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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM
- --------------- TO
- ---------------.
COMMISSION FILE NO. 0-22446
DECKERS OUTDOOR CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 95-3015862
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
495-A SOUTH FAIRVIEW AVENUE, GOLETA, 93117
CALIFORNIA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
Registrant's telephone number, including area code: (805) 967-7611
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which
None registered
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Common Stock, $.01 par value
(Title of Class)
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (sec.229.405 of this chapter) is not contained herein, and
will not be contained to the best of registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. [ ]
Aggregate market value of the Common Stock of the registrant held by
nonaffiliates of the registrant on February 28, 1998 based on the closing price
of the Common Stock on the NASDAQ National Market System on such date was
$35,647,164.
The number of shares of the registrant's Common Stock outstanding at
February 28, 1998 was 8,796,729.
Portions of registrant's definitive proxy statement relating to
registrant's 1998 annual meeting of shareholders, which will be filed pursuant
to Regulation 14A within 120 days after the end of registrant's fiscal year
ended December 31, 1997, are incorporated by reference in Part III of this Form
10-K.
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DECKERS OUTDOOR CORPORATION
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
INDEX TO ANNUAL REPORT ON FORM 10-K
CAPTION PAGE
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 17
Item 3. Legal Proceedings........................................... 17
Item 4. Submission of Matters to a Vote of Security Holders......... 17
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 18
Item 6. Selected Financial Data..................................... 18
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 19
Item 7A. Quantitative and Disclosures about Market Risk.............. 24
Item 8. Financial Statements and Supplementary Data................. 24
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 25
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 44
Item 11. Executive Compensation...................................... 44
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 44
Item 13. Certain Relationships and Related Transactions.............. 44
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 44
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PART I
ITEM 1. BUSINESS
GENERAL
The Company designs, produces and markets innovative, function-oriented
footwear and apparel that have been developed for high-performance outdoor,
sports and other lifestyle related activities, as well as for casual use.
Currently, the Company offers four primary product lines under the following
recognized brand names: Teva(R) - high-performance sports sandals with a unique,
patented strapping system, as well as casual footwear for everyday use and a
newly introduced line of casual apparel; Simple(R) - innovative shoes that
combine the comfort elements of athletic footwear with casual styling; Ugg(R) -
authentic sheepskin boots and other footwear; and Picante(R) - casual,
hand-woven apparel for men and women. All of the Company's footwear and apparel
possess the common features of high quality with a primary focus on
functionality and comfort. In 1997, the Company sold approximately 3,865,000
pairs of footwear. Revenues from sales of Teva(R) products have been
$55,925,000, $43,898,000 and $61,863,000 during 1995, 1996 and 1997,
representing 54.7%, 43.1% and 58.0% of net sales, respectively. Through
continued expansion and development, the Company hopes to further increase its
brand awareness and appeal to a wide variety of consumers. Deckers Outdoor
Corporation (" the Company") was incorporated in 1993 in the state of Delaware
and is the successor to a company incorporated in California in 1973.
MARKET OVERVIEW
The casual, outdoor and athletic footwear market is comprised of footwear
worn for casual everyday use and for outdoor and athletic activities such as
hiking, boating, basketball, tennis, fitness and jogging. The market for such
footwear has grown significantly during the last decade, and even more recently
there appears to be a shift from traditional athletic footwear toward more
casual and outdoor footwear. This shift has occurred as consumers have accepted
the more understated look in contrast to the traditional athletic shoes that had
gained popularity in previous years. The Company believes that the principal
reasons for the growth in sales of such footwear have been the growing
acceptance of casual wear including the increasing casualization of the
workplace, increasingly active consumer lifestyles, as well as the aging
demographics and the related growing emphasis on comfort.
A recent development in the overall footwear market has been the
significant growth of the outdoor segment as well as the growing emphasis on
comfort. Outdoor footwear includes shoes, boots and sandals for outdoor
recreational activities such as hiking, river rafting, camping and casual wear.
Companies engaged in the outdoor footwear market include Nike, Adidas,
Timberland, Merrell, Wolverine and Hi-Tec U.S.A. The Company believes that the
growth in outdoor footwear is driven by several factors including a general
shift in consumer preferences and lifestyles to include more outdoor, sports and
recreational activities such as hiking and camping. As consumers engage in
outdoor activities, they typically desire footwear specifically designed for
these purposes, yet demand the same level of quality and high-performance that
they have come to expect from traditional athletic footwear. In addition, with
the aging demographics, more consumers are turning to an emphasis on casual and
comfortable footwear and apparel. The Company believes that its products have
benefited from this growing trend and that its footwear addresses consumers'
demands for highly functional footwear that is durable as well as comfortable
and fashionable.
The casual, outdoor and athletic footwear markets are generally
characterized by a high level of recognition of brand names, logos and
trademarks. Unique and identifying features create brand awareness among
consumers and allow a favorable reputation to be transferred to new products.
The manufacture of casual, outdoor and athletic footwear is typically conducted
overseas through either company-owned facilities or a wide variety of
independent manufacturers. Casual and athletic footwear is distributed through
athletic footwear stores, department stores and specialty retailers. Outdoor
footwear is generally distributed through these channels as well but is to a
large extent distributed through outdoor specialty retailers. Retailers may
purchase footwear on a "futures" basis (orders placed in advance of a season) or
an "at once" basis (orders placed and filled immediately). Futures orders allow
a company to more accurately predict its manufacturing and sourcing needs.
Retailers are generally encouraged to purchase goods on a futures basis by
receiving discounts or special payment terms not otherwise available.
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RISK FACTORS
While management of the Company is optimistic about the Company's long-term
prospects, the following issues and uncertainties, among others, should be
considered in evaluating its outlook. This Annual Report on Form 10-K contains
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995, which involve known and unknown risks,
uncertainties and other factors which may cause the actual results, performance
or achievement of the Company, or industry results, to differ materially from
any future results, performance or achievements expressed or implied by such
forward-looking statements. Actual results could differ materially from those
contemplated by such statements. The factors listed below represent certain
important factors the Company believes could cause such results to differ. These
factors are not intended to represent a complete list of the general or specific
risks that may affect the Company. It should be recognized that other risks may
be significant, presently or in the future, and the risks set forth below may
affect the Company to a greater extent than indicated.
TEVA(R) LICENSE AGREEMENTS
The Company manufactures and sells its Teva(R) sport sandals and clothing
line pursuant to two exclusive licensing agreements with Mark Thatcher, the
inventor of the Teva(R) sport sandal and owner of the Teva(R) patents and
trademark. One license agreement applies to the United States, Canada and the
Caribbean, and the other covers certain countries in Europe and Asia. The
current term of each such licensing agreement continues through August 2001. Mr.
Thatcher may terminate the licensing agreement if specific minimum annual sales
targets (such levels that are substantially below the Company's sales during the
past several years) are not met, if the Company breaches its obligations under
the agreements or upon the occurrence of certain other circumstances. Sales of
Teva(R) sports sandals accounted for approximately 54.7%, 43.1% and 58.0% of the
Company's net sales for fiscal years 1995, 1996 and 1997, respectively. The
termination of the licenses would have a material adverse effect on the
Company's results of operations. The Company is endeavoring to secure an
extension of the Teva(R) License Agreements, but there are no assurances that
such extensions can be secured.
BRAND STRENGTH; CHANGES IN FASHION TRENDS
The Company's success is largely dependent on the continued strength of the
Teva(R), Simple(R) and Ugg(R) brands (collectively, "Deckers Brands") and on its
ability to anticipate the rapidly changing fashion tastes of its customers and
to provide merchandise that appeals to their preferences in a timely manner.
There can be no assurance that consumers will continue to prefer the Deckers
Brands or that the Company will respond in a timely manner to changes in
consumer preferences or that the Company will successfully introduce new models
and styles of footwear and apparel. Achieving market acceptance for new products
may also require substantial marketing and product development efforts and the
expenditure of significant funds to create consumer demand. Decisions with
respect to product designs often need to be made many months in advance of the
time when consumer acceptance can be determined. As a result, the Company's
failure to anticipate, identify or react appropriately to changes in styles and
features could lead to, among other things, excess inventories and higher
markdowns and lower gross margins due to the necessity of providing discounts to
retailers. Conversely, failure by the Company to anticipate consumer demand
could result in inventory shortages, which can adversely affect the timing of
shipments to customers, negatively impacting retailer and distributor
relationships and diminishing brand loyalty. The failure to introduce new
products that gain market acceptance would have a material adverse effect on the
Company's business, financial condition and results of operations, and could
adversely affect the image of the Deckers Brands.
In response to consumer demand, the Company also uses certain specialized
fabrics and materials in its footwear and apparel. The failure of footwear or
apparel using such fabrics and materials to perform to customer satisfaction
could result in a higher rate of customer returns and could adversely affect the
image of the Deckers Brands, which could have a material adverse effect on the
Company's business, financial condition and results of operations.
The Company is a new entrant in the apparel business. The apparel industry
is highly competitive and fragmented, and many of the Company's competitors have
significantly greater financial resources than the Company and spend
substantially more on product advertising than the Company. Additionally, the
apparel
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industry is particularly dependent on changes in fashion, which will require the
Company to devote substantial resources to respond to changes in consumer
preferences in a timely manner.
ECONOMIC CYCLICALITY AND FOOTWEAR RETAILING
The footwear industry historically has been subject to cyclical variation,
with purchases of footwear tending to decline during recessionary periods. This
cyclicality could adversely affect the Company's business. In addition, various
retailers, including some of the Company's customers, have experienced financial
difficulties during the past several years, thereby increasing the risk that
such retailers may not pay for the Company's products in a timely manner. No
assurance can be given that the Company's bad debt expense will not increase
relative to net sales in the future. Any significant increase in the Company's
bad debt expense relative to net sales would adversely impact the Company's net
income and cash flow, and could affect the Company's ability to pay its
obligations as they become due.
DEPENDENCE ON FOREIGN MANUFACTURERS
Virtually all of the Deckers footwear products are manufactured by third
party suppliers in the Far East, Mexico and Costa Rica. There can be no
assurance that the Company will not experience difficulties with such
manufacturers, including reduction in the availability of production capacity,
errors in complying with product specifications, inability to obtain sufficient
raw materials, insufficient quality control, failure to meet production and
delivery deadlines or increases in manufacturing costs. In addition, if the
Company's relationship with any of its manufacturers were to be interrupted or
terminated, alternative manufacturing sources will have to be located. The
establishment of new manufacturing relationships involves numerous
uncertainties, and there can be no assurance that the Company would be able to
obtain alternative manufacturing sources on terms satisfactory to it. Should a
change in its suppliers become necessary, the Company would likely experience
increased costs, as well as substantial disruption and a resulting loss of
sales.
Foreign manufacturing is subject to a number of risks, including work
stoppage, transportation delays and interruptions, political instability,
foreign currency fluctuations, changing economic conditions, expropriation,
nationalization, imposition of tariffs, import and export controls and other
non-tariff barriers (including quotas) and restrictions on the transfer of
funds, environmental regulation and other changes in governmental policies.
There can be no assurance that such factors will not materially adversely affect
the Company's business, financial conditions and result of operations.
All Deckers Brands manufactured overseas and imported into the United
States and other countries are subject to duties collected by the Customs
Service in the applicable country. Customs information submitted by the Company
is subject to review by the Customs Service. The Company is unable to predict
whether additional Customs duties, quotas or restrictions may be imposed on the
importation of its products in the future. The enactment of any such duties,
quotas or restrictions could result in increases in the cost of such products
generally and might adversely affect the sales or profitability of the Company.
The European Commission has enacted anti-dumping duties of 49.2% on certain
types of footwear imported into Europe from China and Indonesia. Dutch Customs
has issued an opinion to the Company that two of the most popular Teva styles,
the Valkyrie and the Storm, are covered by this anti-dumping duty legislation.
The Company does not believe that these styles are covered by the legislation
and is working with Customs to resolve the situation. In the event that Customs
makes a final determination that such styles are covered by the anti-dumping
provisions, the Company expects that it would have an exposure to prior anti-
dumping duties for 1997. In addition, if Customs determines that these styles
are covered by the legislation, the duty amounts could cause such products to be
too costly to import into Europe from China in the future. As a result, the
Company could have to cease shipping such styles from China into Europe in the
future or could have to begin to source these styles from countries not covered
by the legislation.
INTERNATIONAL BUSINESS OPERATIONS; RISKS OF FOREIGN CURRENCY FLUCTUATIONS
The Company may experience certain risks of doing business directly in
foreign countries including, but not limited to, managing operations effectively
and efficiently from a far distance and understanding and complying with local
laws, regulations and customs. Additionally, these entities may, from time to
time, collect payments in the customers' local currencies and purchase raw
materials or product in currencies other
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than U.S. dollars. Accordingly, the Company is exposed to transaction gains and
losses that could result from changes in foreign currency exchange rates.
COMPETITION AND INFRINGING PRODUCTS
The outdoor and footwear industries are both highly competitive, and the
recent growth in the markets for sports sandals and casual footwear has
encouraged the entry of many new competitors as well as increased competition
from established companies. Many of the Company's competitors have substantially
greater financial, distribution and marketing resources, as well as greater
brand awareness in the footwear market, than the Company. In addition, the
general availability of offshore manufacturing capacity allows rapid expansion
by competitors and new market entrants. The Company believes that it has been
able to compete successfully because of the brand recognition, quality and
selective distribution of its products. From time to time, the Company also
discovers products in the marketplace that infringe upon patent and trademark
rights held by or licensed to the Company. Under the Company's licensing
arrangements with the licensor of the Teva(R) products, Mark Thatcher, Mr.
Thatcher initially may bring proceedings to halt infringement of the Teva(R)
patents and trademark. If Mr. Thatcher elects not to bring such proceedings
within one year after discovery, the Company may initiate such proceedings. To
date, Mr. Thatcher has vigorously pursued infringements following discovery. To
the extent permitted in its agreement with Mr. Thatcher, the Company will
vigorously pursue infringements in the event Mr. Thatcher elects not to do so.
However, if Mr. Thatcher or the Company is unsuccessful in challenging a third
party's products on the basis of patent and trademark infringement, continued
sales of such products by that or any other third party could adversely impact
the Company's business, financial condition and results of operations. See
"Business -- Competition" and "Business -- Legal Proceedings."
DEPENDENCE ON KEY PERSONNEL
The Company's continued success will depend upon its ability to retain
Douglas B. Otto, its President and Chief Executive Officer, and Diana M. Wilson,
its Chief Operating Officer, and a core group of key executive officers and
employees. Mr. Otto and Ms. Wilson have executed employment agreements with the
Company through 2001 and 1999, respectively. Mr. Otto's agreement prohibits him
from competing with the Company for one year following termination. However,
none of the other executive officers is subject to employment agreements or
agreements that restrict his or her ability to compete with the Company
following termination of employment. The Company believes that its future
success will depend in large part on its ability to attract and retain
highly-skilled personnel. Competition for such personnel is intense, and there
can be no assurance that the Company will be successful in attracting and
retaining such personnel. The loss of certain key employees or the Company's
inability to attract and retain other qualified employees could have an adverse
impact on the Company's business.
INVENTORY RISK
The footwear industry has relatively long lead times for design and
production of product and, thus, the Company must often commit to production
tooling and to production in advance of orders. If the Company fails to
accurately forecast consumer demand or if there are changes in consumer
preference or market demand after the Company has made such production
commitments, the Company may encounter difficulty in filling customer orders or
in liquidating excess inventory, which may have an adverse effect on the
Company's sales, margins and brand image.
INTELLECTUAL PROPERTY
The Company believes that its trademarks, technologies and designs are of
great value. From time to time, the Company has been, and may in the future be,
the subject of litigation challenging its ownership of certain intellectual
property. Loss of the Teva(R), Simple(R) or Ugg(R) trademark rights could have a
serious impact on the Company's business. Because of the importance of such
intellectual property rights, the Company's business is subject to the risk of
counterfeiting, parallel trade or intellectual property infringement. The
Company is, however, vigilant in protecting its intellectual property rights.
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ECONOMIC FACTORS
The Company's business is subject to economic conditions in the Company's
major markets, including, without limitation, recession, inflation, general
weakness in retail markets and changes in consumer purchasing power and
preferences. Adverse changes in such economic factors could have a negative
effect on the Company's business.
TAX RATE CHANGES
If the Company were to encounter significant tax rate changes in the major
markets in which its operates, it could have an adverse effect on its business.
SUBSTANTIAL OWNERSHIP OF THE COMPANY
At December 31, 1997, Douglas B. Otto and all executive officers of the
Company, as a group, owned approximately 45.8% and 49.8% respectively of the
outstanding shares of the Company's Common Stock. Due to such ownership
position, Mr. Otto, whether acting alone or together with one or more of the
other executive officers of the Company, may be able to control the affairs and
policies of the Company and may be able to elect a sufficient number of
directors to control the Company's Board of Directors and to approve or
disapprove any matter submitted to a vote of the stockholders. The ownership
positions of Mr. Otto and of the executive officers of the Company, as a group,
together with the anti-takeover effects of certain provisions in the Delaware
General Corporation Law (the "DGCL") and in the Company's Certificate of
Incorporation and Bylaws, may have the effect of delaying, deferring or
preventing a change in control of the Company. Such factors could have a
negative effect on the market price of the Company's Common Stock.
