, at the London Interbank Offered Rate, or LIBOR, (5.12% at September 30, 2007) plus 1.0% to 2.5%, depending on the ratio of liabilities to earnings before interest, taxes, depreciation and amortization, and is secured by substantially all assets. The Facility includes annual commitment fees of $60 per year and expires on June 1, 2009. At September 30, 2007, the Company had no outstanding borrowings under the Facility, no foreign currency reserves for outstanding forward contracts and outstanding letters of credit aggregated $78. As a result, $19,922 was available under the Facility at September 30, 2007.

 

The agreements underlying the Facility contain certain financial covenants including a quick ratio requirement, profitability requirements and a tangible net worth requirement, among others, as well as a prohibition on the payment of dividends.

 

(9)                      Income Taxes

 

Income taxes for the interim periods were computed using the effective tax rate estimated to be applicable for the full fiscal year, which is subject to ongoing review and evaluation by management. For the three months ended September 30, 2007 and 2006, the Company recorded an income tax expense of $11,974 and $7,336, respectively, representing an effective income tax rate of 38.3% and 41.4%, respectively. For the nine months ended September 30, 2007 and 2006, the Company recorded an income tax expense of $20,271 and $13,178, respectively, representing an effective rate of 39.5% and 41.8%, respectively.

 

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained.  The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any.  Tax positions taken are not offset or aggregated with other positions.  Tax positions that meet the more likely than not recognition threshold are measured as the largest amount of tax benefit that is more than 50% likely of being realized upon settlement with the applicable taxing authority.  The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in income taxes payable in the accompanying condensed consolidated balance sheets. On January 1, 2007, the Company adopted the provisions of FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes – an interpretation of SFAS No. 109.”  Effective with the implementation of FIN 48, any associated interest and penalties that would be payable to the taxing authorities upon examination is reflected as a liability in other accrued expenses in the accompanying condensed consolidated balance sheets.  For periods prior to January 1, 2007, such interest and penalties were reflected as a liability in income taxes payable.

 

 

 

13



 

DECKERS OUTDOOR CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

(amounts in thousands, except share quantity and per share data)

 

The total amount of unrecognized tax benefits, including related interest, is shown in the following table:

 

 

 

Unrecognized Tax 
Benefits

 

Accrued
Interest

 

Total
Unrecognized
Tax Benefits

 

As of January 1, 2007

 

$

1,310

 

$

193

 

$

1,503

 

Gross increases as a result of tax positions taken during a prior year

 

 

208

 

208

 

Gross increases as a result of tax positions taken during the current period

 

818

 

 

818

 

As of September 30, 2007

 

$

2,128

 

$

401

 

$

2,529

 

 

The amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate as of the date of adoption and as of September 30, 2007 were $1,486 and $2,128, respectively. Since the adoption of FIN 48, the Company has accounted for interest and penalties generated by income tax contingencies as interest and other expense, net, in the condensed consolidated statements of income.  For the nine months ended September 30, 2007, $208 of interest generated by income tax contingencies was recognized in the condensed consolidated statements of income. As of September 30, 2007, $401 of interest has been accrued in the condensed consolidated balance sheets. The adoption of FIN 48 did not have a material impact on the Company’s condensed consolidated financial statements.

 

The Company files income tax returns in the U.S. federal jurisdiction and various state, local and foreign jurisdictions.  With few exceptions, the Company is no longer subject to U.S. federal, state, local or non-U.S. income tax examinations by tax authorities for years before 2002. The Internal Revenue Service (“IRS”) commenced an examination of the Company’s U.S. income tax return for the year 2004 in the first quarter of 2007 that is anticipated to be completed by the end of the first quarter of 2008.  As of September 30, 2007, the IRS has not proposed any adjustments to the Company’s tax positions.  Management does not anticipate the IRS audit will result in a material change to the Company’s consolidated financial statements. Accordingly, it is reasonably possible that the Company’s unrecognized tax benefit could change; however, the Company does not expect any change to be material.

 

(10)             Recent Accounting Pronouncements

 

In September 2006, the FASB issued Statement No. 157 (“SFAS 157”), “Fair Value Measurements.”  SFAS 157 standardizes the definition and approaches for fair value measurements of financial instruments for those standards which already permit or require the use of fair value. It does not require any new fair value measurements. SFAS 157 defines a hierarchy for valuation techniques and also requires additional disclosures. The provisions of SFAS 157 are effective for the Company as of January 1, 2008. The Company does not expect the adoption of this statement to have a material effect on its consolidated financial statements.

 

In February 2007, the FASB issued Statement No. 159 (“SFAS 159”), “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115.”  SFAS 159 provides companies the option to measure many financial instruments and certain other items at fair value. This provides companies the opportunity to mitigate volatility in earnings caused by measuring instruments differently without complex hedge accounting provisions. SFAS 159 is effective for the Company beginning

 

14



 

DECKERS OUTDOOR CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

(amounts in thousands, except share quantity and per share data)

 

January 1, 2008. The Company does not expect the adoption of this statement to have a material effect on its consolidated financial statements.

 

(11)             Business Segments, Concentration of Business, and Credit Risk and Significant Customers

 

The Company’s accounting policies of the segments below are the same as those described in the summary of significant accounting policies, except that the Company does not allocate interest, income taxes, or certain unusual items to segments. The Company evaluates performance based on net sales and income or loss from operations. The Company’s reportable segments include the strategic business units responsible for the worldwide wholesale operations of each of its brands and its Consumer Direct business. They are managed separately because each business may require different marketing, research and development, design, sourcing and sales strategies. The income from operations for each of the segments includes only those costs which are specifically related to each segment, which consist primarily of cost of sales, costs for research and development, design, marketing, sales, commissions, bad debts, depreciation, amortization and the costs of employees and their respective expenses that are directly related to each business segment. The unallocated corporate overhead costs are the shared costs of the organization and include the following: costs of the distribution centers, information technology, human resources, accounting and finance, credit and collections, executive compensation, legal, and facilities costs, among others. The operating income derived from the sales to third parties of the Consumer Direct segment is separated into two components:  (i) the wholesale profit is included in the operating income of each of the three brands, and (ii) the retail profit is included in the operating income of the Consumer Direct segment.

 

Net sales and operating income (loss) by business segment are summarized as follows:

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Net sales to external customers:

 

 

 

 

 

 

 

 

 

Teva wholesale

 

$

9,404

 

$

8,515

 

$

68,814

 

$

62,915

 

UGG wholesale

 

105,661

 

63,995

 

148,852

 

90,912

 

Simple wholesale

 

3,714

 

3,996

 

9,202

 

9,889

 

Consumer Direct

 

10,602

 

5,816

 

27,818

 

16,331

 

 

 

$

129,381

 

$

82,322

 

$

254,686

 

$

180,047

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations, as Restated:

 

 

 

 

 

 

 

 

 

Teva wholesale

 

$

538

 

$

1,077

 

$

18,385

 

$

17,783

 

UGG wholesale

 

42,533

 

23,965

 

58,447

 

33,069

 

Simple wholesale

 

(395

)

(655

)

(1,258

)

(911

)

Consumer Direct

 

2,212

 

1,034

 

5,997

 

3,869

 

Unallocated overhead costs

 

(14,228

)

(8,230

)

(32,975

)

(23,883

)

 

 

$

30,660

 

$

17,191

 

$

48,596

 

$

29,927

 

 

15



 

DECKERS OUTDOOR CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

(amounts in thousands, except share quantity and per share data)

 

Business segment asset information is summarized as follows:

 

 

 

September 30,

 

December 31,

 

 

 

2007

 

2006

 

Total assets for reportable segments:

 

 

 

 

 

Teva wholesale

 

$

65,713

 

$

70,862

 

UGG wholesale

 

145,528

 

62,646

 

Simple wholesale

 

6,612

 

4,194

 

Consumer Direct

 

4,553

 

2,956

 

 

 

$

222,406

 

$

140,658

 

 

The assets allocable to each reporting segment generally include accounts receivable, inventory, intangible assets and certain other assets, that are specifically identifiable with one of the Company’s segments. Unallocated corporate assets are the assets not specifically related to one of the segments and generally include the Company’s cash and cash equivalents, short-term investments, deferred tax assets, and various other assets shared by the Company’s segments. Reconciliations of total assets from reportable segments to the condensed consolidated balance sheets are as follows:

 

 

 

September 30,

 

December 31,

 

 

 

2007

 

2006

 

Total assets for reportable segments

 

$

222,406

 