WEATHER CONDITIONS
Sales of the Company's products, particularly those under the Teva(R) and
Ugg(R) lines, are very sensitive to weather conditions. In recent months, large
segments of the United States, particularly on the East and West coasts, have
experienced severe weather conditions due to the "El Nino" weather phenomenon.
The effects of such weather conditions cannot be determined by the Company.
BUSINESS STRATEGY
Management's business strategy is to offer diverse lines of footwear and
apparel that emphasize functionality, quality, comfort and technical performance
tailored to a variety of activities and demographic groups. Specifically, the
Company's business strategy emphasizes the following elements:
Acquire or Develop New Brands. The Company intends to continue to focus on
identifying and building brands for growth. The Company has been successful in
taking the concepts of entrepreneurs for innovative, fashionable footwear
targeted at niche markets and building the products into viable brands. The
Company intends to continue to identify concepts for potential future niche
products which have the potential of developing into successful brands or
product lines.
Introduce New Products under Existing Brands. The Company intends to
leverage consumer recognition of its existing brands by developing and
introducing additional innovative footwear products that satisfy the Company's
standards of practicality, comfort and quality. The Company believes the
introduction of additional products, such as the variety of new models in its
Teva(R), Simple(R) and Ugg(R) lines which are offered in the Company's 1998
product offerings, have broadened the Company's customer base, further
diversified the Company's product lines, and helped reduce the effects of
seasonality on the Company's sales. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Seasonality." Relying on the
public awareness and demand for the Teva(R) name, the Company has expanded this
brand into the casual footwear market, with increased offerings of leather and
other casual footwear in recent years. In 1997, the Company further leveraged
the Teva(R) brand, introducing a line of casual apparel under the Teva(R) brand
name. The Simple(R) brand has been expanded to include a variety of sneakers,
clogs, sandals and other casual footwear and accessories. In 1998, the Company
expects that its Ugg(R) product line will offer new innovations in outsoles, as
well as a new Town Collection which is aimed at reaching a more diverse customer
base. During the past several years, the Company has expanded into the women's
and children's markets, by offering additional styles specifically designed for
these demographic groups.
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Preserve Brand Image through Selective Distribution. In order to maintain
its brand image, the Company intends to continue its policy of selective
distribution of current product offerings. The Company implements this strategy
by generally limiting its distribution of its current offerings to those
retailers who market products that are consistent with the Company's standards
and that provide a high level of customer service and expertise. This selective
distribution network includes outdoor retailers, athletic footwear stores,
specialty retailers and upscale department stores. For its current offerings,
the Company avoids "off price," low service retailers and outlets. The Company
maintains its retailer relationships through an emphasis on customer service and
support. The Company and its independent sales representatives and technical
representatives also provide in-store, technical training and support, and offer
distinctive point-of-purchase displays and other promotional materials.
Pursue Additional Market Opportunities. Management intends to continue to
explore new markets for its existing line of products. The Company continues to
pursue expansion in the international markets. For the years ended December 31,
1995, 1996 and 1997 international net sales totaled $16,608,000, $24,061,000 and
$26,704,000, representing 16.2%, 23.6% and 25.0% of net sales, respectively.
Management believes that significant opportunities exist to market its products
abroad, especially in Europe, and intends to selectively expand its distribution
worldwide. To bolster these efforts, in 1997 the Company opened a European
office, managed by the Company's senior sales executive, to service the
international markets and formed Deckers Japan, a subsidiary to concentrate on
the Japanese market. The Company also has the exclusive distribution rights for
Teva(R) sports sandals in certain countries in Europe, including France, Germany
and the United Kingdom, as well as in Asia and the Caribbean. However, the
Company's ability to maintain or expand its European distribution could be
impacted by the European Commission's 1997 enactment of anti-dumping duty
provisions on certain types of footwear produced in China, if it is determined
that the Company's footwear falls under such antidumping provisions. See "Risks
of Foreign Operations/Restrictions on Imports".
PRODUCTS
The Company currently offers four principal product lines: (1) Teva(R)
sports sandals and apparel; (2) Simple(R) casual footwear; (3) Ugg(R) sheepskin
footwear; and (4) Picante(R) casual apparel. Each of these lines, as well as
individual models within these lines, is designed to appeal to various
demographic groups. The Company's footwear products emphasize function, comfort
and technical performance, and are suitable for a variety of demanding outdoor
and athletic activities, as well as casual and everyday use. The Company's
products are designed and marketed to promote a high level of brand name
recognition and consumer appeal by combining functional and creative designs
with quality materials and construction. The Teva(R) footwear line is generally
first previewed to accounts in the summer of each year, with deliveries
commencing in the fall. The Teva(R) apparel line is generally previewed twice
per year, once in the summer for deliveries that commence in the fall and once
in the winter for the back to school season. The Simple(R) line is generally
previewed three times per year, for the spring, back-to-school and holiday
seasons, with most deliveries occurring in the winter to target spring sales and
in the summer and fall to target the "back to school" market. The Ugg(R) line of
sheepskin footwear is generally previewed in the first quarter with most
deliveries occurring in the fall and winter. The Picante(R) line of casual
apparel has been less seasonal than the Company's footwear lines and is
previewed year-round. The following sets forth a summary description of each of
the Company's primary product lines along with the Company's domestic suggested
retail price for adult models.
Teva(R) Sports Sandals and Apparel. The Teva(R) sports sandal is one of
the first sports sandals to be developed and has become popular among outdoor
enthusiasts and the general public during the past several years. The Company
licenses the Teva(R) patents and trademark from Mark Thatcher, a professional
river guide who invented the Teva(R) sport sandal. The terms of such licenses
run through August 31, 2001. Certain styles of the Teva(R) sports sandal
incorporate a proprietary strapping configuration ideally suited for outdoor
activities such as hiking, boating and river rafting. This strapping system
consists of high-quality nylon webbing or
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leather, is fully adjustable, and holds the foot firmly to the sandal's durable,
cellular rubber, molded EVA, polyurethane or leather footbed. Teva(R)sports
sandals are extremely durable and many of the styles are water resistant. In
addition, the Company offers 20 styles of leather footwear designed for casual
everyday use. The spring 1998 line of Teva(R) sports sandals consists of 50
models that are available in one or more versions. These include new models of
thongs and slides, plus the introduction of a women's performance walking
sandal. Certain Teva(R) models target the women's and children's markets. The
domestic manufacturer's suggested retail prices for adult sizes of Teva(R)
footwear products range from $20.00 to $80.00.
Teva(R) Apparel and Accessories is a natural extension of the Company's
sport sandal business. The Fall 1998 line is comprised of two very distinctive
collections, the "Wilderness Collection" and the "Utility Collection." Each
collection reflects the same product philosophy, design and functional features
of the corresponding Teva(R) sport sandal categories, and satisfies a broad
range of technical and lifestyle product requirements of the target customer.
The line includes men's and women's shirts, shorts, pants and jackets, among
other apparel and accessory items. Consistent with Teva(R) sports sandals,
Teva(R) apparel is made of high quality, durable fabrics and is designed for
outdoor activities as well as for casual everyday use. The domestic
manufacturer's suggested retail prices range from $8.00 to $110.00.
Simple(R) Casual Footwear. The Simple(R) line consists of casual shoes
that combine athletic footwear construction with the simple, understated style
of back-to-basics, casual footwear. The Simple(R) line is designed to appeal to
young adults between the ages of 12 and 35 and others who are looking for
comfortable, fashionable, basic shoes. The 1998 Simple(R) line includes 34
models of sneakers, clogs and other casual footwear in various colors including
several newly introduced models for men, women and children. The Spring 1998
line also includes the addition of a collection of men's and women's styles of
leather sandals. The domestic manufacturer's suggested retail prices for adult
sizes for the Spring 1998 line range from $55.00 to $85.00.
Ugg(R) Sheepskin Footwear. Ugg(R) is a line of authentic sheepskin
footwear, popularized in Australia in the 1960's and 1970's. These sheepskin
boots, slippers and other footwear have fleece linings which act as a natural
insulator, keeping feet warm and comfortable. The 1998 Ugg(R) line offers an
expanded line of 31 models of casual, fashionable and rugged styles of sheepskin
footwear in various colors, including several new styles of shoes and boots for
men and women. The 1998 line includes innovations in uppers, redesigned outsoles
to offer better traction as well as other new features on certain styles to
address more inclement weather conditions. The 1998 line also includes an
expanded children's offering and the new Town Collection of men's and women's
casual footwear made with a combination of high quality waterproof leathers and
Australian sheepskin to provide a more weather resistant construction. The
domestic manufacturer's suggested retail prices for adult sizes for the Ugg(R)
line range from $65.00 to $175.00.
Picante(R) Casual Apparel. Picante(R) casual apparel is a line of imported
hand-woven long and short sleeve cotton camp shirts and other casual apparel for
men and women, which are sold through many of the same retail channels as the
Teva(R) and Simple(R) lines. Picante(R) clothing is designed using classic
silhouettes and colorations that are expected to appeal to the same demographic
groups as the Company's footwear lines. The unique fabrication and the quality
workmanship are consistent with the high standards associated with the Company's
other products and are complementary to those products. The domestic
manufacturer's suggested retail prices for this line of apparel range from
$20.00 to $82.00.
MARKETING AND DISTRIBUTION
The Company's products are distributed throughout North America by a
network of approximately 57 independent sales representatives, organized
geographically, who make sales, visit retail stores to train personnel and
review sales of the Company's footwear on a periodic basis. The Company's
Vice-Presidents of sales manage this network of representatives, recruit
experienced sales representatives in the industry and coordinate sales to
national accounts. The Company currently sells its products internationally,
through a combination of independent distributors and independent sales
representatives. The Company's goal is to promote retail sales of the Company's
products at attractive profit margins for its customers through selective
distribution and marketing, targeted toward distinct groups of consumers. As a
result of this approach, the Company's accounts have a strong incentive to
devote greater selling space to the Company's products, and
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the Company is better able to assess consumer preferences, the future ordering
needs of its customers and inventory requirements.
The Company's principal domestic customers for its current offerings are a
select group of specialty retailers, upscale department stores, outdoor
retailers and athletic footwear stores which market products consistent with the
Company's standards. The Company's five largest customers accounted for
approximately 16.3% of the Company's net sales for the year ended December 31,
1997, compared to 17.7% for the year ended December 31, 1996. The Company
intends to continue its policies of selective distribution and avoidance of "off
price," low service outlets for its current offerings that could adversely
impact the image of the Company's products.
For the Company's larger accounts, the Company offers volume discounts for
preseason orders, which vary depending upon the size of the order. In order to
encourage smaller accounts to place orders early in the season and to allow them
to participate in a discount program, the Company has also implemented a
preseason discount program under which smaller accounts are offered discounts on
preseason orders placed. The Company's strategy is to emphasize this "futures"
program, as compared to "at once" sales, in order to reduce the risk of customer
cancellations and to benefit from the significant positive impact of the program
on the Company's inventory costs, sourcing schedule and allocation of marketing
resources. In addition, in the fourth quarter of 1997, the Company implemented a
spring 1998 early delivery program that provided retailers an incentive to bring
Teva(R) product in for the fourth quarter. Domestic deliveries generally
originate from the Company's 126,000 square foot warehouse facility in Ventura
County, California. International deliveries also originate from offshore
factories or warehouses in Australia, Canada and the Netherlands.
ADVERTISING AND PROMOTION
The Company attempts to maximize the impact of its advertising and
promotional expenditures by utilizing media that provide high visibility within
targeted market segments. The Company's brand names are generally advertised and
promoted through a variety of consumer print advertising campaigns as well as
distinctive, in-store, "point of purchase" visual support and production
packaging. The Company's in-house marketing department works closely with
certain accounts in virtually all aspects of these activities.
Historically, a majority of the Company's advertising has been related to
Teva and has been directed toward the outdoor markets. However, with the
broadened appeal of the Teva(R) offerings, including the leather casual models,
the Company has increased its Teva(R) advertising focus in more mainstream print
publications, including Men's Health, GQ, Details, Shape, Elle and Self, among
others. Simple(R) also focuses its advertising toward print publications for its
target consumer group of young men and women between the age of 16 and 32.
Simple(R) is currently advertising in Wired, Details, Spin, Outside, Surfer and
Snowboarding, among others.
Historically, Ugg(R) was advertised primarily through a series of radio
advertising spots on the Rush Limbaugh radio program, which proved to be
increasingly ineffective. Beginning in 1997, however, the Ugg(R) marketing
program was retargeted to its original "core" markets of surf and California
lifestyles, as well as to upscale department store customers during the holiday
season. In 1997, Ugg(R) was advertised in a variety of surf publications as well
as newspaper advertisements in highly targeted geographical regions.
In order to maintain the Company's historically high visibility among core
enthusiasts such as leading river rafters, kayakers, mountain bikers and rock
climbers, Teva(R) products are given or sold at professional discounts to
members of this group. In order to further bolster the loyalty of these
individuals, the Company offers a line called the "Guide series," incorporating
the latest technological developments and highest quality materials. In 1996,
Teva(R)was the official supplier to the United States Canoe and Kayak Team.
Additionally, Ugg(R) was selected by Champion Sportswear to provide footwear for
the winter 1994 and the summer 1996 U.S. Olympic athletes. By outfitting these
highly visible teams, the Company creates awareness among targeted consumers at
relatively low cost.
In addition, the Company has independent technical representatives who
travel to various festivals, outdoor sporting events and competitions including
the Pole, Pedal, Paddle Race in Oregon, The Phoenix Bouldering Championship in
Arizona, The Taos Talking Picture Film Festival in New Mexico, the Mt. Snow
Micro-Brew Festival in Vermont, Reggae on the River in California and The Spirit
of Unity Tour, among many others. These representatives promote the Teva(R)
products through exhibits, demonstrations, sponsor-
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ships and product give-aways. Also, the Company promotes Simple(R) shoes at the
grassroots level by attending and sponsoring snowboard, surfing and other
outdoor sports events, and promotes the products by sponsoring top athletes in
these "alternative" sports. In addition, Simple(R) sponsors "alternative" music
bands which are popular with teens and young adults. The Company believes that
being associated with such events and the use of the Company's products by these
core groups of opinion leaders increases the products' brand awareness, thereby
broadening its markets and increasing sales.
In 1995, 1996 and 1997 the Company incurred $4,594,000, $4,738,000 and
$4,096,000 respectively, for advertising expenses. The Company is required under
its Teva(R) license agreements to spend a minimum amount for advertising and
promoting the Teva(R) products, which ranged from 2.64% to 3.14%, depending on
sales levels, of net sales during the period from September 1995 to August 1997.
Subsequent to August 1997, the required advertising rates reverted to the 3.5%
to 4.0% range that were in effect prior to September 1995. However, the Company
typically elects to spend more on advertising than is contractually required.
The Company works closely with Mr. Thatcher, its Teva(R) licensor, in managing
its advertising program for the Teva(R) products.
DESIGN AND PRODUCT DEVELOPMENT
The Company's design and product development staff creates and introduces
new innovative footwear products that are consistent with the Company's
standards of high quality, combined with comfort and functionality. Research and
development costs aggregated $1,509,000, $1,546,000 and $1,780,000 in 1995, 1996
and 1997, respectively.
With respect to Teva(R), in order to ensure that the Company's high
performance technical products continue to satisfy the requirements of its
historical customer base of performance-oriented "core enthusiasts," the
Company's design staff solicits comments and feedback from these professional
outdoorsmen, as well as certain of its retailers, including REI, Track 'n Trail
and L.L. Bean. Certain models are modified and technical innovations are
developed in response to such comments and feedback, primarily by outside
technicians retained by the Company for such purposes. For example, certain
styles within the "Guide series" of high-performance Teva(R) sandals employ
quick release buckles rather than "hook and loop" fasteners in response to such
feedback.
While Teva(R) continues to develop high performance sport sandals by
continually updating and designing new styles for this category, the Company
continues to increase its focus on the casual footwear market. The Company has
increased the number of styles of leather casual footwear as well as the number
of styles targeted directly toward women and children. The Company has also
increased the number of styles offered under the Simple(R) line for men, women
and children. By monitoring changes in consumer lifestyles and preferences and
then focusing first on function and practicality, the Company develops footwear
designed to appeal to quality-minded consumers seeking comfortable casual
footwear.
Prior to and shortly after the Company's 1995 acquisition of Ugg Holdings,
Inc., the Ugg(R) product was in need of updates and became subject to low cost
imitations. Since then, the Company has taken steps to update the Ugg(R)
products and make them functional for use in cold and wet climates. For example,
the popular Ultra styles of men's and women's boots have been updated in 1998
with new lug outsoles to improve traction. In addition, the 1998 Town Collection
includes footwear made with a combination of high quality waterproof leathers
and Australian sheepskin to provide a more weather resistant construction.
Integral factors in the design and product development process include an
evaluation of the availability and cost of raw materials, the capabilities of
the factories that will manufacture products and the target retail cost of new
models and lines. The Company has increased its design and product development
staff and has further strengthened it by developing teams for each product line.
These teams remain focused on their respective product lines and therefore are
better able to consistently design and develop products aimed at each brand's
target consumers. These teams work together with brand management to develop new
styles of footwear and components for their various product lines. Drawings and
prototypes are utilized to produce samples of proposed new concepts. Throughout
the development process, the design staff coordinates closely with each other
and with the Company's product development, manufacturing and sourcing personnel
toward a common goal of developing and sourcing a high-quality product that will
be delivered on a timely basis. The
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Company endeavors to minimize the risk of changing fashion trends by offering a
diverse line of functional products and monitoring sales to its accounts after
introduction.
MANUFACTURING
The Company sources a significant portion of its Teva(R) footwear from the
Far East, and to a lesser extent from the U.S., Mexico and Costa Rica. In
addition, the Company imports nearly all of its finished Simple(R) footwear from
independent contract manufacturers in the Far East and imports the majority of
its finished Ugg(R) footwear from independent contract manufacturers in
Australia, New Zealand and the Far East. The majority of Picante(R) casual
apparel is manufactured in Guatemala at a wholly owned subsidiary of Heirlooms,
Inc., a 50% owned subsidiary of the Company.
Through spring 1997, the Company manufactured certain styles of Teva(R)
sandals at its Carpinteria, California location. However, in March 1997, the
Company closed this facility, moving the related production to its manufacturing
facility in Mexico and increasing its reliance on independent subcontractor
manufacturing in the Far East. The manufacturing process consists primarily of
cutting, sewing, gluing and packaging its footwear products. The Company
currently has manufacturing capacity at its Mexico production facility, as well
as independent subcontractors in Southern California, the Far East and Costa
Rica. A portion of the foreign facilities is utilized to manufacture completed
footwear and a portion is utilized to manufacture and process certain
components, which are currently delivered to the United States subcontractors
for assembly of finished products. As the Company continues to grow, it expects
to further increase its foreign manufacturing capacities and rely more heavily
on independent subcontractors.
In 1992, the Company entered into a long-term manufacturing relationship
with a third party, Prosperous Dragon Manufacturing Co., Ltd. ("Prosperous
Dragon"), for the processing of the Company's footwear and footwear components
in the People's Republic of China ("PRC"). Under the agreement, Prosperous
Dragon is prohibited from manufacturing any products for any person other than
the Company, without the Company's prior consent. In return, the Company has
agreed to loan up to $4,000,000 on a revolving basis to Prosperous Dragon to
finance Prosperous Dragon's original start up and expansion, of which $2,466,000
was outstanding at December 31, 1997 ($966,000 net of allowance). The Company
purchases goods from Prosperous Dragon for an amount equal to its manufacturing
costs plus a fixed percentage. A portion of the payments that would otherwise be
made to Prosperous Dragon by the Company for products shipped are applied to
reduce the balance of the loan. Prosperous Dragon began supplying the Company
with bottom soles in June 1993 and has since begun supplying midsoles and uppers
for certain styles of Teva(R) footwear, as well as bottom soles for certain
Simple(R) and Ugg(R) styles. In addition, for the 1997 season, Prosperous Dragon
began supplying finished footwear for the Teva(R) line, for both domestic and
international distribution. Prosperous Dragon has become the supplier of a
significant portion of the components for the Company's products. A key employee
of the Company's Hong Kong subsidiary, Holbrook Limited ("Holbrook"), is the son
of the owner of Prosperous Dragon. This employee is currently entitled to
receive up to 8% of certain net profits of Holbrook derived from the sourcing of
products from Prosperous Dragon. This percentage will increase to 16% when 50%
or more of both the Company's investment in Holbrook and the outstanding balance
of the original loan from the Company to Prosperous Dragon is repaid, and to 24%
when the Company's investment in Holbrook and the original loan are repaid in
full.
The Company's manufacturing facility in Mexico is leased by Deckers Baja,
S.A. de C.V., a Mexican corporation that is a subsidiary of a domestic
subsidiary of the Company. The facility currently produces Teva(R) finished
footwear, uppers for certain Teva(R) styles and sockliners for certain Ugg(R)
styles. Established under the "maquiladora" program, the Company is not required
to pay duty on the raw materials or equipment imported into Mexico. The Company
pays customs duties on the finished uppers imported into the United States. The
duties are based upon the full value of the imported article, less the cost or
value of the United States components.
The Company currently obtains certain components for its products from a
limited group of suppliers. The topsoles used in several of the Company's
Teva(R) styles are made by two unrelated outside suppliers. While other
manufacturers are available to supply topsoles for most of the Company's models,
the topsoles of certain Teva(R) models are made with proprietary rubber
currently available only from these two suppliers. The
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proprietary rubber available from those two suppliers is interchangable. In
addition, the Company's agreement with Prosperous Dragon provides for the
processing of rubber sheets, from which topsoles are made. The footbeds and
bottom soles used by the Company for several of its models are currently
supplied to the Company solely by Prosperous Dragon. However, such components
are available at a number of foreign factories, in addition to the Prosperous
Dragon facility. The Company believes that the other raw materials it uses for
its sandals, principally rubber, leather and nylon webbing, are generally
available from multiple sources at competitive prices.
In addition to the agreement with Prosperous Dragon, the Company has an
agreement with a Costa Rican webbing manufacturer to order 3,600,000 yards of
webbing at approximately $0.40 to $0.45 per yard through April 30, 1997. As of
December 31, 1997, the Company has a remaining commitment of approximately
1,500,000 yards, and the Company and the supplier are in negotiations related to
the remaining commitment and future orders. In addition, the Company has an
agreement with an Australian manufacturer of Ugg(R) footwear to purchase a
quantity of sheepskin footwear at prices comparable to those of similar
Australian manufactured products. The Company and the Australian manufacturer,
which is currently in receivership proceedings, are in negotiations regarding
the obligation. Aside from these agreements, the Company does not have any other
long-term agreements with the manufacturers or suppliers for any of its
products, but does business based on individual purchase orders. Generally all
manufacturing of footwear is performed in accordance with detailed
specifications furnished by the Company and is subject to quality control
standards. The bulk of all raw materials used in production is generally
purchased from independent contractors at the Company's direction.
QUALITY CONTROL
The Company has instituted inspections and other procedures at each level
of the production process to satisfy the high quality demanded by users of the
Company's products. The Company conducts periodic on-site inspections of the
production of raw materials and conducts quality tests prior to placing orders.
The Company also has on-site inspectors at several of its independent suppliers
who oversee the production process. At the Company's Mexico facility,
inspections are conducted at each stage of production.
LICENSES
Teva(R) License. The Company manufactures its Teva(R) footwear line
pursuant to two exclusive license agreements with Mark Thatcher, the designer of
the patented strapping system. Mr. Thatcher owns two United States patents on
strap designs used in Teva(R) sports sandals and has a United States trademark
registration for the Teva(R) mark. The first of these agreements authorizes the
Company to make, use and sell products using the Teva(R) patents and trademark
and any other United States patents later issued to or acquired by Mr. Thatcher
relating to footwear in the United States, Canada, Puerto Rico and the countries
in the Caribbean. Any new sandal developed by Mr. Thatcher that is not covered
by the current patents will be added to the agreement as a licensed product at
the election of the Company. In addition, the Company has a right of first
refusal should Mr. Thatcher offer to license to any third party the rights to
develop, market and sell nonfootwear products that use the Teva(R) name. In
1996, the Company exercised its right of first refusal with respect to the
licensing of apparel under the Teva(R) name and began selling Teva(R) apparel in
1997.
In 1992, the Company and Mr. Thatcher entered into the second license
agreement allowing the Company to manufacture and sell Teva(R) products in eight
countries in Europe in which Mr. Thatcher had registered the Teva(R) trademark,
including France, Germany and the United Kingdom. As Mr. Thatcher obtains
registrations of the Teva(R)trademark in other European countries, such
countries will be included in the license. The material provisions of the
European license agreement are substantially similar to the provisions in the
license agreement for the United States, Canada, Puerto Rico and the Caribbean
as described above and will be automatically terminated upon any termination of
the United States license agreement. Mr. Thatcher may also terminate the
European license agreement if certain minimum sales targets are not met. Upon
any termination of the European license agreement, the Company must cease the
manufacture of Teva(R) sports sandals and, for a period of five years
thereafter, may not directly or indirectly engage in the licensed territory in
the manufacture of products using know-how related to Teva(R) sports sandals
acquired during the term of the agreement.
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As a result of the Company's selling a specified minimum of Teva(R) sport
sandals in Europe for the year ended August 31, 1993, the European license by
its terms was extended to include various countries in the Far East and Pacific
Rim, if Mr. Thatcher registers the Teva(R) trademark in those countries. Mr.
Thatcher has subsequently obtained the Teva(R) registered trademark in the
Peoples' Republic of China, Japan and Australia and has also filed for trademark
protection for the Teva(R) brand name in Hong Kong, New Zealand, Indonesia,
Singapore, Korea, Tahiti and Fiji, among others. Mr. Thatcher and the Company
have separately agreed that the Company may continue to operate in other Pacific
Rim countries until written notice from Mr. Thatcher to the contrary. Mr.
Thatcher and the Company have also agreed to sell Teva(R) products to a party in
Israel designated by Mr. Thatcher and to cooperate in the development of a
licensee or distributor for Teva(R) products in Israel.
The Company has the exclusive rights to manufacture and distribute the
Teva(R) footwear line through August 2001. In conjunction with the exercise of
its five year extension of the license period through August 31, 2001, the
Company paid the licensor consideration of $2,000,000. The Company is required
to pay royalties to the licensor at rates ranging from 5% to 6 1/2% on the net
sales of most Teva(R) products, depending on sales levels, and 3% to 4 1/2% of
net sales of certain styles, depending on sales levels. The Company is required
to pay minimum annual royalties ranging from $420,000 to $820,000 over the
license period. In addition, the Company is obligated to pay minimum annual
advertising costs which ranged from 2.64% to 3.14%, depending on sales levels,
of net sales during the period from September 1995 to August 1997. Subsequent to
August 1997, the required advertising rates reverted to the 3.5% to 4.0% range
that were in effect prior to September 1995.
The Teva(R) license agreements require that the Company obtain the approval
of Mr. Thatcher for new product designs as well as changes in designs or
materials. Mr. Thatcher also has the right to inspect the Company's
manufacturing facilities and product samples to assure that quality standards
are being maintained and may specify certain sizes and models to be manufactured
by the Company in reasonable quantities. The Company is obligated to sell
Teva(R) sandals to Mr. Thatcher with certain guaranteed terms of delivery.
Either party may terminate the agreement upon a breach which is not cured by the
other, and Mr. Thatcher may terminate the agreement if minimum annual sales
levels (such levels that are substantially below levels of the Company's sales
during the past several years) are not met, except if substantial trademark
infringement has occurred. In addition, the agreement will automatically
terminate upon the bankruptcy or insolvency of the Company or a sublicense or
assignment of the licensing agreement by the Company without Mr. Thatcher's
consent. Upon any termination of the agreement, the Company must cease the
manufacture of Teva(R) sports sandals and, for a period of three years
thereafter, may not directly or indirectly engage anywhere in the manufacture of
products using know-how specifically related to Teva(R) sports sandals acquired
during the term of the agreement.
Such agreement also provides that the Company may not manufacture or sell
sandals that are "competitive" with Teva(R) sports sandals. "Competitive
sandals" are defined as sandals with a secure fit and a heel strap system with
adjustable fasteners attached to the sole in a specified area. Whether a
particular sandal is "competitive" within the meaning of the agreement is to be
determined by Mr. Thatcher and the Company or, if they cannot agree, by
arbitration. To the extent any present or future sandal manufactured, sold or
planned by the Company is determined to be a "competitive sandal," the Company's
results of operations could be adversely affected. In addition, Mr. Thatcher may
not manufacture or sell, or enter into any other agreement for the assembly,
manufacture or sale, of Teva(R) sports sandals within the territory covered by
the license agreement. Concurrent with the Company's acquisition of the rights
to manufacture and distribute Alp(R) sport sandals in February 1995, the Company
agreed with Mr. Thatcher to market such sandals under the Teva(R) trademark. The
Company further agreed to pay a royalty to Mr. Thatcher on net sales of such
products at a rate of 3% to 4 1/2%, depending on sales volume, and to pay
minimum advertising costs similar to that for the other Teva(R) footwear
products.
Under the Company's licensing arrangement with Mr. Thatcher, Mr. Thatcher
initially may elect to bring proceedings to halt infringement of the Teva(R)
patents and trademark. In addition, if, within 365 days of notice of a possible
infringement, Mr. Thatcher declines to pursue an enforcement action against such
infringement, the Company may bring an enforcement action in its own name at its
own cost if the Company delivers to
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Mr. Thatcher an opinion of patent counsel that an infringement has occurred. The
Company would receive all of any recovery from such an action. If there is
substantial infringement and Mr. Thatcher does not proceed with any action, the
Company may terminate the license agreement upon 365 days' notice. See "Legal
Proceedings."
The Company has entered into preliminary exploratory discussions with the
licensor, Mr. Thatcher, to extend the two licenses. There can be no assurances
that the licenses will be extended or as to the terms and conditions to such an
extension. The failure of the Company to extend the two licenses, or to extend
such licenses on profitable terms, would have a material adverse effect on the
Company.
SIMPLE SHOES AGREEMENT
The Company is a party to an agreement with Eric Meyer, the founder of
Simple Shoes, Inc. under which Mr. Meyer is to provide consulting services to
the Company at a rate of $225,000 per year through December 31, 1998 for
advertising, marketing, brand image, strategic planning, pricing and product
line design, development and extension. The parties also agreed that the Company
would continue to use Mr. Meyer's name for advertising and promotional purposes
under a three year licensing agreement through December 31, 1998. Mr. Meyer
receives a licensing fee equal to 0.2% of net sales of Simple Shoes, Inc. plus
0.1% of the net sales resulting from any licensing of Simple products by the
Company to third parties.
UGG HOLDINGS, INC. AGREEMENT
Effective August 1, 1995, the Company acquired all of the issued and
outstanding shares of Ugg Holdings, Inc. and subsidiaries ("Ugg Holdings"),
which manufactures and markets a line of sheepskin footwear. Under the terms of
the transaction, the purchase price of approximately $12,700,000 included a
$12,000,000 down payment, a $500,000 final payment due in March 2000, and
approximately $200,000 of out-of-pocket expenses. The Company was required to
make further payments equal to 2 1/2% of net sales of Ugg Holdings, as defined
in the agreement, for the years ending March 31, 1996 through March 31, 2000,
and an amount equal to earnings before income taxes of Ugg Holdings, as adjusted
for certain items, for the year ending March 31, 1996.
In 1997, some of the former shareholders of Ugg Holdings gave notice of a
demand for arbitration regarding the periodic payments and, in September 1997,
the Company and the former Ugg shareholders arrived at a settlement agreement.
In addition, the remaining former Ugg shareholders who were not a party to the
arbitration agreed to accept the same economic terms as those involved in the
arbitration. Under the terms of the settlement, the Company and all former
shareholders of Ugg agreed to final payments aggregating $2.6 million. Of this,
approximately $600,000 was paid in December 1997 and the balance of $2,000,000
was paid in January 1998. These payments replaced all future earn-out payments
that were to be paid through the year 2000 in accordance with the original
acquisition agreement, including the $500,000 final payment. The corresponding
increase to goodwill has been reflected in the December 31, 1997 consolidated
financial statements.
TRUKKE WINTER SPORTS PRODUCTS, INC. AGREEMENT
The Company, Rich Breuner, the designer and founder of the Trukke(R) winter
boot, and the other shareholders of the predecessor Trukke company ("Old
Trukke"), entered into an agreement effective August 1995, pursuant to which the
Company paid $280,000 to the selling shareholders and became a 50% owner of the
newly formed Trukke Winter Sports Products, Inc. ("Trukke"). Mr. Breuner
contributed his shares of Old Trukke to Trukke in return for a 50% interest in
the newly formed corporation. In addition, the Company agreed to provide Trukke
a line of credit for up to $2,000,000.
In connection with the Company's investment, Trukke agreed to employ Mr.
Breuner for a period of three years at a compensation based in part on the
financial performance of Trukke.
Effective December 31, 1997, the Company sold its 50% interest to Mr.
Breuner for a purchase price of $602,000. Mr. Breuner issued two notes payable
to the Company, one note for $280,000, which is guaranteed by Mr. Bruener's
father, and a second note for $322,000 which is not so guaranteed. Both notes
are secured by
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all of the assets of Trukke and are payable over five years with interest at
10%. This transaction and the resulting gain were immaterial to the Company's
1997 consolidated financial statements.
HEIRLOOMS, INC. AGREEMENT
The Company and Bob Eason, the designer and founder of Picante(R) clothing,
entered into an agreement that became effective in December 1993, pursuant to
which the Company paid $125,000 and became a 50% owner of Heirlooms, Inc.
("Heirlooms"), the manufacturer and distributor of Picante(R) clothing. Mr.
Eason transferred to Heirlooms all of his rights to the related products. The
Company has also agreed to extend credit to Heirlooms. All obligations of
Heirlooms to the Company under such credit arrangement are secured by the assets
of Heirlooms.
Pursuant to the agreement, Mr. Eason has granted the Company the option to
acquire all or part of his interest in Heirlooms, exercisable beginning June 30,
1996 and expiring June 30, 1999, as subsequently amended. The purchase price for
such shares is $2,000,000, which is based on a formula tied to Heirlooms' 1996
pre-tax earnings. Mr. Eason may elect to retain a 20% interest in Heirlooms, in
which case the purchase price would be reduced proportionately.
In connection with the Company's investment, Heirlooms agreed to employ Mr.
Eason as President for three years at a compensation based in part on the
financial performance of Heirlooms. Mr. Eason continues to be employed as
President of Heirlooms on an at-will basis.