$

140,658

 

Unallocated deferred tax assets

 

4,713

 

4,713

 

Other unallocated corporate assets

 

81,846

 

104,602

 

Consolidated total assets

 

$

308,965

 

$

249,973

 

 

The Company sells its footwear products principally to customers throughout the U.S. The Company also sells its footwear products to foreign distributors located in Europe, Canada, Australia, Asia, and Latin America among other regions. International sales were 11.0% and 10.9% of the Company’s total net sales for the three months ended September 30, 2007 and 2006, respectively. International sales were 18.0% and 15.9% of the Company’s total net sales for the nine months ended September 30, 2007 and 2006, respectively. The Company does not consider international operations a separate segment, as management reviews such operations in the aggregate with the aforementioned segments.

 

As of September 30, 2007, approximately $11,951 of trademarks and $466 of goodwill are held in Bermuda by a subsidiary of the Company. Substantially all other long-lived assets are held in the U.S.

 

Management performs regular evaluations concerning the ability of its customers to satisfy their obligations and records a provision for doubtful accounts based upon these evaluations. One customer accounted for 10.8% and 11.2% of the Company’s net sales for the nine months ended September 30, 2007 and 2006, respectively. No other customer accounted for more than 10% of the Company’s net sales for the nine months

 

16



 

DECKERS OUTDOOR CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

(amounts in thousands, except share quantity and per share data)

 

ended September 30, 2007 and 2006. As of September 30, 2007 and December 31, 2006, the Company had one customer representing 15.2% and 31.5%, respectively, of net trade accounts receivable.

 

The Company’s production and sourcing are concentrated primarily in China, Australia and New Zealand, with the vast majority of its production at five independent contractor factories in China. The Company’s operations are subject to the customary risks of doing business abroad, including, but not limited to, currency fluctuations, customs duties, and related fees, various import controls and other nontariff barriers, restrictions on the transfer of funds, labor unrest and strikes and, in certain parts of the world, political instability.

 

(12)             Contingencies

 

See Note 2 for a discussion of certain matters in the Far East that resulted in a restatement of the Company’s condensed consolidated financial statements.

 

The Company is currently involved in various legal claims arising from the ordinary course of its business. Management does not believe that the disposition of these matters will have a material effect on the Company’s consolidated financial position or results of operations. The Company indemnifies its licensees, distributors and certain promotional partners in connection with claims alleging use of the Company’s licensed intellectual property.  The terms of the agreements range up to five years initially and do not provide for a limitation on the maximum potential future payments.  Management believes the likelihood of any payments is remote and would be immaterial.  The Company is not currently involved in any indemnification matters in regards to its intellectual property.

 

17



 

Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Forward-Looking Statements

 

The matters discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report that are not historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We sometimes use words such as “anticipate,” “believe,” “continue,” “estimate,” “expect,” “intend,” “may,” “project,” “will” and similar expressions, as they relate to us, our management and our industry, to identify forward-looking statements. Forward-looking statements relate to our expectations, beliefs, plans, strategies, prospects, future performance, anticipated trends and other future events. Specifically, this report and the information incorporated by reference in this report contain forward-looking statements relating to, among other things:

 

                        our business, growth, operating and financing strategies;

 

                        our product mix;

 

                        the success of new products;

 

                        our licensing strategy;

 

                        the impact of seasonality and weather on our operations;

 

                        expectations regarding our net sales and earnings growth;

 

                        expectations regarding our liquidity;

 

                        our future financing plans; and

 

                        trends affecting our financial condition or results of operations.

 

We have based our forward-looking statements largely on our current expectations and projections about future events and financial trends affecting our business. Actual results may differ materially. Some of the risks, uncertainties and assumptions that may cause actual results to differ from these forward-looking statements are described in our Amended Annual Report on Form 10-K/A under Item 1A. Risk Factors and in this quarterly report on Form 10-Q under Item 1A. Risk Factors. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this report and the information incorporated by reference in this report might not happen.

 

You should read this report completely as well as the documents that we file as exhibits to this report and the documents that we incorporate by reference in this report, with the understanding that our future results may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements and we assume no obligation to update such forward-looking statements publicly for any reason.