PATENTS AND TRADEMARKS
Mr. Thatcher holds two United States patents and one patent in each of
Australia, New Zealand and Korea for the Teva(R) strapping system. As a result
of the expiration of the applicable period during which foreign patent
applications were required to have been filed, Mr. Thatcher does not and cannot
hold such patent rights in other countries. Mr. Thatcher also currently holds
Teva(R) trademark rights in the United States and in several other countries,
including, among others, France, Germany, the United Kingdom, Japan and
Australia. Mr. Thatcher's patent and trademark rights are licensed to the
Company under the two license agreements discussed previously. Both the Company
and Mr. Thatcher regard such proprietary rights as valuable assets, and the
Company cooperates with Mr. Thatcher in vigorously protecting such rights
against infringement by third parties. To date, Mr. Thatcher has successfully
enforced his patent and trademark rights in all 18 concluded lawsuits brought
against such third parties. Under certain circumstances, if Mr. Thatcher
declines to challenge a potential infringement, the Company may bring an
infringement action at its own cost. See "Licenses -- Teva(R) License."
The Company also owns the Simple(R) and Ugg(R) trademarks and has applied
for or received registrations for them in the United States and several foreign
countries. In addition, the Company has filed for patent registrations on
several of its designs and has filed trademark applications for the names of
many of its models and features and for certain marketing slogans.
The Company has acquired the patent and trademarks for Alp(R) sport sandals
and holds the trademark on the Deckers(R) name. The trademark registrations for
the Picante(R) mark in the United States and Benelux (Belgium, Netherlands and
Luxembourg) and the mark for Rancho Picante(R) in the United States are
currently held by Heirlooms, Inc.
BACKLOG
Historically, the Company has encouraged and has received a significant
portion of its orders as preseason orders, which are generally placed by
customers approximately four to eight months prior to shipment date. The Company
emphasizes this "futures" business, as compared to "at once" sales as it allows
the Company to better forecast its inventory requirements and assists with the
Company's sourcing schedule. As a result, the Company provides its customers
with incentives to participate in such preseason programs. Unfilled customer
orders ("backlog"), as of any date, represent orders scheduled to be shipped at
a future date and do not represent firm sales. The mix of future and immediate
delivery orders can vary significantly from quarter to quarter and year to year.
The backlog as of a particular date is affected by a number of factors,
including seasonality and the scheduling of manufacture and shipment of products
as well as variations in the quarter to
14
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quarter and year to year preseason incentive programs. As a result, comparisons
of backlog from period to period are not meaningful and the Company's backlog at
any given time is generally not indicative of sales levels expected to be
achieved in the future.
COMPETITION
The casual, outdoor and athletic footwear markets are highly competitive.
The Company believes that its largest current competitors for the Teva(R) line
are Nike, Adidas, Timberland and Clarks. Airwalk, Vans, Skechers and Doc Marten
are the principal competitors for the Simple(R) line. The Ugg(R) line's most
significant competitors include Acorn, as well as retailers' private label
footwear. Many of the Company's competitors have substantially greater
financial, distribution and marketing resources than the Company.
Competition in the Company's footwear is primarily based on brand
awareness, product quality, design, pricing, fashion appeal, marketing,
distribution, performance and brand positioning. The Company's Teva(R) line of
footwear competes primarily on the basis of its patented strapping system, which
offers high-performance features, consumer brand recognition due to the Teva(R)
sports sandal being one of the first sandals of its kind, and the diversity of
styles offered. The Company competes through its Simple(R) line by offering a
diversity of styles designed for a variety of recreational and leisure
activities. Ugg(R) competes with others primarily on the basis of its
authenticity as well as its brand name recognition, identifiable with the United
States sheepskin footwear market. The Company believes that its business
strategy has resulted in increasing brand awareness. However, no assurance can
be given that in the future the Company will be able to further increase its
brand awareness, increase its market share or respond to changing consumer
preferences.
RISKS OF FOREIGN OPERATIONS/RESTRICTIONS ON IMPORTS
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 non-tariff barriers
(e.g., quotas), restrictions on the transfer of funds, labor unrest and strikes,
and in certain parts of the world, political instability. The Company believes
that it has acted to reduce these risks by diversifying manufacturing among
various countries and, within those countries, among various factories.
Importations into the United States are also affected by the cost of
transportation, customs duties, other non-tariff barriers, increased competition
and greater production demands abroad. Countries where the Company's products
are manufactured and sold may, from time to time, seek to increase customs
duties or impose other non-tariff barriers (e.g., quotas), all of which have the
potential to affect the Company's operations and its ability to maintain or
increase the current level of importations of the Company's products. The
Company is unable to predict the likelihood or frequency of the occurrence of
any of these events.
The products imported by the Company into the United States are subject to
various duty rates which are established by law. At the present time these
duties range between 8.5% and 10% of the entered value of footwear made
principally of leather, 7.5% and 37.5%, plus $.90 per pair of the entered value
of footwear made of synthetic textiles, and 0% and 7.2% of the entered value of
footwear components of various materials. Certain footwear and components
manufactured in countries designated as beneficiary countries for purposes of
the Caribbean Basin Economic Recovery Act, using components and ingredients of
United States origin, may be imported without payment of duties. Tariff
preferences are also available pursuant to the North American Free Trade
Agreement for qualifying footwear products and components originating in Mexico
or Canada. Certain of the items imported by the Company are not finished
products, but are raw materials or components used by the Company's domestic
subcontractors. In most instances, raw materials or components have a lower duty
rate than finished footwear.
From time to time, the Company may be subject to claims for additional
duties arising as a result of the United States Customs Service, or similar
agencies of foreign countries, disagreeing with the classification and/or
valuation used by the Company to enter various styles of footwear.
The United States Trade Representative ("USTR") is required by the Trade
Act of 1974, as amended by the Trade and Tariff Act of 1984, the Omnibus Trade
and Competitiveness Act of 1988 and the 1994 Uruguay Round Agreements Act, to
submit an annual National Trade Estimates Report on Foreign Trade Barriers
15
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(the "NTE Report") identifying significant restrictions or barriers on United
States access to foreign markets. On March 3, 1994 and September 27, 1995, the
President reinstated, by Executive Orders, the "Super 301" Provisions of the
Trade Act. Relying on the NTE Report, the USTR is required to report to Congress
any trade barriers, trade distorting practices and particular countries
identified as priorities for trade liberalization.
On April 30, 1997, the USTR designated China for monitoring under Section
306 of the 1974 Trade Act. This provision focuses on compliance with bilateral
trade agreements and allows the U.S. government to impose a variety of sanctions
if a party fails to comply with the terms of a bilateral agreement. The USTR did
note that China had made "significant progress" regarding intellectual property
protection. The USTR will continue to monitor China's commitment under the 1995
IPR Enforcement Agreement and the June 17, 1996 IPR Accord to insure compliance.
The Company is not in a position at this time to determine whether or not a
"Special 301" will be used in the future against China.
The renewal of China's Most-Favored-Nation or ("MFN") status was again the
subject of vigorous debate in the Congress. Several U.S. industries continue to
urge the granting of permanent MFN status to China. At the same time, there
remains a high degree of opposition, particularly in the House of
Representatives, to granting permanent MFN status to China. MFN has been
extended through July of 1998; however, the Company is unable to predict if the
United States will revoke China's MFN status at some point in the future. If a
revocation of MFN status were to occur, it would result in significantly higher
duties on imports from China.
On April 30, 1997, the USTR announced that 36 countries had been placed on
the lower tier of intellectual property protection concerns. Seven of the
countries will be subjected to "out-of-cycle" reviews including: Canada, Hong
Kong, Panama and Thailand. Other watch list countries include: Australia,
Denmark and Korea. The Company is unable to predict whether or not additional
countries will be added to the priority watch list, or if any other actions will
be imposed by the United States and if such actions were taken, whether such
actions would include footwear imports or otherwise result in increased costs
for the Company's products or restrict the supply of footwear, generally, or of
the Company's footwear in particular.
In 1997, Mexico, Hong Kong, Australia, New Zealand and the European Union
were not identified by the USTR as priority foreign countries under "Special
301"; however, the European Union has been placed on the priority watch list and
Australia has been placed on the watch list according to the 1997 USTR NTE
Report. The Company is unable to predict whether or not any other countries will
be placed on the priority watch list, or if any other actions will be imposed by
the United States and if such action is taken, whether such action would include
footwear imports or otherwise result in increases in the cost or restrict the
supply of footwear, generally, or the Company's footwear in particular.
The European Commission has enacted anti-dumping duties of 49.2% on certain
types of footwear imported into Europe from China and Indonesia. Dutch Customs
has issued an opinion to the Company that two of the most popular Teva styles,
the Valkyrie and the Storm, are covered by this anti-dumping duty legislation.
The Company does not believe that these styles are covered by the legislation
and is working with Customs to resolve the situation. In the event that Customs
makes a final determination that such styles are covered by the anti-dumping
provisions, the Company expects that it would have an exposure to prior anti-
dumping duties for 1997. In addition, if Customs determines that these styles
are covered by the legislation, the duty amounts could cause such products to be
too costly to import into Europe from China in the future. As a result, the
Company could have to cease shipping such styles from China into Europe in the
future or could have to begin to source these styles from countries not covered
by the legislation.
The European communities also impose quantitative limits on imports from
China of certain leather upper and textile upper footwear. The Company is unable
to predict how long the anti-dumping duty and import quota restrictions will
remain in effect or changes in the scope or severity of such restrictions.
EMPLOYEES
At December 31, 1997, the Company employed approximately 188 full-time
employees in its U.S. facilities, approximately 107 persons in its manufacturing
facility in Mexico, and 25 at its Hong Kong subsidiaries, none of whom is
represented by a union. The Company historically hired up to approximately
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120 temporary employees, from time to time, as was needed for its U.S.
production facilities, which were closed in March 1997. The Company believes its
relationship with its employees is good.
ITEM 2. PROPERTIES
The Company leases approximately 30,000 square feet for its corporate
offices in Goleta, California and approximately 126,000 square feet for its
warehouse facility in Ventura County, California. The Company also leased
approximately 36,000 square feet for its manufacturing facility located in
Carpinteria, California through April 1997. In addition, through a second-tier
subsidiary, the Company leases an approximately 18,000 square foot manufacturing
facility in Mexico. The Company paid approximately $1,153,000 in rent for such
facilities in 1997. The terms of the leases for the Company's corporate offices
and its Ventura County warehouse expire in 2001. The terms of the leases for the
Company's manufacturing facilities in Carpinteria expired in March 1997 and
April 1997, to coincide with the closing of the Company's factory. The lease
term on the Mexican manufacturing facility is on a month-to-month basis. The
Company's Ugg subsidiary leases approximately 23,000 square feet of office and
manufacturing space in Oregon through 2000 which it has subleased, as Ugg's
operations have been consolidated with the Company's other facilities. The
Company believes that its existing corporate, manufacturing and warehousing
space will be adequate to meet its current and foreseeable requirements, and
that suitable additional or alternative space will be available as needed on
commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in routine litigation arising in the ordinary
course of business. Such routine matters, if decided adversely to the Company,
would not, in the opinion of management, have a material adverse effect on the
financial condition or results of operations of the Company. From time to time,
Mr. Thatcher and the Company are also involved in other legal proceedings to
protect the Teva(R) patents and trademarks from infringement by third parties.
Any decision or settlement in any such infringement proceeding which allowed a
third party to continue to manufacture and sell the products at issue could have
an adverse effect on the Company's sales to the extent such other products are
purchased in lieu of the Company's products.
An action was brought against the Company in 1995 in the United States
District Court, District of Montana (Missoula Division), by Molly Strong-Butts
and Yeti by Molly, Ltd. (collectively, "Molly") alleging, among other things,
that the Company violated certain non-disclosure agreements and infringed
purported trade secrets regarding certain footwear products and then capitalized
on the information by developing a competing product and incorporating certain
concepts or technologies into other product lines. Molly claims specified
damages of $15 million, as well as other unspecified damages. The Company
believes such claims are without merit. No trial date has been set. The Company
anticipates that this matter will proceed to trial in 1998. The Company has
contested, and intends to continue contesting this claim vigorously. A motion
for summary judgment seeking dismissal of Molly's suit is pending. The Company
does not anticipate that the ultimate outcome will have a material adverse
effect upon its financial condition, results of operations or cash flows.
A portion of the purchase price for Ugg Holdings, Inc. included periodic
payments through the year 2000, some of which were based on formulas tied to net
sales and earnings before taxes. In 1997, some of the former shareholders of Ugg
Holdings gave notice of a demand for arbitration regarding the periodic payments
and in September 1997, the Company and the former Ugg shareholders arrived at a
settlement agreement. In addition, the remaining former Ugg shareholders who
were not a party to the arbitration agreed to accept the same economic terms as
those involved in the arbitration. Under the terms of the settlement, the
Company and all former shareholders of Ugg agreed to final payments aggregating
$2.6 million. Of this, approximately $600,000 was paid in December 1997 and the
balance of $2,000,000 was paid in January 1998. These payments replaced all
future earn-out payments that were to be paid through the year 2000 in
accordance with the original acquisition agreement, including the $500,000 final
payment. The corresponding increase to goodwill has been reflected in the
December 31, 1997 consolidated financial statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded in the National Market System of the
NASDAQ stock market (the "NMS") under the symbol "DECK."
As of February 28, 1998, the number of holders of record of the Common
Stock was 159, and the number of beneficial owners was approximately 2,500.
1997 1996
--------------- ---------------
HIGH LOW HIGH LOW
------ ----- ------ -----
First Quarter........................................... $ 7.88 $6.25 $ 7.38 $5.25
Second Quarter.......................................... 8.50 6.00 10.25 6.25
Third Quarter........................................... 8.44 6.88 9.50 6.25
Fourth Quarter.......................................... 10.00 7.00 10.00 6.50
The Company has never declared or paid cash dividends on its capital stock.
The Company currently intends to retain any earnings for use in its business and
does not anticipate paying any cash dividends in the foreseeable future. Payment
of dividends is within the discretion of the Company's Board of Directors and
will depend upon, among other factors, the Company's earnings, financial
condition and capital requirements. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources."
ITEM 6. SELECTED FINANCIAL DATA
The following tables set forth selected consolidated financial data of the
Company for, and as of the end of, each of the years in the five-year period
ended December 31, 1997.
YEARS ENDED DECEMBER 31
--------------------------------------------------
INCOME STATEMENT DATA 1997 1996 1995 1994 1993
--------------------- -------- -------- -------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net Sales................................ $106,713 $101,838 $102,334 $85,818 $57,086
Cost of Sales............................ 62,453 61,009 65,856 43,979 27,316
-------- -------- -------- ------- -------
Gross profit........................... 44,260 40,829 36,478 41,839 29,770
Selling, general and administrative
expenses............................... 35,648 32,989 32,373 24,287 18,652
Loss on factory closure.................. 500 -- -- -- --
-------- -------- -------- ------- -------
Earnings from operations............... 8,112 7,840 4,105 17,552 11,118
Other (income) expense................... 143 1,241 1,382 (563) 163
-------- -------- -------- ------- -------
Earnings before income taxes........... 7,969 6,599 2,723 18,115 10,955
Income taxes............................. 3,445 2,943 1,287 7,609 4,650
-------- -------- -------- ------- -------
Net earnings........................... $ 4,524 3,656 1,436 10,506 6,305
======== ======== ======== ======= =======
Net earnings per common share (1):
Basic.................................. $ .50 $ .40 $ .13 $ 1.09 $ .82
Diluted................................ .50 .39 .13 1.09 .81
-------- -------- -------- ------- -------
Weighted average common shares
outstanding:
Basic.................................. 8,961 9,248 9,324 9,630 7,720
Diluted................................ 9,012 9,292 9,352 9,673 7,809
======== ======== ======== ======= =======
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AT DECEMBER 31
-----------------------------------------------
BALANCE SHEET DATA 1997 1996 1995 1994 1993
------------------ ------- ------- ------- ------- -------
(IN THOUSANDS)
Current assets.............................. $48,801 $49,348 $50,031 $53,987 $47,318
Current liabilities......................... 9,579 9,618 6,262 5,731 5,420
Total assets................................ 74,693 74,897 74,917 62,651 51,901
Long-term debt, less current installments... 7,983 10,290 15,170 -- 150
Total stockholders' equity.................. 57,131 54,989 53,485 56,920 46,331
======= ======= ======= ======= =======
- ---------------
(1) For information pertaining to the calculation of net earnings per common
share, see note 1 to the accompanying consolidated financial statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
The following table is derived from the Company's statement of earnings and
sets forth, for the periods indicated, certain income statement data as a
percentage of net sales.
YEARS ENDED DECEMBER 31
-----------------------
1997 1996 1995
----- ----- -----
Net sales................................................... 100.0% 100.0% 100.0%
Cost of sales............................................... 58.5 59.9 64.4
----- ----- -----
Gross profit.............................................. 41.5 40.1 35.6
Selling, general and administrative expenses................ 33.4 32.4 31.6
Loss on factory closure..................................... 0.5 0.0 0.0
----- ----- -----
Earnings from operations.................................. 7.6 7.7 4.0
Other expense............................................... 0.2 1.2 1.3
----- ----- -----
Earnings before income taxes.............................. 7.4 6.5 2.7
Income taxes................................................ 3.2 2.9 1.3
----- ----- -----
Net earnings................................................ 4.2% 3.6% 1.4%
===== ===== =====
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Net sales increased by $4,875,000 or 4.8% between the years ended December
31, 1997 and 1996. Sales of the Teva(R) line increased from $43,898,000 for the
year ended December 31, 1996 to $61,863,000 for the year ended December 31,
1997, a 40.9% increase. Sales of Teva(R) products represented 43.1% and 58.0% of
net sales for the years ended December 31, 1996 and 1997, respectively. The
increase in Teva(R) sales was primarily due to increased demand for this line.
In addition, in early 1996, sales of the Teva(R) line were adversely impacted by
the excess inventory at retail, which the retailers had carried into 1996 from
the 1995 season. This situation did not recur in 1997. Also, in the fourth
quarter of 1997, the Company implemented a spring 1998 early delivery program
that provided retailers an incentive to bring Teva(R) products in for the fourth
quarter and expand the length of the selling season. Due to the success of this
program approximately $5 to $6 million of Teva(R) product was shipped in the
fourth quarter of 1997, which the Company believes ordinarily would have shipped
in the first quarter of 1998. Net sales of footwear under the Simple(R) product
line decreased 19.8% from $36,029,000 to $28,901,000 between the years ended
December 31, 1996 and 1997. This decrease was primarily due to the continued
repositioning of the Simple(R) brand and its distribution, and the
non-recurrence of last year's demand for certain styles of Simple(R) clogs. Net
sales of footwear under the Ugg(R) product line decreased 38.2% from $14,831,000
to $9,169,000 between the years ended December 31, 1996 and 1997. This decrease
was due to reduced demand for the Company's product offering, resulting from
pricing pressures, reduced advertising spending and a carry-over of product at
retail from 1996. Overall, international sales for all of the Company's products
increased 11.0% from $24,061,000 to $26,704,000, representing 23.6% of net sales
in 1996 and 25.0% in 1997. Because the increase in the volume of sales of
Teva(R) footwear products more than offset the decrease in the volume of sales
of Simple(R) and Ugg(R) footwear
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products, the volume of footwear sold increased 7.8% from 3,587,000 pairs during
the year ended December 31, 1996 to 3,865,000 pairs during the year ended
December 31, 1997.
The weighted average wholesale price per pair sold during the years ended
December 31, 1997 and 1996 decreased 6.7% from $27.85 to $25.97. The decrease
was primarily due to a change in the sales mix resulting from the reduction in
sales of Ugg(R) products in 1997, which have a significantly higher weighted
average selling price than the Company's other product lines. In addition, the
Company experienced a change in the sales mix for Simple(R) products, with
significantly greater sales of the relatively higher priced clogs and fewer
close-outs during the year ended December 31, 1996 compared to the year ended
December 31, 1997. This decrease was partially offset by the lower volume of
Teva(R)close-outs during the year ended December 31, 1997 compared to the year
ended December 31, 1996.
Cost of sales increased by $1,444,000 or 2.4% to $62,453,000 for the year
ended December 31, 1997, compared with $61,009,000 for the year ended December
31, 1996. Gross profit increased by $3,431,000, or 8.4% to $44,260,000 for the
year ended December 31, 1997 from $40,829,000 for the year ended December 31,
1996 and increased as a percentage of net sales to 41.5% from 40.1%. The
increase in gross profit margin as a percentage of net sales was primarily due
to significantly reduced levels of Teva(R) and Ugg(R) close-outs during the year
ended December 31, 1997 compared to the corresponding levels for the year ended
December 31, 1996. This increase was partially offset by higher levels of
Simple(R) close-outs during this period.
Selling, general and administrative expenses increased by $2,659,000, or
8.1% between the years ended December 31, 1996 and December 31, 1997 and
increased as a percentage of net sales from 32.4% in 1996 to 33.4% in 1997. The
increase was largely a result of increased royalties payable to the licensor of
the Teva(R) patents and trademarks due to a change in the sales mix toward
Teva(R) products. In addition the Company experienced increased legal costs
related to disputes with some of the former shareholders of Ugg Holdings, Inc.,
increased European operating expenses due to the opening and operation of the
European office in 1997, increased amortization of intangible assets, increased
costs associated with the Teva(R) apparel line and an increase in research and
development spending. The increase in amortization of intangible assets was
primarily due to the amortization of Teva(R) license fees for the five year
period beginning September 1996, as well as increased goodwill amortization
associated with the 1997 Ugg(R) acquisition payments. These increases were
partially offset by a decrease in bad debt expense and Ugg advertising costs
between the years ended December 31, 1996 and December 31, 1997.
In 1997, the Company also incurred a loss on factory closure aggregating
$500,000 related to the March 1997 closure of its California manufacturing
facility. Upon closure, the Company moved the related production requirements to
its manufacturing facility in Mexico and to other independent subcontractors in
the Far East, Costa Rica and the United States. The $500,000 loss included
property and equipment write-downs, employee severance and other exit costs. No
similar closure occurred in 1996.
Other expense decreased from $1,241,000 in 1996 to $143,000 in 1997. The
decrease resulted from a $566,000 decrease in net interest expense, primarily
due to repayments on the Company's borrowings under its credit facility in 1997.
In addition, in 1996 the Company incurred a loss on disposal of assets
aggregating $548,000, compared with a net gain on disposal of assets of $51,000
in 1997.
Income taxes were $3,445,000 for the year ended December 31, 1997,
representing an effective income tax rate of 43.2% compared with income taxes of
$2,943,000 for the year ended December 31, 1996, representing an effective
income tax rate of 44.6%. The lower effective income tax rate in 1997 compared
to 1996 is due to certain non-deductible expenses and losses being a lower
proportion to earnings before income taxes in 1997 than in 1996. Such
non-deductible items include the amortization of goodwill and losses at certain
subsidiaries which are consolidated for financial reporting purposes but which
are not consolidated for income tax reporting purposes.
The Company had net earnings of $4,524,000 for the year ended December 31,
1997 as compared with net earnings of $3,656,000 for the year ended December 31,
1996, an increase of 23.7%, for the reasons discussed above.
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23
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Net sales decreased by $496,000 or 0.5% between the years ended December
31, 1996 and 1995 due to several offsetting factors. In early 1995, the Company
experienced strong sales of the Teva(R) line. However, beginning in the second
quarter of 1995, the Company was impacted by the poor overall retail markets and
the abundance of sports sandals in the marketplace. As a result, the Company
began heavy discounting in efforts to move the resulting oversupply of 1995
Teva(R) product and was able to sell a significant portion of this excess
inventory in the latter half of 1995 and the first half of 1996. This excess
1995 inventory was carried by retailers in 1996, thus negatively impacting the
Company's 1996 Teva(R) sales. As a result, net sales of the Teva(R) line
decreased from $55,925,000 to $43,898,000, a 21.5% decrease between the years
ended December 31, 1995 and 1996, respectively. Sales of Teva(R) products
represented 54.7% and 43.1% of net sales for the years ended December 31, 1995
and 1996, respectively. The Company also experienced a decrease in sales for the
year ended December 31, 1996, of its Ugg(R) product line as the Company
repositioned this brand toward higher-end retailers, avoiding some of the
lower-end retailers which were sold to previously. Consistent with the Teva(R)
and Simple(R) lines, the Company is trying to sell Ugg(R) primarily in the
higher-end retail markets in an effort to promote the brand where it can command
higher prices and margins. In addition, due to the unseasonably late winter in
1995, many retailers had a remaining stock of 1995 Ugg(R) products which they
carried over into the fall and winter of 1996, thereby negatively impacting 1996
sales. These factors, combined with the increased competition for the brand
caused net sales for Ugg(R) to decrease from $18,304,000 for the year ended
December 31, 1995 to $14,831,000 for the year ended December 31, 1996, a 19.0%
decrease. The decline in Ugg(R) sales was exacerbated by substantially higher
costs for sheepskin and consequently higher prices charged by the Company on
Ugg(R) products. Offsetting these factors, net sales of footwear under the
Simple(R) product line increased 52.8% from $23,577,000 to $36,029,000 between
the year ended December 31, 1995 and 1996. Simple(R) sales represented 23.0% and
35.4% of net sales for the year ended December 31, 1995 and 1996, respectively.
Overall, international sales for the Company's products increased 44.9% from
$16,608,000 to $24,061,000, representing 16.2% of net sales in 1995 and 23.6% in
1996. The combination of these factors led to a net decrease in the volume of
footwear sold, which decreased from 3,604,000 pairs for the year ended December
31, 1995 to 3,587,000 pairs for the year ended December 31, 1996, a 0.5%
decrease.
The weighted average wholesale price per pair sold during these periods
decreased from $28.17 to $27.85, or by 1.1% for the years ended December 31,
1995 and 1996, respectively. In late 1996, the Company made a decision not to
carry over into 1997 certain styles of its 1996 Ugg(R) boots and as a result, it
sold its remaining supply of such styles at reduced prices in December 1996. In
addition, the Company reduced the prices of certain Teva(R) styles in the spring
1996 line, in order to promote a more even distribution of price points between
the high and low points. The Company believes that having such an even price
point distribution will place one or more styles at each desired price level.
Also, the Company experienced a reduction in Ugg(R) sales, which have a higher
weighted average selling price than the Company's other lines.
Cost of sales decreased by $4,847,000 to $61,009,000 for the year ended
December 31, 1996, compared with $65,856,000 for the year ended December 31,
1995, a decrease of 7.4%. Gross profit increased by $4,351,000 or 11.9% to
$40,829,000 for the year ended December 31, 1996 from $36,478,000 for the year
ended December 31, 1995, an increase as a percentage of net sales to 40.1% from
35.6%. The increase in gross profit margin as a percentage of net sales was
primarily due to the non-recurrence of the significant inventory write-downs as
well as the heavily discounted selling prices which were experienced in 1995.
Selling, general and administrative expenses increased by $616,000 or 1.9%
between the years ended December 31, 1995 and December 31, 1996, and increased
as a percentage of net sales from 31.6% in 1995 to 32.4% in 1996. The increase
was primarily due to the addition of the operations of Ugg Holdings, Inc. ("Ugg
Holdings") in August 1995. As a result, the Company's financial statements
include twelve months of operating expenses for Ugg Holdings in 1996 compared to
only five months in 1995. The added months in 1996 were during the Company's
seasonally slow period for revenues, resulting in an increase in operating
expenses as a percentage of sales. The increase in operating expenses and the
increase as a percentage of sales was also due to increased warehouse costs,
which were partially a result of the Company's move to a new warehouse facility
in 1996, as well as increased advertising costs and increased payroll costs for
newly created positions.
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Income taxes were $2,943,000 for the year ended December 31, 1996,
representing an effective income tax rate of 44.6% compared with income taxes of
$1,287,000 for the year ended December 31, 1995, representing an effective
income tax rate of 47.3%. The higher effective income tax rate in 1995 compared
to 1996 is due to certain non-deductible expenses and losses being a greater
proportion to earnings before income taxes in 1995 than in 1996. Such
non-deductible items include the amortization of the goodwill associated with
the acquisition of Ugg Holdings, Inc., and in 1995 the Company experienced
greater non-deductible losses at certain subsidiaries which are consolidated for
financial reporting purposes but which are not consolidated for income tax
reporting purposes.
The Company had net earnings of $3,656,000 for the year ended December 31,
1996, as compared with net earnings of $1,436,000 for the year ended December
31, 1995, an increase of 154.6% for the reasons discussed above.
OUTLOOK
This outlook section contains a number of forward-looking statements, all
of which are based on current expectations. Actual results may differ
materially.
Due to the success of Teva's(R) fourth quarter early delivery program in
1997, approximately $5 to $6 million of Teva product was shipped in the fourth
quarter of 1997, which the Company believes ordinarily would have shipped in the
first quarter of 1998. The Company expects that while sales for Teva(R) will
increase on a season to season basis (October 1 to September 30), on a calendar
basis in 1998 Teva(R) sales will be relatively flat in comparison to 1997.
Net sales of the Simple(R) product line decreased by 19.8% from 1996 to
1997. The Company currently expects the decline to continue at least through the
first half of 1998, with a potential for improvement in the latter half of the
year. For the full year, the Company expects that sales of Simple(R) in 1998
will be flat to down slightly in comparison to 1997.
Whereas Ugg(R) sales declined by 38.2% in 1997, the Company expects that
sales of Ugg will increase in 1998 in comparison to 1997.
In an effort to position the Company for growth in 1999, the Company
currently plans to increase spending in 1998 on advertising, research and
development, international sales operations, Teva(R) apparel infrastructure and
continued improvements in the Company's management information systems. While
the Company currently expects that it will fund a portion of these increased
expenditures from efficiencies gained elsewhere, the Company currently expects
that there will be a net increase in the Company's operating expenses as a
percentage of sales in comparison to 1997.
The foregoing forward-looking statements represent the Company's current
analysis of trends and information. Actual results could be affected by a
variety of factors. For example, the Company's results are directly dependent on
consumer preferences, which are difficult to assess and can shift rapidly. Any
shift in consumer preferences away from one or more of the Company's product
lines could result in lower sales as well as obsolete inventory, both of which
would adversely affect the Company's results of operations, financial condition
and cash flows. The Company is also dependent on its customers continuing to
carry and promote its various lines. Availability of product can also affect the
Company's ability to meet its customers' orders. In addition, sales of each of
the Company's different lines have historically been higher in different
seasons, with the highest percentage of Teva(R) sales occurring in the first and
second quarter of each year, the highest percentage of Simple(R) sales occurring
in the third quarter and the highest percentage of Ugg(R) sales occurring in the
fourth quarter. Consequently, the results for these product lines are highly
dependent on results during these specified periods.
Sales of the Company's products, particularly those under the Teva and Ugg
lines, are very sensitive to weather conditions. In recent months, large
segments of the United States, particularly on the East and West coasts, have
experienced severe weather conditions due to the "El Nino" weather phenomenon.
The effects of such weather conditions cannot be determined by the Company.
In addition, the Company's ability to maintain or expand its European
distribution could be impacted by the European Commission's 1997 enactment of
anti-dumping duty provisions on certain types of footwear
22
25
produced in China, if it is determined that certain styles of the Company's
footwear fall under such anti-dumping provisions. See "Risks of Foreign
Operations/Restrictions on Imports."
The Company cautions the reader not to rely on the forward-looking
statements in this section. They merely represent the Company's current
assessment of trends and information and may not be indicative of actual future
results. The Company disclaims any intent or obligation to update these
forward-looking statements.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, working capital was $39,222,000 including $3,238,000
of cash and cash equivalents. Cash provided by operating activities aggregated
$8,901,000 for the year ended December 31, 1997.
The Company has a revolving credit facility with a bank (the "Facility"),
providing a maximum borrowing availability of $25,000,000, with an amended
credit availability of $30,000,000 from March 16, 1998 to May 31, 1998. The
Facility also requires the Company to pay down the outstanding balance to less
than $2,500,000 for at least thirty consecutive days during each of the thirteen
month periods ending January 31, 1999 and 2000. The Facility can be used for
working capital and general corporate purposes and expires August 1, 2000.
Borrowings bear interest at the bank's prime rate (8.5% at December 31, 1997)
plus up to 0.25%, depending on whether the Company satisfies certain financial
ratios. Alternatively, the Company may elect to have borrowings bear interest at
LIBOR plus 1.5% to 1.75%, depending on whether the Company satisfies such
financial ratios. Up to $10,000,000 of borrowings may be in the form of letters
of credit. The Facility is secured by substantially all assets of the Company.
As of December 31, 1997, the Company had borrowed $7,300,000 under the Facility
and had approximately $14,956,000 available for borrowings.
The agreement underlying the Facility includes certain restrictive
covenants which, among other things, require the Company to maintain certain
financial tests. The Company was in compliance as of December 31, 1997.
The Company has an agreement with a supplier, Prosperous Dragon, to provide
financing for the original startup and the expansion of the supplier's
operations, of which $2,466,000 was outstanding at December 31, 1997 ($966,000
net of allowance). The note is secured by all assets of the supplier and bears
interest at the prime rate (8.5% at December 31, 1997) plus 1%.
Capital expenditures totaled $1,731,000 for the year ended December 31,
1997. The Company's capital expenditures related primarily to continued upgrades
to the Company's computer systems, leasehold improvements at the facilities
which the Company moved into in December 1996, and production molds for new
product styles. The Company currently has no material future commitments for
capital expenditures.
A portion of the purchase price for Ugg Holdings, Inc. included periodic
payments through the year 2000, some of which were based on formulas tied to net
sales and earnings before taxes. In 1997, some of the former shareholders of Ugg
Holdings gave notice of a demand for arbitration regarding the periodic payments
and in September 1997, the Company and the former Ugg shareholders arrived at a
settlement agreement. In addition, the remaining former Ugg shareholders who
were not a party to the arbitration agreed to accept the same economic terms as
those involved in the arbitration. Under the terms of the settlement, the
Company and all former shareholders of Ugg agreed to final payments aggregating
$2.6 million. Of this, approximately $600,000 was paid in December 1997 and the
balance of $2,000,000 was paid in January 1998. These payments replaced all
future earn-out payments that were to be paid through the year 2000 in
accordance with the original acquisition agreement, including the $500,000 final
payment. The corresponding increase to goodwill has been reflected in the
December 31, 1997 consolidated financial statements.
In February 1998, the Company's Board of Directors approved an increase in
the number of shares of common stock authorized for repurchase under its
existing stock repurchase program from 900,000 shares to 1,200,000 shares. Such
repurchases shall occur from time to time in open market or in privately
negotiated transactions, subject to price and market conditions. Under this
program, the Company repurchased 300,000 shares in 1996 for cash consideration
of $2,390,000 and 330,000 shares in 1997 for cash consideration of $2,581,000.