 

The “Deckers,” “UGG,” “Teva,” and “Simple” families of related marks, images and symbols are our trademarks and intellectual property. Other trademarks, trade names and service marks appearing in this report are the property of their respective holders. References to “Deckers,” “we,” “us,” “our,” or similar terms refer to Deckers Outdoor Corporation together with its consolidated subsidiaries. Unless otherwise specifically indicated, all dollar amounts herein are expressed in thousands, except for share quantity, per share data, and weighted-average wholesale prices per pair.

 

Restatement

 

On September 4, 2007, management and the Audit Committee of the Board of Directors of Deckers Outdoor Corporation concluded that it was necessary to restate our previously issued consolidated financial statements for the fiscal years 2004 through 2006 as well as certain financial information related to fiscal 2002 and 2003 contained in our Annual Report on Form 10-K for the year ended December 31, 2006 and the condensed consolidated financial statements for the periods ended March 31, 2007 and 2006 contained in our Quarterly Report on Form 10-Q.  We have restated such financial statements and certain financial information as contained in our Form 10-K/A and Form 10-Q/A filed on October 11, 2007. We have also concluded that the condensed consolidated financial statements for the three and nine month periods ended September 30, 2006 as contained in this Form 10-Q, should be restated. Accordingly,

 

18



 

DECKERS OUTDOOR CORPORATION

AND SUBSIDIARIES

 

such prior condensed consolidated financial statements as contained in the Form 10-Q for the period ended September 30, 2006 should no longer be relied upon. The restatement is the result of underreporting of employee payroll expense and underpayment of certain tax obligations to authorities in China for one of our foreign subsidiaries, Holbrook Limited, a Hong Kong company.

 

See Note 2, “Restatement,” of the notes to the condensed consolidated financial statements for a detailed discussion of the effects of the restatement.

 

Overview

 

We are a leading designer, producer and brand manager of innovative, high-quality footwear and the category creator in the sport sandal, luxury sheepskin, and sustainable footwear segments. We market our products under three proprietary brands:

 

                  Teva®: High performance sport sandals and rugged outdoor footwear and accessories;

 

                  UGG®: Authentic luxury sheepskin boots and a full line of luxury and comfort footwear and accessories; and

 

                  Simple®: Innovative sustainable-lifestyle footwear and accessories.

 

In 2004, we embarked on a strategy to license our footwear brands to complementary products outside of footwear, generally in apparel and accessories. We currently have ten licensing agreements with five licensees for the Teva and UGG brands combined.  We record licensing revenues and expenses within their respective brand and do not currently have or expect to have significant incremental net sales and profits from licensing in the near future.

 

We sell our three brands through domestic retailers and international distributors and directly to our end-user consumers through our Consumer Direct business. We sell our products in both the domestic market and international markets. Independent third parties manufacture all of our products.

 

Our business has been impacted by several important trends affecting our end markets:

 

                        The markets for casual, outdoor and athletic footwear have grown significantly during the last decade. We believe this growth is a result of the trend toward casual dress in the workplace, increasingly active outdoor lifestyles and a growing emphasis on comfort.

 

                        Consumers are more often seeking footwear designed to address a broader array of activities with the same quality, comfort and high performance attributes they have come to expect from traditional athletic footwear.

 

                        Our customers have narrowed their footwear product breadth, focusing on brands with a rich heritage and authenticity as market category creators and leaders.

 

                        Consumers have become increasingly focused on luxury and comfort, seeking out products and brands that are fashionable while still comfortable.

 

By emphasizing our brand image and our focus on comfort, performance and authenticity, we believe we can better maintain a loyal consumer following that is less susceptible to fluctuations caused by changing fashions and changes in consumer preferences.

 

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DECKERS OUTDOOR CORPORATION

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Below is an overview of the various components of our business, including some of the important factors that affect each business and some of our strategies for growing each business.

 

Teva Brand Overview

 

We initially produced Teva products under a license from the inventor of the Teva Universal Strap technology, Mark Thatcher. In November 2002, we purchased from Mr. Thatcher the Teva worldwide assets, including the Teva internet and catalog business and all patents, trade names, trademarks and other intellectual property associated with the acquired Teva assets, which we refer to collectively as the Teva Rights.