23
26
The Company believes that internally generated funds, the available
borrowings under its existing credit facilities and the cash on hand will
provide sufficient liquidity to enable it to meet its current and foreseeable
working capital requirements.
YEAR 2000 ISSUE
The Year 2000 issue results from computer programs written using two digits
to identify the year in the date field. These computer programs were designed
and developed without consideration of the impact of the upcoming change in the
century. If not corrected, those programs could create erroneous information by
or at the year 2000.
The Company is assessing the internal readiness of its computer systems for
handling the Year 2000 issue. The Company expects to implement the systems and
programming changes necessary to address Year 2000 issues with respect to its
internal systems and does not believe that the cost of such actions will have a
material adverse effect on its results of operations or financial condition.
Although the Company is not aware of any material operational issues or costs
associated with preparing its internal systems for the year 2000, there can be
no assurance that there will not be a delay in, or increased costs associated
with, the implementation of the necessary systems and changes to address the
Year 2000 issues, and the Company's inability to implement such systems and
changes in a timely manner could have an adverse effect on future results of
operations.
The Company is in the process of evaluating the extent to which the Company
is vulnerable to third parties' failure to address their own Year 2000 issues.
Those parties include customers, suppliers and other third party business
partners. The Company has not yet completed a review process with respect to
these third parties. As a result, the Company cannot determine at this time the
extent, if any, to which the Company may be exposed to financial risk from the
inability of the Company's customers, suppliers and other business partners to
remediate their own Year 2000 issues.
SEASONALITY
Financial results for the outdoor and footwear industries are generally
seasonal. Based on the Company's historical product mix, the Company would
expect greater sales in the first and second quarters than in the third and
fourth quarters.
OTHER
The Company believes that the relatively moderate rates of inflation in
recent years have not had a significant impact on its net sales or
profitability.
RECENTLY ISSUED PRONOUNCEMENTS
The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards (FAS) No. 130, "Reporting Comprehensive Income" and FAS No.
131, "Disclosure about Segments of an Enterprise and Related Information." FAS
No. 130 establishes standards for reporting and display of comprehensive income
and its components. FAS No. 131 supersedes previous reporting requirements for
reporting on segments of a business enterprise. FAS No. 130 and FAS No. 131 are
effective for periods beginning after December 15, 1997. Accordingly, the
Company plans to implement these two standards during 1998. Management does not
anticipate that the disclosure requirements of the above Statements will have a
material impact on the Company's financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 14(a) and page 26 for an index to the consolidated financial
statements and supplementary information included herein.
24
27
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
25
28
DECKERS OUTDOOR CORPORATION
AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
PAGE
--------
Consolidated Financial Statements:
Independent Auditors' Report.............................. 27
Consolidated Balance Sheets as of December 31, 1996 and
1997................................................... 28
Consolidated Statements of Earnings for each of the years
in the three-year period ended December 31, 1997....... 29
Consolidated Statements of Stockholders' Equity for each
of the years in the three-year period ended December
31, 1997............................................... 30
Consolidated Statements of Cash Flows for each of the
years in the three-year period ended December 31,
1997................................................... 31
Notes to Consolidated Financial Statements................ 32
SCHEDULE
--------
Consolidated Financial Statement Schedule:
Valuation and Qualifying Accounts......................... 43
All other schedules are omitted because they are not applicable or the
required information is shown in the Company's consolidated financial statements
or the related notes thereto.
26
29
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Deckers Outdoor Corporation:
We have audited the accompanying consolidated financial statements of
Deckers Outdoor Corporation and subsidiaries as listed in the accompanying
index. In connection with our audits of the consolidated financial statements,
we also have audited the financial statement schedule as listed in the
accompanying index. These consolidated financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Deckers
Outdoor Corporation and subsidiaries as of December 31, 1996 and 1997 and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1997 in conformity with generally accepted
accounting principles. Also, in our opinion, the related consolidated financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
KPMG PEAT MARWICK LLP
Los Angeles, California
February 13, 1998
27
30
DECKERS OUTDOOR CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1997
ASSETS
1996 1997
----------- -----------
Current assets:
Cash and cash equivalents................................. $ 1,287,000 $ 3,238,000
Trade accounts receivable, less allowance for doubtful
accounts of $1,292,000 and $1,092,000 as of December
31, 1996 and 1997, respectively........................ 17,866,000 23,037,000
Inventories (note 4)...................................... 24,930,000 18,979,000
Prepaid expenses and other current assets................. 3,643,000 2,190,000
Deferred tax assets (note 8).............................. 1,622,000 1,357,000
----------- -----------
Total current assets.............................. 49,348,000 48,801,000
Property and equipment, at cost, net (note 5)............... 2,794,000 2,509,000
Intangible assets, less applicable amortization............. 20,805,000 21,866,000
Note receivable from supplier, net (note 7)................. 1,838,000 966,000
Other assets, net........................................... 112,000 551,000
----------- -----------
$74,897,000 $74,693,000
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable (note 2).................................... $ -- $ 2,000,000
Current installments of long-term debt (note 6)........... 99,000 107,000
Trade accounts payable.................................... 5,494,000 3,629,000
Accrued bonuses........................................... 957,000 1,095,000
Other accrued expenses.................................... 2,085,000 2,726,000
Income taxes payable (note 8)............................. 983,000 22,000
----------- -----------
Total current liabilities......................... 9,618,000 9,579,000
----------- -----------
Long-term debt, less current installments (note 6).......... 10,290,000 7,983,000
Commitments and contingencies (notes 6, 10 and 11)
Stockholders' equity (note 9):
Preferred stock, $.01 par value. Authorized 5,000,000
shares; none issued.................................... -- --
Common stock, $.01 par value. Authorized 20,000,000
shares; issued 9,283,556 and outstanding 8,983,556 at
December 31, 1996; issued 9,419,431 and outstanding
8,789,431 at December 31, 1997......................... 90,000 88,000
Additional paid-in capital................................ 26,790,000 25,034,000
Retained earnings......................................... 28,109,000 32,633,000
----------- -----------
54,989,000 57,755,000
Less note receivable from stockholder/officer............. -- (624,000)
----------- -----------
Total stockholders' equity........................ 54,989,000 57,131,000
----------- -----------
$74,897,000 $74,693,000
=========== ===========
See accompanying notes to consolidated financial statements.
28
31
DECKERS OUTDOOR CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
THREE-YEAR PERIOD ENDED DECEMBER 31, 1997
1995 1996 1997
------------ ------------ ------------
Net sales (notes 10 and 12)...................... $102,334,000 $101,838,000 $106,713,000
Cost of sales.................................... 65,856,000 61,009,000 62,453,000
------------ ------------ ------------
Gross profit........................... 36,478,000 40,829,000 44,260,000
Selling, general and administrative expenses..... 32,373,000 32,989,000 35,648,000
Loss on factory closure (note 3)................. -- -- 500,000
------------ ------------ ------------
Earnings from operations............... 4,105,000 7,840,000 8,112,000
Other expense (income):
Interest expense, net.......................... 797,000 910,000 344,000
(Gain) loss on disposal of assets.............. 583,000 548,000 (51,000)
Minority interest in net loss of unconsolidated
subsidiary.................................. (4,000) (55,000) (45,000)
Miscellaneous expense (income)................. 6,000 (162,000) (105,000)
------------ ------------ ------------
Earnings before income taxes........... 2,723,000 6,599,000 7,969,000
Income taxes (note 8)............................ 1,287,000 2,943,000 3,445,000
------------ ------------ ------------
Net earnings........................... $ 1,436,000 $ 3,656,000 $ 4,524,000
============ ============ ============
Net earnings per share (note 1):
Basic.......................................... $ .13 $ .40 $ .50
Diluted........................................ .13 .39 .50
============ ============ ============
Weighted average shares (note 1):
Basic.......................................... 9,324,000 9,248,000 8,961,000
Diluted........................................ 9,352,000 9,292,000 9,012,000
============ ============ ============
See accompanying notes to consolidated financial statements.
29
32
DECKERS OUTDOOR CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
THREE-YEAR PERIOD ENDED DECEMBER 31, 1997
COMMON STOCK ADDITIONAL STOCKHOLDER/ TOTAL
------------------- PAID-IN RETAINED OFFICER STOCKHOLDERS'
SHARES AMOUNT CAPITAL EARNINGS NOTE RECEIVABLE EQUITY
--------- ------- ----------- ----------- --------------- -------------
Balance at December 31, 1994............ 9,630,925 $96,000 $33,807,000 $23,017,000 $ -- $56,920,000
Common stock repurchased................ (400,000) (4,000) (4,896,000) -- -- (4,900,000)
Common stock issuance under stock
incentive plan........................ 11,450 -- 29,000 -- -- 29,000
Net earnings............................ -- -- -- 1,436,000 -- 1,436,000
--------- ------- ----------- ----------- --------- -----------
Balance at December 31, 1995............ 9,242,375 92,000 28,940,000 24,453,000 -- 53,485,000
Common stock repurchased................ (300,000) (2,000) (2,388,000) -- -- (2,390,000)
Common stock issuance under stock
incentive plan........................ 11,000 -- 66,000 -- -- 66,000
Common stock issued under the employee
stock purchase plan................... 17,008 -- 86,000 -- -- 86,000
Noncash stock compensation.............. 13,173 -- 86,000 -- -- 86,000
Net earnings............................ -- -- -- 3,656,000 -- 3,656,000
--------- ------- ----------- ----------- --------- -----------
Balance at December 31, 1996............ 8,983,556 90,000 26,790,000 28,109,000 -- 54,989,000
Common stock repurchased................ (330,000) (3,000) (2,578,000) -- -- (2,581,000)
Common stock issuance under stock
incentive plan........................ 126,000 1,000 771,000 -- (624,000) 148,000
Common stock issued under the employee
stock purchase plan................... 9,875 -- 51,000 -- -- 51,000
Net earnings............................ -- -- -- 4,524,000 -- 4,524,000
--------- ------- ----------- ----------- --------- -----------
Balance at December 31, 1997............ 8,789,431 $88,000 25,034,000 32,633,000 (624,000) 57,131,000
========= ======= =========== =========== ========= ===========
See accompanying notes to consolidated financial statements.
30
33
DECKERS OUTDOOR CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE-YEAR PERIOD ENDED DECEMBER 31, 1997
1995 1996 1997
------------ ----------- -----------
Cash flows from operating activities:
Net earnings.............................................. $ 1,436,000 $ 3,656,000 $ 4,524,000
------------ ----------- -----------
Adjustments to reconcile net earnings to net cash provided
by operating activities:
Depreciation of property and equipment.................. 1,045,000 1,338,000 1,235,000
Amortization of intangible assets....................... 672,000 965,000 1,271,000
Provision for doubtful accounts......................... 2,426,000 2,587,000 966,000
(Gain) loss on disposal of assets....................... 583,000 548,000 (51,000)
Loss on factory closure................................. -- -- 500,000
Stock compensation...................................... 17,000 86,000 84,000
Minority interest in net loss of unconsolidated
subsidiary............................................ (4,000) (55,000) (45,000)
Changes in assets and liabilities (net of effects of
acquisitions and dispositions):
(Increase) decrease in:
Trade accounts receivable............................. (2,501,000) 5,000 (5,114,000)
Other receivables..................................... 25,000 258,000 (461,000)
Inventories........................................... 9,588,000 (5,374,000) 5,951,000
Prepaid expenses and other current assets............. 200,000 (1,101,000) 1,448,000
Deferred tax assets................................... (632,000) 403,000 265,000
Refundable income taxes............................... (2,841,000) 2,969,000 --
Note receivable from supplier......................... 833,000 1,000 372,000
Other assets.......................................... (1,025,000) (877,000) (159,000)
Increase (decrease) in:
Trade accounts payable................................ (2,117,000) 2,474,000 (1,870,000)
Accrued expenses...................................... (1,286,000) 55,000 948,000
Income taxes payable.................................. (1,558,000) 983,000 (963,000)
------------ ----------- -----------
Total adjustments.................................. 3,425,000 5,265,000 4,377,000
------------ ----------- -----------
Net cash provided by operating activities.......... 4,861,000 8,921,000 8,901,000
------------ ----------- -----------
Cash flows from investing activities:
Net proceeds from securities transactions................. $ 4,850,000 $ -- $ --
Purchase of property and equipment........................ (1,850,000) (1,407,000) (1,731,000)
Cash paid for acquisitions, net of cash received.......... (11,200,000) (495,000) (954,000)
Cash advanced to Ugg related to acquisition............... (3,000,000) -- --
------------ ----------- -----------
Net cash used in investing activities.............. (11,200,000) (1,902,000) (2,685,000)
------------ ----------- -----------
Cash flows from financing activities:
Proceeds from (repayments of) notes payable and long-term
debt.................................................... 11,576,000 (4,891,000) (1,799,000)
Cash received from issuances of common stock.............. 13,000 152,000 739,000
Cash paid for repurchases of common stock................. (4,900,000) (2,390,000) (2,581,000)
Cash paid for purchase of stock option.................... -- (1,825,000) --
Cash paid to stockholder/officer.......................... -- -- (624,000)
------------ ----------- -----------
Net cash provided by (used in) financing
activities....................................... 6,689,000 (8,954,000) (4,265,000)
------------ ----------- -----------
Net increase (decrease) in cash and cash
equivalents...................................... 350,000 (1,935,000) 1,951,000
Cash and cash equivalents at beginning of year.............. 2,872,000 3,222,000 1,287,000
------------ ----------- -----------
Cash and cash equivalents at end of year.................... $ 3,222,000 $ 1,287,000 $ 3,238,000
============ =========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest................................................ 615,000 874,000 524,000
Income taxes............................................ $ 6,143,000 $ 480,000 $ 3,437,000
============ =========== ===========
Supplemental disclosure of noncash investing and financing activities -- In
connection with the Ugg shareholder settlement in 1997, the Company incurred
$2,000,000 of debt which was allocated to goodwill.
See accompanying notes to consolidated financial statements.
31
34
DECKERS OUTDOOR CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1997
(1) THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company and Basis of Presentation
The consolidated financial statements include the accounts of Deckers
Outdoor Corporation and its subsidiaries (collectively referred to as the
Company). All significant intercompany balances and transactions have been
eliminated in consolidation.
The Company designs, manufactures and markets innovative function-oriented
footwear and apparel, developed specifically for high-performance outdoor,
sports and other lifestyle-related activities as well as for casual use. The
Company's products are offered under the Teva, Simple, Ugg and Picante brand
names.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market
(net realizable value).
Revenue Recognition
Revenue is recognized upon shipment of the merchandise. Allowances for
estimated returns and discounts are provided when related revenue is recorded.
Long-Lived Assets
It is the Company's policy to account for long-lived assets, including
intangibles, at amortized cost. As part of an ongoing review of the valuation
and amortization of long-lived assets, management assesses the carrying value of
such assets if facts and circumstances suggest that it may be impaired. If this
review indicates that the long-lived assets will not be recoverable, as
determined by a nondiscounted cash flow analysis over the remaining amortization
period, the carrying value of the Company's long-lived assets would be reduced
to its estimated fair market value based on discounted cash flows. As a result,
the Company has determined that its long-lived assets are not impaired as of
December 31, 1996 and 1997.
Depreciation and Amortization
Depreciation of property and equipment is computed using the straight-line
method based on estimated useful lives ranging from three to ten years.
Leasehold improvements are amortized on the straight-line basis over their
estimated economic useful lives or the lease term, whichever is shorter.
Goodwill and other intangibles are amortized on the straight-line basis
over periods of 20 to 30 years, and 5 to 15 years, respectively. Accumulated
amortization at December 31, 1996 and 1997 was $1,444,000 and $2,676,000,
respectively.
Fair Value of Financial Instruments
The fair values of the Company's cash, trade accounts receivable, other
receivables, prepaid expenses and other current assets, trade accounts payable,
accrued expenses and current notes payable approximate the carrying values due
to the relatively short maturities of these instruments.
The fair value of the Company's revolving credit line approximates the
carrying value due to variable interest rates associated with the credit line.
32
35
DECKERS OUTDOOR CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
The fair values of the Company's other notes payable are estimated by
discounting future cash flows of each instrument at rates currently available to
the Company for similar debt instruments of comparable maturities by the
Company's bankers. The fair values of these notes approximate the carrying
value.
Stock Compensation
The Company has adopted Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" (FAS 123), effective January 1,
1996, and has elected to continue to measure compensation cost under APBO No. 25
and comply with the pro forma disclosure requirements. The adoption of FAS 123
has had no impact on the Company's financial position or results of operations.
Use of Estimates
Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets, liabilities, revenues and expenses and the
disclosure of contingent assets and liabilities to prepare these consolidated
financial statements in conformity with generally accepted accounting
principles. Actual results could differ from these estimates.
Research and Development Costs
Research and development costs are charged to expense as incurred. Such
costs amounted to $1,509,000, $1,546,000 and $1,780,000 in 1995, 1996 and 1997,
respectively.
Advertising Costs
The Company expenses the cost of advertising as incurred. Advertising
expense charged to operations for the years ended 1995, 1996 and 1997 is
$4,594,000, $4,738,000 and $4,096,000, respectively.
Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred
taxes of a change in tax rates is recognized in income in the period that
includes the enactment date.
Earnings per Share
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (FAS) No. 128, "Earnings per Share." FAS 128
specifies the computation, presentation and disclosure requirements for earnings
per share (EPS) and became effective for both interim and annual periods ending
after December 15, 1997. All prior period EPS have been restated to conform with
the provisions of FAS 128. The adoption of FAS 128 did not have a material
impact on the Company's earnings per share calculations.
33
36
DECKERS OUTDOOR CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
The reconciliations of basic to diluted weighted average shares are as
follows:
1995 1996 1997
---------- ---------- ----------
Net earnings used for basic and diluted
earnings per share................... $1,436,000 $3,656,000 $4,524,000
========== ========== ==========
Weighted average shares used in basic
computation.......................... 9,324,000 9,248,000 8,961,000
Dilutive stock options................. 28,000 44,000 51,000
---------- ---------- ----------
Weighted average shares used for
diluted computation............. 9,352,000 9,292,000 9,012,000
========== ========== ==========
Options to purchase 582,000, 430,000 and 572,000 shares of common stock at
prices ranging from $9.50 to $15.00, $7.00 to $15.00 and $7.50 to $15.00 were
outstanding during 1995, 1996 and 1997, respectively, but were not included in
the computation of diluted EPS because the options' exercise prices were greater
than the average market price of the common shares.
Foreign Currency Translation
Assets and liabilities of the foreign operations denominated in local
currencies are translated at the rate of exchange at the balance sheet date.
Expenses have been translated at the weighted average rate of exchange during
the period of existence. Foreign currency translation adjustments were
immaterial to the accompanying consolidated financial statements.
(2) ACQUISITIONS
Effective August 1, 1995, the Company acquired all of the issued and
outstanding shares of Ugg Holdings, Inc. and subsidiaries (Ugg), which
manufactures and markets a line of sheepskin footwear, for cash consideration of
$12.2 million (including out-of-pocket expense of $200,000) and a note payable
to sellers of $500,000. Additionally, the Company was required to make future
payments equal to 2 1/2% of net sales of Ugg, as defined in the agreement for
the years ended March 31, 1996 through March 31, 2000, plus an amount equal to
earnings before income taxes for Ugg for the year ended March 31, 1996
(collectively referred to as the earn-out payments). Pursuant to this provision,
the Company paid additional cash consideration of $495,000 in 1996 and $351,000
in 1997. During 1997, the former shareholders of Ugg gave notice of a demand for
arbitration regarding the earn-out payments, asserting that additional payments
were due them. In September 1997, the Company and the former Ugg shareholders
reached an agreement. In addition, the remaining Ugg shareholders who were not a
party to the arbitration agreed to accept the same economic terms as those
involved in the arbitration. The settlement called for total payments of $2.6
million to be made to the former shareholders, thus eliminating any future due
payments. As of December 31, 1997, the Company had unpaid notes payable to the
former shareholders of $2 million, which were paid in full in January 1998.
These amounts are included in the overall purchase price and allocated to
goodwill. During 1997, the Company incurred legal and other administrative costs
associated with the arbitration aggregating $607,000. Such costs were charged to
operations as incurred. This acquisition was accounted for as a purchase and the
results of Ugg's operations are included in the Company's consolidated financial
statements from the date of acquisition. The excess of the purchase price over
the estimated fair values of the net assets acquired aggregating $17,505,000 has
been recorded as goodwill and is being amortized over 30 years.
In connection with the acquisition of Simple Shoes, Inc. (Simple) in 1994,
the founder and President of Simple (the Founder) retained an option to acquire
up to a 10% interest in Simple. On April 4, 1996, the Company entered into an
agreement, effective January 1, 1996, to reacquire such option from the Founder
for
34
37
DECKERS OUTDOOR CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
$2,500,000, less the $300,000 exercise price of the option. The Company
allocated the entire purchase price to goodwill, which is being amortized over
the remaining 18-year life of the goodwill.
(3) FACTORY CLOSURE
In March 1997, the Company closed its California manufacturing facility.
The Company moved the related production requirements to its manufacturing
facility in Mexico and to other independent subcontractors in the Far East,
Costa Rica and the United States. In connection with the closure, the Company
incurred property and equipment write-downs, employee severance and other exit
costs aggregating $500,000.
(4) INVENTORIES
Inventories are summarized as follows:
1996 1997
----------- -----------
Finished goods.................................... $20,494,000 $14,081,000
Work in process................................... 1,197,000 1,189,000
Raw materials..................................... 3,239,000 3,709,000
----------- -----------
Total inventories....................... $24,930,000 $18,979,000
=========== ===========
(5) PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows:
1996 1997
---------- ----------
Machinery and equipment............................. $4,322,000 $4,328,000
Furniture and fixtures.............................. 537,000 529,000
Leasehold improvements.............................. 232,000 560,000
---------- ----------
5,091,000 5,417,000
Less accumulated depreciation and amortization...... 2,297,000 2,908,000
---------- ----------
Net property and equipment................ $2,794,000 $2,509,000
========== ==========
(6) LONG-TERM DEBT
Long-term debt consists of the following:
1996 1997
----------- ----------
Revolving credit line, secured by all the assets of
the Company...................................... $ 9,000,000 $7,300,000
Unsecured note payable in quarterly installments of
$41,700, including interest at a rate of 7.93%,
due December 2003................................ 889,000 790,000
Other unsecured notes payable...................... 500,000 --
----------- ----------
10,389,000 8,090,000
Less current installments.......................... 99,000 107,000
----------- ----------
$10,290,000 $7,983,000
=========== ==========
35
38
DECKERS OUTDOOR CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
The aggregate maturities of long-term debt as of December 31, 1997 are as
follows:
1998............................. $ 107,000
1999............................. 7,416,000
2000............................. 125,000
2001............................. 136,000
2002............................. 147,000
Thereafter....................... 159,000
----------
$8,090,000
==========
The revolving credit agreement with a bank, as amended, permits borrowings
up to $25,000,000 (with an amended credit availability of $30,000,000 from March
16, 1998 to May 31, 1998) under a revolving credit facility for working capital
and general corporate purposes, expiring August 1, 2000. The Facility also
requires the Company to reduce the outstanding balance to less than $2,500,000
for at least thirty consecutive days during the thirteen month periods ending
January 31, 1999 and 2000. Borrowings bear interest at the bank's prime rate
(8.5% at December 31, 1997) plus up to .25%, depending on whether the Company
satisfies certain financial ratios. Alternatively, the Company may elect to have
borrowings bear interest at LIBOR plus 1.5% to 1.75%, depending on whether the
Company satisfies such financial ratios. Up to $10,000,000 of borrowings may be
in the form of letters of credit. As of December 31, 1997, outstanding letters
of credit aggregated $2,744,000 and the Company had $14,956,000 available for
borrowings under the line of credit. The agreement underlying these credit
facilities includes certain restrictive covenants which, among other things,
require the Company to meet certain financial tests. At December 31, 1997, the
Company was in compliance with the terms of the agreement.
(7) NOTE RECEIVABLE FROM SUPPLIER
The Company has an Equipment Purchase and Loan Agreement, as amended, with
a Hong Kong supplier (the Supplier) to provide up to $4,000,000 of financing.
The Supplier produces completed footwear and footwear components for sale to
Holbrook, Ltd., a wholly owned subsidiary of the Company (Holbrook). The note is
secured by all the assets of the Supplier and bears interest at prime (8.5% at
December 31, 1997) plus 1%. The outstanding balance of the note is being repaid
primarily through Company purchases of goods from the Supplier. In connection
with this agreement, the Supplier is prohibited from manufacturing any products
for any person other than Holbrook without Holbrook's prior consent. In
addition, a key employee of Holbrook is the son of the owner of the Supplier.
This employee is entitled to receive a bonus of up to 24% of certain net profits
of Holbrook when the loan is fully repaid. The outstanding balance under the
note at December 31, 1996 and 1997 was $2,838,000 and $2,466,000, respectively.
Additionally, the Company has a valuation allowance related to the note of
$1,000,000 and $1,500,000 at December 31, 1996 and 1997, respectively.
36
39
DECKERS OUTDOOR CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
(8) INCOME TAXES
Components of income taxes are as follows:
FEDERAL STATE TOTAL
------- ----- -----
1995:
Current............................. $1,683,000 $ 620,000 $ 2,303,000
Deferred............................ (800,000) (216,000) (1,016,000)
---------- --------- -----------
$ 883,000 $ 404,000 $ 1,287,000
========== ========= ===========
1996:
Current............................. $2,018,000 $ 614,000 $ 2,632,000
Deferred............................ 263,000 48,000 311,000
---------- --------- -----------
$2,281,000 $ 662,000 $ 2,943,000
========== ========= ===========
1997:
Current............................. $3,108,000 $ 900,000 $ 4,008,000
Deferred............................ (509,000) (54,000) (563,000)
---------- --------- -----------
$2,599,000 $ 846,000 $ 3,445,000
========== ========= ===========
Actual income taxes differ from that obtained by applying the statutory
Federal income tax rate to earnings before income taxes as follows:
1995 1996 1997
---------- ---------- ----------
Computed "expected" tax expense........ $ 927,000 $2,244,000 $2,710,000
State income taxes, net of Federal
income tax benefit................... 170,000 405,000 492,000
Other.................................. 190,000 294,000 243,000
---------- ---------- ----------
$1,287,000 $2,943,000 $3,445,000
========== ========== ==========
Deferred income tax (benefit) expense resulted from the following for the
years ended December 31, 1995, 1996 and 1997:
1995 1996 1997
----------- --------- ---------
Inventory obsolescence................. $ (920,000) $ 401,000 $ 8,000
State income taxes..................... 276,000 (100,000) (134,000)
Accrued expenses....................... (259,000) (213,000) (211,000)
Goodwill............................... 312,000 18,000 18,000
Bad debt reserve....................... (458,000) 214,000 (282,000)
Other.................................. 33,000 (9,000) 38,000
----------- --------- ---------
$(1,016,000) $ 311,000 $(563,000)
=========== ========= =========
37
40
DECKERS OUTDOOR CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and deferred tax liabilities at December 31,
1996 and 1997 are presented below:
1996 1997
---------- ----------
Deferred tax assets:
Uniform capitalization adjustment to inventory.... $ 181,000 $ 144,000
Inventory obsolescence reserve.................... 129,000 --
Bad debt and other reserves....................... 1,326,000 1,547,000
State income taxes................................ 296,000 275,000
Preacquisition net operating loss of acquired
subsidiary..................................... 571,000 268,000
---------- ----------
Total gross deferred tax assets........... 2,503,000 2,234,000
Less valuation allowance.......................... (571,000) (268,000)
---------- ----------
Net deferred tax assets................... 1,932,000 1,966,000
---------- ----------
Deferred tax liabilities:
Depreciation...................................... 80,000 27,000
Goodwill.......................................... 230,000 248,000
Accounts receivable - mark-to-market adjustment... -- 334,000
---------- ----------
Total deferred tax liabilities............ 310,000 609,000
---------- ----------
Net deferred tax assets................... $1,622,000 $1,357,000
========== ==========
Management believes it is more likely than not that the results of future
operations and available loss carryback provisions will generate sufficient
taxable income to realize the net deferred tax assets. Any subsequently
recognized tax benefits related to the valuation allowance, which relates
entirely to preacqusition net operating loss carryforwards, will be applied to
reduce the related goodwill.
(9) STOCKHOLDERS' EQUITY
In February 1998, the Company amended the 1993 Stock Incentive Plan (1993
Plan) subject to stockholder approval. Under the terms of the amended 1993 Plan,
2,000,000 shares of common stock are reserved for issuance to officers,
directors, employees and consultants of the Company. Awards to 1993 Plan
participants are not restricted to any specified form and may include stock
options, securities convertible into or redeemable for stock, stock appreciation
rights, stock purchase warrants or other rights to acquire stock. Under the 1993
Plan, 24,173 and 126,000 shares of common stock were issued in 1996 and 1997,
respectively, including 100,000 shares issued to an officer of the Company,
which was financed through the issuance of a note receivable to such officer
(bearing interest at 6.39%, secured by the underlying Company stock as well as
any accrued bonuses or severance, with principal and interest due April 18, 2002
or upon termination of employment) and common stock options exercised as noted
below.
38
41
DECKERS OUTDOOR CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
Common stock option activity under the 1993 Plan for the years ended
December 31, 1996 and 1997 is as follows:
WEIGHTED-
AVERAGE
SHARES EXERCISE PRICE
-------- --------------
Outstanding at December 31, 1994..................... 187,500 $9.98
Granted.............................................. 739,000 9.78
Exercised............................................ (10,250) 1.13
Canceled............................................. (172,000) 12.13
--------
Outstanding at December 31, 1995..................... 744,250 5.38
Granted.............................................. 98,500 6.98
Exercised............................................ (11,000) 5.95
Canceled............................................. (218,000) 10.75
--------
Outstanding at December 31, 1996..................... 613,750 8.59
Granted.............................................. 237,500 7.96
Exercised............................................ (26,000) 5.65
Canceled............................................. (108,000) 9.08
--------
Outstanding at December 31, 1997..................... 717,250 8.42
======== =====
Options exercisable at December 31, 1997............. 353,216 $8.43
======== =====
The per share weighted average fair value of stock options granted during
1996 and 1997 was $3.92 and $4.44 on the date of grant using the Black-Scholes
option pricing model with the following weighted average assumptions:
1995 -- expected dividend yield of 0%, stock volatility of 48.4%, risk-free
interest rate of 6.5% and expected life of seven years. 1996 -- expected
dividend yield of 0%, stock volatility of 48.4%, risk-free interest rate of
5.9%, and an expected life of seven years. 1997 -- expected dividend yield of
0%, stock volatility of 43.3%, risk-free interest rate of 6.1%, and an expected
life of seven years.
The Company applies APB Opinion No. 25 in accounting for its plans, and
accordingly, no compensation cost has been recognized for its stock options in
the consolidated financial statements. Had the Company determined compensation
cost based on the fair value at the grant date for its stock options under FAS
123, the Company's net earnings would have been reduced to the pro forma amounts
below:
1995 1996 1997
---------- ---------- ----------
Pro forma net earnings................... $1,034,000 $3,281,000 $4,318,000
========== ========== ==========
Pro forma net earnings per share:
Basic.................................. $ .11 $ .35 $ .48
Diluted................................ .11 .35 .48
Pro forma net earnings reflect only options granted in 1995, 1996 and 1997.
Therefore, the full impact of calculating compensation cost for stock options
under FAS No. 123 is not reflected in the pro forma amounts presented above
because compensation cost is reflected over the options' vesting period of up to
five years and compensation cost for options granted prior to January 1, 1995 is
not considered.
In August 1995, the Company adopted the 1995 Employee Stock Purchase Plan
(1995 Plan). The 1995 Plan is intended to qualify as an Employee Stock Purchase
Plan under Section 423 of the Internal Revenue Code. Under the terms of the 1995
Plan, 100,000 shares of common stock are reserved for issuance to employees who
have been employed by the Company for at least six months. The 1995 Plan
provides for
39
42
DECKERS OUTDOOR CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
employees to purchase the Company's common stock at a discount below fair market
value, as defined by the 1995 Plan. Under the 1995 Plan, 17,008 and 9,875 shares
were issued in 1996 and 1997, respectively.
In February 1998, the Company's Board of Directors approved an increase in
the number of shares of common stock authorized for repurchase under its
existing stock repurchase program, from 900,000 shares to 1,200,000 shares.
Under this program, the Company repurchased 300,000 shares in 1996 for cash
consideration of $2,390,000 and 330,000 shares in 1997 for cash consideration of
$2,581,000.
(10) LICENSING AGREEMENT
The Company has the exclusive rights to manufacture and distribute the Teva
product line through August 31, 2001. The Company is required to pay royalties
to the licensor at rates ranging from 5% to 6 1/2% on the net sales of most Teva
products, depending on sales levels and 3% to 4 1/2% of net sales of certain
styles, depending on sales levels. The Company is required to pay minimum annual
royalties ranging from $420,000 to $820,000 over the license period. In
addition, the Company is obligated to pay minimum annual advertising costs of
3.5% to 4% of net sales of Teva products, depending on sales levels, reducing to
a range of 2.64% to 3.14% during the period from September 1995 to August 1997,
depending on sales levels.
Royalty expense related to Teva sales is included in selling, general and
administrative expenses in the accompanying consolidated financial statements
and was $2,489,000, $2,281,000 and $3,503,000 during the years ended December
31, 1995, 1996 and 1997, respectively. Advertising expense, which is included in
selling, general and administrative expenses in the accompanying consolidated
financial statements, related to Teva sales was $2,425,000, $2,177,000 and
$1,960,000 during the years ended December 31, 1995, 1996 and 1997,
respectively.
The sale of sandals under the Teva product line generated approximately
55%, 43% and 58% of the Company's revenues during the years ended December 31,
1995, 1996 and 1997, respectively.
(11) COMMITMENTS AND CONTINGENCIES
The Company leases office facilities under operating lease agreements which
expire through December 2001.
Future minimum commitments under the lease agreements are as follows:
Year ending December 31:
1998........................... $1,017,000
1999........................... 919,000
2000........................... 891,000
2001........................... 820,000
==========
Total rent expense for the years ended December 31, 1995, 1996 and 1997 was
approximately $945,000, $1,207,000 and $1,153,000 respectively.
An action was brought against the Company in 1995 whereby the plaintiff
alleges, among other things, that the Company violated certain non-disclosure
agreements and infringed purported trade secrets regarding certain footwear
products and capitalized on the information by developing a competing product
and incorporating certain concepts or technologies into other product lines. The
complaint seeks specified damages of $15 million and other unspecified damages.