 

From fiscal 2002 to 2004, wholesale net sales of Teva brand products increased at a compound annual growth rate of 13.5%. However, for fiscal years 2005 and 2006, wholesale net sales of Teva products decreased by approximately 3.6% and 6.4%, respectively, compared to the year ago periods. We attribute this decline in sales primarily to a prolonged period of weak product innovation, coupled with a significant increase in competitor activity.  We began to address this situation in 2006 by dedicating significantly greater resources to product planning, design, and development, and through aggressive marketing. We also repositioned the Teva brand to a younger target consumer. These efforts resulted in a wholesale net sales increase of 15.9% for the fourth quarter of 2006 compared to the same period of 2005.  For the first three quarters of 2007, the Teva brand’s wholesale net sales increased by 11.5%, 5.4% and 10.4%, respectively, over the same periods of 2006. Including consumer direct net sales, we expect Teva brand growth to be approximately 10% year over year in 2007.

 

We continue to see a shift in consumer preferences and lifestyles to include more outdoor recreational activities.  The Teva brand has remained popular among professional and amateur outdoor enthusiasts, who consider the brand authentic and performance oriented.  Our Spring 2007 product line was over 70% new, and included innovative technical performance styles, as well as new colors and fresh new casual styles, which target a new generation of young outdoor athletes and enthusiasts. Also, our Fall 2007 product line includes a broader offering of closed footwear, both performance and casual.

 

To further capitalize on the growth of outdoor recreational activities and the acceptance of certain outdoor footwear products for everyday use, we will continue to explore opportunities to broaden the Teva brand’s distribution with high quality retailers beyond our core outdoor specialty and sporting goods channels. Through effective channel management, we believe we can continue to expand into new distribution channels without diluting our outdoor heritage and our appeal to outdoor enthusiasts. Through appropriate channel product line expansion, we continue to broaden our product offerings beyond sport sandals to new products that meet the style and functional needs of our consumers.

 

UGG Brand Overview

 

The UGG brand has been a well-known brand in California for many years and over the past few years has become a recognized brand throughout the remainder of the country and overseas. Over the past few years, our UGG brand has received increased media exposure including increased print media in national ads and cooperative advertising with our customers, which contributed to broader public awareness of the UGG brand and significantly increased demand for the collection. We believe that the increased media focus and demand for UGG products were driven by the following:

 

            consumer brand loyalty, due to the luxury and comfort of UGG footwear,

 

            increased marketing in high-end magazines,

 

            successful targeting of high-end distribution,

 

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DECKERS OUTDOOR CORPORATION

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                                    adoption by high profile film and television celebrities as a favored footwear brand,

 

                                    increased media attention that has enabled us to introduce the brand to consumers much faster than we would have otherwise been able to,

 

                                    continued geographic expansion across the U.S. and internationally, and

 

                                    continued innovation of new product categories.

 

We believe the luxury and comfort features of UGG products will continue to drive long-term consumer demand. Recognizing that there is a significant fashion element to UGG footwear and that footwear fashions fluctuate, our strategy seeks to prolong the longevity of the brand by offering a broader product line suitable for wear in a variety of climates and occasions and by limiting distribution to selected higher-end retailers. As part of this strategy, we have significantly increased our product line to approximately 125 styles in Fall 2007 from approximately 50 styles in 2002. This product line expansion includes our significantly expanded Fashion Collection and Men’s offering, as well as new styles in our Driving Collection, our newly introduced Surf Collection, our Cold Weather Collection and our luxury slipper category. Nevertheless, we cannot assure investors that UGG brand sales will continue to grow at their recent pace or that revenue from UGG products will not at some point decline. For the first three quarters of 2007, the UGG brand’s wholesale net sales increased 62.1%, 59.1% and 65.1%, respectively, compared to the same periods in 2006. Including consumer direct net sales, we expect the UGG brand growth to be approximately 50% year over year in 2007.

 

Simple Brand Overview

 

Simple Shoes began in 1991 as an alternative to all the over-built, over-priced, and over-hyped products in the marketplace at that time.  The brand’s legacy was built on its original sneaker design, the Old School Sneaker, and grew to include successful sandal and casual products.  In Fall 2005, as a response to the massive amount of waste produced by the footwear industry, the Simple brand launched a new collection of sustainable footwear called Green Toe®. Green Toe represents a revolutionary shift in thinking about footwear by building a shoe from the inside out using sustainable materials and processes.