The Company believes such claims are without merit. The Company anticipates that
this matter will proceed to trial in 1998. The Company has contested, and
intends to continue contesting this claim vigorously. A motion for summary
judgment seeking dismissal of this matter is
40
43
DECKERS OUTDOOR CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
pending. The Company does not anticipate that the ultimate outcome of the
complaint will have a material adverse effect upon the Company's financial
position, results of operations or cash flows.
The Company is currently involved in various legal claims arising from the
ordinary course of business. Management does not believe that the disposition of
these matters will have a material effect on the Company's financial position or
results of operations.
The European Commission has enacted anti-dumping duties of 49.2% on certain
types of footwear imported into Europe from China and Indonesia. Dutch Customs
has issued an opinion to the Company that two of the most popular Teva styles,
the Valkyrie and the Storm, are covered by this anti-dumping duty legislation.
The Company does not believe that these styles are covered by the legislation
and is working with Customs to resolve the situation. In the event that Customs
makes a final determination that such styles are covered by the anti-dumping
provisions, the Company expects that it would have an exposure to prior anti-
dumping duties for 1997. In addition, if Customs determines that these styles
are covered by the legislation, the duty amounts could cause such products to be
too costly to import into Europe from China in the future. As a result, the
Company could have to cease shipping such styles from China into Europe in the
future or could have to begin to source these styles from countries not covered
by the legislation. At this time the Company is unable to predict the outcome of
this matter and the effect, if any, on the Company's consolidated financial
statements.
(12) CONCENTRATION OF BUSINESS AND CREDIT RISK AND SIGNIFICANT CUSTOMERS
The Company sells its footwear products principally to customers throughout
the United States. The Company also sells its footwear products to foreign
customers located in Europe, Canada, Australia and Asia. Export sales to
unaffiliated customers were 16.2%, 23.6% and 25.0% of net sales for the years
ended December 31, 1995, 1996 and 1997, respectively. 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. At December 31, 1996 and 1997, the Company had no customers
exceeding 10% of total annual sales or trade accounts receivable.
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. The Company believes that it has
acted to reduce these risks by diversifying manufacturing among various
countries and within those countries, among various factories. To date, these
factors have not had a material adverse impact on the Company's operations.
(13) QUARTERLY SUMMARY OF INFORMATION (UNAUDITED)
Summarized unaudited financial data are as follows:
1996
------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
----------- ----------- ------------ -----------
Net sales........................... $28,772,000 $27,550,000 $23,485,000 $22,031,000
Gross profit........................ 12,590,000 11,095,000 9,194,000 7,950,000
Net earnings........................ 1,479,000 1,024,000 567,000 586,000
=========== =========== =========== ===========
Net earnings per share:
Basic............................. $ .16 $ .11 $ .06 $ .06
Diluted........................... .16 .11 .06 .06
=========== =========== =========== ===========
41
44
DECKERS OUTDOOR CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
1997
------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
----------- ----------- ------------ -----------
Net sales........................... $34,441,000 $28,103,000 $20,783,000 $23,386,000
Gross profit........................ 14,950,000 12,532,000 7,330,000 9,448,000
Net earnings........................ 1,990,000 1,589,000 468,000 477,000
=========== =========== =========== ===========
Net earnings per share:
Basic............................. $ .22 $ .18 $ .05 $ .05
Diluted........................... .22 .18 .05 .05
=========== =========== =========== ===========
42
45
DECKERS OUTDOOR CORPORATION
AND SUBSIDIARIES
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
THREE-YEAR PERIOD ENDED DECEMBER 31, 1997
BALANCE AT
BEGINNING OF BALANCE AT
DESCRIPTION PERIOD ADDITIONS DEDUCTIONS END OF PERIOD
----------- ------------ ---------- ---------- -------------
Year ended December 31, 1995:
Allowance for doubtful accounts......... $ 622,000 $2,426,000 $ 423,000 $2,625,000
Reserve for sales discounts............. 462,000 626,000 874,000 214,000
Reserve for inventory obsolescence...... 100,000 4,136,000 421,000 3,815,000
========== ========== ========== ==========
Year ended December 31, 1996:
Allowance for doubtful accounts......... $2,625,000 $1,587,000 $2,920,000 $1,292,000
Reserve for sales discounts............. 214,000 482,000 555,000 141,000
Reserve for inventory obsolescence...... 3,815,000 574,000 3,375,000 1,014,000
Allowance for doubtful note
receivable........................... -- 1,000,000 -- 1,000,000
========== ========== ========== ==========
Year ended December 31, 1997:
Allowance for doubtful accounts......... $1,292,000 $ 466,000 $ 666,000 $1,092,000
Reserve for sales discounts............. 141,000 492,000 377,000 256,000
Reserve for inventory obsolescence...... 1,014,000 1,594,000 1,040,000 1,568,000
Allowance for doubtful note
receivable........................... 1,000,000 500,000 -- 1,500,000
========== ========== ========== ==========
43
46
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information relating to Directors and Executive Officers of the Registrant
is set forth in the Company's definitive proxy statement relating to the
Registrant's 1998 annual meeting of shareholders, which will be filed pursuant
to Regulation 14A within 120 days after the end of the Company's fiscal year
ended December 31, 1997, and such information is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
Information relating to Executive Compensation is set forth in the
Company's definitive proxy statement relating to the Registrant's 1998 annual
meeting of shareholders, which will be filed pursuant to Regulation 14A within
120 days after the end of the Company's fiscal year ended December 31, 1997, and
such information is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information relating to Security Ownership of Certain Beneficial Owners and
Management is set forth in the Company's definitive proxy statement relating to
the Registrant's 1998 annual meeting of shareholders, which will be filed
pursuant to Regulation 14A within 120 days after the end of the Company's fiscal
year ended December 31, 1997, and such information is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information relating to Certain Relationships and Related Transactions is
set forth in the Company's definitive proxy statement relating to the
Registrant's 1998 annual meeting of shareholders, which will be filed pursuant
to Regulation 14A within 120 days after the end of the Company's fiscal year
ended December 31, 1997, and such information is incorporated herein by
reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Consolidated Financial Statements and Schedules required to be filed
hereunder are indexed on page 26 hereof.
(b) Reports on Form 8-K. The Company filed the following Current Reports
on Form 8-K:
(1) Form 8-K filed on October 1, 1997 (Item 5 -- reporting the settlement
reached in arbitration involving a group of former shareholders of Ugg
Holdings, including the related press release dated September 22, 1997).
(c) Consolidated Financial Statements and Schedules required to be filed
hereunder are indexed on page 26 hereof.
(d) Exhibits
44
47
EXHIBIT
-------
2.1 Certificate of Ownership and Merger Merging Deckers
Corporation into Deckers Outdoor Corporation. (Exhibit 2.1
to the Registrant's Registration Statement on Form S-1, File
No. 33-67248 and incorporated by reference herein)
3.1 Amended and Restated Certificate of Incorporation of Deckers
Outdoor Corporation. (Exhibit 3.1 to the Registrant's
Registration Statement on Form S-1, File No. 33-67248 and
incorporated by reference herein)
3.2 Restated Bylaws of Deckers Outdoor Corporation. (Exhibit 3.2
to the Registrant's Registration Statement on Form S-1, File
No. 33-67248 and incorporated by reference herein)
10.1 License Agreement, dated as of March 13, 1991, by and
between Mark Thatcher d/b/a Teva Sport Sandals and Deckers
Corporation. (Exhibit 10.1 to the Registrant's Registration
Statement on Form S-1, File No. 33-67248 and incorporated by
reference herein)
10.2 License Agreement for Europe, dated as of November 15, 1991,
by and between Mark Thatcher d/b/a Teva Sport Sandals and
Deckers Corporation. (Exhibit 10.2 to the Registrant's
Registration Statement on Form S-1, File No. 33-67248 and
incorporated by reference herein)
10.3 Letter Amendment to License Agreement, dated as of December
3, 1992, by and between Mark Thatcher d/b/a Teva Sport
Sandals and Deckers Corporation. (Exhibit 10.3 to the
Registrant's Registration Statement on Form S-1, File No.
33-67248 and incorporated by reference herein)
10.4 License Agreement Amendment for U.S. License, dated as of
August 5, 1993, by and between Mark Thatcher d/b/a Teva
Sport Sandals and Deckers Corporation. (Exhibit 10.4 to the
Registrant's Registration Statement on Form S-1, File No.
33-67248 and incorporated by reference herein)
10.5 License Agreement Amendment for Europe, dated as of August
5, 1993, by and between Mark Thatcher d/b/a Teva Sport
Sandals and Deckers Corporation. (Exhibit 10.5 to the
Registrant's Registration Statement on Form S-1, File No.
33-67248 and incorporated by reference herein)
10.6 Subsidiary Agreement, dated as of August 5, 1993, by and
between Mark Thatcher d/b/a Teva Sport Sandals and Deckers
Corporation. (Exhibit 10.6 to the Registrant's Registration
Statement on Form S-1, File No. 33-67248 and incorporated by
reference herein)
10.7 1993 Employee Stock Incentive Plan. (Exhibit 99 to the
Registrant's Registration Statement on Form S-8, File No.
33-47097 and incorporated by reference herein)
10.8 Form of Incentive Stock Option Agreement under 1993 Employee
Stock Incentive Plan. (Exhibit 10.9 to the Registrant's
Registration Statement on Form S-1, File No. 33-67248 and
incorporated by reference herein)
10.9 Form of Non-Qualified Stock Option Agreement under 1993
Employee Stock Incentive Plan. (Exhibit 10.10 to the
Registrant's Registration Statement on Form S-1, File No.
33-67248 and incorporated by reference herein)
10.10 Form of Restricted Stock Agreement. (Exhibit 10.11 to the
Registrant's Registration Statement on Form S-1, File No.
33-67248 and incorporated by reference herein)
10.11 Employment Agreement with Douglas B. Otto. (Exhibit 10.13 to
the Registrant's Registration Statement on Form S-1, File
No. 33-67248 and incorporated by reference herein)
10.12 First Amendment to Employment Agreement with Douglas B.
Otto. (Exhibit 10.14 to the Registrant's Registration
Statement on Form S-1, File No. 33-67248 and incorporated by
reference herein)
10.13 Second Amendment to Employment Agreement with Douglas B.
Otto. (Exhibit 10.15 to the Registrant's Registration
Statement on Form S-1, File No. 33-67248 and incorporated by
reference herein)
10.14 Modification Agreement, dated August 9, 1993, by and between
Mark Thatcher d/b/a Teva Sport Sandals and Deckers
Corporation. (Exhibit 10.25 to the Registrant's Registration
Statement on Form S-1, File No. 33-67248 and incorporated by
reference herein)
10.15 Loan and Guarantee Agreement, dated as of June 1, 1993,
among Holbrook Limited, Prosperous Dragon Manufacturing
Company Limited, Zhongshan Prosperous Dragon Shoes Co. Ltd.
and Robin Huang. (Exhibit 10.26 to the Registrant's
Registration Statement on Form S-1, File No. 33-67248 and
incorporated by reference herein)
45
48
EXHIBIT
-------
10.16 Assignment and Assumption of Loan and Guarantee Agreement
and Promissory Note, dated as of July 1, 1993, among
Holbrook Limited, Prosperous Dragon Manufacturing Company
Limited, Zhongshan Prosperous Dragon Shoes Co. Ltd., Robin
Huang and Deckers Corporation. (Exhibit 10.27 to the
Registrant's Registration Statement on Form S-1, File No.
33-67248 and incorporated by reference herein)
10.17 Third Amendment to Employment Agreement with Douglas B.
Otto. (Exhibit 10.30 to the Registrant's Registration
Statement on Form S-1, File No. 33-67248 and incorporated by
reference herein)
10.18 Adjustment Agreement, dated March 21, 1994, between Mark
Thatcher and Deckers Outdoor Corporation. (Exhibit 10.35 to
the Registrant's Form 10-K for the period ended December 31,
1993 and incorporated by reference herein)
10.19 Agreement for Sales of Assets, dated January 26, 1995,
between Ken and Nancy Young and Deckers Acquisition
Corporation. (Exhibit 10.36 to the Registrant's Form 10-K
for the period ended December 31, 1994 and incorporated by
reference herein)
10.20 Amendment of Loan and Guarantee Agreement and Promissory
Note, dated December 31, 1994, among Holbrook Limited,
Prosperous Dragon Manufacturing Company Limited, Zhongshan
Prosperous Dragon Shoes Company Limited, Robin Huang and
Deckers Outdoor Corporation. (Exhibit 10.38 to the
Registrant's Form 10-K for the period ended December 31,
1994 and incorporated by reference herein)
10.21 Consent and Agreement re: Alp Sport Sandals, dated December
30, 1994, between Mark Thatcher and Deckers Outdoor
Corporation. (Exhibit 10.39 to the Registrant's Form 10-K
for the period ended December 31, 1994 and incorporated by
reference herein)
10.22 Credit Agreement for Deckers Outdoor Corporation and First
Interstate Bank, dated July 27, 1995. (Exhibit 10.41 to the
Registrant's Form 10-Q for the period ended September 30,
1995 and incorporated by reference herein)
10.23 Promissory Note for Deckers Outdoor Corporation and First
Interstate Bank, dated July 27, 1995. (Exhibit 10.42 to the
Registrant's Form 10-Q for the period ended September 30,
1995 and incorporated by reference herein)
10.24 Pledge Agreement for Deckers Outdoor Corporation and First
Interstate Bank, dated July 27, 1995. (Exhibit 10.43 to the
Registrant's Form 10-Q for the period ended September 30,
1995 and incorporated by reference herein)
10.25 Security Agreement for Deckers Outdoor Corporation and First
Interstate Bank, dated July 27, 1995. (Exhibit 10.44 to the
Registrant's Form 10-Q for the period ended September 30,
1995 and incorporated by reference herein)
10.26 Deckers Outdoor Corporation 1995 Employee Stock Purchase
Plan. (Exhibit 4.4 to the Registrant's Registration
Statement on Form S-8, File No. 33-96850 and incorporated by
reference herein)
10.27 Letter agreement dated March 5, 1996 between Deckers Outdoor
Corporation and First Interstate Bank. (Exhibit 10.39 to the
Registrant's Form 10-K for the period ended December 31,
1995 and incorporated by reference herein)
10.28 Employment Agreement between Diana M. Wilson and Deckers
Outdoor Corporation, dated December 12, 1995. (Exhibit 10.40
to the Registrant's Form 10-K for the period ended December
31, 1995 and incorporated by reference herein)
10.29 Option Purchase Agreement, dated April 4, 1996, by and
between Eric Meyer, Deckers Outdoor Corporation, Simple
Shoes, Inc. and Phillipsburg, Ltd. (Exhibit 10.41 to the
Registrant's Form 10-Q for the period ended March 31, 1996
and incorporated by reference herein)
10.30 Amended Compensation Plan for Outside Members of the Board
of Directors. (Exhibit 10.42 to the Registrant's Form 10-Q
for the period ended September 30, 1996 and incorporated by
reference herein)
10.31 Extension Agreement to Employment Agreement with Douglas B.
Otto. (Exhibit 10.36 to the Registrant's Form 10-K for the
period ended December 31, 1996 and incorporated by reference
herein)
10.32 Extension and Restatement of Employment Agreement between
Diana M. Wilson and Deckers Outdoor Corporation, dated April
18, 1997. (Exhibit 10.37 to the Registrant's Form 10-Q for
the period ended March 31, 1997 and incorporated by
reference herein)
46
49
EXHIBIT
-------
10.33 Limited Recourse Secured Promissory Note between Diana M.
Wilson and Deckers Outdoor Corporation, dated April 18,
1997. (Exhibit 10.38 to the Registrant's Form 10-Q for the
period ended March 31, 1997 and incorporated by reference
herein)
10.34 Stock Pledge Agreement between Diana M. Wilson and Deckers
Outdoor Corporation, dated April 18, 1997. (Exhibit 10.39 to
the Registrant's Form 10-Q for the period ended March 31,
1997 and incorporated by reference herein)
10.35 Third Amendment to Credit Agreement between Deckers Outdoor
Corporation and Wells Fargo Bank, dated March 24, 1998.
10.36 Fourth Amendment to Credit Agreement between Deckers Outdoor
Corporation and Wells Fargo Bank, dated March 25, 1998.
21.1 Subsidiaries of Registrant.
23.1 Independent Auditors' Consent.
47
50
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
DECKERS OUTDOOR CORPORATION
(Registrant)
/s/ DOUGLAS B. OTTO
--------------------------------------
Douglas B. Otto
Date: March 31, 1998 Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ DOUGLAS B. OTTO Chairman of the Board, President
- --------------------------------------------- and Chief Executive Officer
Douglas B. Otto
/s/ M. SCOTT ASH Chief Financial Officer
- --------------------------------------------- (Principal Financial and Accounting Officer)
M. Scott Ash
/s/ DIANA M. WILSON Director
- ---------------------------------------------
Diana M. Wilson
/s/ KARL F. LOPKER Director
- ---------------------------------------------
Karl F. Lopker
/s/ RONALD D. PAGE Director
- ---------------------------------------------
Ronald D. Page
/s/ GENE E. BURLESON Director
- ---------------------------------------------
Gene E. Burleson
/s/ REX A. LICKLIDER Director
- ---------------------------------------------
Rex A. Licklider
48