 

The movement in Green Toe has also changed the rest of the Simple product line, which is evident in the addition of sustainable innovations like water-based cements, shoelaces and footbeds made from recycled plastic bottles, and outsoles made from recycled car tires. The brand’s sustainable message and product line are supported by a dedicated sales force in all key markets, in-house public relations management, and innovative and humorous national print ad campaigns in publications like Vanity Fair and Rolling Stone, as well as an internet ad campaign on websites like Treehugger.com and TheOnion.com.

 

2006 marked a critical year in the brand’s growth as men’s and women’s products continued to perform well at retail, the demand for Green Toe product increased, and brand visibility domestically and internationally increased in both new and existing accounts due to successful sell–through at retail. This effort resulted in net wholesale sales growth of 12.6% for the first quarter of 2007 compared to the same period of 2006. While Green Toe continued its success at retail in the second quarter, brand sales were negatively impacted due to a delayed start to the Spring selling season which affected reorder business. Given this industry-wide unseasonable cold weather issue and a shift of international shipments to the third quarter of 2007, Simple’s wholesale net sales decreased 30.3% for the second quarter of 2007 compared to the same period of 2006. In the third quarter of 2007, the Simple brand launched ecoSNEAKS™, a sneaker collection made from sustainable materials with mainstream, commercial appeal. However, due to production delays, which have since been resolved, Simple’s wholesale net sales decreased 7.1% for the third quarter of 2007 compared to the same period of 2006. Despite these delays, ecoSNEAKS™ had a solid debut across a broad spectrum of retailers. This further validates our brand strategy of bringing sustainable product designs to the

 

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DECKERS OUTDOOR CORPORATION

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mainstream. Based on this growing consumer lifestyle shift in purchasing sustainable products, we expect the Simple brand's sales growth including consumer direct net sales to be in the low teens year over year for the full year of 2007.

 

Our Simple segment is committed to innovation and bringing 100% sustainable products to the market, growing the brand’s business while at the same time bringing awareness and creating meaningful, environmentally friendly products for a global market.

 

Consumer Direct Overview

 

Our Consumer Direct business includes our internet and catalog retailing operations as well as our retail stores. We acquired our internet and catalog retailing business in November 2002 as part of the acquisition of the Teva Rights. In addition to the outlet store in Ventura, California that existed at that time, we have since opened four more outlet stores: one in Camarillo, California; one in Wrentham, Massachusetts; one in Riverhead, New York; and one in Woodbury, New York. We also opened our first UGG brand concept store in New York, New York in 2006 and an additional UGG brand concept store in October 2007 in Chicago, Illinois. Also in October 2007, our Canadian distributor opened an UGG brand concept store in Montreal, Quebec, which it owns and operates.

 

Our Consumer Direct business, which today sells all three of our brands, enables us to meet the growing demand for our products, to sell our products at retail prices and to provide us with significant incremental operating income. From the time we initiated our Consumer Direct business through the third quarter of 2007, the segment has had significant revenue growth, much of which occurred as the UGG brand gained popularity as consumers have continued to increase reliance on the internet for footwear and other purchases and as we began to open retail stores. Net sales of the Consumer Direct business increased 82.3% and 70.3% in the three and nine months ended September 30, 2007, respectively, compared to the same periods in 2006.

 

Managing our internet business requires us to focus on generating internet traffic to our websites, to effectively convert website visits into orders, and to maximize average order sizes. We distribute approximately two million consumer brochures throughout the year to drive our catalog order business. We plan to continue to grow this business through improved website features and performance, increased marketing on our websites and the expansion of European websites. Overall, our Consumer Direct business benefits from the strength of our brands and, as we grow our brands over time, we expect this business to continue to be an important segment of our business.

 

 

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DECKERS OUTDOOR CORPORATION

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Seasonality

 

Our business is seasonal, with the highest percentage of Teva brand net sales occurring in the first and second quarters of each year and the highest percentage of UGG brand net sales occurring in the third and fourth quarters. To date, the Simple brand has not had a seasonal impact on the Company.

 

 

 

2007

 

 

 

First
Quarter

 

Second
Quarter

 

Third
Quarter

 

 

 

 

 

 

 

 

 

Net sales

 

$

72,575

 

$

52,730

 

$

129,381

 

Income from operations

 

$

15,072

 

$

2,864

 

$

30,660

 

 

 

 

2006

 

 

 

First
Quarter

 

Second
Quarter

 

Third
Quarter

 

Fourth
Quarter

 

Net sales

 

$

56,004

 

$

41,721

 

$

82,322

 

$

124,376

 

Income from operations, as Restated*

 

$

8,823

 

$

3,913

 

$

17,191

 

$

21,515

 

 

 

 

 

 

 

 

 

 

 

 

 

2005

 

 

 

First
Quarter

 

Second
Quarter

 

Third
Quarter

 

Fourth
Quarter

 

Net sales

 

$

64,263

 

$

40,341

 

$

69,193

 

$

90,963

 

Income from operations, as Restated

 

$

14,321

 

$

4,595

 

$

13,933

 

$

19,059

 

 


* Included in income from operations in the fourth quarter of 2006 is a $15,300 impairment loss on our Teva trademark.

 

With the dramatic growth in the UGG brand in recent years, combined with the introduction of a Fall Teva product line, net sales in the last half of the year have exceeded that for the first half of the year. Given our expectations for each of our brands in 2007, we currently expect this trend to continue. Nonetheless, actual results could differ materially depending upon consumer preferences, availability of product, competition and our customers continuing to carry and promote our various product lines, among other risks and uncertainties. See Item 1A. “Risk Factors.”

 

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DECKERS OUTDOOR CORPORATION

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Results of Operations

 

The following table sets forth certain operating data for the periods indicated.

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Net sales by location:

 

 

 

 

 

 

 

 

 

U.S.

 

$

115,197

 

$

73,344

 

$

208,891

 

$

151,385

 

International

 

14,184

 

8,978

 

45,795

 

28,662

 

Total

 

$

129,381

 

$

82,322

 

$

254,686

 

$

180,047

 

 

 

 

 

 

 

 

 

 

 

Net sales by product line and Consumer Direct business:

 

 

 

 

 

 

 

 

 

Teva:

 

 

 

 

 

 

 

 

 

Wholesale

 

$

9,404

 

$

8,515

 

$

68,814

 

$

62,915

 

Consumer Direct

 

1,819

 

1,501

 

5,190

 

4,576

 

Total

 

11,223

 

10,016

 

74,004

 

67,491

 

UGG:

 

 

 

 

 

 

 

 

 

Wholesale

 

105,661

 

63,995

 

148,852

 

90,912

 

Consumer Direct

 

8,065

 

3,898

 

20,959

 

10,665

 

Total

 

113,726

 

67,893

 

169,811

 

101,577

 

Simple:

 

 

 

 

 

 

 

 

 

Wholesale

 

3,714

 

3,996

 

9,202

 

9,889

 

Consumer Direct

 

718

 

417

 

1,669

 

1,090

 

Total

 

4,432

 

4,413

 

10,871

 

10,979

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

129,381

 

$

82,322

 

$

254,686

 

$

180,047

 

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

As Restated

 

 

 

As Restated

 

Income (loss) from operations by product line and Consumer Direct business:

 

Teva wholesale

 

$

538

 

$

1,077

 

$

18,385

 

$

17,783

 

UGG wholesale

 

42,533

 

23,965

 

58,447

 

33,069

 

Simple wholesale

 

(395

)

(655

)

(1,258

)

(911

)

Consumer Direct

 

2,212

 

1,034

 

5,997

 

3,869

 

Unallocated overhead costs

 

(14,228

)

(8,230

)

(32,975

)

(23,883

)

Total

 

$

30,660

 

$

17,191

 

$

48,596

 

$

29,927

 

 

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DECKERS OUTDOOR CORPORATION

AND SUBSIDIARIES

 

The following table sets forth certain operating data as a percentage of net sales for the periods indicated, and the percent change in each item of operating dollars between the periods.

 

 

 

Three Months Ended
September 30,

 

Percent
Change

 

 

 

2007

 

2006

 

2007 to 2006

 

 

 

 

 

As Restated

 

 

 

Net sales

 

100.0

%

100.0

%

57.2

%

Cost of sales

 

54.6

 

55.0

 

56.1

 

Gross profit

 

45.4

 

45.0

 

58.5

 

Selling, general and administrative expenses

 

21.7

 

24.1

 

41.2

 

Income from operations

 

23.7

 

20.9

 

78.4

 

Other income, net

 

(0.5

)

(0.6

)

22.7

 

Income before income taxes

 

24.2